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Understanding the Tax Implications of ASC 606 Revenue Recognition

Everybody likes to be recognized. If the explosion of social media has taught us anything, it’s that we REALLY like to be applauded👏…liked👍…loved🥰…RECOGNIZED. Now when it comes to accounting codes and revenue recognition, there’s a bit of room for error if you don’t have full context and visibility. Like that late night Tweet someone deleted the next morning, generally people AND revenue only like to be recognized positively. 

As we take a look back on one of the biggest changes to accounting code in recent history, which was as disruptive to accounting as social media was to our culture. Metaphorically speaking, it comes with all the feels, the good, the bad, and the ugly. Here’s everything you need to know to make sure you and your revenue is recognized by the book #accuracy #authenticity 👏👍🥰. 

ASC 606 guidelines have been in effect since 2018, but some companies and accounting professionals are still finding the most efficient, accurate ways to comply with the updated framework. The changes introduced some new challenges—particularly when it comes to revenue recognition. There are a few extra things to keep track of for your tax preparation to be ASC compliant.

In this article, we’ll provide a quick overview of revenue recognition under ASC 606, and we’ll take a look at some of the specific tax implications.

How revenue recognition works under ASC 606

Business entities may use a variety of different revenue recognition methods depending on their particular needs. Some of the most common methods include:

  • Sales-basis method
  • Completed-contract method
  • Installment method
  • Cost-recoverability method
  • Percentage of completion method

Each method comes with its own set of nuances and should be chosen based on the specifics of your company’s operations.

Under ASC 606, you must report amortization on tangible and intangible expenses like licenses, trademarks, and patents. For SaaS companies, this usually means accounting for amortization periods from around three to six years. No matter which revenue recognition method you use, you’ll have to incorporate this amortization reporting. 

ASC 606 lists five steps to recognizing revenue:

  1. Identify the contract with the customer.
  2. Identify performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price.
  5. Recognize revenue when the entity satisfies the performance obligation.

This differs from ASC 605, which allowed business to account for commissions, bonuses, and incentive pay as direct expenses.

How to keep your tax preparation ASC 606–compliant

ASC 606 includes certain compliance requirements for tax preparation. Improper revenue recognition—such as reporting revenue too soon—may be treated as fraud, leading to fines and other punitive measures from the Securities and Exchange Commission (SEC). To avoid this, only recognize revenue when the following criteria are met:

  • There is clear evidence of a financial arrangement.
  • A product or service has been delivered.
  • The price is fixed or measurable.
  • Funds are reasonably collectible.

1. Determine the best revenue recognition method

Using your current revenue recognition method, can you easily complete all five steps in the recognition process outlined by ASC 606? If not, you should explore alternative methods with the ASC 606 framework in mind. Each method has its own pros and cons, and some will better account for your business’s performance obligations than others.

If you aren’t sure which method to use, consider consulting a tax professional or CPA to help you select the one best suited to your business.

2. Formalize any changes to your accounting method with the IRS

If you continue using the same revenue recognition method as you have previously, you can skip this section. But, if you change either your overall method of accounting or the accounting treatment of any item, you may be required to file Form 3155, Application for Change in Accounting Method, with your Federal taxes.

Failure to properly file Form 3155 can lead to penalties enforced by the IRS or, at the very least, amendments to your paperwork. Before filing, determine whether the IRS has published any new guidance regarding revenue recognition.

3. Follow the ASC 606 revenue recognition framework with tax obligations in mind

If you still rely on manual accounting, you need to add safeguards to your processes to ensure you stay within the ASC 606 framework.

For example, you have to include qualitative data like performance obligations in revenue recognition, and you need to present it in a manner that’s easy to interpret. You must also include the amortization of sales commissions, as well as the amortization of rebates and sales incentives.

Say goodbye to spreadsheets

ASC 606 is complex. While the guidelines lead to more uniform practices and simplified comparative analyses, they can be tricky to implement—especially if you’re calculating commissions with a sea of spreadsheets, drastically increasing the possibility of human error.

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Download the free ebook, "The Practical Guide to Managing Commissions: Why Spreadsheets aren't a Scalable Solution" to learn more. 

Reduce the risk of accounting errors with Performio

You can save yourself a lot of time, headaches, and penalties by using the right software.

Performio brings automation to the process of the sales commissions and revenue recognition, ensuring ASC 606 compliance. Our platform takes care of the hard work for you while reducing the risk of accounting errors—and the amount of time it would take to fix those accounting errors.

Request a demo today, and see how we can help your business.

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