Most executives and business owners have better things to do than think about accounting standards. But there’s a new one that demands your attention, for two reasons:
1. It significantly changes how companies recognize and report their revenue.
2. It’s mandatory for any organization that uses Generally Accepted Accounting Principles (GAAP).
I’m referring to ASC 606. Developed by the International Accounting Standards Board (IASB), the global authority for accounting principles, ASC 606 establishes new rules for recognizing revenue in contracts with customers. Essentially, it changes how and when your company can count customer payments.
How Does ASC 606 Change Your Accounting?
If your company uses GAAP accounting, ASC 606 could drastically alter your accounting practices and financial situation. The basic impact of the new standard is in revenue recognition—that is, the way an organization determines when it makes money.
In a cash accounting system, revenue is recognized when money changes hands; you earn revenue when you receive cash, not before or after. Under GAAP, a company doesn’t necessarily recognize revenue when cash changes hands. Instead, the company records revenue when the transaction occurs. A sale is counted as a sale regardless of when the money hits the seller’s account.
ASC 606 creates a framework within GAAP for recognizing revenue from customer contracts.
It’s meant to standardize and streamline the accounting of contract-based transactions. Prior to ASC 606, this was a variable process—it differed from organization to organization, industry to industry. As a result, it could be difficult to get a sense of a company’s revenue from contracts, or to compare one company’s transactions to another’s.
To comply with ASC 606, an organization must follow five steps:
1. Identify the contract with a customer. First things first—is there an agreement in place?
2. Identify the performance obligations in the contract. Consider what product, services, or both the agreement includes, as well as the duration of the relationship with the customer.
3. Determine the transaction price. How much is the customer paying, and when? Is it in a lump sum or in installments?
4. Allocate the transaction price to the separate performance obligations. Figure out what portion of the transaction each contractual detail is worth.
5. Recognize revenue when the entity satisfies each performance obligation. When the customer receives a product or service, record the money earned from the sale of that specific product or service.
Watch Out: ASC 606 Compliance Can Get Complicated
While that process may seem simple, and standardization may sound like a good thing, ASC 606 can be exceedingly complicated in practice. A company needs to look at every single customer agreement—written and unwritten—and pick it apart to determine financial particulars.
This is time- and resource-intensive if the company has…
- multiple contracts
- multiple kinds of contracts
- highly detailed contracts
- multiple products and/or services
- complex or flexible product/service delivery models
- products/services that are continually updated
…or all of the above.
Some organizations are less equipped than others for ASC 606. Consider an enterprise business-to-business SaaS provider, for instance. The company might have hundreds of contracts, each one tailored to the client’s individual needs and specifications. Users may be paying for a software platform as well as support and consulting services. Some may be paying for features that others opt out of. And payment arrangements may be all over the map.
In this case, allocating the price of every transaction to every obligation within every single contract could take hundreds of hours and involve difficult and perhaps uncertain accounting decisions. Plus, whenever the platform gets patched or updated, or whenever interconnected technology or relevant regulations change, the organization would need to revisit its accounting practices.
Perhaps it’s no wonder that most SaaS companies have been loath to adopt ASC 606.
Fortunately, you don’t have to do it alone. No organization needs to choose between the costs of compliance and the potentially even greater costs of non-compliance. Your accounting partner can take the lead and help you ensure you’re following the new revenue recognition rules—so you can focus on more important things. Ask us about implementing ASC 606.