What is ASC 606 - A Complete Guide

Are you looking for standardized accounting principles for revenue recognition? If yes, then you are on the right page.

ASC 606 introduces a principles-based approach to revenue recognition, focusing on the transfer of control of goods or services to customers. It emphasizes the importance of accurately reflecting the amount and timing of revenue recognition to provide more useful and comparable financial information.

The objective of ASC 606 is to provide a more robust and transparent framework for recognizing revenue, enabling users of financial statements to understand the nature, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The standard applies to all entities that enter into contracts with customers, regardless of industry or size.

By adopting ASC 606, companies strive to provide stakeholders with more transparent and reliable financial information regarding their revenue streams, fostering consistency and comparability in revenue recognition practices across different organizations and industries.

This article will be your complete guide for ASC 606 by covering the following topics:

• What is ASC 606?
• What is Revenue Recognition?
• Five-Step Model for Revenue Recognition under ASC 606
• Why did Authorities Implement ASC 606?
• What is the Impact of ASC 606 on Businesses?
• How Does ASC 606 Impact the Accounting Process?
• How Does ASC 606 Impact the Sales Compensation Team?
• Steps to Prepare for ASC 606
• How to Implement ASC 606 Standards?
• Benefits of ASC 606 Compliance
• Drawbacks of ASC 606 Compliance
• Penalties for Non-Compliance with ASC 606
• FAQs related to ASC 606
• How can Deskera Help You with Revenue Recognition?
• Key Takeaways
• Related Articles

What is ASC 606?

ASC 606 stands for Accounting Standards Codification (ASC) Topic 606, which is a set of accounting principles issued by the Financial Accounting Standards Board (FASB) in the United States. ASC 606 provides guidance on revenue recognition for companies across various industries. It establishes a comprehensive framework for recognizing revenue from contracts with customers.

The purpose of ASC 606 is to standardize the principles and requirements for revenue recognition to ensure consistency and comparability in financial reporting. It replaced the previous revenue recognition standards, including ASC 605 (formerly known as SOP 97-2 and EITF 08-1).

Under ASC 606, companies are required to follow a five-step model for revenue recognition:

• Identify the contract with the customer
• Identify the performance obligations
• Determine the transaction price
• Allocate the transaction price to performance obligations
• Recognize revenue as performance obligations are satisfied

ASC 606 also provides guidance on other topics, such as contract modifications, warranties, and accounting for costs related to obtaining or fulfilling a contract.

The adoption of ASC 606 has significantly impacted the way companies recognize revenue and report their financial statements. It promotes a more principles-based approach, focusing on the transfer of control rather than the transfer of risks and rewards.

The goal is to provide users of financial statements with more useful and transparent information about the nature, timing, and uncertainty of revenue and cash flows from contracts with customers.

What is Revenue Recognition?

Revenue recognition is the process of determining and recording revenue in an entity's financial statements. It involves recognizing revenue when it is earned and reasonably certain of collection, in accordance with the applicable accounting standards and principles.

Revenue recognition is crucial because it provides valuable information about an entity's financial performance, profitability, and cash flows. It allows stakeholders, such as investors, creditors, and analysts, to assess the entity's ability to generate revenue and the economic value it creates through its core operations.

The recognition of revenue generally depends on the nature of the entity's activities and the specific circumstances surrounding the transaction. However, there are some common principles and criteria that guide the revenue recognition process:

1. Earnings Process: Revenue is typically recognized when the earnings process is considered complete or substantially complete. This usually occurs when the entity has fulfilled its obligations under a contract and transferred control of goods or services to the customer.
2. Realization of Revenue: Revenue is recognized when it is realized or realizable. This means that the entity has the ability to collect the amount of consideration it is entitled to in exchange for the goods or services provided. It is important to have reasonable assurance that the consideration will be collected.
3. Persuasive Evidence of an Arrangement: There must be a legally enforceable arrangement or contract between the entity and the customer, specifying the goods or services to be provided and the consideration to be received.
4. Determinable and Measurable: The amount of revenue to be recognized should be determinable and measurable with reasonable accuracy. This requires estimating variable considerations, such as discounts, rebates, refunds, or performance bonuses, and considering the time value of money if applicable.
5. Control Transfer: Revenue is recognized when control of the goods or services is transferred to the customer. Control refers to the ability to direct the use of and obtain the benefits from the goods or services. Control may be transferred at a specific point in time or over a period of time, depending on the terms of the contract.

Accounting standards, such as ASC 606 or IFRS 15, provide specific guidance and principles for recognizing revenue in different industries and scenarios. These standards aim to ensure consistency, comparability, and transparency in revenue recognition practices.

It is important for entities to carefully assess their contracts, apply the appropriate criteria for revenue recognition, and ensure compliance with the relevant accounting standards to provide accurate and reliable financial information to stakeholders.

Five-Step Model for Revenue Recognition under ASC 606

The 5-step model for revenue recognition is a framework outlined by the International Financial Reporting Standards (IFRS) and the Financial Accounting Standards Board (FASB) to guide entities in recognizing revenue from contracts with customers.

Under ASC 606, the five-step model for revenue recognition is as follows:

Identify the Contract with the Customer

This step involves determining whether a contract exists between the company and the customer. Let's delve into the details:

a. Approval and commitment: The company must ensure that there is a mutual agreement and approval between the parties involved. This requires both the company and the customer to have legally binding rights and obligations. The contract can be written, verbal, or implied based on customary business practices.

b. Identification of rights: The contract must identify the rights of the parties, including the goods or services to be transferred, any specific performance obligations, and the payment terms.

c. Payment terms and collectability: The contract should include clear payment terms, such as the amount and timing of consideration. The company needs to assess the collectability of the consideration to determine if it is probable that it will collect the amount it is entitled to.

d. Commercial substance: The contract should have commercial substance, meaning that the outcome of the contract will result in a significant change in the company's cash flows, costs, or risks.

e. Parties' ability and intention to perform: Both the company and the customer should have the ability and intention to perform their respective obligations under the contract.

