By now, you've probably already heard of the term ASC 606 but have no idea exactly how it will affect you or your employees. Well, the ASC 606 revenue recognition standard, also known as the IFRS 15 is quite the hot topic. What makes it so relevant is the way it will eventually transform how companies go to market—in every industry.
Starting now, organizations must reformulate how they package and price their products, in addition to how their sales reps tailor deals. In fact, ASC 606 even affects sales commissions. It is also critical to note that public companies are expected to make these changes by January 1, 2018.
On the other hand, private companies have until January 1, 2019. Another reason why ASC 606 can be so complex is that it is principles-based. This means there are no rules set in stone for compliance.
A Bit of History
The Accounting Standard Codification 606, or ASC 606, made its debut in May 2014. It is an industry-neutral revenue recognition model designed to increase financial statement comparability among companies and industries. The objective is to decrease complexity involved with the current models for revenue recognition.
As a result, the new unit of account for revenue recognition is the obligation of a good or a service. In other words, a deliverable. This feels like a big issue, even more so than transitions made to accommodate SOX or Y2K. For starters, all U.S. public companies must file their financial statements following the guidelines issued by the U.S. GAAP. Revenue comes from delivering goods and/or services.
On a company's financial statements, revenue recognition is simply the notation of revenue. Moreover, the revenue number is used to tally an organization's value and affects both ratios and measurements. As a result of ASC 606, almost every company will have to utilize a new approach to revenue recognition. Furthermore, there are expanded disclosure requirements, meaning more meticulous records must be kept and reported.
Where Revenue Numbers Count
When it comes to ASC 606, some companies will be impacted more than others—especially those under industry-specific guidance. These are the types of companies that will see an impact on their revenue numbers. This matters, because the revenue number is important for items such as agreements and contracts.
Plus, the revenue number is looked at in management contracts, loan documents, award-based compensation agreements, buy-sell provisions and more. Many companies will, and already are, consulting with attorneys who are often hired to negotiate and draft various contracts. Attorneys will need to comprehend a company's revenue recognition goals and modify contracts under the new guidelines of the ASC 606.
Digging a Bit Deeper into ASC 606
Upon reading, you'll find 130 pages of new guidance. Previously, the U.S. GAAP directed revenue recognition guidance for industries including:
- Financial services
- Engineering and construction
- Real estate
- Entertainment and media
Yet, the ASC 606 encompasses all industries where most contracts that include the transfer of goods and/or services to customers or nonfinancial assets must follow one set of revenue recognition principles.
Essentially, companies must depict revenue recognition as the transfer of goods and/or services to customers in the amount that the company expects to be paid for those goods and/or services. This is where some confusion comes in with the principles-based method, as the company must use its judgment. Also, here are five steps that must be taken:
- Designate the contract
- Determine the performance obligations—sale of goods and/or services
- Identify the price
- Align the price with the performance obligations
- Provide revenue recognition when performance obligations have been met
Seems simple enough, doesn't it? Not so fast. Each step also relies on new determinations. Plus, every step requires the company's judgment and analysis of the contract's terms and conditions. And, that's not all. Companies will also have to determine how ASC 606 affects their current revenue recognition practices, and this requires a deeper analysis of existing contracts. Take a look at this description of revenue from contracts with customers.
To illustrate, entities must look at the performance obligations and now decide if the new guidelines will result in revised conclusions around how performance obligations are successfully met and reported. Then, there is the possibility of having to figure out how warranties must be calculated and whether some contracts need to be combined.
Not to mention, contract terms are even more important under ASC 606, which means new contracts must be drafted in adherence to the guidance. Again, companies will have to work closely with lawyers to ensure each step is met adequately.
Sales and ASC 606
Since ASC 606 is up for interpretation, there will be many gray areas up for debate. On the surface, it looks like an accounting exercise. Nonetheless, it will have a major impact on sales operations. Companies have to create a tighter structure for how sales reps organize and even discount deals.
This also means the installation of updated and automated controls. ASC 606 will make it imperative to create a consistent structure for how you capture data when needed for use with quotes, contracts, and orders. The data must be captured accurately to reduce risk and produce reliable revenue recognition numbers.
There are also compensation plans to consider. ASC 606 must be a part of designing compensation plans for 2018. Channel and sales commissions are some of the largest aspects of a company’s costs. So, ASC 606 will require more in-depth forecasting and reporting of commissions spend.
Companies have already started planning for months, while others are scrambling to catch up. You can never turn a blind eye to ASC 606 because then you may have to deal with expensive recalculations and changes in the middle of the year. This is not the best way to keep your sales reps happy. You can learn more about managing implementation here.
So, it will be a delicate balance between following the guidance provided through ASC 606 and designing compensation plans that motivate your sales reps to help achieve your company's financial objectives and strategic goals. Keep in mind that ASC 606 has already gone through several iterations since its launch, meaning it's possible for more changes to be on the way.
Now is not the time to ignore ASC 606 or delay implementation. ASC 606 has to take effect for fiscal years that start after December 15, 2017, or after December 15, 2018, for private companies. The goal is to increase the consistency of financial reporting throughout all industries. The sooner you get started on incorporating the changes, the easier it will be to transition.