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Revenue Recognition: Tax Implications Under ASC 606

The most recent revenue recognition guidance from the Financial Accounting Standards Board (FASB), ASC 606, includes several major changes to the way companies must account for their earnings. Here, we’ll review these changes, recap their implications as they apply to your business, and answer a pressing question: How does ASC 606 impact taxes?

The updated criteria for revenue recognition requires more detailed disclosures about revenue streams, connections between pre-existing liabilities and earned revenue, and performance obligations.

Let’s look at a quick review of revenue recognition under ASC 606 then learn more about specific tax implications.

Review of Revenue Recognition Under ASC 606

Officially, the new guidelines of ASC 606 went into effect in 2018. Yet, some accounting professionals and companies are only now successfully transitioning to the updated framework. Of course, accounting complexity can vary based on which revenue recognition method is used.

Some of the most common methods are as follows:

  • 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 on a case-by-case basis.

Looking at an explanation of ASC 606, you learn that amortization must now be reported on tangible and intangible expenses such as licenses, trademarks, and patents. For SaaS companies, this usually equates to accounting for amortization periods from three years up to five or six years.

There are five steps to recognizing revenue under the current model.

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

How Does ASC 606 Affect Business Tax Preparation and Filing Processes?

Now that ASC 606 is in-effect, the change will undoubtedly affect your relationship with Uncle Sam, but this doesn’t have to be a bad thing. When you know what to expect, you can avoid future stress. So, here’s what could go wrong and how to avoid problems when you file.

Improper revenue recognition such as reporting revenue too soon, might be perceived as fraud. Hence, it could lead to fines and other punitive measures from the Securities and Exchange Commission (SEC), a headache no business wants.

So, make sure revenue is recognized only when there is clear evidence of a financial arrangement, a product or service has been delivered, the price is fixed or measurable, and funds are reasonably collectible, and all performance obligations have been met.

1. Determine the Best Revenue Recognition Method for Your Operations Under the New Standards

Under your previous revenue recognition method, could you easily complete all five steps in the recognition process? If not, you will need to explore alternative methods with the ASC 606 framework in mind. Each method has its own nuances and can typically account for various types of performance obligations.

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

2. Make the Formal Change to Your Accounting Method with the IRS (if Applicable)

Will you continue to use the same revenue recognition method used prior to ASC 606? If so, you can skip this section. But, if you are one of business owners who will change 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 file Form 3155 properly can lead to penalties enforced by the IRS or, at the very least, undue amendments to your paperwork. Before filing, be sure to find out if the IRS has published any new guidance regarding revenue recognition.

3. Implement Periodic Accounting with Tax Obligations in Mind

If you still rely on manual accounting, you must now add safeguards to your processes that ensure the new framework is followed. Qualitative data like performance obligations must now be presented in a way that is easy to interpret.

ASC 606 is complex. While the guidelines undoubtedly lead to more uniform accounting practices and simplified comparative analyses, they can be tricky to implement. Luckily, technology has you covered.

Our software helps companies calculate compensation payouts and commission expenses accurately. It can also help you scale as you hire more staff, introduce new products, or acquire smaller companies.

With Performio, you can do all of this without worrying about manually calculating commissions. Request a demo today to see for yourself how the platform can help with your sales commission and compensation accounting.

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