Most organizations have now entered year two of applying ASC 606, aka revenue recognition. As we sit back and reflect on one of the largest changes to GAAP in over a generation, what have we learned?
We’ve put together seven top takeaways:
1. We learned that now more than ever, the sales and accounting teams need to be in constant communication regarding contracts and what those contracts entail.
Some sales teams and accounting teams have been disconnected in the past. The sales teams were given the ability to modify contracts as needed and, under ASC 605, it did not have a significant impact on the accounting for the transaction. With the implementation of ASC 606, that has changed. Small tweaks in the contracts (or lack of a contract) can have a big impact on the accounting.
Specifically, items negotiated within the contract by the sales teams — such as discounts and financing — may now impact revenue recognition. Variable consideration can come in many forms, and the variable amounts of consideration may be explicitly stated in the contract but can also be implicit. As a result, it is extremely important to make the accounting team aware of any changes made to the standard contract or special negotiations.
2. We learned there are a lot of factors to consider in determining how many performance obligations we have.
The standard intended to simplify accounting for contractual agreements — in which a series of distinct goods and service that are substantially the same are treated as a single performance obligation — caused some complications in areas such as evaluating if the design and installation services are distinct.
When identifying distinct goods or services, we need to take into consideration as to whether an item is capable of being separate, as well as whether the item is viewed by the customer as being distinct within the context of the contract taken as a whole.
An important factor in identifying whether goods or services are distinct is how the sales team presented the performance obligation to the customer. Is the customer purchasing a final installed product, or is the customer purchasing a product and installation?
3. We learned ASC 606 caused some changes to the presentation for variable considerations.
For example, we learned that rights of return revenue should only be recognized for those goods not expected to be returned. As a result, a refund liability presented separately from the associated refund asset should be recognized for those goods expected to be returned. The asset should consider any expected costs to recover those products. If the value is less than the amount recorded, the carrying amount is reduced with a corresponding adjustment to cost of goods sold.
4. We learned that some of our revenue changed from point-in-time recognition to over-time recognition.
We learned that revenue that had historically been recorded as point in time — such as work completed using customer owned raw materials, safety stock, custom products with no alternative use, etc. — now typically meets at least one of the three criteria to be recognized over time.
The three criteria to be recognized over time are: 1) the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs, 2) the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced and 3) the 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.
As stated in the third criteria for evaluating if revenue should be recognized over time, not only must you create an asset with no alternative use, but it also must have an enforceable right to payment for performance completed to date. Under ASC 606, you have a right to payment for performance completed to date if you would be entitled to an amount that, at a minimum, compensates you for your performance completed to date in the event that the customer or another party terminates the contract for reasons other than your failure to perform as promised. The enforceable amount needs to approximate the selling price of the goods or services transferred to date, which should recover the cost incurred plus a reasonable profit margin. If the contract only requires the customer to compensate for costs incurred, there is no enforceable right to payment and therefore does not meet the third criteria to recognize revenue over time.
5. As more organizations found themselves recording revenue over time, we learned that having a good way of tracking progress throughout the term of the contract was now more important.
Tracking mechanisms come in a variety of forms from automated systems within the accounting software to manual systems as simple as a spreadsheet. The key to successfully tracking progress is understanding system limitations and having proper controls in place.
6. We learned the importance of footnotes.
The previously required revenue disclosure requirements were limited and varied among industries. For many companies, the revenue recognition footnote was one sentence. We learned that the revenue recognition footnoted disclosures now help tell a story, improving the reader’s understanding about the nature, amount, timing and uncertainty of revenue recognition.
For example, what transition guidance did the company elect to use? Did they apply full retrospective accounting and restatement prior year, or did they elect the modified retrospective method, which only identified the effect of the change on the current year?
Also, the footnotes now disclose which revenue streams are recognizing revenue at a point in time versus over time, significant payment terms (this was a big surprise for many companies) and significant judgments used, such as the method used for recognizing revenue for performance obligations satisfied over time (input or output method).
While some companies have found the quantitative impact of applying ASC 606 has not been significant, all companies have been surprised by the length of their new revenue recognition footnote, most cases spanning multiple pages.
7. Overall, we learned change is hard.
How can you help your staff embrace change and reduce resistance and pushback? See our November article on “Accounting and change management: What’s your ADKAR score?” for help.
The ASC 606 standard wasn’t a one-time-only implementation. Organizations will be learning as they go and making adjustments annually based on what they learned. If you need assistance with ASC 606, contact us. We’re here to help make these changes easier and ensure you can comply with the new standard.
Time is running out on ASC 606 revenue recognition implementation — Are you ready?