It's important to note that the identification of a contract is not always straightforward, especially when there are multiple agreements or complex arrangements. In some cases, the company may need to consider the presence of modifications or amendments to existing contracts and determine if they give rise to separate contracts or modifications of existing contracts.

If a contract is not identified, revenue recognition under ASC 606 is delayed until a contract is deemed to exist. This step sets the foundation for the subsequent steps of the revenue recognition model by establishing the contractual framework within which the company's obligations and performance are evaluated.

Properly identifying contracts ensures that revenue is recognized in accordance with the criteria outlined in ASC 606, promoting transparency and consistency in financial reporting.

Identify the Performance Obligations

The second step of the five-step model for revenue recognition under ASC 606 is to identify the performance obligations in the contract. This step involves determining the distinct goods or services that the company has promised to transfer to the customer. Let's explore this step in detail:

a. Separately identifiable goods or services: The company needs to identify the distinct goods or services that it has promised to transfer to the customer. A performance obligation is a promise to transfer a good or service to the customer. To be considered distinct, the customer must be able to benefit from the good or service either on its own or together with other resources that are readily available to the customer.

b. Evaluating separability: When evaluating whether goods or services are distinct, the company considers factors such as the nature of the goods or services, their distinct functionality, and whether they are sold separately by the company or other vendors in similar circumstances.

c. Bundled goods or services: If the promised goods or services are provided as a bundle or package, the company needs to determine whether they are distinct and should be accounted for separately. If the bundle contains multiple promised goods or services that are not separately identifiable or do not meet the criteria of being distinct, the company accounts for them as a single performance obligation.

d. Series of distinct goods or services: In some cases, a contract may include a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. The company needs to evaluate if the series should be treated as separate performance obligations or as a single performance obligation over time.

e. Modifications and additions: If modifications or additions to the contract occur after its inception, the company needs to assess whether they give rise to separate performance obligations or if they modify existing performance obligations.

f. Implied promises: The company must also consider any implied promises to the customer that create performance obligations. These promises may arise from customary business practices, published policies, or other factors.

It's important to assess and clearly define the performance obligations as they form the basis for revenue recognition. Each distinct performance obligation will have specific criteria for revenue recognition, such as whether revenue should be recognized at a point in time or over time.

Determining the performance obligations accurately is crucial to ensure that revenue is recognized in a manner that reflects the transfer of goods or services to the customer. It allows for appropriate allocation of the transaction price and proper matching of revenue with the satisfaction of performance obligations.

Determine the Transaction Price

The transaction price is the amount of consideration that an entity expects to receive in exchange for transferring goods or services to the customer. It represents the estimated value of the promised goods or services and is usually expressed in monetary terms.

To determine the transaction price, entities consider the following factors:

a.Variable Consideration: Variable consideration refers to the situations where the amount of consideration the entity is entitled to receive is subject to change due to factors such as discounts, rebates, refunds, performance bonuses, penalties, or any other contingent consideration. In such cases, the entity estimates the variable consideration using either the expected value method or the most likely amount method, depending on which method is most predictive and appropriate based on the available information.

b.Constraining Estimates of Variable Consideration: IFRS and FASB provide specific guidelines on constraining estimates of variable consideration. Entities must evaluate whether there is a significant risk of revenue reversal. Revenue should be recognized only to the extent that it is highly probable that there will not be a significant reversal in future periods when the uncertainty is resolved.

c.Time Value of Money: If there is a significant financing component in the contract, the transaction price needs to be adjusted for the time value of money. This is done by discounting the future cash flows to present value using an appropriate discount rate. The financing component arises when the timing of the transfer of goods or services and the customer's payment does not align.

d. Non-Cash Consideration: If the consideration includes non-cash assets, such as goods or services received from the customer, the transaction price should be measured at fair value, which is the price that would be agreed upon in an orderly transaction between market participants.

e. Consideration Payable to the Customer: If the entity expects to pay consideration to the customer, such as incentives or rebates, the consideration payable to the customer is subtracted from the transaction price. This reduces the net amount of revenue recognized.

It's important to note that the transaction price is determined at the contract level. If a contract involves multiple performance obligations, the transaction price is allocated to each performance obligation based on their relative standalone selling prices. This allocation is discussed in detail in Step 4 of the revenue recognition model.

Overall, determining the transaction price requires careful evaluation of all relevant factors to estimate the consideration the entity expects to receive in exchange for its goods or services. It involves considering variable consideration, constraining estimates, accounting for the time value of money, non-cash consideration, and consideration payable to the customer.

Allocate the Transaction Price to the Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. Contracts often involve multiple performance obligations, which can be explicitly stated or implicitly implied.

This step focuses on determining how much of the transaction price should be assigned to each distinct good or service promised in the contract. To allocate the transaction price to the performance obligations, entities follow these guidelines:

a. Standalone Selling Prices: The allocation is based on the standalone selling prices of each distinct good or service promised in the contract. The standalone selling price is the price at which an entity would sell the goods or services on a standalone basis in similar circumstances.

