Not trying to scare you or anything, but if you haven’t done one thing to address ASC 606 compliance yet, and you operate a contract-based business with multi-year contracts especially, you are pushing it.
Revenue is the key indicator of your company’s financial performance and health. That’s not news. What is news? The accounting rules you must follow to recognize and report on that revenue are about to change. ASC 606 creates a major shift in how your business handles its accounting — particularly if you have a subscription-based business that derives revenue from contracts with customers.
The Impact of ASC 606
What’s the big deal? For starters, the impact of the change extends beyond a mere tweak to your accounting methods. It necessitates changes to your tracking, processes, and internal controls. The purpose of this blog post is to highlight the basics of ASC 606, what it means for your business, and the risks of not taking action. When the Financial Accounting Standards Board (FASB) originally issued ASC 606, it was supposed to be effective in 2017.
However, due to the magnitude of the change, the effective date has since been delayed until the start of 2018 for public companies, and the start of 2019 for private companies. Although you may think you have plenty of time, the reality is the contracts you are writing today that extend into the 2018/2019 adoption date must be accounted for under ASC 606. If you are not up to speed with ASC 606, here’s the highlights!
- The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU), Revenue from Contracts with Customers (Topic 606) which was originally supposed to be effective in 2017. The 2017 compliance goal proved to be too monumental a task — so the deadline was extended.
- Specifically, the ASC 606 compliance effective date was delayed until the start of 2018 for public companies, and the start of 2019 for private companies. Although you may think you have time, the reality is the contracts you are writing today that extend into the 2018 and 2019 adoption dates must be accounted for under ASC 606.
The revenue recognition standard prescribes accounting for an individual contract with a customer, but allows for application of the guidance to a portfolio of contracts with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying this guidance to the portfolio would not differ materially from applying this guidance to the individual contracts within that portfolio. The core principle of ASC 606 is that an entity should recognize revenue to depict the transfer of 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.
Don’t Put your Head in the Sand on ASC 606!
It’s essential to ensure revenue recognition processes are running smoothly, ideally in advance of the ASC 606 required time frames. Remember, under ASC 606, your accounting system now needs to be contract aware, ideally with contract management capabilities built into it. You’ll need to be able to look at the group of contracts pertinent to a customer and have clear transparency when the need arises. Under ASC 606, subscription-based companies will recognize revenue over time as the performance obligation is delivered to the customer.
Things to keep in mind?
- If you have a subscription-based business, you likely enter into complex contracts and agreements with customers. The new standard requires your company to capture and report on this information, which your accounting system may not currently track. As a result, you need to identify and remedy critical data gaps.
Preparing your business for the shift will be a time-consuming process — especially if your accounting system lacks built-in readiness. Anticipate significant time and resource contributions on the part of your management, accounting, and IT teams. The good news is, the earlier you identify the implications of the new standard, the better positioned you will be to ease the transition.
- For the purpose of revenue recognition, the new ASC 606 standard requires businesses to treat multiple related contracts with customers effectively as one contract. In addition, you’ll need to track the likelihood that the revenue in a contract will actually be collected. You can’t recognize this revenue until it meets the collect-ability threshold — or the contract is amended.
- A performance obligation is a promise to deliver a good or service. Identifying performance obligations has an important impact on when and how much revenue will be recognized.
- The ASC 606 criteria for determining whether a good or service is a performance obligation include two key targets — capable of being distinct and distinction within the contract. In the case of capable of being distinct, the customer can benefit from the good or service either on its own or together with other resources that are readily available. In the instance of distinction within the contract, the promise to transfer the good or service is separately identifiable from other promises in the contract.
- Before adoption, you need to identify variable pricing terms in contracts and understand the impact to revenue under the new guidelines.
- After adoption, you’ll want to automate transactions by applying variable consideration using consistent methods and flagging contracts that have non-standard terms.
Under ASC 606, allocating transaction prices will require a complex rules-based approach that is beyond the scope of most accounting solutions used by organizations today. Organizations that attempt to allocate on a per arrangement basis using spreadsheets expose the business to risk, and the accounting team to significant headaches. For organizations operating under complex billing arrangements, like usage based billing, it’s incredibly important that billing and revenue recognition systems work in sync, so that when the customer consumes the benefits of the performance obligations, your organization can recognize it. Unfortunately, businesses unable to handle complex contracts within their accounting systems will get overwhelmed with spreadsheets and subjective decisions. To maintain efficiency, and not increase risk, accounting software and business automation technology is the only answer to this new standard.
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This article, “New Rule Requires Changes in Accounting Practices for Contract Based Businesses” was first published on Small Business Trends