Most public companies started complying with the new revenue recognition standard, Revenue From Contracts With Customers (ASC 606), when it took effect Jan. 1, 2018. Meanwhile, private companies are counting down to Jan. 1, 2019. For these firms, now is the time to seize the opportunity for a smooth transition.
The first step is an immersive study of the actual guidance. Each provision of ASC 606 will not apply to every company. Indeed, two companies within the same industry may face different issues based on the individual circumstances negotiated in the contracts with their customers. Therefore, it is vital to understand the guidance in the specific context of each business.
Questions to Ask
Following is a short sample of questions that implementation teams should ask to assess the impact of ASC 606.
Does a contract exist? If so, does it have commercial substance, as defined? Did both parties approve the contract and, if so, how is that evidenced? Are identifiable rights afforded to both parties? Does the contract have identifiable payment terms? Is collection of consideration probable?
What are the performance obligations (defined as a good or service that is distinct in the context of the contract) promised in the contract? To determine if a good or service is distinct, determine if it has value on its own, how the good or service will be used by the customer, if it is separately identifiable from other promises in the contract and if it is material in the context of the contract.
How much consideration does the company expect to be entitled to? Is compensation fixed (a single price point for each promise in the contract) or variable (inclusive of incentives, rebates, returns, credits, concessions, etc.)? If it is variable, how is the variable component estimated? If there is uncertainty about the variable compensation, how or when will that uncertainty be resolved? Does the contract contain a significant financing component? Does the contract contain any payables required to be paid to the customer?
How will the consideration in the contract be allocated to each performance obligation? Does each performance obligation have a standalone selling price? If not, which performance obligations will need to use the residual approach? Do discounts or other variable consideration need to be allocated?
Will the revenue be recognized at a point in time or over a period of time? The default in the guidance is recognition at a point in time that all obligations are satisfied. Does point in time recognition apply in the case being analyzed, or is period of time recognition more appropriate? If the latter, how will progress be measured?
Start This Time-consuming Process Now
The ASC 606 guidance provides further context and support for answering each of these questions. This process will be time-consuming to apply to even a single contract template. Many companies will have more than one contract template, if not more than one entirely unique revenue stream for their business (e.g., engineering services, construct/build services, construction management services or maintenance), which is why it’s so important to begin this process now.
Clearly, it is vital to understand if ASC 606 will result in any changes to the amount and, perhaps more importantly, the timing of revenue that can be recognized under individual contracts. It may very well come to pass that a company’s revenue recognition behavior does not change once ASC 606 is implemented. However, the journey taken to reach that conclusion will be different, particularly if an outside CPA firm performs an audit or a review.
A CPA will need to consider compliance with ASC 606 in the conduct of its work. The company may instinctively know that the timing and amount of revenue recognition will not materially change under the new guidance. Still, a CPA conducting an audit or review will need to document the key provisions of the new guidance and how the client demonstrated compliance with those provisions to support an opinion/conclusion on the financial statements.
Accordingly, the company will need to complete this process to allow for a smooth audit or review in the year of implementation.
Given the importance of this journey, companies also will need to provide financial statement users with a “trail guide” to their revenue recognition decisions in the form of enhanced disclosures.
One of the distinguishing features of ASC 606 relative to previous guidance is the ability for preparers to use their judgment in reaching revenue recognition conclusions.
If a preparer has the ability to use a judgment-based approach in applying this guidance, then the reader needs to be made aware of the key factors that drove those decisions.
New Disclosure Requirements
Following are highlights of the new disclosure requirements under ASC 606.
The disclosure requirements have many similarities to current guidance.
Public companies will have broader disclosure requirements than private companies. Private companies will have the opportunity to observe the disclosures made by their public company peers and utilize those examples in applying the disclosure requirements to their own financial statements.
Disclosures must include significant judgments and changes in judgment in applying the guidance.
The amount of assets recognized to obtain or fulfill a contract must be disclosed.
A description of performance obligations must be disclosed to include, among other things, when the entity typically satisfies its performance obligations, and revenues associated with point in time contracts versus period of time contracts; significant payment terms; the nature of goods or services delivered; obligations for refunds, returns, etc.; and warranty obligations.
The sun is setting on the path that leads to a smooth transition, so grab a CPA “trail guide” and get an early start on the journey.
