ASC 606, Revenue From Contracts With Customers, changes the way that software and professional services companies, among others, need to record and recognize revenue from their various contracts. It’s one of the big new changes that we’re keeping tabs on closely this year, and we recommend that anyone in software or professional service do the same.
ASC 606 affects all entities—public, private, and not-for-profit—that enter into contracts with customers to transfer good or services. Public entities need to abide by ASC 606 by December 15, 2017, and other entities are given an additional year—December 15, 2018.
What does ASC 606 mean? Essentially, it breaks down the contract creation process into five steps.
1. Identify the contract with a customer
ASC 606 dictates that a business can account for a contract when all these criteria are met.
- Both parties should approve the contract (in writing, orally, or via some other agreed-upon practice)
- Both parties can identify what goods or services are to be transferred to the customer
- Payment terms are identified and agreed upon
- The contract has commercial substance
- The business believes it is probable that they will collect on the payment agreed upon in exchange for the goods or services transferred to the customer.
2. Identify the performance obligations in the contract
A performance obligation is the promise to transfer goods or services to a customer. In this step, the business needs to identify all the distinct performance obligations in an arrangement. A good or service is defined as distinct if 1) the customer can benefit from it on their own, or with resources they already have, and 2) can be transferred independent of other performance obligations. Any goods or services that can’t be deemed distinct should be bundled together until they can be.
Performance obligations can also cover an obligations the customer might expect because of their history, which can make this step more complex.
3. Determine the transaction price
The transaction price is the amount the business expects to receive in return for transferring the goods or services outlined in Step 1. The amount can be fixed, variable, or a combination, but is allocated specifically to the performance obligations outlined in Step 2. Once these performance obligations are fulfilled, the business can recognize this as revenue.
When a certain amount of cash is transferred to the business simultaneously with the promised goods or services, this is quite easy. But, more complex payment arrangements require additional thought.
There is some suggestion that companies that implement ASC 606 rules early might be able to recognize more upfront revenue on sales, but that shouldn’t be taken as a guarantee.
4. Allocate the transaction price
If a contract has more than one performance obligation, the business needs to provide an accurate estimation as to that obligation’s standalone selling price versus the total agreed upon amount. ASC 606 allows for includes three methods of figuring this amount—adjustment market assessment, expected cost plus margin, and residual.
Want better financial visibility?
A free, 14-day trial of NetSuite can get you started on the path toward having a complete version of your financial truth
5. Recognize revenue as performance obligations are satisfied
Finally, the business can recognize revenue when they meet the performance obligations. If that fulfillment happens at a distinct point in time, revenue can be recognized right then. If the obligation is satisfied over time—for example, a technical support contract—the business needs to decide how to measure the progress and completion of that obligation.
Where to go next
We recognize that ASC 606 and revenue recognition, as a whole, is remarkably complex, even in this revised form. Each of these steps are far more complex than we can get into here, but we’ll cover each of them in detail on the Bi101 Revenue Recognition hub in the near future. In the meantime, the American Institute of Certified Public Accountants has published an excellent guide detailing the nuances of ASC 606.
If you have questions right now, Bi101 is here to help answer them—feel free to get in touch and we’ll start you along the road to understanding how your particular business needs to recognize revenue under ASC 606. For the more proactive, our NetSuite-based Business in a Box platform will give you the cloud-based accounting platform that you’ll need to comply with ASC 606 in this coming year, and take advantage of its new guidelines well into the future.