What is ASC 606?
ASC 606 is the new revenue recognition standard that affects all businesses that enter into contracts with customers to transfer goods or services – public, private and non- profit entities. Both public and privately held companies should be compliant now based on the 2017 and 2018 deadlines. Is your company compliant yet? Continue reading for guidance on your compliance efforts.
Developed jointly by the Financial Accounting Standard’s Board (FASB) and International Accounting Standards Board (IASB), ASC 606 provides a framework for businesses to recognize revenue more consistently. The standard’s purpose is to eliminate variations in the way businesses across industries handle accounting for similar transactions. This lack of standardization in financial reporting has made it difficult for investors and other consumers of financial statements to compare results across industries, and even companies within the same industry.
Meeting the new compliance standards will take time and careful planning but it shouldn’t be a dreaded process. In fact, organizations large and small will find the transition provides an opportunity to transform their businesses for the better.
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The ASC 606 5 Step Model
In developing ASC 606, FASB and IASB wanted to provide a framework to drive consistency in financial reporting, improve comparative analysis and reporting, and simplify the preparation of financial statements through a 5 Step Model for Revenue Recognition.
ASC 606 breaks the contract process into the following 5 steps:
- Identify the contract with a customer
This step outlines the criteria that must be met when establishing a contract with a customer to supply goods or services
- Identify the performance obligations in the contract
This step describes how distinct performance obligations in the contract must be handled
- Determine the transaction price
This step outlines what must be considered when establishing the transaction price, which is the amount the business expects to receive for transferring the goods and services to the customer
- Allocate the transaction price
This step outlines guidelines for allocating the transaction price across the contract’s separate performance obligations, and is what the customer agrees to pay for the goods and services
- Recognize revenue when or as the entity satisfies a performance obligation
Revenue can be recognized as the business meets each performance obligation. This step specifies how that should happen
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What is the Impact of ASC 606?
The rule, “Revenue from Contracts with Customers” standardizes and simplifies how companies record revenue in customer contracts. Effective for fiscal years beginning after Dec. 15, 2017, it covers how businesses report the nature, amount, and timing regarding contracts with customers.
The impact might not be as significant for companies, such as retailers, that sell products and receive revenue at one time. But for companies that sell recurring services like subscriptions or licenses, the rule may improve the results.
Under the previous law, if a company for example, sold a 12-month software product license, it could apply only six months of revenue to its books. It would not be able to count the next six months of revenue until the following year. But under ASC 606 it can count all the revenue at once.
Implementing ASC 606 also has broad ramifications. Meeting the standard will impact not just your accounting and financial departments, but will impact your IT systems, HR policies and more. It’s these broader implications and unknowns that have many companies concerned.
Know the scope of work required so you can assemble the right plan, team, and budget. Several factors will impact your resource allocation and cost calculations:
- Contract evaluation requirements: You’ll need to develop a new rules-based framework for your accounting policies based on an assessment of your contracts. If your contracts are highly variable, will it be burdensome for the transition team to thoroughly evaluate each one and draft new policies accordingly?
- Choice of transition method: The full retrospective and modified retrospective methods each have pros and cons, but both require significant implementation efforts. The full retrospective method requires restatement of the prior two comparative years (possibly three), while the modified retrospective method requires dual recordkeeping during the adoption year. Do you have the necessary systems and people in place?
- Handling comprehensive disclosures: The new standards’ requirements for quantitative and qualitative disclosures are significantly more expansive than those under the current guidelines. How will you create a method for systematically gathering, reviewing, and disclosing information about remaining performance obligations, including resources consumed, labor hours expended, costs incurred, or machine hours used?
- Post-transition revenue recognition plans: How will you track performance obligations and apply your new revenue calculation rules? How much manpower will be required to handle complex revenue scenarios, multiple revenue streams, and contract modification? How will you institute controls along the way?
Assessing impact on your business
If you aren’t armed with the proper information, making the best business decision can be difficult.
At some point in the transition process you’ll need to assess how the new standards will affect your company. This includes an evaluation of primary revenue streams and key contracts to identify the revenue recognition changes required and the business units where these changes may have the greatest impact.
The questions that come up during this phase are weighty. When you apply the new five-step compliance model to a sampling of mission-critical contracts, what happens to your revenue recognition profile? Will you need to change the design of your customer contracts? Can your sales process stay the same, or does it need tweaking? If you aren’t armed with the proper information, making the best business decision becomes difficult.
Deliver the right reports to internal
and external stakeholders
About 50% of spreadsheet models used operationally in large businesses have material defects. You’ll need to deliver the right reports internally and externally, to pass an audit—the crux of this entire endeavor. If your process is based on spreadsheets, this will be painful. Inefficient and error-prone, spreadsheets are notoriously difficult to audit. Furthermore, multiple user access easily leads to version-control problems, which degrades data quality. It’s not just anecdotal: the European Spreadsheet Risks Interest Group cites research stating that 50% of spreadsheet models used operationally in large businesses have material defects.
The right technology for compliance
A robust technology solution, e.g. a revenue recognition cloud application, can offer two key ways of reducing the amount of required manual effort: automation and flexibility across your revenue recognition processes. First and foremost, the right solution helps you track various revenue streams, automate allocations and calculations, and configure different rules and templates for different calculations—all while eliminating your reliance on overly complex spreadsheets.
Additionally, a strong technology solution also eases the pain of implementing a transition method. Your choice of method should be driven by what’s best for investors, auditors, and financial statement readers, not by the capabilities of your IT systems (or lack thereof). With a strong technology solution, you can recognize revenue under the current standards up to the transition date, then seamlessly deploy retrospective or parallel recognition processes. Let your systems empower you to make the best choice for your stakeholders.
With the right system in place, you can produce clear audit trails and attach supporting documents and evidence directly to transactions. A robust tool also provides user-friendly reporting options, allowing you to slice, dice, and customize your data on a summary level or on an item-by-item basis. With better reports, your business teams will make better decisions.
What to look for in a revenue recognition
- Powerful, flexible data models: Revenue models continue to multiply, from product-based to SaaS to bundled and usage-based contracts. The right tool recognizes revenue from multiple sources, including directly from opportunities, orders, contracts, projects, and invoices. The data model should also handle complex use cases, including multi-element arrangements.
- Seamless integration with other applications: The best cloud applications harness the power of your existing platforms (e.g. Salesforce) and integrate directly with your other applications, including customer relationship management (CRM) and professional services automation (PSA).
- Configurable templates and rules: The right tool enables you to adapt to whatever comes next. Create different rules based on your needs and how you want to recognize revenue. Find a tool that adapts to what’s best for your business—not the other way around.
- Forecasting capabilities: Go beyond retrospective reporting to gain a complete picture of your business. A cloud application should empower you to derive revenue forecasting with both recognized and forecasted values on multiple revenue source data.