It’s no surprise that revenue is the most critical financial measure for most businesses as well as their owners, lenders, and stakeholders. In the early aughts, both the FASB and IASB recognized that their guidance for revenue accounting had some glaring weaknesses. They also determined that the disclosure requirements for revenue were inadequate. The boards met together to find a way to do the following:
- create a more robust framework for addressing revenue issues;
- simplify financial statement preparation;
- improve comparability across entities, industries, jurisdictions, and capital markets;
- remove the weaknesses and inconsistencies; and
- improve the usefulness of financial statements and disclosures.
The end result is ASC 606, which now has a principles-based approach when it comes to revenue.
- Principle 1 – Revenue should be recognized in a way that reflects the transfer of promised goods or services to customers.
- Principle 2 – The amount of revenue recognized should equal the consideration to which an entity expects to be entitled for those promised goods or services.
As such, industries will now have to interpret and apply these principles to their transactions. This guidance applies to all industries, and the only customer transactions that the ASC 606 excludes are lease contracts, insurance contracts, and financial instruments.
The guidance further offers a five-step approach to applicable revenue recognition.
- Identify customer contracts (that are not the exclusions listed above).
- Identify performance obligations.
- Determine the transaction price.
- Allocate the transaction price to performance obligations.
- Recognize revenue when or as performance obligations are satisfied.
These new requirements have a few differences from the ASC 605, which is a set of rules whereas 606 is a set of principles. Be sure to take note of these three key differences when it comes to revenue recognition.
- The current revenue recognition guidance primarily looks at when the revenue is earned and realizable. The new guidance instead applies the following criteria on recognizing revenue:
- Persuasive evidence an agreement exists.
- Delivery has occurred or service has been rendered.
- The price is fixed or determinable.
- Collectability is reasonably assured.
- The current GAAP has extensive industry-specific guidance, while the new guidance applies to all industries.
- Current GAAP requires very few disclosures about revenue, particularly regarding policy-related accounting. The new guidance requires far more disclosures about revenue.
For private companies, this new guidance is effective for annual reporting periods starting after December 15, 2018 and any interim periods in the subsequent annual period. The guidance allows for early application with certain limitations.
FASB ASC 606 requires retrospection adoption using either a full retrospective or a modified retrospective. The full includes all prior periods presented in the adoption period. The modified has a cumulative effect adjustment as of the date of initial application. Meaning, businesses only apply the guidance retroactively to contracts not completed by the application date.
Since the new guidance may affect a business’s revenue recognition, measurement, and disclosures as well as its operations, systems, processes, and internal controls, smooth ASC 606 implementation is key. Some businesses will have little issue with implementing the new guidance, but others will require a significant overhaul and effort from their employees.
To help businesses implement smoothly, we created a tool to do just that. It’s modeled after the five-step approach the ASC 606 provides, but is far easier to follow than the FASB manual. While our tool is detailed and extensive, it does not include every foreseeable scenario a business will need for implementation. As such, we highly recommend a consultation with us to help create a custom seamless implementation method tailored for your business. Of course, we can still provide you our tool even without a consultation. Just drop us a line and we will be in touch soon.
Need more info? Be sure to check out the the webinar on this topic below. Also, be sure to check out the second part of the webinar that touches on how NetSuite helps.