ASC 606 became effective for public companies in 2018 and privately-held companies in 2019. Previously, the reporting standard varied according to industry. Now, under ASC 606, the standard is industry neutral, making it more transparent.
Accounting Standards Codification 606 Made Fundamental Changes
In practice, the principle requires that a revenue-generating activity must be completed or effectively completed in the same accounting period that payment is received or is expected to be received. Accounting Standards Codification (ASC) 606, which was enacted in 2014, fundamentally changed how it is applied. ASC 606 became effective for public companies in 2018 and privately-held companies in 2019. Previously, the reporting standard varied according to industry. Now, under ASC 606, the standard is industry neutral, making it more transparent.
ASC 606 applies to all contracts with customers, except for leases, insurance contracts, financial instruments, guarantees and certain non-monetary exchanges between entities in the same line of business. Under the new standard, a contract does not need to be written, and can include verbal agreements and arrangements customary in business practice. In this case, a point of sale transaction may still qualify as a contract.
Five Steps to Determining When Revenue Is Recognized
These five steps should be used to determine when revenue is recognized:
1. Identify the contract;
2. Identify the contractual performance obligations;
3. Determine the amount of consideration/price for the transaction;
4. Allocate the determined amount of consideration or price to the contractual obligations; and
5. Recognize revenue when or as the performing party satisfies performance obligations.
This may sound simple, but following ASC 606 may require adjustments to a company’s policies, processes, and systems. Segmenting each performance obligation and its associated costs can be difficult and time-consuming, and may differ from current practice.
Adopting the Standard: Tax Implications
There are two alternatives for adoption of the new standard:
- The full retrospective method. This method requires the restatement of the company’s 2018 results of operations to reflect a cumulative effect adjustment as of the beginning of 2018.
- The modified retrospective method. This method does not require restatement. Instead, it presents the cumulative effect adjustment as of the beginning of 2019. It requires, however, additional footnote disclosures that explain any inconsistencies between the company’s 2018 and 2019 financial statements.
Tax implications also must be considered. Adoption of the new standard will affect taxable income, including pretax income, of all entities. In addition, adoption of ASC 606 will require making income tax-related adjustments under ASC 740 on the date of adoption.
Before preparing your next financial statement you should be aware how ASC 606 affects your business.
Contact Randy Brammer or Leslie Prichard with questions on the impact of ASC 606 on your business.