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ASC 606 Revenue Recognition Adoption Methods: Full Retrospective or Modified Approach

Jun 11, 2019

U.S. generally accepted accounting principles (GAAP) require nonpublic entities to apply the new revenue recognition standard for annual reporting periods beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. Previously, companies could use industry-specific guidelines for recognizing revenue from customer contracts, but now they must adopt a consistent principles-based approach using the ASC 606 framework.

Issued under guidance from the Financial Accounting Standards Board (FASB), the new standard is meant to provide better comparability across industries. The new standard replaces nearly all existing revenue guidance, and most companies will be affected. 

Public companies with annual reporting periods were required to adopt the new standard in 2018, and many of them shared a vital lesson for the private companies implementing now: It’s a lot of work! Transitioning to the new standard takes significant time and expertise. Don’t underestimate the effort involved.

Choosing Your Path Forward

According to a recent survey of more than 700 accounting and finance executives conducted by PwC and the Financial Executives Research Foundation, 52% of the survey respondents indicated they have yet to decide on an adoption method. 

Companies have two options when implementing ASC 606: You can adopt using either the full retrospective or the modified retrospective approach.

If you elect the full retrospective approach, you will be required to determine the cumulative effect (difference between the actual retained earnings reported at the beginning of the year using the old method versus what it would have been if you used the new method) of applying the new standard as of the beginning of the first historical period presented. In addition, you will need to recast all prior period financial statements presented.

Under the modified retrospective approach, you will need to apply the guidance to all new contracts initiated after the effective date. For existing contracts with terms extending beyond the effective date, you will need to compute and record a cumulative catch up adjustment to opening balance equity.

As you select your approach, consider which method will be most useful to your stakeholders. The modified retrospective approach, while generally less time consuming to implement, could result in significant distortions to recognized revenue and income trends. In certain cases, a full retrospective approach may be preferable to provide consistency and comparability between periods, ensuring investors and business leaders have the information needed to make sound business decisions.

Here’s an overview of each approach:

Full Retrospective

As noted above, preparing statements under the full retrospective method will require a comprehensive recasting of the prior year’s financial statements (2018 for private companies required to adopt in 2019). Although more effort will be needed, the full retrospective approach ensures comparability, better data and more useful trends. This method may be preferable if you have a lot of open contracts at the end of the year, as it will ensure apples-to-apples insight across reporting periods.

Notably, because of the high volume of data and comprehensive analysis required to implement ASC 606 under the full retrospective approach, FASB allows for the use of four practical expedients:

  1. An entity is not required to restate revenue from contracts that begin and are completed within the same annual reporting period.
  2. An entity may use hindsight when considering variable consideration for purposes of determining the transaction price for completed contracts, meaning the variable consideration can be evaluated after completion of the contract.
  3. For uncompleted contracts, an entity is not required to disclose the amount of the transaction price allocated to the remaining performance obligations or when that portion is expected to be recognized as revenue.
  4. For contracts that were modified before the beginning of the earliest period presented, an entity does not need to retroactively restate the specific contract for contract modifications in accordance with ASC 606, but rather shall reflect the aggregate effect with the original contract in determining performance obligations, transaction prices and allocation of those transaction prices.

Hurdles to the Full Retrospective Approach

Evaluate your contracts and consider the cost and effort of implementation before choosing the full retrospective approach. As indicated earlier, under this method, you will be required to analyze and possibly restate revenue previously recognized on your multi-period contracts, even those that were completed before ASC 606 went into effect. This will most likely require a larger time commitment from your associates and consultants, as well as additional historical data that may or may not be readily available. It all comes down to: Will the benefits of comparability and consistency outweigh the efforts and cost? 

Modified Retrospective

Under the modified retrospective approach, you will apply the new standard to all contracts initiated after the effective date. Under this method, the prior year’s data is not recast. Rather, for contracts with outstanding obligations (i.e., not substantially complete), you will recognize a cumulative catch-up adjustment to the opening balance of retained earnings as of the effective date.

While the modified retrospective approach does not require the restatement of prior years, it does require maintaining two sets of accounting records in the year of adoption, one under the new standard and one under the old. This information will be needed to meet your expanded footnote disclosure requirements, as companies reporting under this method must report what the year of adoption would have looked like had you still been under the old method.

The primary benefit of this approach is less historical information is required relative to the full retrospective method and may be sufficient for your typical investor if the qualitative and quantitative impacts are immaterial.

A downside to the modified retrospective approach is that only one practical expedient can be used. Specifically, an entity can reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented under ASC 606 (same as practical expedient #4 discussed previously with the full retrospective method).

Hurdles to the Modified Retrospective Approach

While this method is generally considered the simpler, more pragmatic option, many companies will be challenged by the need to keep two sets of books. In addition, because you won’t have a clear comparison to previous years, certain performance measurements and key performance indicators might be skewed.

Last, the modified approach also creates potential for vanishing revenue. Here’s an example of how that might happen:

  • On December 31, 2018, you sell 300 units of product to a distributor for $12 million. You grant rights of return and price protection. Under legacy GAAP, you would follow the sell-through method and defer revenue recognition until the fee becomes fixed or determinable — in this case, January 2019.
  • Under the new guidance, you must estimate the transaction price upfront and recognize revenue in an amount that is not probable of reversal in the future; thus, a portion of the revenue would be recognized in December 2018. Assuming adoption using the modified retrospective approach in 2019, you would reflect this change in the cumulative catch-up adjustment to the opening balance of retained earnings. Essentially, the revenue vanishes; it does not actually hit the income statement in either year presented.

Urgent Action, Challenges All Around

No matter which option you choose, transitioning to ASC 606 is challenging and could be a significant burden on your staff and existing accounting systems. If you haven’t done so already, evaluate your readiness for ASC 606 and develop an adoption plan.

Although time is running short, Wipfli is here to help. Don’t underestimate the work required, and don’t wait any longer. Contact us or reach out to your Wipfli relationship advisor.


Brad Werner, CPA, MBA
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