If the standalone selling price is readily observable, the entity uses that amount. However, in many cases, the standalone selling price may need to be estimated, especially when goods or services are not sold separately or there is limited or no historical data available. In such cases, entities can use various estimation techniques, such as adjusted market assessment, expected cost plus a margin, or a residual approach.

b. Variable Consideration Allocation: If the transaction price includes variable consideration, such as performance bonuses or penalties, the entity needs to allocate the variable consideration to the performance obligations. This allocation should be done proportionately to the standalone selling prices of the performance obligations, based on the relative standalone value they provide to the customer.

c. Constraint on Variable Consideration Allocation: Similar to Step 3, entities need to apply the constraint on variable consideration to ensure that any allocated variable consideration is not in excess of what is highly probable to not result in a significant reversal of cumulative revenue recognized.

d. Non-Cash Consideration Allocation: If the transaction price includes non-cash consideration, such as goods or services received from the customer, the entity needs to measure and allocate the fair value of that consideration to the performance obligations. This allocation should be done based on the relative standalone selling prices of the performance obligations.

e. Consideration Payable to the Customer Allocation: If the entity expects to pay consideration to the customer, such as incentives or rebates, the consideration payable to the customer is subtracted from the transaction price before allocating it to the performance obligations. This reduces the net amount of consideration available for allocation.

Once the transaction price is allocated to each performance obligation, entities recognize revenue for each performance obligation when or as the control of the goods or services is transferred to the customer. The amount of revenue recognized is based on the allocated transaction price for each performance obligation.

It's important to note that the allocation of the transaction price should reflect the entity's best estimate of the consideration to which it will be entitled in exchange for satisfying the performance obligations. This estimation requires judgment and consideration of all relevant factors, such as standalone selling prices and the nature of the performance obligations.

Overall, the fourth step of the revenue recognition model involves allocating the transaction price to the distinct goods or services promised in the contract, considering standalone selling prices, variable consideration, non-cash consideration, and consideration payable to the customer. This ensures that revenue is recognized in a manner that reflects the transfer of goods or services to the customer.

Recognize Revenue When or As the Entity Satisfies Performance Obligations

The fifth and final step of the 5-step model for revenue recognition is to recognize revenue when or as the entity satisfies its performance obligations. This step focuses on determining when revenue should be recognized based on the transfer of control of goods or services to the customer.

In this step, the entity recognizes revenue by applying the principle of when or as control is transferred to the customer. Control represents the ability to direct the use of and obtain substantially all the remaining benefits from the goods or services.

To determine when or as the entity satisfies its performance obligations, entities consider the following criteria:

a. Transfer of Control: The entity assesses whether it has transferred control of the promised goods or services to the customer. Control may be transferred over time or at a point in time, depending on the nature of the performance obligations.

i. Control over Time:

Control is deemed to be transferred over time if one of the following conditions is met:

• The customer receives and consumes the benefits of the entity's work as it progresses.
• The entity's work creates or enhances an asset that the customer controls.

For revenue recognition over time, entities use an appropriate method to measure progress, such as output methods (e.g., surveys of work completed) or input methods (e.g., costs incurred or time elapsed).

ii. Control at a Point in Time:

Control is deemed to be transferred at a point in time if one of the following conditions is met:

• The entity has a present right to payment for the asset.
• The customer has legal title to the asset.
• The customer has physical possession of the asset.
• The customer has the significant risks and rewards of ownership.

b. Satisfaction of Performance Obligations: Revenue is recognized as the entity satisfies each performance obligation. If control is transferred over time, revenue is recognized over the period of satisfaction. If control is transferred at a point in time, revenue is recognized at that specific point.

It's important to note that if a contract has multiple performance obligations, entities need to assess and determine the timing of revenue recognition for each performance obligation individually, based on the transfer of control criteria.

Entities also need to consider any practical expedients or specific guidance provided by the applicable accounting standards when determining the timing of revenue recognition. These may include guidance for certain types of contracts or industries.

Overall, the fifth step of the revenue recognition model involves recognizing revenue when or as the entity satisfies its performance obligations by assessing the transfer of control of goods or services to the customer. This step ensures that revenue is recognized in a manner that reflects the timing of the entity's performance and the customer's receipt of benefits.

It's important to note that the revenue recognition process does not end with Step 5. Entities also need to disclose relevant information in the financial statements to provide users with a clear understanding of the nature, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

Why did Authorities Implement ASC 606?

The implementation of ASC 606, or Accounting Standards Codification 606, was driven by the need to improve consistency, comparability, and transparency in revenue recognition practices across different industries and jurisdictions. Several reasons prompted the authorities to implement ASC 606:

1. Inconsistent Revenue Recognition Practices: Prior to ASC 606, revenue recognition practices varied significantly across different industries and jurisdictions. This inconsistency made it difficult for users of financial statements to compare and analyze companies' financial performance accurately. ASC 606 aimed to establish a single, comprehensive revenue recognition standard that could be applied consistently across all industries.
2. Complexity and Lack of Clarity: The previous revenue recognition guidance, such as the industry-specific guidance or the general principles outlined in the Generally Accepted Accounting Principles (GAAP), was often complex and lacked clarity. This complexity made it challenging for entities to apply the guidance correctly and resulted in diverse interpretations and practices. ASC 606 aimed to simplify and clarify the revenue recognition guidance, providing a robust framework for entities to follow.
3. Focus on Principles-Based Approach: ASC 606 introduced a principles-based approach to revenue recognition. The previous guidance often relied on numerous detailed rules and industry-specific requirements, which sometimes resulted in an overly prescriptive and rules-based approach. By shifting to a principles-based approach, ASC 606 aimed to provide more judgment and flexibility to entities, allowing them to apply the standard in a manner that reflects the economic substance of their contracts with customers.
4. Alignment with International Standards: The implementation of ASC 606 also aimed to achieve convergence with international accounting standards, particularly with IFRS 15 (International Financial Reporting Standard 15). The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) worked together to develop a unified revenue recognition standard to enhance global comparability and consistency in financial reporting.
5. Enhanced Financial Statement Presentation: ASC 606 aimed to improve the presentation of revenue-related information in financial statements. By providing more comprehensive and transparent information, the standard intended to enhance the understanding of users of financial statements regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

The implementation of ASC 606 was a significant step towards harmonizing revenue recognition practices and providing a more accurate and consistent representation of revenue in financial statements. The goal was to improve the usefulness and comparability of financial information, enabling users to make better-informed decisions.

