ASC 606, the new revenue recognition standard, requires an explanation in order to fully understand. If that’s what you want, you’re in the right place.
Here, we will answer your questions about ASC 606.
- What are the Criteria for Revenue Recognition?
- What is ASC 606?
- What is the Purpose of ASC 606?
- Who Does ASC 606 Apply to?
- How is ASC 606 Implemented?
- How is ASC 606 Different Than the Previous Standard?
- Final Thoughts
What are the Criteria for Revenue Recognition?
As far as GAAPs are concerned, revenue recognition has four central criteria.
- Clear evidence of a financial arrangement
- Completion of product or service delivery
- Price to the buyer is fixed or measurable
- Funds are reasonably collectible
And, there are several methods to measure revenue recognition. Here are some of the most common:
- Sales basis method - Revenue is recognized at the time that goods or services are delivered to the buyer, whether paid or invoiced.
- Percentage of completion method - Revenue is recognized based on the percentage of project completion with long-term contracts.
- Cost-recoverability method - Revenue is recognized when all costs to complete the project or transaction are complete.
- Installment method - Revenue is recognized each time a payment (installment) toward a project or transaction is made.
- Completed-contract method - Revenue is recognized when a contract is complete, and all costs and transactions have been recorded.
Other revenue recognition methods include accrual, appreciation, brokerage agreement, deposit, proportional performance, and transactions under bill & hold. Each method has its own set of pros and cons and specific situations wherein they would be most effective.
So, based on your operations, you should select the most appropriate method. Then, using this method, you’ll need to make changes to your accounting based on the new standards outlined ASC 606.
What is ASC 606?
In accounting, ASC stands for Accounting Standards Codification as defined by the Financial Accounting Standards Board (FASB). FASB’s purpose is to establish best practices for GAAP accounting professionals and companies who follow these principles.
ASC 606 is a recent change in standardized accounting principles for revenue recognition. In a nutshell, Topic 606 covers revenue from contracts with customers and identifies performance and licensing obligations. The document explains, step-by-step, how to account for revenue earned from your business operations.
What is the Purpose of ASC 606?
The reason Topic 606 was issued by the FASB and International Accounting Standards Board (IASB) was to update the pre-existing standards for revenue recognition and drive a more consistent financial reporting experience. Furthermore, this codification enhances and simplifies comparative analysis and financial statement preparation.
Basically, ASC 606 is supposed to make it easier for companies to get on the same page with their accounting. The guidelines help establish a clear outline to determine revenue calculations for tax purposes.
Who Does ASC 606 Apply to?
All businesses and organizations that enter into contracts or sales agreements with customers starting in the fiscal year after December 15, 2017 are affected by ASC 606. Both private and public as well as profitable and non-profit institutions are included. So, if you sell goods or services, this framework applies to you.
How is ASC 606 Implemented?
The structure of ASC 606’s new guidance is laid out in five steps:
- Identify the contract with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price
- Recognize revenue when or as the entity satisfies the performance obligation
For each step, there are distinct guidelines. The idea is that, by following the process, companies should gain a sharper image of their actual revenue generation.
How is ASC 606 Different Than the Previous Standard?
The primary change with ASC 606 versus 605 is that more comprehensive and detailed disclosures are now required. For example, entities will need to reveal separate revenue streams. And, if a contract liability was disclosed at the beginning of an accounting period and becomes revenue at the end of the period, the dots will need to be connected.
In addition to the quantitative data, companies must now share qualitative data such as performance obligations. ASC 605 did not require such information. Hence, there are strong debates taking place (such as which length amortization periods to use within SaaS and subscription business structures).
In most cases, new systems need to be implemented and can take excessive time and effort to adjust. So, if you’re not yet implementing the new standards, they might be overwhelming at first.
You should now have a stronger understanding of ASC 606 and how the new instructions might affect your accounting. Still, the details and added requirements can be a bit overwhelming. That’s why you should be able to turn to incentive compensation management software to take the load off your plate.
Performio’s platform already collects the granular data needed to meet updated revenue recognition standards such as total commission paid, product category, the period in which 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.
Request a demo today and let us help you manage your sales commissions.