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What Is ASC 606, and What Does It Mean for Sales Compensation?

Do you ever hear or look at an acronym and simply nod your head in recognition knowing that you think you know what it means and know you should know what it means, but you end up Googling it anyway just to be sure? You go to acronym finder or the acronym free dictionary, type in your query and bam…you’re hit with a list of corporate speak that might as well be written in a different language. Well, when it comes to accounting acronyms, we feel you finance. So, here is our ASC 606 Opus…everything you ever needed to know about this illustrious accounting code. 

ASC 606 is the most recent iteration of the Accounting Standards Codification (ASC) that defines standardized accounting principles for revenue recognition. Its purpose is to eliminate discrepancies in how businesses handle accounting for similar transactions across various industries, providing all businesses with a unified framework for recognizing revenue.

Developed by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), ASC 606 went into effect in the fiscal year following December 15, 2017. All businesses and organizations engaging in contracts or sales agreements with customers must comply with these standards, whether they’re public or private, for-profit, or nonprofit.

If you sell goods or services, ASC 606 applies to you.

In this article, we’ll go over the major changes from ASC 605 to ASC 606, briefly consider the history of the ASC, and explain what you need to know about revenue recognition under the latest standards.

 

The most significant changes with ASC 606

ASC 606 replaces ASC 605, updating existing standards to bring revenue recognition in the US to a better level of compliance with the International Financial Reporting Standards (IFRS) and to create a more consistent financial reporting experience. Where previously different rules existed for specific industries, ASC 606 provides unified guidelines for financial reporting to be followed by all industries.

Additionally, ASC 606 requires more detailed and comprehensive disclosures than previous standards. Under ASC 606, businesses and organizations must:

  • Disclose all separate revenue streams.
  • Establish connections between contract liabilities disclosed at the beginning of an accounting period that become revenue at the end of the period.
  • Share qualitative data, such as performance obligations, in addition to quantitative data.
  • Capitalize sales commissions, rather than expensing them.

While many of the changes are new requirements, the updated framework also eases requirements when it comes to software. ASC 606 allows the sale of software to be broken into multiple chunks, whereas ASC 605 only allowed the support and product revenue to be broken up.

The Accounting Standards Codification

The Financial Accounting Standards Board (FASB) is a private, non-profit organization for standard-setting, working to improve the Generally Accepted Accounting Principles (GAAP). They announced their Accounting Standards Codification (ASC) in 2009 as an effort to organize and codify already accepted accounting principles in the United States.

The ASC is structured in nine topic series from 100 (general principles) to 900 (industry) with the 600 series relating to revenue. ASC 606 is the latest set of standards for revenue recognition, superseding ASC 605, which superseded ASC 604, etc.

The FASB issued the original guidance for ASC 606 in May 2014 for their regular Accounting Standards Updates (ASU), and it went into effect in the fiscal year following December 15, 2017.

Previous, outdated Generally Accepted Accounting Principles are known as legacy GAAPs, and they’re mostly used when comparing different iterations of revenue recognition standards.

Revenue recognition under ASC 606

GAAP dictates that revenue must be recognized by an accrual accounting feature called the revenue recognition principle. This means revenue is recognized in the period when it was earned and realized (on the income statement), rather than when the money was received.

What are the criteria for revenue recognition?

Four primary criteria exist for revenue recognition under GAAP:

  1. There is clear evidence of a financial arrangement.
  2. The product or service delivery is completed.
  3. The price to the buyer is fixed or measurable.
  4. The funds are reasonably collectible.

What methods can be used for revenue recognition?

The framework provided by the four criteria allows for different methods of revenue recognition. Some of the most common methods include:

  • Sales-basis method: Revenue is recognized at the time goods or services are delivered to the buyer, whether paid or invoiced.
  • Completed-contract method: Revenue is recognized when a contract is complete (all obligations fulfilled) and all costs and transactions have been recorded.
  • Percentage of completion method: Revenue is recognized based on the percentage of project completion. This method is often used for long-term or large contract agreements where you need to recognize revenue over time.
  • Cost-recoverability method: Revenue is recognized when all costs to complete the project or transaction are complete. This method is often used for contracts where the likelihood of collection can’t be reasonably estimated.
  • Installment method: Revenue is recognized each time a payment (installment) toward a project or transaction is made. This method is often used for high-value purchases like large machinery or real estate, where the reliability of buyer payments isn’t guaranteed.

Other revenue recognition methods include accrual, appreciation, brokerage agreement, deposit, proportional performance, and transactions under bill and hold.

Each method comes with pros and cons that make it more or less effective in specific situations. You’re free to select whichever method makes the most sense for your company’s operations.

What are the steps for revenue recognition?

ASC 606 describes a series of five steps for implementation:

  1. Identify the contract with a customer.
  2. Identify the 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.

By following this process, business entities should be able to gain a clear picture of their real revenue generation.

Easy ASC 606 compliance with Performio

The changes under ASC 606 brought challenges for implementation. Many businesses needed to rework their accounting processes in order to achieve compliance with the new standards.

In particular, those who manage sales compensation have to determine which method of revenue recognition to use, how to handle amortization, and how to track each sale and commission per period.

Save yourself the time, headache, and possible penalties for falling out of compliance, and switch to an incentive compensation management (ICM) system to tackle these challenges.

Performio handles everything, collecting the granular data needed for ASC 606 compliance, like total commission paid, product category, the period in which the commission was paid, amortization amount, PTD amount expensed, and asset balance. We can help you automate sales commission calculations and reporting, no matter how complicated your compensation plans may be.

Schedule a demo today, and see how Performio can help your business.

ing principles allow for revenue recognition via multiple methods. In most cases, there must be a critical event that signals the existence of a transaction, like a product sale or a contracted project with an incoming payment that matches the agreed-upon price. After that, a company may record this as revenue in its accounting books.
nized revenue, also referred to as unearned or deferred revenue, represents money received for a product or service that has not been delivered or provided at the time of the transaction. In other words, it's money paid in advance, for services or products that are expected to be delivered or performed at some point in the future.

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