ASC 606 -The New Revenue Recognition Standard
Are you still working through the implementation?
As most companies are currently well underway with their 2019 year-end close, private companies are likely still working through certain aspects of implementing the new Revenue Recognition Standard ASC 606 for the first time. The new standard is effective for non-public companies for reporting periods beginning after 12/15/2018. If your company is still working on the adoption and implementation, we’re here to help with the analysis.
The new GAAP revenue model within ASC 606 requires an entity to recognize revenue based on the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
GAAP outlines that revenue be recognized based on the following 5-step model within ASC 606 (from fasb.org):
- Step 1: Identify the contract(s) with a customer
- Step 2: Identify the performance obligations
- Step 3: Determine the transaction price (for each separate performance obligation)
- Step 4: Allocate the transaction price to the performance obligations in the contract
- Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation(s)
There are some interesting components that should be closely analyzed when implementing the new standard. The following are some key top-level considerations.
Step 1 – Do your contracts with customers represent commercial substance, and are they approved by all parties? Are the payment terms for what is being exchanged included in the contract, or if not, easily estimated? Also, for change orders and modifications to contracts, an analysis should be done to determine whether the change orders should be combined or treated as separate contracts.
Step 2 – Have all distinct performance obligations been determined within each of the contracts? For this analysis, the two requirements to determine “distinct” are as follows:
- if the customer can benefit from the good or service on its own or with resources readily available to the customer; and
- if the promises to transfer goods and services can be separately identifiable in the contract.
Further, sometimes there is a series of distinct goods or services that have the same pattern of transfer to the customer which should be considered a single performance obligation.
Step 3 –Under the model, entities are required to determine transaction prices for each distinct performance obligation. The transaction price should represent the amount of consideration that an entity expects to be entitled to receive in exchange for transferring the goods or services.
The transaction price analysis also includes analyzing for potential variable considerations like discounts, refunds, incentives, etc. If there are any components of variable consideration, the standard also sets clear guidelines as to how variable considerations must be estimated.
Entities must also analyze and assess for the impact of significant financing components, noncash consideration or consideration payable to customers.
Step 4 – Allocate the total transaction price amongst all distinct performance obligations, based on standalone value.
Step 5 – Now it’s time to determine how to recognize revenue! Revenue should be recognized either Over Time, or at a Point in Time. We have seen that this step has created certain instances of accelerated revenue using the new model.
Revenue should be recognized over time if one of the below criteria is met:
- Customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs
- Entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced
- 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.
If revenue should be recognized over time, an entity must also determine the appropriate measure of progress for recognizing revenue based on output methods, or input methods.
If revenue should be recognized at a point in time, are the appropriate guidelines being used to determine when control of the asset is transferred to customers?
The new standard also requires using either a modified retrospective approach or full retrospective approach for the first year of implementation, which requires restatement of certain accounts depending on the periods presented in the financial statements, and the level of impact the standard has compared to current practice.
In addition to the above analysis, there are several new disclosure requirements and some practical expedients that can be used when implementing the new standard.
For additional information and for access to certain implementation tools, contact Destiny Flood, Audit Senior Manager, at firstname.lastname@example.org or (408) 287-7911.