What is the Impact of ASC 606 on Businesses?

ASC 606, the revenue recognition standard, has a significant impact on businesses across various industries. Here are some key impacts of ASC 606:

1. Standardization and Consistency: ASC 606 provides a unified framework for revenue recognition, replacing the previously diverse and industry-specific guidance. This standardization promotes consistency in revenue recognition practices across different entities and industries, making it easier for stakeholders to compare financial statements.
2. Change in Timing of Revenue Recognition: ASC 606 introduces the concept of recognizing revenue when control of goods or services is transferred to the customer, which may result in changes to the timing of revenue recognition. This can affect financial metrics, such as revenue, profit, and key performance indicators, particularly for industries that previously recognized revenue at different points in the transaction lifecycle.
3. Enhanced Disclosure Requirements: ASC 606 introduces new and enhanced disclosure requirements, aimed at providing more transparency and information about revenue recognition to financial statement users. Entities are required to provide detailed disclosures about the nature, amount, timing, and uncertainty of revenue and cash flows from contracts with customers.
4. Impact on Contract Evaluation and Documentation: ASC 606 requires entities to carefully evaluate contracts to identify performance obligations, variable consideration, and other contractual terms that impact revenue recognition. This may require changes in contract evaluation processes and the documentation of contracts to ensure accurate recognition of revenue.
5. Increased Judgment and Estimation: ASC 606 requires entities to exercise more judgment and estimation in certain areas, such as determining the transaction price, allocating consideration to performance obligations, and assessing variable consideration. This can introduce additional complexity and subjectivity in the revenue recognition process.
6. Potential System and Process Changes: ASC 606 may require changes to financial systems, processes, and internal controls to capture and report the necessary data for revenue recognition. Entities may need to update their systems to track and allocate revenue appropriately, enhance data collection and reporting capabilities, and ensure compliance with the new standard.
7. Impact on Sales and Compensation Structures: ASC 606 can influence sales and compensation structures, as it may require changes to performance metrics, commission structures, and the timing of commission payments. Sales teams may need to align their activities with the new revenue recognition principles to ensure accurate and timely recognition of revenue.
8. Increased Collaboration between Departments: ASC 606 necessitates increased collaboration between finance, accounting, sales, legal, and other relevant departments. Close coordination is required to ensure that contracts, revenue recognition policies, and sales activities align with the requirements of ASC 606.

Overall, ASC 606 has a broad impact on financial reporting, contract evaluation, processes, and systems within organizations. It requires careful assessment, planning, and implementation to ensure compliance and the accurate presentation of revenue in financial statements.

How Does ASC 606 Impact the Accounting Process?

ASC 606, the revenue recognition standard, has a significant impact on the accounting process of entities that are subject to its requirements. Here are some key ways in which ASC 606 impacts the accounting process:

1. Contract Identification: ASC 606 emphasizes the importance of identifying contracts with customers. Entities need to assess whether a contract exists and determine the specific criteria that need to be met for a contract to be recognized under the standard. This involves evaluating whether there is a legally enforceable agreement, the parties' rights and obligations, and the collectability of consideration, among other factors.
2. Performance Obligation Identification: Under ASC 606, entities are required to identify and evaluate the distinct performance obligations within a contract. A performance obligation is a promise to transfer a distinct good or service to the customer. The accounting process involves identifying these separate obligations and determining how to account for them individually or as a bundle.
3. Transaction Price Determination: ASC 606 requires entities to determine the transaction price, which is the amount of consideration expected to be received in exchange for transferring goods or services to the customer. This involves assessing variable consideration, constraining estimates, accounting for the time value of money, and considering non-cash or consideration payable to the customer. The accounting process involves estimating and allocating the transaction price to the identified performance obligations.
4. Revenue Recognition Timing: ASC 606 introduces the concept of recognizing revenue when or as control of goods or services is transferred to the customer. This can occur over time or at a point in time, depending on the nature of the performance obligations. Entities need to evaluate the transfer of control criteria to determine the appropriate timing of revenue recognition for each performance obligation.
5. Measurement of Revenue: ASC 606 requires entities to measure revenue based on the transaction price allocated to each performance obligation. The accounting process involves applying the appropriate measurement method, which could be based on standalone selling prices, observable market prices, or other estimation techniques. Measurement may also be impacted by factors such as variable consideration and the time value of money.
6. Ongoing Disclosure Requirements: ASC 606 introduces enhanced disclosure requirements to provide users of financial statements with a better understanding of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Entities need to disclose relevant information to ensure transparency and comparability.

Overall, ASC 606 significantly impacts the accounting process by introducing new concepts, criteria, and guidelines for revenue recognition.

Entities need to carefully evaluate contracts, identify performance obligations, determine transaction prices, allocate revenue, and disclose relevant information.

The standard requires judgment, estimation, and consistent application to ensure compliance and provide transparent financial reporting.

How Does ASC 606 Impact the Sales Compensation Team?

