What You Should Know about the Fundamental Concepts of Revenue Recognition Under ASC 606

Written by Dev Swaly, CPA, CISA, CGMA on October 7, 2019

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Until now, companies haven’t all been held to the same standards when it comes to recognizing revenue, but that’s all about to change thanks to ASC 606.

Public companies have historically had more stringent disclosure requirements related to revenue. This is especially true under the new revenue recognition standard, ASC 606, Revenue from Contracts with Customers. Public companies were required to adopt this standard last year, and moving forward, this new revenue recognition standard is applicable to most privately-held companies (annual periods beginning after December 15, 2018).

Pro: ASC 606 will help bring consistency and transparency in regards to the revenue recognition and disclosures of companies.

Con: Many companies—both private and (yes, still) public—aren’t ready to make the change and don’t fully understand the impact.

Don’t navigate revenue recognition alone. Have a Warren Averett advisor reach out to you to start the conversation about what’s right for your business.

What ASC 606 is and Why It Matters for Today’s Companies

According to the ASC itself, “The core principle of Topic 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.”

The main goal of ASC 606 is to standardize how companies, regardless of industry, recognize their revenue—creating an apples-to-apples understanding across the board when it comes to the ways companies report revenue. In its most basic function, ASC 606 replaces all previously-issued industry standards and interpretive guidance concerning revenue recognition, and it sets forth standard accounting guidance.

Why Understanding the New Revenue Recognition Standard is Important

Some say that the new revenue recognition standard is the biggest accounting standards change in the last century, so it’s important to have a thorough understanding of what ASC 606 means for your company.

Since public companies have already adopted the new standard, they have also already been through the pains of adoption. For example, in late 2018, Oracle, a computer software company, turned heads with its own revenue recognition confusion.

Accounting Today reports that Oracle, “announced its quarterly earnings, then re-announced them a day later, with a half a billion dollars missing from the top line. Wall Street had a collective spit take. The end result was a lot of confused analysts and a hit to Oracle’s earnings estimates…Oracle’s re-announced earnings report was ASC 606 compliant, but the company apparently failed to disclose or release 606 results on the day quarterly earnings were released.”

What Privately-Held Companies Should Know about the New Disclosure Requirements of Revenue Recognition

In addition to understanding the overall accounting implications of ASC 606, companies need to understand the increased complexity of the new disclosure requirements.

Privately-held companies will still be able to use certain practical expedients in order to avoid some of the more stringent disclosure requirements (like those for public companies), but there are several new disclosures that privately-held companies will need to prepare for. Privately-held companies must meet the following minimum required disclosures:

1.     Contracts with customers

Privately-held companies should disclose the following unless it is already presented on the company’s income statement:

  • Revenue recognized from contracts with customers, separate from its other revenue sources
  • Impairment losses recognized on any receivables or contract assets arising from the company’s contracts with customers

2.     Disaggregated revenue

The new standard requires companies to present more disaggregated information about revenue that depicts how “the nature, amount, timing and uncertainty of future cash flows that arise from contracts” are affected by economic factors. Examples of categories include type of good or service, geography, market or type of customer, sales channels, contract duration, type of contract and the timing of transfer of goods and services.

If segmented information is presented, then the entity should also show the relationship between disaggregated revenue and the segments. Privately-held companies under a practical expedient may elect not to apply the quantitative disaggregation of revenue disclosure guidance. If this election is made, companies should indicate this and at a minimum should disclose:

  • Disaggregated revenue based on the timing (over time or at a point in time) of transfer of goods or services in the financial statements
  • How economic factors such as geography, market condition, type of customer and the type of contract affect “nature, amount, timing and uncertainty.”

3.     Reconciliation of contract balances

  • At a minimum, “the opening and closing balances of contract assets, contract liabilities and trade receivables”[1]

4.     Performance obligations

Disclosures regarding the balance of unsatisfied or partially satisfied performance obligations are options, but at a minimum, the following will need to be disclosed:

  • When the company typically satisfies its performance obligations for example on shipment, on delivery, as services are rendered or on completion of service
  • “The significant payment terms, for example, whether the contract has a significant financing component, whether variable consideration exists and whether the variable consideration is constrained)” [2]
  • The nature of the goods or services that the company has promised to transfer
  • Obligations for returns and refunds and any other similar obligations
  • Types of warranties and related obligations, and
  • “Revenue recognized in the reporting period from performance obligations satisfied (or partially satisfied) in previous periods (e.g., changes in transaction price).”[3] This information is not required if the contract has a duration of less than a year or if the company elects a practical expedient to recognize revenue in the amount it has the right to invoice.

5.     Significant judgments

  • For performance obligations satisfied over time, the company must describe the methods used to recognize revenue, including a description of the output or input method, how the methods are applied and “why the methods represent a realistic depiction of the transfer of goods and services.“
  • For performance obligations that are satisfied at a point in time, the company is required to disclose the significant judgments made to evaluate when the customer obtains control of the promised goods or services.
  • Qualitative information about the methods, inputs and assumptions used to determine transaction price including variable consideration, assessing whether variable consideration is constrained, adjusting the consideration for a significant financing component and measuring non-cash consideration”[4]

Key Terms to Know for Understanding the Accounting and Disclosure Requirements of ASC 606

It’s important to understand some of the new terms within the standard. That’s why I’ve included a few definitions and explanations (some even straight from the ASC) that may be helpful as your privately-held company seeks to understand and implement ASC 606.

“Contract – An agreement between two or more parties that creates enforceable rights and obligations”

“Contract Assets – a Company’s right to consideration in exchange for goods and services that the company has transferred to the customer“

Contract Liabilities – a Company’s obligation to transfer goods or services for which it has received some sort of payment (consideration), similar to deferred revenues

Customer – A party that has contracted with the company to obtain goods or services that are an output of the Company’s ordinary activities in exchange for consideration

Understanding Revenue Recognition and Its Implications

Understanding ASC 606 and what it means for your company is no small task, but it should be a top priority for public and privately-held companies alike.

For revenue recognition adoption guidance and for information about how these principles impact the way that your business recognizes revenue, our team recommends consulting an advisor who can offer tailored insight for your business. Contact a Warren Averett advisor about revenue recognition.

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1 – 4  Bedwell, Robert P. “The New Revenue Recognition Standard – Now is the Time to Prepare!” [PowerPoint Slides] Florida Institute of Certified Public Accountants. Radius CPE. Birmingham, Alabama. 10.1.18.

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