What is ASC 606 and how could it impact you? An Overview of ASC 606
ASC 606 – Revenue from Contracts with Customers has changed the landscape for revenue recognition from the traditional rules-based accounting standards that were industry specific, to a new principles-based framework that is to be consistently used by industry types. The new framework, which is required to be adopted by private companies for years beginning after December 15, 2018, is centered around the satisfaction of performance obligations and the ultimate transfer of control of a good or service to a customer. Companies will need to apply the new principles included in the five-step model, and as a result many companies will potentially need to make a variety of changes to their accounting and other business processes.
The five-step process is as follows:
- Identify the contract with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the separate performance obligations.
- Recognize revenue when the entity satisfies each performance obligation.
Companies that have been most impacted are those that have long-term contracts with customers or have transactions that include various types of variable consideration, such as performance bonuses, discounts, free product offerings, etc. This concept of variable consideration can require significant estimates or judgements from management. Those estimates or judgements will also need to consider the idea of constraint, which means that revenue should not be recognized for any variable consideration that could be susceptible to a significant future reversal. Judgement is also required in assessing the criteria for whether revenue should be recognized over time or at a specific point in time, based on transfer of control.
It’s important to note that this is not just an accounting department issue. Leaders and employees of other departments made need to get involved, including but not limited to:
- HR – The new principles could result in deferrals or even escalations of revenue recognition. Commission and performance bonus based compensation agreements could be impacted by the changes.
- Sales/Marketing – The sales and marketing department could be responsible for various forms of variable consideration that they are offering to customers in order to make sales. The accounting department might not be aware of all of these offerings. It doesn’t matter if the incentive offering is verbal or in writing, it will have an impact on the analysis of variable consideration for potential revenue recognition issues.
- Legal – Adoption of the new standard could have an impact on your covenant requirements, if you conclude that revenue should be recognized sooner or deferred over a longer period of time. If adoption changes your recognition patterns, it will be important to discuss with your lender as soon as possible.
All companies who use generally accepted accounting principles (GAAP) for reporting purposes will feel the effects of implementation in some way. At a minimum, even if it is believed by management that the standard will have no impact, every company will need to make sure it’s current revenue recognition policies and practices fit into the new framework and prove that it in fact has no financial impact. The new standard also brings many new disclosure requirements that will be appearing in any audited, reviewed or compiled GAAP financial statement for the year ended 12/31/2019. Be sure to speak to your accounting professionals and get an understanding of how this standard will impact your business.
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Article prepared by Christopher Kunkle.