ASC 606, the revenue recognition standard, can have an impact on the sales compensation team within an organization. Here are some key ways in which ASC 606 can impact the sales compensation team:

1. Changes in Performance Metrics: ASC 606 may lead to changes in the performance metrics used to determine sales compensation. As the standard focuses on recognizing revenue when control of goods or services is transferred to the customer, sales compensation plans may need to align with this timing. Performance metrics may need to be revised to reflect the transfer of control criteria, such as when a contract is signed, when goods are shipped, or when specific milestones are achieved.
2. Recognition of Variable Consideration: ASC 606 provides guidance on accounting for variable consideration, such as bonuses, incentives, or penalties. The sales compensation team may need to align the variable compensation components with the principles of ASC 606. This may involve considering how variable consideration is estimated, constrained, and recognized, and adjusting sales compensation plans accordingly.
3. Impact on Commission Structures: The changes brought by ASC 606 may necessitate adjustments to commission structures. The sales compensation team may need to review and modify commission plans to ensure they align with the revenue recognition principles of the standard. This could include changes in commission rates, the timing of commission payments, or the introduction of new commission triggers based on the transfer of control criteria.
4. Enhanced Documentation and Communication: ASC 606 places an emphasis on documentation and transparency in revenue recognition. The sales compensation team may need to work closely with the finance and accounting teams to ensure accurate and complete documentation of sales transactions. They may also need to communicate any changes in commission structures or performance metrics to the sales force effectively, ensuring that the sales team understands how revenue recognition impacts their compensation.
5. Collaboration with Finance and Accounting Teams: ASC 606 requires increased collaboration between the sales compensation team and the finance and accounting teams. The teams may need to work together to ensure the accurate and timely recognition of revenue and the appropriate allocation of consideration to performance obligations. This collaboration helps align sales compensation plans with the principles of ASC 606 and ensures consistency in financial reporting.
6. Training and Education: ASC 606 introduces new concepts and guidelines for revenue recognition. The sales compensation team may require training and education on the principles and requirements of the standard. This ensures that the team understands the impact of ASC 606 on sales compensation plans, can accurately communicate the changes to the sales force, and can effectively address any questions or concerns raised by the sales team.

Overall, ASC 606 can impact the sales compensation team by requiring adjustments to performance metrics, commission structures, documentation processes, and collaboration with finance and accounting teams.

It emphasizes the need for transparency, accuracy, and alignment with revenue recognition principles to ensure compliance with the standard while appropriately incentivizing the sales force.

Steps to Prepare for ASC 606

Preparing for ASC 606, the revenue recognition standard requires careful planning and implementation to ensure compliance. Here are the steps to prepare for ASC 606:

1. Understand the Standard: Begin by thoroughly understanding the principles and requirements of ASC 606. Familiarize yourself with the five-step model for revenue recognition and the key concepts, such as performance obligations, transaction price allocation, and control transfer criteria. Review the specific guidance provided in the standard and any industry-specific considerations that may apply to your organization.
2. Assess Impact: Evaluate the impact of ASC 606 on your organization's financial statements and business processes. Identify the contracts you have with customers and assess how the new standard will change revenue recognition for each type of contract. Determine the potential impact on financial metrics, such as revenue, profit, and key performance indicators.
3. Establish a Project Team: Create a cross-functional project team comprising members from finance, accounting, sales, legal, IT, and other relevant departments. Assign roles and responsibilities to team members to ensure proper coordination and implementation of ASC 606. The team should include individuals with a deep understanding of revenue recognition principles, contract management, and financial reporting.
4. Review Contracts: Perform a comprehensive review of your existing contracts with customers. Identify the specific performance obligations, variable consideration, non-cash consideration, and other contractual terms that may impact revenue recognition. Ensure that contracts are properly documented and accessible for future reference.
5. Evaluate Systems and Processes: Assess your organization's current systems, processes, and internal controls related to revenue recognition. Determine whether any changes or enhancements are required to capture the necessary data, support the allocation of transaction prices, and generate accurate and timely financial information in accordance with ASC 606. Consider the need for system upgrades, data integration, or the implementation of specialized revenue recognition software if necessary.
6. Develop New Policies and Procedures: Update your accounting policies and procedures to reflect the requirements of ASC 606. Establish clear guidelines for revenue recognition, transaction price allocation, performance obligation identification, and any other specific areas impacted by the standard. Communicate the new policies and procedures to relevant stakeholders and ensure their understanding and adherence.
7. Train and Educate Staff: Provide training and education to your finance, accounting, sales, and other relevant staff members on ASC 606. Ensure that they understand the principles and requirements of the standard, the changes to revenue recognition processes, and their roles and responsibilities in implementing ASC 606. Consider providing ongoing training to address any updates or changes in the standard.
8. Implement Changes: Implement the necessary changes to your systems, processes, and controls to align with ASC 606. This may involve updating software systems, modifying contract templates, revising commission structures, and enhancing data collection and reporting capabilities. Test the changes to ensure they are functioning as intended and producing accurate results.
9. Monitor and Evaluate: Continuously monitor and evaluate the effectiveness of the ASC 606 implementation. Regularly review revenue recognition processes, financial statements, and internal controls to ensure compliance with the standard. Stay updated on any amendments or interpretations issued by regulatory bodies and assess their impact on your organization.
10. Communicate with Stakeholders: Maintain open and transparent communication with stakeholders, including investors, auditors, and regulators. Disclose relevant information about the impact of ASC 606 on your financial statements, revenue recognition policies, and any significant changes in financial metrics. Address any questions or concerns raised by stakeholders and provide clarifications as needed.

Preparing for ASC 606 requires a comprehensive and structured approach. By understanding the standard, assessing its impact, and implementing necessary changes, organizations can ensure a smooth transition to the new revenue recognition requirements.

How to Implement ASC 606 Standards?

