You may have heard the term ASC 606 or new revenue recognition standard, but you may not understand the impact that it has on your business or your employees. Major changes in the way that a business recognizes revenue came into force in the year 2018. It could be argued that these are some of the most significant changes that will affect businesses in a generation.
The new revenue recognition model is called Accounting Standard Codification 606: Revenue from Contracts with Customers, or simply, ASC 606.
ASC 606 is the product of a joint effort between the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB).
ASC 606 sets out to standardize the way that all businesses recognize revenue, bringing them in line with international models. The bottom line is that no business remains unaffected by these sweeping changes. In this article, we’ll explore ASC 606 compliance and discuss how it affects you and your business.
What Is ASC 606?
The ASC 606 revenue recognition model came into force with all private companies needing to come on board by January 2019. That means that it is now essential that any and all businesses be compliant with these new rules. So, if you’re starting out in your business, or you’ve had some time away from the industry, you’ll need to catch up and get your head around ASC 606.
Firstly, we should address what revenue recognition means. Put simply; it’s the way that revenue is noted down. In the past, the way that revenue was recorded was inconsistent and messy. Many factors come into play in the lifecycle of a sale; these could include:
- Different models of subscription. For example, those that have up-front charges, and those that take monthly payments
- The bundling of products and services
- Additional charges such as rebates, cancellation fees, warranties, and shipping.
When you have several different ways of recognizing your revenue and have transactions running into billions of dollars, these different accounting methods can become problematic. The ASC 606 seeks to standardize the way businesses record revenue.
What Is The ASC 606 5-Step Model?
The ASC 5-step model creates a standard process for recognizing revenue from contracts with customers:
1. Identify the contract
2. Identify performance obligations
3. Set the transaction price
4. Allocate the transaction price
5. Recognize revenue when the performance obligation is satisfied
This model can be applied to all businesses regardless of the industry.
How Does ASC 606 Affect My Business?
The new revenue recognition standard, ASC 606, will affect all businesses in one way or another. However, some businesses will feel a greater impact depending on the different types of revenue that they have. There is one principle that underlines ASC 606, and that is that companies need to recognize revenue when goods and services are transferred to the customer.
This should be done in an amount that’s proportionate to what’s been delivered. Although previous regulations were generally more industry-specific, and ASC 606 is more general, applying the same principles to all types of business can be tricky. Here are some examples of how they will affect specific areas of businesses.
If your business is adapting to new ASC 606 compliance guidelines, then the legal department will need to reevaluate all contracts and policy wordings.
The revenue recognition changes brought in by ASC may make financial processes more complicated. Businesses may be required to put new systems in place to help with forecasting and implementing new quote-to-cash technology that will align with the new standards.
If you operate a business that relies on commission selling models, you will need to align sales with new revenue recognition models. Where salespeople have previously been able to throw in free product upgrades or add-ons in order to close a sale, this may not present a challenge in revenue recognition.
For many businesses, the use of deal sweeteners may no longer be a cost-effective model for their business. On the flip side of this, where businesses take upfront payments for a fixed-length contract, revenue recognition will become much faster, and as such, organizations may wish to further incentivize sales staff with increased bonuses or commission in their pay packet for this type of contract.
The Impact on Businesses With Subscription Models
Subscriptions are a common way of delivering goods or services to customers. They provide businesses with the surety of repeat custom, and they provide consumers with the service or product that they require in continuous supply. There is a range of different ways of billing subscriptions, with some taking monthly payments, and others taking full payment upfront.
For some businesses, subscriptions involve credit agreements and additional financial products such as finance or insurance. There may be additional charges to contracts, and there may be mid-term adjustments based on a change in the customer’s circumstances. Where subscriptions change often, this can make recognizing revenue more of a challenge.
Companies that roll out subscription costs over time will need to explore whether they are recording the revenue as it arises or after some time.
Measuring The Impact Of ASC 606 On Your Business
Undertaking the proper research will help to make the implementation of ASC 606 much smoother in your business. You will need to evaluate how your business handles every transaction and compare it to the new revenue recognition framework. This will need to be done for every single revenue stream that your business has.
While evaluating your business, you will need to make some very important decisions. Make use of the 5-step compliance model and ensure your contracts all meet the requirements. For many of your revenue streams, you may find that not much needs to change to achieve ASC 606 compliance. However, for others, you will need to weigh up when you should recognize the revenue.
Review your current sales techniques and explore how you’re currently rewarding your employees in their paychecks for making the sale. We hope this has given you some clarity on the ASC standards. Check out our pay stub generating template to save yourself some time and create your employee paychecks in a jiffy!