Peeling Back the Layers of ASC 606
In my initial posting, I addressed the implementation landscape and how a number of companies have not yet begun their efforts to implement the new revenue recognition guidance. In part 2 of the series, I provided some thoughts on what these companies should be doing now to get started. In this article, I dig into the new standard itself and highlight some of the challenges companies will be facing with the new revenue recognition standard.
ASC 606, Revenue from Contracts with Customers, is a completely new revenue recognition standard that replaces almost all 150+ pieces of existing revenue recognition literature with the use of a new 5-step principle based model. So, whether you are a government contractor building a new fighter jet or a Silicon Valley technology company licensing a software product, you will apply this same 5-step model to determine how revenue should be recognized for your contracts with customers.
I recently had the opportunity to sit down with a true expert on this topic, Scott Taub, in which I asked him his thoughts on the key changes and challenges resulting from the new revenue recognition standard. Among many other attributes, Scott is a member of the FASB’s revenue recognition Transition Resource Group (TRG) and is literally “writing the book” on the new revenue recognition guidance (currently authoring a comprehensive guide to accounting for revenue recognition under ASC 606). Below are some of the key messages from this discussion:
- All in all, an improvement compared to current GAAP. While current GAAP has a lot of detail, there are entire revenue recognition areas that are not addressed at all. The new standard plugs these holes by at least providing a framework for which to assess the entire revenue recognition process, from start to finish. For example, except for certain specific industries, current guidance does not address contract modifications. ASC 606 on the other hand provides a comprehensive set of principles for which to analyze contract modifications.
- Significantly more judgment – In today’s world of revenue recognition, there are a lot of rules governing specific types of revenue transactions. These rules go away, leaving the need to apply professional judgment in many cases. Many people in the US GAAP world may not be fully comfortable with this new approach.
- On balance, faster revenue recognition – While it will be dependent on facts and circumstances, there will be more cases of accelerated revenue recognition. For example, in the new standard, variable consideration is estimated and included in the transaction price on day 1. Today, variable consideration typically is not recognized as revenue until the contingency is resolved.
- Not many changes, but many impacted – According to Scott’s rough estimates, approximately 95% of transactions will be treated the same, but half of companies will have significant transactions that fall within the 5%. In addition, all companies will have changes because of the significantly expanded disclosure requirements.
- General agreement between US GAAP & IFRS communities– Through his involvement with the TRG, Scott was pleasantly surprised to find general agreement among the US GAAP and IFRS communities regarding how to interpret the new revenue recognition standards. This provides some hope that consistent outcomes can be achieved under the two sets of GAAP throughout the world.
- A fresh look is needed – Companies will start off on the wrong foot if they look only at what changes under the new guidance. The point of the exercise is not to justify the current way revenue is recognized, but rather companies need to start by figuring out what the new standard requires and take a fresh look.
Without a doubt all great insight from Scott. On this last point in particular, I reiterate Scott’s thoughts that it is critical to take a fresh look at all of your revenue arrangements within the lens of the new 5-step model. While you may not expect significant changes, there are sure to be some surprises lurking around the corner. With that in mind, in my next post I will provide some insight into how to go about analyzing and documenting your revenue arrangements and policies under the new guidance.