The new revenue standard is here! Calendar year-end private companies are required to adopt Accounting Standards Codification 606 (“ASC 606”), Revenue from Contracts with Customers, now for their year-ending December 31, 2020 financial statements.
It has been five years since the Financial Accounting Standards Board issued ASC 606, which introduced a new 5-step revenue recognition model, with the intent to improve comparability of revenue recognition practices across entities and industries. The 5-step process for identifying when and in what amounts to recognize revenue in financial statements requires some significant technical accounting changes, a whole new “language”, and the application of new estimates and judgements.
Private companies can’t afford to delay their adoption process any longer. Yes, it is a process. The new revenue standard might change the amount and timing of revenue you recognize, along with the treatment of certain costs. The process of evaluating your contracts and concluding if there will be a change to your financial statements will take a significant amount of time and effort. Public and private companies that have already adopted were surprised by how much time the process took.
Revenue Recognition is Changing: Don’t Get it Wrong
When applying the new revenue standard, the 5-step model needs to be followed for each contract; skipping a step or taking shortcuts could lead to errors or potentially even a restatement. Just like a complicated equation on a math exam, each of the many determinations within the five-step revenue recognition model are critical to getting the right answer. Incorrect judgments or conclusions in one step will lead to incorrect answers in a later step. The earlier that you identify changes to revenue recognition, then the more time you will have to communicate those changes to your executives, leaders, shareholders, owners, and auditors and avoid surprises.
We have observed time and again companies that had straightforward revenue patterns under legacy GAAP having to do more estimation and data tracking under ASC 606. Among our clients that have already adopted the new revenue standard, we have seen the most time and effort spent in the following areas:
- Identifying performance obligations based on a determination of whether a promised good or service is distinct within the context of the contract
- A SaaS company might be concluding that certain of its contracts have multiple performance obligations, which could change the timing of revenue recognition.
- Estimating standalone selling prices for new performance obligations
- A software company might change the method it historically used to estimate the revenue allocated between multiple performance obligations, which could change the timing of revenue recognized.
- Determining the timing of transfer of control of performance obligations
- A contract manufacturer might be moving from upfront to over-time revenue recognition on certain contracts, while a software licensor might be moving from over-time to upfront revenue recognition.
- Identifying incremental contract costs for capitalization
- All companies might be capitalizing and amortizing more upfront costs, such as sales commissions and bonuses.
- Achieving auditor concurrence with company judgments now required
- As a principles-based standard, ASC 606 will likely require the application of more judgement and therefore will likely require more documentation to support those judgments and related conclusions.
- Determining the beginning retained earnings adjustment
- Though the revenue standard does not require the recasting of years prior to 2019, companies will likely still need to look back into prior years in order to correctly determine their opening balance sheet adjustment.
- Finding the data to build enhanced financial statement disclosures
- The new revenue standard requires additional quantitative and qualitative disclosures that could require more time and effort to find and validate the related underlying data.
The list above is not all inclusive and adoption complexity will depend upon company specific situations. As such, a tailored and robust analysis of each of the 5 steps of the standard is a necessity to getting this right.
Unfortunately, adoption is not a one-and-done exercise. To achieve efficient ongoing application of the new standard post-adoption, you will potentially need changes to systems, processes and controls. This means there could be more heavy lifting after adoption if the new standard is not operationalized within the company to efficiently and accurately process new and ongoing customer contracts.
MorganFranklin has been helping companies think through the standard since it was first issued. We have also teamed with companies over the years to help them throughout the journey starting with the initial accounting assessment all the way to operationalizing their new systems and processes. To understand our approach to helping companies, read our brochure, Revenue Recognition, Private Companies: Are you Ready to Adopt the New Standard? To learn more about how we can help, contact us at firstname.lastname@example.org.
Get up to speed on revenue recognition
Several methods may lead to compliance with the new ASC 606 revenue recognition standard, but only one is best for your company’s future growth. See how we can help you adopt ASC 606 by the fast-approaching deadline for private companies.