Revenue Recognition

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ASC 606: Determining When Revenue Is Recognized

Nicole Sithithavorn Blog Revenue Recognition, Tax

The Financial Accounting Standards Board created ASC 606, which is essentially a standard that clarifies how businesses must go about recognizing their revenue. The ASC 606 revenue recognition standard provides a consistent, principles-based framework for all businesses, no matter the industry.

The standard is designed to create a path that businesses within all industries can utilize when it comes to recognizing revenue, and ASC 606 sets forth five steps that these businesses can implement across the board. With a standardized method for recognizing revenue, investors and other interested parties can compare a company’s results with those of other companies.

Here is one way to think about ASC 606. Basically, under legacy generally accepted accounting principles, revenue is recognized when substantially all the risks from the sale of goods or services have been passed on to the customer. Under ASC 606, revenue is recognized when the control of the goods or the services is passed along to the customer.

The five-step ASC 606 model

ASC 606 sets out a standard five-step model for its revenue recognition process:

Identify the contract with the customer.
Identify the performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price.
Recognize revenue when or as the entity satisfies a performance-related obligation.

These steps must be adhered to for the duration of the contract’s term. Failing to do so could result in errors or, even worse, a restatement.

Examples of the five steps in action

The five steps that make up the ASC 606 model involve technical accounting changes that include the application of new estimates and judgments.

Here are some examples of the five steps in action:

Identifying performance obligations, such as whether the contract includes more than one good or service that can be considered distinct or whether the goods or services in the contract are either highly independent or highly interrelated.
Determining the timing of the transfer of control of each performance-related obligation.
Identifying incremental contract costs for capitalization.
Listing all variable considerations in the contract, such as claims and pending change orders, unpriced change orders, incentives, penalty provisions, shared savings, price concessions, liquidating damages and unit prices.
Determining whether one or more of the goods or services in the contract significantly modifies one or more of the other goods or services in the contract.
Capitalizing and amortizing costs, such as sales commissions and bonuses.
Determining the beginning retained earnings adjustment.
Adding certain quantitative and qualitative disclosures.

More details regarding ASC 606

ASC 606 applies to both existing and future contracts. In order to be compliant, companies are required to review every contract. ASC 606 also requires them to review any and all existing policies, procedures or internal controls. Additionally, the process will involve the financial, IT and HR departments as well as various other relevant departments.

A good way to approach the implementation of ASC 606 is by naming a multidisciplinary team and charging it with the development of a checklist or decision tree that identifies the items that need to be included in every type of contract that the company enters into. Doing so will help the business successfully identify every contract clause that contains an element of revenue recognition, and from there, each one can be reported correctly, as advised by ASC 606. Also, to ensure that the resulting document remains comprehensive, it should be reviewed periodically.

At the end of the day, determining when the control of the goods or the services is passed along is a matter of judgment, which is based on criteria such as whether the customer or the company holds legal rights to titles or whether the physical possession of the goods or the services has been passed along to the customer.

The process is both complicated and detailed. Businesses should implement revenue recognition software that can help determine their contracts’ performance-related obligations and allocate the transaction price to each obligation. Among the features to look for when comparing software options are flexible data models, configurable templates, forecasting models and seamless integration with other applications.

Everything we have discussed today is merely an introduction to the topics at hand. Other guidance may also affect how you address this. When it comes to revenue recognition, it is especially important for you to work closely with an accounting professional.

Is This Your Situation- Your Internal Controls Are Weak

Is This Your Situation: Applying ASC 606 in Construction

admin Blog Revenue Recognition, Tax

In simple terms, if you’re in the business of entering contracts to deliver goods or services to customers, you’re affected by the FASB’s ASC 606, which provides guidance in recognizing revenue. Although ASC 606 applies to a wide range of businesses, it is of particular interest to construction companies.

When it released the new standard, the FASB said it would:

Result in enhanced disclosures about revenue.
Provide guidance for transactions that were not previously addressed comprehensively.
Improve guidance for multiple-element arrangements.

