Revenue Recognition Principle: Frequently Asked Questions about ASC 606

The new Revenue Recognition Principle, also known as ASC 606 (IFRS 15) is in full effect for both public and private companies as of December 15, 2018. The principle impacts Commission Expense Accounting (CEA) for U.S. businesses.

Below are the quick FAQ of what you need to know about ASC 606 (IFRS 15) compliance. You can get a deeper dive into ASC 606 implementation and the transition process in our recent webinar, Meet Commission Accounting Requirements Under ASC 606 (IFRS 15)."

Q: How did Revenue Recognition Standards Change?

A revision of GAAP was necessary to support IASB and FASB convergence and create compliance with the international system. The FASB replaced GAAP’s existing rule-based methodology with a single revenue recognition principle.

The new standard requires companies to track commission expenses at a more granular level and produce an audit trail that demonstrates:

• The term of the contract and how any given commission in the customer relationship benefits your company as the seller
• The right amount of time over which to amortize the expense
• The impact of all commissions paid

Q: What is the Impact on Accounting for Sales Commissions?

Within the new revenue recognition principle guidance is a small section called the “incremental cost of obtaining a contract” which changes how some organizations manage their accounting for sales commissions.

Sales commissions represent the biggest and most obvious expense for a company, yet these revenue acquisition costs can also include legal or contract arrangement fees and bonuses. Basically, any expense that’s only incurred by a company when they close a sale (Discover more on the “before and after” requirements for commission processes under the new Revenue Recognition standard).

Q: How is This Impacting Sales Organizations?

These CEA changes impact any company paying commissions (or other costs incremental to obtaining contracts) that is reporting under U.S. GAAP. Public companies are required to be GAAP-compliant by the FTC.

The matching principle requires companies to judge how commissions are paid over the lifetime of the customer. This changes existing accounting methodologies—requiring accounting departments to understand sales commission strategy and make judgments based on that knowledge and available data.

For example, in many cases, accounting teams must identify what is being paid to acquire customers, estimate the lifetime of that customer, and identify anticipated future sales to those customers to determine how to amortize commissions.

In addition, each time a customer purchases additional goods or services, accounting may need to evaluate the impact of those transactions on the expense of commissions for that customer.

Q: How are Companies Gaining Compliance?

For most companies, gaining ASC 606 compliance has been a learning process. However, many companies that have simply expensed commissions have transitioned from expensing to making an asset on their balance sheet. In most cases they've followed either the full- or modified-retrospective transition approach.

Q: What Happens to Businesses That Don’t Comply?

If companies are paying commissions and don’t comply, they’ll need to include a non-GAAP disclosure on their financial statements saying that they’re not following the GAAP treatment. In weighing the investment and effort, smaller companies that don’t plan to go public may just go non-GAAP in this area.

They can record in their financial statement disclosures the reasons they have chosen to depart from GAAP. However, for most companies, doing so can be a red flag for banks, investors, and the market.

Q: What are the Major Compliance Challenges Companies are Facing?

There are three major challenges for companies that need to comply with the new CEA requirements:

1. Access to the right level of data
2. Making accounting estimates and judgments
3. Managing amortization and adjusting entries

Companies who started their implementation prior to the implementation date are finding spreadsheets are not effective for adhering to the Revenue Recognition Standard, and compliance is a learning experience for everyone.

Get more tips from companies that are in the full swing of ASC 606 compliance in our ASC 606 implementation roundtable recap.

Q: What Type of Information is Needed to be GAAP Compliant?

Companies need the ability to access the right data at the level of detail needed by accounting to be GAAP compliant. To do this, they need to evaluate their current incentive calculation methods to make sure they can capture the intelligence needed. Namely, comprehensive details about their transactions that allow them to organize and report on data in ways most haven’t yet anticipated.

But first, accounting must understanding of the nature of their transactions and how they’re sold, so they can identify the right kinds of data for their particular circumstances. Companies must look at their commission plans, understand who’s getting paid commissions, what is being paid for, and why they are being paid in this manner. They need to understand what the commission amounts are by customer—and how much they’re paying for customer renewals, add-on sales, etc.

All of this data must be available and easily accessible, so accounting can make needed comparisons, i.e. comparing amounts paid for renewals against original commission expenses. This is quite different than what is done in commissions accounting today.

Q: Should companies provide aggregate data or line-item detail under ASC 606?

This is a question each company should tackle early on and is answered by the approach your accounting team decides best meets the principle-based standard. Often, when it comes to creating an audit trail, the more detail you have access to, the better. Therefore, companies should aim for gathering as much detail as possible for easier compliance.

Q: Does prior period adjustment (PPA) work with Commission Expense Accounting?

Yes, every time you recalculate you can rerun your CEA reports to determine the differences and provide accounting the details to book any changes.

Q: How should companies handle changes to the expected amortization period?

There are several approaches to solving the ongoing maintenance for CEA, and Xactly can support them all. They range from doing an annual evaluation and a "true up" to improve the estimates over time to handling each change at the individual level and booking adjustments.

Using Xactly, you can track the kinds of transactions that occur and require accounting adjustments and provide accounting with reporting at the level of detail they need to make the adjustments.

Q: How should companies amortize compensation costs?

Companies will need to evaluate how to amortize costs and expense commissions over the contract term. The challenge is that this will vary depending on different compensation strategies and a company might have several approaches for different categories of commissions and/or commission strategies.

In the SaaS world, for example, companies must estimate and expense over an approximated life of the customer – which is typically longer than the term of initial contracts because of anticipated renewals. Then, those renewals and any add-on products need to be evaluated to determine if they impact the original estimates and, in some cases, will require that the company alter the remaining asset to change the expensing term.

Businesses must make sure they have the right info to make the right estimates and manage the amortization to give the accounting department the ability to make estimates, track the impact of subsequent transactions, and support long-term mathematical calculations to amortize these costs.

Q: How can companies make compliance easier?

The easiest way for companies to simplify ASC 606 compliance is through automation. Accurate, detailed data is crucial for adherence to the Revenue Recognition Principle. With 80% of spreadsheets having errors, one mistake can be costly.

Xactly Commission Expense Accounting (CEA) is a automation tool designed to help companies gather the information and meet the accounting requirements under ASC 606 (IFRS 15) more efficiently. This tool helps teams break down commission data to a granular level, create the necessary adjusting entries, and even aid in data-driven, strategic decision making for sales and incentive compensation planning.

If you're not convinced just yet, see how Xactly stacks up against traditional ERP systems in our comparison guide, "Commission Expense Accounting Under ASC 606 (IFRS 15): Evaluating ERP Software vs. Xactly CEA."