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Adoption of ASC: 606 Revenue from Contracts with Customers

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ASC 606 is the new revenue recognition standard in US GAAP that has significantly affected the revenue recognition practices of most companies in United States. It provides a comprehensive, industry-neutral revenue recognition model intended to increase financial statement comparability across companies and industries. The standard affects all businesses that enter into contracts with customers to transfer goods or services whether public, private and non-profit entities unless those contracts are within the scope of other standards (for example: leases and insurance contracts). Both the public and private companies should comply with be ASC 606. It focuses on recognizing revenue more consistently. The standard was introduced with the aim of eliminating variations in the way businesses across the country handle accounting for similar transactions. In particular, it identifies and answers the two most fundamental questions related to revenue i.e. when may an entity recognize revenue and how much revenue may an entity recognize?

Sweeping changes in the new revenue recognition model became effective from annual / interim reporting periods beginning after December 15, 2017 for public business entities and became effective from annual periods beginning after December 15, 2018 for non-public entities. Further, entities that report under IFRS are required to apply the revenue standard for annual reporting periods beginning on or after January 1, 2018.

The five step model

The standard has been developed jointly by Financial Accounting Standard’s Board (FASB) and International Accounting Standards Board (IASB) in order to provide a framework that brings a consistency in financial reporting, improve comparative analysis and reporting, and simplify the preparation of financial statements by introducing a 5 step model for revenue recognition.

  1. Identify the contract with a customer: This step outlines the measures that must be met when entering into a contract with a customer to supply goods or services.
  2. Identify the separate performance obligations in the contract: This step describes how different performance obligations in the contract must be dealt with.
  3. Determine the transaction price: This step outlines what must be kept in mind when setting up the transaction price between the two parties, which is the amount the business expects to receive for transferring the goods and services to the customer
  4. Allocate the transaction price: This step outlines guidelines for fixing the transaction price across the contract’s separate performance obligations, and the price that the customer agrees to pay for the goods and services received.
  5. Recognize revenue when or as the entity satisfies a performance obligation: Revenue can be recognized as the business meets each performance obligation. This step specifies how that should be taken care of.

Thus, revenue is recognized when a company satisfies a performance obligation by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service). An entity should consider the terms of the contract and all relevant facts and circumstances when applying the revenue recognition standard. The entity may recognize the amount to which it expects to be entitled under the contract (estimates may be required because this is an “expected” amount).

In addition, ASC 606-10 contains guidance on the disclosures related to revenue in notes to the financial statements. It includes a cohesive set of disclosure requirements that would result in an entity providing users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from the entity’s contracts with customers.

What is the Impact of ASC 606?

The rule has standardized and simplified how the companies record revenue in case of customer contracts. It covers how businesses should report the nature, amount, and timing regarding contracts with customers they enter contract with. Adoption of ASC 606 includes an evaluation of primary revenue streams and key contracts to identify the revenue recognition changes required.

The impact might not be as significant for companies, such as retail traders that sell products and receive revenue at one time. But for companies that sell recurring services like subscriptions or licenses, the rule may improve the results. For an instance, if a company sold a 12-month software product license, it could apply only six months of revenue to its books under the previous laws and would not be able to count the next six months of revenue until the following year. However, under ASC 606 it can count all the revenue at once.

Also, implementing ASC 606 has broad ramifications. The standard might impact not just the accounting and financial departments, but might impact the IT systems, HR policies, legal departments and more. So as you prepare for these changes, assess the current processes and systems, identify where changes need to occur and take actions.

In some cases, applying the five-step model and recognizing revenue under the new standard will be quite straightforward. However, in other cases, applying the new guidance will require significant judgment, increasing the complexity of compliance. We at AJSH have a team of USGAAP & IFRS experts who can assist you in this transition.

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