Let’s admit it- we’ve all done this! Looked at an abbreviation and pretended that we know what it is, but googled it up just in case?
That’s what ASC606 is like for most sales folks! It’s there and it’s important, but corporate jargon has left you confused about what it actually means and why you should know more about it.
Don’t worry, we got you! We jotted down everything you need to know about revenue recognition under ASC 606.
What is ASC 606?
So, what exactly is ASC 606? Well, it’s an accounting code that defines standardized accounting principles for revenue recognition.
Before ASC 606 was introduced, there were a range of discrepancies in how different businesses handled accounting for similar transactions. What ASC606 does is provide these businesses a unified framework for accounting, or recognizing revenue.
Basically, the rules regarding revenue recognition are now simply more clearly defined for businesses! Developed in collaboration by the International Accounting Standards Board (ISAB) and the Financial Accounting Standards Board (FASB), ASC 606 came into effect in 2017 and applies to all organizations (public, private, profit, or non-profit). By incorporating a revenue intelligence platform, organizations can navigate ASC 606 compliance with greater efficiency and accuracy.
ASC 605 to ASC 606: What has changed?
ASC 606 accommodates the entire gamut of industries, and offers robust guidance for revenue recognition. This is a huge leap from ASC 605, which had a lot of bottlenecks and was rather vague in determining these principles.
To make it simpler, ASC 606 essentially affects these three core areas of revenue recognition-
- The way contracts are defined with customers
- How the pricing is done for these contracts
- And, how the revenue that is generated from fulfilling these contracts is recognized
What this also means is that ASC 606 demands more disclosures than the previous code. Now, businesses and organizations need to-
- Disclose all separate revenue streams
- Clearly state contract liabilities at the beginning of the accounting period. These transform into revenue at the end of this period
- Share performance obligations
Under ASC 606, revenue is only recogized when-
- The product is delivered or the service is completed
- The price is measurable
- The funds are collected
- There is evidence of financial arrangement
What methods can be used for revenue recognition?
There are several methods that can be used for revenue recognition, depending on the nature of the business and the industry. Here are some commonly used methods:
- Sales Basis: Under this method, revenue is recognized when a sale is made and the title or ownership of goods or services is transferred to the customer. This method is typically used for businesses that sell physical products.
- Percentage-of-Completion: This method is commonly used in long-term construction or manufacturing projects. Revenue is recognized based on the percentage of completion of the project, measured by costs incurred, physical units produced, or some other reliable method.
- Completed Contract: Unlike the percentage-of-completion method, revenue recognition occurs only when the entire project is completed. This method is often used when it is difficult to reliably estimate the percentage of completion or when the project is short-term.
- Installment Sales: This method is used when goods are sold on an installment basis, and revenue is recognized over the duration of the installment period. This method is commonly used for sales of large-ticket items like cars or real estate.
- Subscription-Based: This method is used by businesses that provide ongoing services or products through a subscription model. Revenue is recognized over the subscription period as services are provided or products are delivered.
- Milestone Method: This method is often used in industries such as software development or pharmaceuticals, where revenue is recognized upon the achievement of specific milestones or events specified in the contract.
- Residual Method: This method is applied when the fair value of one component of a bundled product or service can be determined, but the fair value of another component cannot be reliably determined. Revenue for the component with known fair value is recognized first, and the remaining portion is recognized as revenue using the residual method.
It's important to note that revenue recognition is subject to accounting standards such as the International Financial Reporting Standards (IFRS) or the Generally Accepted Accounting Principles (GAAP) in the United States. These standards provide guidance on when and how to recognize revenue to ensure consistency and comparability across businesses.
The Five-step Process of Recognizing Revenue:
For companies to be able to comply with these above mentioned requirements and guidelines, the new code has also defined a series of five steps for implementation-
- Identify the contract with the customer-
Ideally, all contracts should have the following elements-
- The parties involved have approved the contract
- The rights of each party are clearly defined
- All parties should commit to fulfilling the contract
- Payment is clearly defined
- Identify the performance obligations in the contract-
Performance obligation is simply the promise to transfer the goods or service to the customer. Under ASC 606, any distinct goods or services to the customer should be spelled out clearly.
Any goods or services are distinct when-
- The customer can benefit from these goods or services
- It can be transferred independently from the other performance obligations mentioned in the contract.
- Determine the transaction price-
This refers to the payment that the company is entitled to receive from the customer in exchange for the goods or services. This also includes any other considerations like discounts.
- Allocate the transaction price-
This involves allocating the transaction price across the different performance obligations mentioned in the contract.
- Recognize revenue
That’s it! Revenue is recognized when performance obligations are fulfilled.
What’s the takeaway?
Revenue is recognized when contractual obligation is met and not when the payment is made. When non-compliance is not an option, this makes it very stressful for sales comp leaders. Understanding ASC 606 is crucial for managing incremental sales effectively.
Avoid the pitfalls of non-compliance and penalties, and switch to an ICM solution to face these challenges head-on!
Tackle ASC 606 with Kennect!
Kennect automates the process of data-collection for easy ASC 606 compliance so you can focus on what’s important- sales!
Our automated solution has integrations across CRM, ERP, and HRIS, and can provide sales leaders with the bandwidth and resources to make bold and quick decisions by providing real-time insights. Our no-code sales comp plan designer can significantly reduce workload and fix the gaps in broken ICMs.
To know more about how Incentive Compensation automation can help you with the ASC 606 revenue collection compliance, book a demo today!