ASC 606 is a revenue recognition standardized regulation that applies to public, private, and non-profit enterprises that engage in contracts with customers for the transfer of goods or services. ASC 606 stands for Accounting Standards Codification, and it sets up best practices in accounting teams, professionals, and organizations worldwide.
Table of contents
The purpose of ASC 606 is to develop a framework for organizations to recognize the transfer of said goods and services, which will be proportionate to the amount delivered at a given moment. Revenue is considered recognized when a company fulfills a performance obligation by providing a promised good or service to a customer. When a customer gains control of an asset, the transfer occurs.
In simple words, Accounting Standards Codification (ASC 606) is a revenue standard that affects all existing contracts with customers and which serves to refine it to recognize revenue more consistently. It is a set of guidelines for companies to easily follow Generally Accepted Accounting Principles (GAAP).
Many businesses have extensively researched how to apply the new regulation and measure its impact on their operations when implemented. Before the adoption of ASC 606, revenue recognition processes were uneven. They varied greatly between industries, jurisdictions, and marketplaces. Due to this inconsistency, consumers, investors, and analysts found it challenging to evaluate finances.
To overcome these challenges, ASC 606 offered uniformity and standardization in billing and revenue management. ASC 606 provides worldwide consistency for recognizing revenue in earned value or over time. It also requires more precise timing of realized revenue and greater disclosures on customer contracts. ASC 606 helps increase transparency and accountability between company and customer. Additionally, it consistently identifies when revenue from contracts with customers should be realized and considers the customer lifetime value.
ASC 606 effective dates
Accounting Standard Codification (ASC 606) was established in 2014 by the Financial Accounting Standards Board (FASB). These standards were scheduled for initiation into public companies in 2018 and both privately owned entities the following year. In June 2020, the FASB issued a new amendment as a catch-all for all organizations that have yet to adopt ASC 606. Live updates on ASC 606 effective dates can be found here.
ASC 606’s 5-step framework for determining revenue recognition
Sometimes businesses can change their revenue recognition method. Some may choose to add some flexibility, while others may prefer to amortize. Five steps should be considered while implementing ASC 606. These steps are crucial as they allow companies to analyze revenue and create a recognition schedule methodically.
- Customer Contract Identification
- Performance Obligations Identification
- Transaction Price
- Allocate Transaction Price to Performance Obligation
- Recognize Revenue
STEP 1: Identify the contract with a customer
In its most basic form, a contract is an agreement between at least two entities in which rights and duties are formed and enforced. ASC 606 deals with the entire contract and every function, regardless of whether the contract is consolidated. Contracts that meet the following conditions must comply with ASC 606. If the contract has been approved and committed to by all parties and each party’s rights have been clearly defined, then it must respect the ASC 606 principles.
The contract must also include the terms which ensure entities are entitled to collect for goods or services rendered. As a result, while contemplating how your business will apply the policy, you should regard ASC 606 as the contract’s main focus and guarantee.
STEP 2: Identify the Performance Obligation in the contract
The contract’s performance duties are what was promised in the contract. If a performance obligation is distinct from others, or if a series of similar but distinct bundled goods or services, it must be accounted for separately. There is likely to be more than one performance obligation in more complex agreements. It is just like the regular agreement with all its obligations and rights.
The performance obligation can be classified as distinct or non-distinct. Performances are distinct if the obligations are specified and straight to the point. If not, they are classified as non-distinct.
STEP 3: Determining the transaction price
The amount of cash or non-cash consideration expected for exchanging products or services with a consumer is referred to as transaction price. The contract should include the agreed price the company expects to get in return for transferring the promised goods or services.
Sometimes it is hard to determine the price in the contract, especially when there is a varying level of consideration. The price can be fixed or vary based on timing or other performance factors: price variations, constrained estimates, finances, non-cash options, and price considerations or discounts. Setting the transaction price in the contract is essential to avoid problematic issues that could occur later.
STEP 4: Allocate the transaction price
A distinct transaction price should be assigned to each performance obligation. To calculate this pricing, a company should use the amount expected for contact with at least one performance obligation.
