ASC 606 Considerations for Companies Still Planning for Adoption

Common Changes: Impacts most companies

Incremental costs of obtaining a contract

Although the new revenue guidance is not meant to require companies to reconsider cost accounting, portions of ASC 606 are meant to fill gaps in legacy guidance. These new portions can have significant impacts on financial statements.

Incremental costs of obtaining a contract are often linked to internal and third-party sales commissions. By creating an inventory of those agreements and reviewing them to determine if they qualify for capitalization under the new standard, management can address the accounting and process impacts that result from the requirement to change the way in which costs incurred to obtain a contract are accounted for.

Variable fees

Under legacy accounting, revenue was not recognized until it became fixed or determinable. For example, when payment of the fee was contingent on an event, revenue was generally not recognized until the occurrence of that event. However, under the new standard, companies may be able to recognize revenue if it is probable a subsequent change in any estimated revenue amount would not result in a significant reversal. As a result, revenue recognition may occur sooner (or later) upon adoption of ASC 606.

Variable fees represent a form of variable consideration that will need to be estimated when determining the transaction price. Tracking contracts with variable fees is important, as management will need to update its estimates throughout the contract term in order to appropriately reflect circumstances that exist at each reporting date.

Discounts, rebates, and customer options at a discount

The new revenue recognition standard creates a single framework for assessing variable consideration to determine the amount to be included in the transaction price. The requirement to estimate and include amounts of variable consideration can significantly change companies’ practices.

Discount, rebates, and fees contingent on future events are common forms of variable consideration. Performing a detailed review of contracts to identify all forms of variable consideration will help management to appropriately evaluate and determine the transaction price.

Promised goods or services with combined fees

The new revenue standard requires that distinct goods or services be considered as separate performance obligations and that any combined fees should be allocated to each distinct good or service. A common challenge is identifying the separate performance obligations in a contract and then determining the stand-alone selling price of each distinct good or service. By evaluating the population of contracts to identify those with combined fees that include more than one performance obligation, management can minimize its efforts by focusing only on those types or structures of contracts with multiple goods or services.

Frequent contract modifications including amendments, extensions, renewals, and combinations

Contract modifications are now clearly defined under ASC 606 and, as a result, may differ from how companies previously handled changes to customer contracts.

Management should ensure that arrangements that are modified subsequent to contract inception are appropriately reviewed to determine whether they should be treated as a continuation of the old contract or as a new agreement. This approach can create complexities in the review process as companies are often required to review agreements at the individual contract level. Further, the conclusion reached can result in changes in the amounts and time periods in which revenue is recognized if the modification is determined to be a continuation of the initial contract.

Process Impacts: Adds complexity but is generally a documentation exercise

Multiple revenue streams

Evaluating current revenue streams in order to determine whether they need to be separated or consolidated is an important early step in the implementation process. From there, management should select qualitatively and quantitatively representative samples within each revenue bucket to analyze. To create efficiencies and reduce the risk of rework later in the process, companies should document the sampling methodology used and hold discussions with audit teams on sample coverage early in the process.

Contract reviews are a necessary step in the implementation process and, if contracts are complex or high in volume, will likely require more time to review. Therefore, selecting an appropriate sample of contracts across the different revenue streams is important to ensure consistency of language, terms, and conditions.

Complex and high volume of contracts

By utilizing a contract analyzer template to go through each of the ASC 606 five steps in detail, with an emphasis on covering revenue information in each contract—such as parties to the contract, pricing structure, contract term, the services to be delivered, and incentives and discounts—management can identify and address accounting or business process changes resulting from adoption.

One-off Impacts: Items that appear less consistently but have an impact

Setup or implementation activities

Revenue recognition for setup or implementation services can vary under the new guidance as companies must consider if these services are necessary for a customer to access other goods or services, if the services are significantly modifying or customizing a good or service or if the services are transferring a separate distinct good or service.

The time period of revenue recognition for these fees can change as a result and will either be recognized in conjunction with the good or service that is being set up or implemented (bundled performance obligation) or over the service period.

Payments to customers

Companies are sometimes required to treat cash paid to customers differently under the new guidance. Under legacy guidance, payments are treated as a reduction to revenue; ASC 606 is consistent unless a distinct good or service is being transferred, which would require companies to account for these payments the same as payments to suppliers.

Additionally, in cases where payments to customers may vary, the company must estimate these amounts and reduce revenue when the later of two events occur: 1) Transfer of related goods or services or 2) Payment is promised. Application of the ‘later of’ guidance can result in earlier revenue reduction than under legacy guidance.

Termination clauses for convenience

Contract terms are a primary driver of how revenue is recognized under ASC 606. Termination clauses that allow customers to cancel contracts at any time or that contain termination penalties can have unforeseen impacts on accounting conclusions reached.

Companies should evaluate their contracts to determine whether termination clauses for convenience exist and how they could affect the contract term conclusions and how revenue is recognized. In cases where both the customer and the company can terminate the contract at any time without penalty, the associated contract term does not exist past the “then current period.” Additionally, if termination clauses for convenience include a termination penalty, companies should consider the need to estimate the amount of revenue from a termination penalty based on historical contract termination data available.