The Deadline for Compliance with the new ASC606 Standards
With the deadline for compliance with the new ASC 606 standards one year away, professional services companies, subscription businesses especially could be scrambling to meet the new standards.
In this second part of a two-part blog series, we’ll look at the five steps recommended by the Financial Accounting Standards Board (FASB) to recognize revenue in compliance with ASC 606. Companies with international contracts who must come into compliance with International Accounting Standards Board’s IFRS 15 standards can use the same steps. In the first part of the series, we looked at the implications of ASC 606 and why subscription businesses are particularly impacted.
Coming into compliance with the new standards will require more than minor tweaking to your accounting systems, as you will need to integrate information about contracts and deliverables, which most accounting systems are not ready to accommodate. Here are the five steps recommended by FASB:
Identify Contracts and Thresholds
The first key component of the new revenue recognition standards is that companies who have multiple related contracts with a customer must treat those as one contract.
For example, if your company has one contract to provide a base product to your customer, then other contracts to provide add-on products, then another contract to provide support for these products, all these contracts must be treated as one contract, and revenue generation must be recognized at the different phases of the contracts.
You also will be required to be aware of the likelihood revenue will be collected on each contract phase or each separate contract and at what point in the contract the revenue will be collectible. You will need a rules-based system, so each customer and each contract are treated equally, so having a built-in contract management structure in your accounting system will be the safest way to handle this demand.
Manage Performance Obligations
Performance obligations are those pledges within your contracts on when your company will deliver goods or services. The ability to identify and record when these is vital to determining when and how much revenue you will recognize.
The ASC 606 standards sets two criteria for identifying performance obligations:
- Capable of being distinct: This means the customer can benefit from the new good or service either on its own or in combination with another product or service the customer already has access.
- Distinct within the contract: The pledge to deliver a good or service is defined distinctly from other pledges in the contract.
Automatic renewals in a contract also must be reflected in these determinations.
Determine the Transaction Price
For many businesses, the transaction price is merely the amount of money they expect in return for providing a particular good or service. But for subscription companies, many variables factor into the contract, making determining a transaction price more challenging.
Among factors that could be written into the contract are refunds, credits, rebates, penalties, performance-based incentives, customer-specific terms, bundling discounts and flexible financing.
Because the new standards require consistent treatment, a rules-based system of revenue recognition will be necessary. An automated system is going to be the preferred method for handling this for your numbers to be accurate and in compliance.
Allocate the Transaction Price
The previous two steps come together in this step as you must allocate a portion of the transaction price (step 3) to the defined performance obligations (step 2). An established well-defined, rules-based method for applying transaction prices is the best approach to meet the compliance standards.
Applying these allocations on a per customer basis could expose your company to risk, meaning automation of the process is the safest route to compliance.
Subscription-based companies will be required to recognize revenue as performance obligations are met over the life of a contract. In transferring control of a product or service over time, FASB says companies must meet one of three criteria to recognize revenue:
The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.• The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced.• The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.
Expenses such as sales commissions or royalties also must be factored into these calculations and reflected in revenues at appropriate times.
Meeting these demanding standards will require almost a complete overhaul of current accounting systems. With a one-year deadline for publicly traded and two years for private companies, accounting departments must move quickly to ensure compliance.
Adopting an out-of-the-box accounting system that already is prepared to meet these standards like Intacct’s Contract and Revenue Management Solution is the safest and easiest way to ensure compliance. Contact us to learn how we can partner with your financial management team to have you ready to meet ASC 606 compliance in a matter of weeks.