Accounting Matters: How to Navigate the New Revenue Recognition Rules
You’ve been hearing about the new revenue recognition rules for customer contracts since 2014. The time has finally come to implement them. For privately held companies, ASC 606 is now in effect.
A Quick Recap
As a reminder, ASC 606 requires a five-step model of revenue recognition for all entities that enter into contracts with customers for the transfer of goods, services, or real estate. The five steps apply to each customer contract:
1. Identify all customer contracts. A contract is defined as having the following conditions: It identifies the rights of the parties, has payment terms and commercial value, has been approved by the parties, and payment is likely collectible.
2. Identify performance obligations. The standard requires identification of “distinct” obligations. If the customer can use a deliverable on its own, it is considered a distinct performance obligation. If the deliverable is dependent on other pieces included in the contract, it is not considered to be distinct.
3. Determine transaction price. If a contract includes discounts, rebates, or refunds, what are you actually going to get paid? What about other factors impacting the price, like market volatility or weather? How does the time value of money figure in if a customer pays early or late?
4. Allocate transaction price. If the contract includes separate performance obligations, you must recognize revenue as each is complete. This means you must calculate a standalone price for each obligation.
The same goes for discounts, which must be allocated against the price of each performance obligation or allocated proportionately as revenue is recognized.
5. Recognize revenue. Revenue must be recognized as each performance obligation is completed and control of the goods or services is transferred to the customer.
Some companies have already implemented the new rules, and it’s wise to learn from their experience. For example:
Judgment is key. Every company is different. Even companies in the same industry may arrive at different answers relative to the five steps. With this in mind, be sure to document your contract evaluation process.
Prepare for earlier income. For many companies, the standard results in advanced income recognition. If this is the case for your business, you will need to work with your finance and accounting team to determine the impact of the earlier timing.
Expect enhanced disclosures. The standard requires more significant disclosures on financial statements. What used to be explained in one or two sentences will now likely take one or two pages.
Dig into complicated contracts. If your company has master service agreements or long-term, complicated contracts, you must evaluate them as soon as possible. The process is time-consuming.
The extent and scale of this accounting change can’t be overstated. Indeed, the standard and its related interpretations and implementation guidance total more than 1,000 pages. Expect to invest a significant amount of time and effort to meet the new requirements.