Implementing ASC 606, the revenue recognition standard involves a structured approach to ensure compliance with the new requirements. Here are the general steps to consider when implementing ASC 606:

1. Educate and Train: Begin by educating key stakeholders within the organization about ASC 606 and its impact on revenue recognition. This includes finance and accounting teams, sales teams, legal departments, and executives. Conduct training sessions and workshops to familiarize employees with the new standard and its requirements.
2. Assess Impact: Evaluate the impact of ASC 606 on your organization's financial statements, systems, processes, contracts, and policies. Identify the key changes needed to align with the new standard. This assessment may require reviewing and analyzing existing contracts, revenue streams, and historical revenue recognition practices.
3. Identify Performance Obligations: ASC 606 requires the identification of distinct performance obligations within contracts. Review existing contracts to identify the promised goods or services and assess whether they should be treated as separate performance obligations. This step may involve collaboration between finance, legal, and sales teams.
4. Determine Transaction Price: Determine the transaction price, which is the consideration expected to be received in exchange for the promised goods or services. Consider factors such as variable consideration, discounts, rebates, and the time value of money. Estimate and allocate the transaction price to each performance obligation.
5. Allocate Transaction Price: Allocate the transaction price to each performance obligation based on their relative standalone selling prices. This may require estimation techniques, such as market surveys, cost analysis, or expected margin approaches. The allocation method should be rational and consistently applied.
6. Establish Revenue Recognition Policies: Develop and document revenue recognition policies that align with ASC 606. These policies should outline the criteria for recognizing revenue, the timing of revenue recognition, and the treatment of variable consideration. Ensure that policies are consistent across different revenue streams and contracts.
7. Implement Systems and Controls: Update or modify financial systems, processes, and internal controls to capture the necessary data for ASC 606 compliance. This may involve enhancing contract management systems, revenue recognition modules, and reporting capabilities. Implement robust controls to ensure accurate and reliable revenue recognition.
8. Provide Disclosures: ASC 606 requires enhanced disclosures about revenue recognition in financial statements. Ensure that the necessary information is collected and documented to meet the disclosure requirements of the new standard. Review and update the organization's financial statement footnotes and other relevant disclosures.
9. Test and Review: Conduct thorough testing and review of the implemented ASC 606 processes and controls. Perform retrospective testing on a sample of contracts to ensure that revenue is recognized in accordance with the new standard. Identify and rectify any discrepancies or issues that arise during testing.
10. Monitor and Train: Continuously monitor the effectiveness of ASC 606 implementation and provide ongoing training to employees. Stay updated on any amendments or interpretations issued by accounting standard setters. Regularly review contracts, revenue streams, and revenue recognition practices to ensure continued compliance with ASC 606.

It is important to involve relevant stakeholders, including finance, accounting, sales, legal, and IT teams, throughout the implementation process. Seek professional guidance if needed to ensure accurate interpretation and implementation of ASC 606.

Benefits of ASC 606 Compliance

Complying with ASC 606, the revenue recognition standard offers several benefits for organizations. Here are some key benefits of ASC 606 compliance:

1. Enhanced Financial Statement Transparency: ASC 606 promotes greater transparency in financial statements by providing a unified framework for revenue recognition. This enables stakeholders, including investors, creditors, and analysts, to better understand and compare the revenue recognition practices of different entities, leading to improved transparency and decision-making.
2. Consistency and Comparability: ASC 606 standardizes revenue recognition practices across industries, facilitating consistency and comparability of financial statements. This allows stakeholders to more accurately assess an organization's financial performance, profitability, and cash flows, as revenue recognition practices become more aligned and transparent.
3. Improved Decision-Making: ASC 606 compliance provides stakeholders with more reliable and consistent information about an organization's revenue. This enhances decision-making processes, such as assessing investment opportunities, evaluating business performance, and determining creditworthiness. By providing clearer and more accurate revenue recognition information, ASC 606 helps stakeholders make better-informed decisions.
4. Clearer Contract Evaluation: ASC 606 requires organizations to carefully evaluate contracts and identify performance obligations, variable considerations, and other contractual terms that impact revenue recognition. This process ensures that all relevant aspects of a contract are considered, leading to a clearer understanding of contractual obligations and revenue recognition criteria.
5. Better Risk Assessment: ASC 606 compliance helps organizations identify and mitigate risks associated with revenue recognition. By following a standardized and comprehensive approach, organizations can identify potential revenue recognition issues, assess their impact on financial statements, and take appropriate measures to address and mitigate those risks.
6. Improved Internal Controls: ASC 606 compliance requires organizations to review and enhance their internal controls related to revenue recognition. This helps ensure that revenue is recognized accurately, risks are appropriately managed, and financial reporting is reliable. Strengthening internal controls can lead to improved operational efficiency, reduced errors, and increased confidence in financial reporting.
7. Increased Investor Confidence: ASC 606 compliance enhances the quality and reliability of financial information related to revenue recognition. This, in turn, can increase investor confidence and trust in an organization's financial statements. Improved transparency, comparability, and adherence to standardized revenue recognition practices can positively impact an organization's reputation and attract potential investors.
8. Regulatory Compliance: Complying with ASC 606 ensures that organizations adhere to the applicable accounting standards and regulations. This mitigates the risk of non-compliance, potential penalties, and reputational damage that may arise from inaccurate or non-standard revenue recognition practices.

While implementing ASC 606 may involve initial costs and efforts, the long-term benefits include improved financial statement transparency, better decision-making, and increased stakeholder confidence.

By aligning revenue recognition practices with the requirements of ASC 606, organizations can achieve greater consistency, reliability, and comparability in their financial reporting.

Drawbacks of ASC 606 Compliance

While ASC 606, the revenue recognition standard, offers several benefits, it also comes with certain drawbacks and challenges. Here are some potential drawbacks of ASC 606:

