ASC 606 Revenue Recognition Series: Who, What, Where, When and Why (Part I)

The Financial Accounting Standards Board (FASB) recently amended the rules for revenue recognition in the Accounting Standards Codification (ASC) to add ASC 606: Revenue from Contracts with Customers. This addition will replace ASC 605: Revenue Recognition as well as most industry specific guidance. The implementation of this new standard will affect operations and financial reporting for almost all entities that enter into contracts with their customers, making it one of the most profound ASC amendments. This blog will explore the who, what, where, when and why of ASC 606.

Who

ASC 606 affects all entities that have adopted accounting principles generally accepted in the United States of America (GAAP) and enter into contracts with customers to transfer goods, services, or non-financial assets. It will not cover contracts with customers that are already covered in other topics, such as lease and insurance contracts.

In conjunction with these changes, the International Accounting Standards Board (IASB) has updated its International Financial Reporting Standards (IFRS) to include IFRS 15: Revenue from Contracts with Customers, which provides a similar framework as ASC 606. As such, the new standard will have a global impact across industries.

What

ASC 606 focuses on the transfer of control rather than the satisfaction of obligations prescribed by ASC 605. It’s a principles-based framework that introduces more judgement into the revenue recognition process. Its core principles are focused on the nature of the promises in a contract.

The underlying principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that they expect to be entitled to in the exchange for goods and services provided. A five step process has been designed for individual or pools of contracts to keep financial statement preparers focused on this principle. The steps include:

1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract(s)
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract(s)
5. Recognize revenue when or as the entity satisfies a performance obligation

While this process may seem straightforward, there are many detailed considerations that need to be made for each step.

ASC 606 requires more comprehensive and detailed disclosures than what is currently required under ASC 605. The new disclosure requirements aim to provide information that will make it easier for financial statements users to understand the nature, amount, timing, and uncertainty of revenue and cash flows. Entities will be required to disclose quantitative information, including:

• Disaggregation of revenue streams
• Revenue recognized in the current period that was included in the contract liability balance at the beginning of the period
• Total contract value related to performance obligations that are unsatisfied at the end of the period

Qualitative information should also be disclosed, including performance obligation information, significant judgements made to determine performance obligations and transaction price, and assumptions made to determine and allocate transaction price. Additionally, information related to assets recognized from costs paid to obtain or fulfill a contract must be disclosed. These required disclosures are more robust than what is required under ASC 605, and will likely take time, effort and possibly even require the implementation of new systems in order to be compliant.

Where and When

For public entities, the adoption of the new standard is required for fiscal years beginning after December 15, 2017, including interim periods in the year of adoption. Non-public entities have until fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning after December 15, 2019 to adopt this standard. Both public and non-public entities may elect to early adopt the standard in fiscal years beginning after December 15, 2016.

Why

FASB has added this new standard for a few major reasons. First of all, there have always been significant differences between GAAP and IFRS in regards to revenue recognition and disclosure requirements. As the worldwide economy is becoming more interconnected, the governing boards of FASB and IASB decided to work together on a new standard that would improve the quality of revenue recognition guidance and allow for better financial statement comparability on a global landscape.

Additionally, ASC 605 is comprised of broad revenue recognition concepts along with numerous industry specific revenue recognition and disclosure requirements. This could result in different accounting treatments for economically similar transactions.

FASB and IASB’s goals for this new frameworks and standards include:

1. Remove inconsistencies and weaknesses in revenue requirements
2. Provide a robust framework for addressing revenue issues
3. Improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets
4. Provide useful information to users of the financial statements through improved disclosure requirements
5. Simplify the preparation of financial statements by reducing the number of publications

This standard overhaul will have varying impacts on different entities’ revenue recognition, depending on how they currently recognize revenue. Schedule a consultation with an experienced Aprio advisor to discuss your Financial Consulting Services needs.