The contract is created when establishing or determining the correct amount to allocate to each performance obligation. This contract takes into consideration the selling price or fair value of each obligation at the time. The basis for establishing a transaction price should be this value or worth.
STEP 5: Recognize Revenue as Performance Obligation
Revenue is acknowledged when the seller meets the performance commitments stated in the contract. This happens when control of services is transferred to the customer. In that case, the customer has autonomy over an asset’s use and benefits. The user also can prevent others from using and obtaining benefits from the asset.
Recognizing revenue as a performance obligation is the fifth step of ASC 606, but it can also be divided into several smaller steps. To satisfy these obligations:
- The consumer must get and utilize benefits at the same time
- The seller must enable the consumer the control of the assets – the customer owns physical possession, legal ownership, as well as specific risks or benefits of the asset
- The seller’s performance does not result in the creation of an asset with a secondary use for the seller and has a claim to payment for the performance that has been done to date
It must be determined whether the seller meets the performance obligation at a single time or over time. If a performance obligation is not met promptly, income will be recognized at an uncertain time in the future, making it more complicated to meet the contract conditions. If these conditions are not met, two questions arise:
- Does the seller have the right to payment?
- Does the customer have legal title to the goods?
ASC 606 revenue recognition standard control transition
With the ASC 606 standard, the seller recognizes revenue when control of a promised asset or service is transferred to the customer. The seller can transfer control either at a point in time or over a certain period. The seller must determine whether each performance obligations are satisfied over time or at a point in time and then recognize revenue in a way that best represents the transfer of control to the customer.
When the seller transfers the control to the customer, then the customer has physical and legal title to the asset. When a customer owns the asset, the rewards are great, but risks are also significant.
Terms in the contract play a great role here. What has been previously agreed upon as performance obligations and executions must always be respected?
Practical implementation of ASC 606
Nowadays, organizations must focus on collecting and reporting data. Most ASC 606 data requirements have not been previously gathered, processed, or reported. To comply with the new standard, IT departments must implement this process. On the other hand, implementing ASC 606 5 steps requires significant research, resources, and people.
Most IT systems do not know how to cope with gathering performance obligations. As a result, new data points must be captured using the existing IT infrastructure, such as contract commencement and end dates. The implementation will also require the assistance of many different departments, including sales, account managers, executives, and others. Legal teams will also be required to help with this implementation. They will have to examine existing contracts to see if there are any instances where the current wording would negatively impact the revenue. Legal departments will also have to analyze existing contracts to identify areas where current terminology will produce an undesirable revenue impact on ASC 606’s introduction. Implementing a system like this takes a lot of thought and design.
To achieve this consistency in data gathering, ASC 606 relies more upon judgments and estimates. This implementation should include disclosures detailing the data used and the decisions of estimates applied. This is why, apart from the IT sector, companies are required to renovate their accounting procedures, too.
The ASC 606 revenue recognition Solutions
In order to succeed, companies need ASC 606 to meet the standards for pricing and selling. They can always opt to buy ASC 606 solutions on the market. For example, Tridens Monetization cloud-based billing software already has ASC 606 standard compliance designed into them.
ASC 606 standard can exponentially affect compensations linked to revenue, such as sales commissions and executive bonuses. The solutions they look for should focus on billing, compensation, and revenue.
If a company already implements ASC 606, it can upgrade its solutions by offering:
- Replicating the previous standard’s pay structure
- Program (upgrade) design
- Maintain separate records – old records should be divided from new records
Either of these options has its challenges. These solutions are just some of the possibilities. These rules can certainly be upgraded and perfected to fit both company and client. The only certain thing is that businesses should implement ASC 606 as part of their efforts to satisfy the standards for selling and pricing.
How companies approach the ASC 606 revenue recognition standard
It took many years of negotiations and amendments to get the policy adopted by all governing bodies. The ideas of the ASC 606 revenue recognition standard can be interpreted in many ways. As a result, each company will take a unique strategy to satisfy the criteria. Regardless of where your company is in the ASC 606 adoption process, you probably face some difficulties that ASC 606 can help suppress.
Want to get more information about our solutions? Leave a comment below or Schedule a Demo!