1. Increased Complexity: ASC 606 introduces a more principles-based approach to revenue recognition, which can be complex and require significant judgment and estimation. The standard requires organizations to evaluate contracts, allocate transaction prices, and assess variable considerations, which may involve subjective assessments and lead to increased complexity in the revenue recognition process.
2. Implementation Challenges: Implementing ASC 606 may require organizations to make changes to their systems, processes, and internal controls to capture and report the necessary data for revenue recognition. This can be a complex and time-consuming process, particularly for organizations with large volumes of contracts and diverse revenue streams. Implementing new policies, updating systems, and training staff on the new standard can pose implementation challenges.
3. Increased Costs: Complying with ASC 606 may entail additional costs for organizations. These costs can include updating accounting systems, enhancing data collection and reporting capabilities, conducting contract reviews, and providing training to staff. The initial costs of implementation and ongoing costs of maintaining compliance with the standard can be significant, particularly for small and medium-sized businesses.
4. Impact on Financial Metrics: ASC 606 can impact financial metrics, such as revenue, profit, and key performance indicators, particularly due to changes in the timing of revenue recognition. Depending on the industry and specific circumstances, there may be a shift in the timing of revenue recognition, which can affect financial ratios, trend analysis, and year-over-year comparisons. It is important for stakeholders to be aware of these potential impacts and adjust their analyses and interpretations accordingly.
5. Subjectivity and Estimation Uncertainty: ASC 606 requires organizations to exercise judgment and estimation in various areas, such as determining the transaction price, allocating consideration, and assessing variable consideration. This subjectivity and estimation uncertainty can introduce challenges in achieving consistent and comparable revenue recognition across different entities. It may also increase the risk of errors or potential differences in interpretations among organizations and auditors.
6. Impact on Sales and Compensation Structures: ASC 606 can influence sales and compensation structures, as it may require changes to performance metrics, commission structures, and the timing of commission payments. Organizations may need to align their sales activities and compensation models with the new revenue recognition principles, which can pose challenges in terms of system updates, employee communication, and potential resistance to change.
7. Potential for Disruption: The transition to ASC 606 may disrupt business operations and processes, particularly during the initial implementation phase. Organizations may need to dedicate significant resources, including time and personnel, to ensure a smooth transition to the new standard. This can divert attention from other strategic initiatives and day-to-day operations.

Despite these drawbacks, ASC 606 aims to improve financial reporting transparency, comparability, and decision-making by providing a more comprehensive and principles-based approach to revenue recognition.

While the standard poses challenges, careful planning, implementation, and ongoing monitoring can help organizations navigate and address these potential drawbacks effectively.

Penalties for Non-Compliance with ASC 606

The penalties for non-compliance with ASC 606, the revenue recognition standard, can vary depending on the jurisdiction and the specific circumstances of the non-compliance.

Here are some potential penalties or consequences that organizations may face for non-compliance:

1. Regulatory Actions: Regulatory bodies, such as the Securities and Exchange Commission (SEC) in the United States, have the authority to take enforcement actions against companies that fail to comply with accounting standards. These actions can include fines, sanctions, and the requirement to restate financial statements to rectify non-compliance.
2. Legal Liabilities: Non-compliance with ASC 606 can expose organizations to legal liabilities. Stakeholders, including shareholders, investors, and customers, may initiate legal actions if they believe that the non-compliance has resulted in financial harm or misleading financial information. Organizations may face lawsuits, claims for damages, or reputational damage as a result.
3. Impact on Audits and Reviews: Non-compliance with ASC 606 can lead to audit or review issues. Auditors may identify instances of non-compliance during their examination of financial statements, which can result in qualified audit opinions, the need for additional procedures, or delays in completing the audit process. Non-compliance can also erode the confidence and credibility of financial statements.
4. Investor Confidence and Perception: Non-compliance with accounting standards can undermine investor confidence and trust in an organization. Investors rely on accurate and reliable financial information for their investment decisions, and non-compliance may lead to doubts about the organization's financial reporting and governance practices. This can impact stock prices, access to capital, and overall investor perception.
5. Reputational Damage: Non-compliance with accounting standards, including ASC 606, can damage an organization's reputation. Negative publicity, media scrutiny, and public perception of financial mismanagement or lack of transparency can harm an organization's brand and relationships with stakeholders, including customers, suppliers, and business partners.
6. Remedial Actions and Costs: Organizations that fail to comply with ASC 606 may need to take remedial actions to rectify the non-compliance. This can involve restating financial statements, implementing internal control improvements, and conducting additional audits or reviews. The costs associated with remediation efforts can be substantial, including expenses related to hiring external consultants, revising financial systems, and addressing regulatory inquiries.

It is important for organizations to understand and comply with ASC 606 and other applicable accounting standards to mitigate the risk of penalties and consequences.

Proactive steps, such as staying informed about accounting standards, conducting internal assessments, seeking professional guidance, and maintaining robust internal controls, can help organizations ensure compliance and avoid potential penalties.

FAQs related to ASC 606

• What is the effective date of ASC 606?

ASC 606 became effective for public companies for annual reporting periods beginning after December 15, 2017, and for non-public companies for annual reporting periods beginning after December 15, 2018.

• What are the core principles of ASC 606?

The core principles of ASC 606 are to recognize revenue when control of goods or services is transferred to the customer and to reflect the amount of consideration the entity expects to receive in exchange for those goods or services.

• How does ASC 606 impact revenue recognition timing?

ASC 606 may change the timing of revenue recognition as it focuses on control rather than risks and rewards of ownership. Revenue is recognized when control of the goods or services is transferred to the customer.

• How does ASC 606 define a contract?

ASC 606 defines a contract as an agreement between parties that creates enforceable rights and obligations. The agreement must have commercial substance, the parties must approve it, and payment terms must be identifiable.

• How does ASC 606 address variable consideration?

ASC 606 requires entities to estimate variable considerations, such as discounts, rebates, or performance bonuses. It allows recognition of variable consideration if it is probable and can be reliably estimated.

• How does ASC 606 affect multiple-element arrangements?

ASC 606 requires companies to identify separate performance obligations within a contract and allocate the transaction price to each obligation based on their relative standalone selling prices.

• How does ASC 606 impact contract modifications?

ASC 606 provides specific guidance on accounting for contract modifications. A modification is accounted for as a separate contract if the modification reflects a distinct performance obligation.

• How does ASC 606 affect the recognition of contract costs?

ASC 606 requires entities to capitalize and amortize incremental costs of obtaining a contract that is expected to be recovered. The guidance also addresses costs incurred to fulfill a contract.

• What disclosures are required under ASC 606?