To make sure you are getting off on the right foot with your construction company, ask yourself the following five questions:

Can you identify the contract? This means, among other things, looking into the ability to collect.
Can you identify the performance obligations? This means taking a look not only at the actual promises in the contract but also at the implied promises.
Have you determined the transaction price? This can get especially complicated in construction, as it may also include variable prices.
Have you allocated the transaction price? Again, this may have a special meaning in construction, as contractors have to break out stand-alone prices.
Can you recognize revenue as performance obligations are satisfied? In construction, this means calculating at what point control of the assets passes to the customer.

One of the key aspects of applying ASC 606 is understanding key definitions and practices not only within revenue recognition generally but also within the construction industry in particular. For example:

You have to identify distinct obligations within the contract. In this context, “distinct” means your customer must be able to use a good or service on its own.
You have to understand common scenarios. In certain construction projections, inspection walk-throughs may be implied, even if such walk-throughs are not actually noted in the written contract.
Make sure you’re clear on liabilities versus assets. You may have a contract liability if the customer has paid consideration or if payment is due but you as the contractor have not yet satisfied the performance obligation. On the other hand, if you have transferred goods or services as of the reporting date but the customer has not yet paid, you would recognize either a contract asset or a receivable.

This is just a basic introduction to a complex series of requirements. To make sure you are in compliance from the start of a project, be sure to work with us closely from the beginning and through the job.

Construction Companies: Recognizing Revenue Under ASC 606

glevi Blog Construction, Revenue Recognition

Recently, construction companies industrywide made a change in how they calculated revenue. Before ASC 606, Revenue from Contracts with Customers, was adopted, different industries used different methods for reporting income even when they were accounting for similar transactions. Standardizing transactions is an important step, but now that all public and private companies must use the same accounting methods for reporting revenue, companies need to make certain adjustments.

ASC 606 is designed to standardize reporting for the delivery of the goods or services promised in a contract. It takes the place of all existing transaction- and industry-specific guidance.

The standard uses different terminology from previous versions, describing the delivery of promised goods as a “performance obligation.” One contract may include several performance obligations, each of which must be identified and tracked separately. Keep in mind that while lease contracts, insurance contracts, financial instruments, guarantees and nonmonetary exchanges generally are excluded from ASC 606, there may be other guidance that affects these types of agreements.

For construction companies, the changes are especially far-reaching because they affect some documents that are commonly created during the life of a project, including change orders. This is not a simple semantic change. Any of these documents may qualify as a performance order, which requires every contract to be carefully examined.

ASC 606 provides five steps for recognizing revenue.

Step 1: Identifying the contract with the customer

This step involves recognizing each of the enforceable rights and obligations the parties have to each other. The seller promises to deliver goods and/or services, and the customer promises payment and determines when payment is to be made. The contract may be either written or oral, in accordance with customary business practices.

Step 2: Identifying the performance obligations within the contract

You generally do not need to draft separate contracts for two performance obligations if they are for essentially the same goods or services. However, separate contracts may be needed if the promised goods or services are substantially different.

Step 3: Determining the transaction price

The transaction price may be set in the contract, or the contract may state that the selling price will be based on certain variables.

Step 4. Allocating the transaction price to the performance obligations

This step requires you to estimate all variables in the selling price, including ones that may not be apparent.

Step 5. Recognizing revenue as the performance obligations are satisfied

Once control over the promised goods or services is delivered to the customer, you have met your performance obligation. Sometimes, control is handed over in stages, such as when a particular phase of a project is completed. When that happens, ASC 606 requires the seller to choose an appropriate way to measure progress relating to when the obligation will be completed.

There are myriad subtleties involved in each of these steps. Incentives like discounts, bonuses for meeting performance deadlines, high material costs and the impact of state and local taxes all need to be considered. In addition, the way performance obligations are stipulated in contracts also has an impact. Each of these items, and many others, must be reviewed under the ASC 606 guidelines.

Construction company leaders need to review all existing contracts to be sure their financial reports are in compliance with ASC 606. This process will need time and planning and will require changes to certain processes and procedures. Keep in mind that all future contracts must be compliant as well.