Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers, says that all companies that sign contracts with customers must record revenue.
The Financial Accounting Standards Board (FASB) established this rule. It became law on January 1, 2018, for most public businesses, but companies that are not public had two more years to follow it.
What does ASC 606 mean?
The basic idea behind ASC 606 is that it tells groups when and how to report their income. This standard builds on the advice in traditional GAAP by providing a more robust framework for recording contract revenue.
All businesses that sell goods and services must follow the new income recognition standard. This includes public companies, private companies, and not-for-profit (NFP) organizations. In addition, it covers all kinds of contracts, such as sales of things, services, land, and ideas.
ASC 606 says companies must record income when the customer receives the goods or services. What a company hopes to get in return for its goods or services should be reflected in the amount of money it makes.
Like words
It stands for
- Accounting Standards Codification 606: The full name of this FASB accounting standard is “Accounting Standards Codification 606.”
- ASC Topic 606: Revenue from Contracts with Customers: The FASB gave the standard this name in its actual form.
- IFRS 15: The International Accounting Standards Board put out International Financial Reporting Standards 15, which is the same thing.
How to Report Income from Contracts According to ASC 606
ASC 606 Revenue from Contracts is based on the following main ideas:
- A company should record revenue when it delivers its goods or services to a buyer.
- The amount of revenue should show the total value the company expects to receive in exchange for its goods or services.
- A company should record revenue based on facts and evidence that can be seen.
The FASB and IASB announced their convergence project on revenue recognition in 2014. That was the start of it all. The project’s goal was to make a single revenue standard that would replace all the present rules on recognizing revenue.
After years of waiting and hearing from businesses and other interested groups, the Board finally released Update 2014-09 on May 28, 2014. It was used for annual reporting periods after December 15, 2016. All other organizations had to follow the new income standard by December 15, 2018.
Not long after the first update, the Board released Accounting Standards Update No. 2015-14, which delayed revenue from contracts with customers (Topic 606) for all companies by one year. However, early adoption was still allowed.
This rule change had the most impact on businesses that depend on subscription services or license fees as their primary source of income. Many of these businesses had to change how they did their accounts and reported their finances.
Before ASC 606, a business could only record six months of income if it sold a software license for twelve months. There would be no records of the other six months until the following year. However, with the new rule, all income can be counted immediately.
ASC 606 changed more than just finance and accounting. It also changed IT systems, HR rules, and other things. Many businesses struggled to adapt because they didn’t know what would happen.
How to Use ASC 606 to Figure Out Revenue: 5 Steps
Businesses must follow a five-step process when they account for income from contracts with customers to follow ASC 606. Here are the steps:
1. Name the contract(s) you have with a customer
The first thing that needs to be done is to see if there is a contract. This might seem easy, but there are times when it’s not.
There are times when a formal contract isn’t necessary, but some conditions should be met.
- Both sides have signed the deal, and they both know what their rights and duties are.
- The contract is helpful for business. For the customer, this means an exchange of things or services that are valuable.
- Both sides must follow the terms of the contract.
- The rights of each party can be found, measured, and understood.
- The client is likely to pay for the products or services. List the things that the contract says the parties must do to perform.
2. Here are some examples of job obligations:
- Good: A business sells a customer a tool. Performance must give the widget.
- Service: A customer hires a company to do gardening work for them. Performance must cut the grass and trim the bushes.
- Guarantee: When a business sells a car, it comes with a guarantee. If parts break during the warranty period, the company must fix or replace them.
A duty could also mean giving customers a good or service at a particular time.
3. Figure out the price of the deal
The amount of money the business hopes to get in exchange for its goods or services is called the deal price. The price of this amount can be set, changed, or be a mix of the two. You can change it if certain things happen, like if the customer pays on time (for example, 2/10 net 30) or gets a deal for paying early.
The sale price also includes things that aren’t cash, like how much loyalty points or frequent flyer miles are worth.
4. Divide the purchase price among the tasks that must be done under the deal.
Companies must give the transaction price to each performance obligation based on how much that commitment is worth. The price at which the things or services would be sold on their own is called the “standalone selling price.”
5. Record income when (or as) the business meets a performance obligation
Revenue isn’t made until the company delivers a good or service to the customer, no matter when that is.
Sometimes, this will be when the package is delivered. For instance, if a business sells a widget to a customer, the money will be counted as income when the widget is sent to the customer.
In some situations, income may be recorded over time. It happens often with service contracts, where the company does a job repeatedly.
How ASC 606 ties together accounting and sales
ASC 606 says that revenue is recognized when the customer takes control of the goods or services. This differs from the old way, based on when the money was made.
Companies need to know more about their sales processes and how they connect to the accounting system for the new way to work.
After that, changes to a quote or contract will lead to more changes in performance responsibilities. To avoid this problem, sales management—in charge of writing customer contracts—needs to work with the teams making money from those contracts.
There are several perks when ASC 606 is used correctly:
Accounting is less of a guessing game now that more objective ways exist to determine when revenue should be recorded. Contracts can be written in a way that is better for the company because everyone knows how the contracts will affect the financial statements. Investors have more information because they can see when revenue is being generated.
How CPQ helps businesses follow ASC 606
CPQ software can help businesses follow ASC 606 in more than one way.
CPQ makes sure that the quote and contract terms align with the company’s sales methods by automating the process.
CPQ helps businesses track how their performance obligations are going and improve their revenue intelligence projects. This is important because ASC 606 says that businesses need a good idea of how they sell things to assign the transaction price correctly.
It also gives companies a complete record of all the changes made to a contract, which lets them keep track of changes to performance obligations. ASC 606 defines this information as dividing the purchase price and recording revenue.
CPQ also helps businesses comply with ASC 606 in the following ways:
- Bringing together the sales, finance, and accounting teams that work together on revenue management.
- Making reports on the status of performance duties in real-time
- Helping businesses determine what parts of their sales processes need to change to meet ASC 606.
- Combining the contracting process with billing and invoicing methods