ASC 606 requires enhanced disclosures about revenue recognition. These disclosures include qualitative and quantitative information about revenue recognition policies, performance obligations, significant judgments, and revenue from contracts with customers.

• Does ASC 606 apply to all industries?

Yes, ASC 606 applies to all industries that enter into contracts with customers, although certain industries, such as telecommunications and software, may have specific implementation guidance.

• Does ASC 606 allow for any practical expedients?

Yes, ASC 606 allows for certain practical expedients related to contracts with a duration of one year or less and certain variable considerations.

• How does ASC 606 affect the recognition of revenue from licensing arrangements?

ASC 606 introduces specific guidance for revenue recognition from licensing arrangements, focusing on identifying performance obligations, determining the timing of revenue recognition, and assessing whether revenue should be recognized over time or at a point in time.

• Are there any transition options available for adopting ASC 606?

Yes, ASC 606 provides multiple transition options, including full retrospective adoption, modified retrospective adoption, and a practical expedient to recognize the cumulative effect of applying ASC 606 as an adjustment to retained earnings.

• How does ASC 606 impact financial statement audits?

ASC 606 may require auditors to perform additional procedures and exercise professional judgment to evaluate the appropriateness of revenue recognition under the new standard. Auditors will focus on the completeness, accuracy, and disclosures of revenue recognition in financial statements.

How can Deskera Help You with Revenue Recognition?

Deskera ERP is a cloud-based software platform that offers various solutions to assist businesses in managing their operations, including revenue recognition.

Here are some ways Deskera can help with revenue recognition:

1. Compliance with Accounting Standards: Deskera is designed to comply with accounting standards such as ASC 606 and IFRS 15. The software helps businesses adhere to the guidelines outlined in these standards, ensuring accurate revenue recognition and compliance with regulatory requirements.
2. Comprehensive Revenue Management: Deskera offers features to manage the entire revenue lifecycle, from sales orders and contracts to invoicing and revenue recognition. Businesses can track revenue generation, monitor contract performance, and ensure revenue is recognized appropriately based on the specific terms and conditions outlined in the contracts.
3. Advanced Reporting and Analytics: Deskera provides robust reporting and analytics capabilities that enable businesses to gain insights into their revenue recognition processes. Users can generate customizable reports, analyze revenue trends, identify potential issues, and make data-driven decisions to optimize revenue recognition and improve financial performance.
4. Audit Trail and Documentation: Deskera facilitates documentation and record-keeping related to revenue recognition. It maintains an audit trail of revenue recognition activities, contract changes, and supporting documentation, ensuring transparency and providing evidence for compliance purposes or audits.
5. Collaboration and Workflow Management: Deskera enables collaboration among team members involved in revenue recognition. It provides workflow management features to streamline communication, track progress, and ensure timely completion of revenue recognition tasks.

Key Takeaways

ASC 606 is the revenue recognition standard issued by the Financial Accounting Standards Board (FASB) that provides guidance on how to recognize revenue from contracts with customers.

• Principle-based Approach: ASC 606 introduces a principles-based approach to revenue recognition, focusing on the transfer of control of goods or services to customers. This shift aims to provide more accurate and transparent revenue recognition.
• Uniform Framework: ASC 606 replaces industry-specific guidance with a unified framework applicable to all entities that enter into contracts with customers. This promotes consistency and comparability across industries and improves financial statement analysis.
• Contract Evaluation: The standard requires companies to carefully evaluate contracts and identify distinct performance obligations. It emphasizes the importance of accurately allocating transaction prices to each obligation.
• Enhanced Disclosures: ASC 606 introduces enhanced disclosure requirements, providing users of financial statements with more comprehensive information about revenue recognition policies, significant judgments, and performance obligations.
• Impact on Systems and Processes: Implementing ASC 606 may require updates to financial systems, processes, and internal controls to capture and track the necessary data for accurate revenue recognition. It is essential to ensure robust controls to comply with the new standard.
• Transition Options: ASC 606 provides various transition options, including full retrospective adoption, modified retrospective adoption, and practical expedients. Companies should carefully consider and select the most appropriate transition method.

Additionally, the five-step model for revenue recognition as under ASC 606 is as follows:

• Identify the contract with the customer: The company must determine whether a valid contract exists with a customer.
• Identify the performance obligations: The company needs to identify the separate performance obligations within the contract, which are distinct goods or services to be provided to the customer.
• Determine the transaction price: The company must determine the transaction price, which is the amount of consideration expected to be received in exchange for transferring the promised goods or services to the customer.
• Allocate the transaction price to performance obligations: The company needs to allocate the transaction price to each identified performance obligation based on their relative standalone selling prices.
• Recognize revenue as performance obligations are satisfied: The company recognizes revenue when it satisfies each performance obligation by transferring control of the promised goods or services to the customer.

Thus, ASC 606 represents a significant shift in revenue recognition practices and aims to improve the transparency and comparability of financial reporting across industries. It emphasizes the transfer of control as the key factor for revenue recognition and introduces enhanced disclosures to provide stakeholders with a clearer understanding of a company's revenue streams.

Companies need to carefully evaluate their contracts, allocate transaction prices, and ensure their systems and processes are aligned with the new standard. Compliance with ASC 606 requires a thorough understanding of the principles and may involve adjustments to existing practices.

By adopting ASC 606, companies can enhance the reliability and usefulness of their financial statements, providing stakeholders with more meaningful information about revenue recognition. It promotes transparency and consistency in revenue recognition practices, facilitating better decision-making and analysis of financial performance.

By leveraging Deskera's software platform, organizations can streamline their revenue recognition processes, reduce manual errors, ensure compliance with ASC 606, and generate accurate and reliable financial information.

It simplifies the complexities of ASC 606 implementation, allowing businesses to focus on their core operations while meeting revenue recognition standards.

Related Articles