Growth & Customers

ASC 606 Q&A—understanding the upcoming revenue recognition rules

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Intacct recently announced compelling results from a widespread accounting survey of top financial executives at U.S-based software companies to gauge their readiness for the upcoming ASC 606 revenue recognition guidelines.

Even though ASC 606 is not yet grabbing headlines, most survey respondents were familiar with the new standards, with 55 percent saying they are very or somewhat familiar, and only 13% saying they have never heard of the regulations.

Below is a brief Q&A for those feeling overwhelmed by the upcoming revenue recognition changes or for organizations not quite sure where to begin.

Q: I understand that businesses can’t recognize revenue until a product or service is delivered under the new rule. How does this apply to a service arrangement where the business depends on a set fee each month, but the level of service varies greatly depending on customer need?

A: Much of the way the new guidelines are set up moves away from having a set transaction-based approach to revenue recognition and provides basic principles to follow. Under the new standard, revenue should now be recognized when control of the contracted goods or services are transferred to the customer, and at a level that is commensurate with what has been delivered by that point. The exact way this will be handled is something the company will need to work on with their auditor to determine a consistent approach. In the case above, it may depend on whether the contract is based on a month-to-month arrangement or covers a longer term.

Q: Can you provide a little detail on the kinds of changes a company has to make in the way it does accounting under the new rule?

A: The standard will hit some sectors harder than others. Given variation across industries, levels of complexity for implementing any one step, and the wide diversity of existing IT systems and accounting processes currently in use.

Many organizations will need to modify existing accounting processes and IT systems to meet the new standard. This effort will require time, planning, resources, and additional investment in software, depending on the industry and the readiness of their current processes and systems.

Some of the questions companies will need to ask are:  Does our accounting system enable us to define and track performance obligations in a structured way? Does it consistently apply accounting treatments that reflect the judgments we’ll need to make from an accounting perspective? Does it offer transparency to help finance and accounting understand the impact of the new rules on the income statement? Can we report our results using both the current and new standards at the same time during the transition period? If not, accounting teams will get dragged down into the weeds of ever-increasing contract and spreadsheet detail— wasting time and creating significant compliance risk.

Q: Why is it important to plan ahead for this change? How much time/effort is involved to change accounting systems to accommodate the new rule?

A: There are a couple of aspects to planning ahead. First and foremost, companies will need to determine to what extent the new guidelines will impact them and whether their existing accounting software can handle the new requirements. This will involve finance understanding the new revenue recognition guidelines, and also the broader company determining the impact on how they handle customer contracts. The FASB has identified 5 steps to applying the standard:

  1. Identify the contract with the customer

  2. Identify any performance obligations in the contract

  3. Determine the transaction price

  4. Allocate the transaction price across the performance obligations

  5. Recognize revenue when or as the entity satisfies the performance obligations

Furthermore, impacted companies will also need to report their results according to both current and new guidelines in order to provide proper comparative and future guidance to investors.  This will obviously require some work and may require updating their existing financial software or switching to a completely new system that can handle the new requirements.

Q: What are some of the risks of not being prepared?

A: Businesses that don’t prepare will be impacted in two ways. First, they may have to expend serious amounts of effort and additional costs to change as the deadline approaches. In addition, companies that fail to make the switch on time will have trouble getting loans and raising VC funds, and companies may have audit problems as well.

Q: Given the description of how dealers use contracts, should they be considering changing the way those contracts are written and priced?  What kinds of changes should they consider?

A: Yes, companies will likely opt to make changes to the way they structure their contracts. To what extent companies will change will vary and must be determined on a company-by-company basis after they have determined the impact of the new regulations on their existing customer contracts.

Q: What mechanisms are in place to make sure companies are in compliance with the new rule?

A: Companies will need to ensure that they are in compliance with the new guidelines in order to earn a clean, unqualified opinion from their auditors on their financial statements. In addition, incorrectly reporting results could lead to restatements which reduce investor confidence.

Still have questions regarding the ASC 606 changes?  Learn more about how to prepare for transitioning to ASC 606.