What You Need to Know About Implementing the Changes of ASC 606: Revenue Recognition
What is ASC 606: Revenue from Contracts with Customers?
In an effort to standardize how companies and industries recognize revenue, the FASB’s new 5-step framework provides a comprehensive, industry-neutral revenue recognition model intended to increase financial statement comparability across companies and industries.
Who must follow ASC 606?
All entities (public, private, and not-for-profit) that enter into contracts with customers must apply this new guidance, unless those contracts are within the scope of other standards (i.e. leases and insurance contracts).
When is it effective?
Nonpublic entities reporting under US Generally Accepted Accounting Principles are required to apply the revenue standard for annual periods beginning after December 15, 2018.
What is changing?
The standard adopts a new 5-Step framework for recognizing revenue under contracts with customers:
1. Identify the Contract
This step requires management to determine what constitutes a contract with a customer. A contract exists when the following 5 criteria are present:
- Parties have approved the contract (may be oral or written)
- Each Party’s rights are identifiable and enforceable
- Payment terms are identifiable and enforceable
- The contract has commercial substance (impact to the entity’s future cash flows is expected)
- It is probable the entity will collect the entitled amount when considering customer intent, ability to pay, and probability of collection
2. Identify Performance Obligations
Every contract will consist of one or more performance obligations, defined as a promise (explicit or implicit) to transfer distinct goods, services, or a series of goods or services that are substantially the same. All performance obligations must be identified at contract inception. Generally, a good or service is distinct if a customer is able to economically benefit from the good, service, or bundle in some way (i.e. use, consume, sell, or otherwise generate economic benefit).
3. Determine Transaction Price
The transaction price is the amount transferred or the amount an entity expects to receive for the transfer of goods and/or services. This may include fixed, variable and other noncash consideration, and will often require judgment.
4. Allocate Transaction Price to Performance Obligations
Allocation should be made to each separately identified performance obligation in a way that represents the stand-alone value (or estimated value) of each performance obligation. Changes in transaction price triggered by a contract modification will follow separate guidance.
5. Recognize Revenue when Performance Obligations are met, or as they are satisfied.
Revenue shall be recognized at a point in time, or over time, based on how and when a performance obligation is satisfied. This step hinges on determination of when control of the good or service is transferred to the customer. Transfer of control over the good or service will be measured using an input (i.e. cost, labor hours etc.…) or output (i.e. units produced) method that cannot be changed once selected.
How will this impact you?
Some companies will be impacted more than others—especially those under industry-specific guidance.
- Implementation is likely to take more time and resources than you think
- Will require an in-depth review and understanding of existing contracts
- May be applied on a modified or full retrospective basis
- For some entities and industries, ASC 606 may change the timing of when revenue is recognized
- Financial statement disclosures will be impacted
- Applying the new standard will require judgment, and well-documented policies
- The impacts are far-reaching, and may affect IT systems, HR policies and more
The time is now to prepare for these changes and assess your current processes in order to properly identify where action is required. Our team is hard at work developing industry-specific resources to aid you in this process. If you have questions, contact us at 217-351-2000 and ask for Katie Duval.