Why Do I Keep Hearing About ASC 606?

General Accounting | January 7, 2019 | Kat Peterson

What is ASC 606?

If you’re in accounting and you’ve paid any attention to the activities of the Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB) or the financial accounting update section of any CPE event since 2014, you’ve probably heard about ASC 606, Revenue from Contracts with Customers. This standard was issued in May 2014 and is effective for public companies for annual reporting periods beginning after December 15, 2017 (i.e., calendar year 2018) and for all other companies for annual reporting periods beginning after December 15, 2018 (i.e., calendar year 2019).

This new revenue standard eliminates hundreds of transaction- and industry-specific revenue recognition guidance that has thus far made up U.S. Generally Accepted Accounting Principles (GAAP), such as construction accounting, software revenue recognition, and oil and gas production, and replaces it with a principles-based approach for determining revenue recognition. Consistent with a principle-based (versus rule-based) standard, significant judgment will be involved in applying this new standard.

Although it is certainly possible to end up with the same amount of revenue recognized under current standards and ASC 606 — especially due to the judgment allowed in recognizing revenue under ASC 606 — some companies may end up with significant adjustments to how much revenue is recognized at a given point in time. For example, software companies that have not been able to substantiate vendor-specific objective evidence (VSOE) of fair value for their software licenses will no longer be restricted to this measure of fair value and will be required to recognize revenue from software licenses when the license performance obligation is satisfied, assuming all other steps of the revenue recognition model are met, at the relative fair value of the software license.

How Will ASC 606 Affect My Company?

As a result of the new standard, all companies must become familiar with the new guidance and evaluate how the changes will affect the timing and amount of revenue recognized each period. If significant differences are identified, you will need to elect either the full retrospective or modified retrospective adoption methodology. Under the full retrospective methodology, all periods presented are restated under ASC 606, with a beginning retained earnings adjustment in the first period presented (2018 for most private companies). Under the modified retrospective methodology, however, only the period of adoption is shown under ASC 606, with prior periods shown under current accounting guidance and a beginning retained earnings adjustment in the period of adoption (2019 for most private companies). Consideration should be given to the optimal adoption methodology as unintended consequences may result.

Returning to the example of a software license vendor without VSOE of fair value, license revenue would be deferred and recognized over the maintenance period. Under ASC 606, the portion of the contract allocated to license revenue would be recognized upon delivery of the license. If delivery of the license by a private company falls into 2018 and the company elects modified retrospective adoption, the license revenue will not appear in either 2018 (as this is presented under current standards and the revenue is recognized over the maintenance period) or 2019 (as this is presented under ASC 606 and the revenue would have been recognized in 2018 upon delivery of the license), and, therefore, would only appear as an adjustment to retained earnings in 2019 and never in the revenue line item. This phenomenon has come to be referred to as “disappearing revenue”. If this is your situation and your “disappearing revenue” is significant, you will likely want to elect full retrospective adoption.

What Changes Should I Expect?

There are additional changes from current guidance that may impact your company. All companies are encouraged to read the standard, review interpretations of the standard, and consult with knowledgeable individuals. The impact of these new changes will vary from company to company.

A relatively minor change has to do with the balance sheet presentation of assets and liabilities. Generally, when a company satisfies delivery obligations ahead of receiving customer payment, under ASC 606 the recognition of revenue will result in the recognition of a contract asset on the balance sheet. Similarly, if the customer pays ahead of the company’s satisfaction of delivery obligations, under ASC 606 the receipt of payment will result in the recognition of a contract liability for amounts probable of being kept and a refund liability for other amounts. Consistent with today’s guidance, revenue is not recognized until all five revenue recognition steps are completed, regardless of the timing of payment.

A major change, for most companies, will be the requirement to capitalize direct costs to obtain a revenue contract, such as variable sales commissions. These costs are to be capitalized and expensed over the period of probable benefit (i.e., the expected contract period) unless this period is one year or less.

Finally, all companies will be impacted by the significant additional disclosure requirements, both quantitative and qualitative, required by ASC 606. Now, companies will need to provide disclosures including:

— Disaggregation of revenue into categories to illustrate how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.

— Information about contract asset and liability opening and closing balances.

— Information about an entity’s remaining performance obligations.

— Losses from impairments of receivables or contract assets.

— Assets from costs to obtain or fulfill contracts (such as commissions expense), including how amounts to be capitalized were determined.

— Amortization and impairment of capitalized assets.

— Disclosure of significant accounting estimates and judgments made in determining the transaction price, allocating the transaction price to performance obligations, and determining when performance obligations are satisfied.

Certain disclosure practical expedients and elections for nonpublic entities are allowed by the guidance.

Companies should begin working on these additional disclosures and ensure they are able to access the required information prior to the applicable implementation date.

This is just a brief overview of ASC 606 and some of the changes that are likely to be applicable to private companies in Austin. If you have any questions or are interested in discussing these standards further, please don’t hesitate to contact our team at Holtzman Partners by calling 512.610.7200.

Our team provides the technical experience and industry depth that your team can trust.