Abstract
The new revenue rule ASC 606, which relates to revenue from customers with contracts, was established in 2014. The state is a single revenue recognition that replaced the other voluminous regulations that had previously been used in the industry. The government requires the industry to recognize its revenue in a way that shows services or goods transfer to the client with the amount reflecting the expected consideration, which is authorized for the exchanges of the particular goods and services (Flood, 2020). The deadline for companies to comply with the revenue recognition standard was set to be 2017-2018. ASC 606 is a useful framework that enables businesses to recognize their revenue consistently. Compliance with the regulation provides a company with an opportunity to transform the industry regardless of its size.
Introduction
The new standard for revenue recognition affects all the industries that engage their customers with contracts for services or goods to be transferred. The standard covers the non-profit entities, private as well as public companies. The rule was developed through the joint coordination of the International Accounting Standards Board (IASB) and Financial Accounting Standard's Board (FASB). The objective of the revenue recognition standard was to reduce the differences that appear while handling similar transactions in different industries (Flood, 2020). It. ASC applies to all customers contracts for the provision of services or goods, which are the products of a given occupational in exchange for a consideration. An entity is thus obliged to apply the new regulation to all contracts that engage the customer. However, some objects have been excluded from the standards. This exception includes the lease contracts whose provisions are within ASC 842 OR ASC 840 scope, commitments that are regulated in the ASC944 range, Guarantees in ASC460 field, financial services such as insurance ASC 310 items which provide for the contractual rights and the financial statements as well as all the exchanges between the business that are non-monetary and are within the same business line that facilitates reaching the potential customers as well as the enhance the sale
The standard was necessitated by the previous experiences of the users of financial information such as among others. They could handily make a comparison of the financial information in different industries as the reporting lacked standardization. In some cases, it was even painful to make a comparison between companies in one sector (Singh, 2018,). SC 606, therefore, provides business with a framework that enhances consistency during financial reporting, simplifies the process of preparing financial statements, and also improve on the comparative analysis model. The contract process is a model that involves five steps, as discussed below.
Identifying the contract
This is the first step of the model, which outlines the set criteria that the business has to meet in order to engage a customer into a contract for supplying services and even the goods.ASC606 applies only to contracts, and therefore the first step involves identifying the arrangements. ASC606 states clearly that the obligations and the rights given in a contract should be enforceable before the application of the revenue model. The business should consider all the legal environments that are relevant within the locality so as to determine the enforceability of the obligation and the rights.
A contract can be defined as the agreement that involves participation of two or even more parties, which creates responsibilities and privileges that are enforceable (ASC 606-10-20). The revenue standards provide given criteria that should be satisfied by the agencies before they enter into a contract with the customers. The agency should be in a position to identify the right of each party about the service or the goods that are being transferred. It should be stated clearly in the contract the amount to be paid by the customer as well as the type of services or products that the customer should receive. Additionally, the payment terms for the transfer of the services of or the goods should be identified by the agency (Flood, 2020). The contract should also be approved by the parties involved either orally, through writing, or even using different customary practices in a business where the parties commit themselves to perform each obligation. Thus the client and the customer should both approve the contract. A termination clause is also recommended. ASC 606 also provides for a contract modification. Modification mostly occurs when an agency identifies change or expansion of a project.ASC606 refers to this change as an adjustment to the existing contracts or even a separate agreement.
Under the revenue recognition rule, a contract can, therefore, exist if the participants involved can identify their rights and those of others, the compensation terms are clear to each party, a commercial substance is available in the contract, approval, and commitment of each party in performing the contractual obligation and that the entity is likely to collect the consideration as expected (Singh, 2018,). The business needs to identify if the client has the ability and also the intention of paying. ASC 606, therefore, requires a contract that been agreed upon mutually with a clear statement on the terms of payment. Additionally, it is not a requirement to state the fee explicitly during contract identification.
We are identifying the contract's performance obligations.
Step two of this model involves an explanation of how the distinct performance obligations as indicated in the contract should be handled. A performance obligation is defined as that assurance to make a handover to the specified services or goods such as the transfer of the products produced, permission for using or accessing the intangible assets, and performing the tasks that have been agreed upon, among others. Previously, accounting principles referred to the performance obligations as the deliverables. As per ASC 606, performance obligations are separate activities that can be separately performed even if their provision to the customers is joined with other services.
Additionally, the customer should have individual benefits from each of the performance obligations. A performance obligation is simply the specific services that the customers are making payment to receive (Singh, 2018,). In some times, the functions may be provided as a part of the package delivered. The second step is very critical in this model. This is because performance obligations are used in the next model steps as the accounting unit. Inappropriate identification of the performance obligation results in issues in the next three steps.
Determining the price of the transaction
The third step of the model involves determining the things to be considered when determining the price of the transaction. The transaction price refers to the amount that a business expects to get from the customers after transferring the services and the goods. According to ASC 606-10-32-2, businesses should establish the transaction price by putting into considerations all the customary practices of the business as well as all the contract terms. The price of transaction can be explained as the amount expected by a business as consideration as an exchange of the services and goods being transferred. The transaction price does not include any amount that is collected for the third party (Flood, 2020).The consideration that have been promised in a contract engaging a customer should either be variable cost , fixed cost or both costs.A deal should, therefore, not be delivered to a customer without stated prices.
The main objective of the third step is to forecast the total considerations amount which business is authorized to collect from a given contract. In some cases, the transaction cost may be fixed while, in other, the transaction cost is variable. Some deals use both variable and fixed amounts as the contract price. The business should estimate the transaction cost at the commencing stage of the contract. It is updated at every period of reporting to reflect all the changes in circumstances and facts.
While identifying the transaction price, the business will make the assumption that the services and the goods that have been promised in the contract must be received by the customers as provided in ASC 606-10-32-4. The assumption made by the business is that the agreement shall not be modified, canceled, or renewed. The transaction price, therefore, includes only the right for the company that is stated in the present contract. For instance, any business that engages a customer with a contract for one year but has an expectation that the customer will renew the contract for a second year should only determine the transaction price of one year, which was the first year. The price transaction should not be referenced with the renewal year but the first year.
In the process of determining the transaction price, an entity should first identify the considerations that are fixed. Fixed payments include all the non-refundable amounts. The constraints and the variable factors, non-cash consideration, payable customer considerations, as well as the significant components for financing, are also affected in addition to the reviews that are fixed. The third step, therefore, guides all the factors to be considered during the establishment of the contract transaction price. In other terms, the contact price refers to the expected amount by a business after the transfer of the promised goods and services.
Allocation of the transaction price
Step four of the model involves allocation of all transactions to the individual performance obligations in the contract. Each performance obligation is given a specific price. ASC 606 explains that every performance obligation should be allocated a transaction price. The transaction price should be grounded on the selling prices of each service or good that is to be provided. ASC 606-10-32-31 explains that for an entity to effectively allocate a transaction price to every obligation that is to be performed, on the basis individual selling price, the entity should determine the selling price of each obligation at the inception stage of the contract. The price of transaction should be proportional to the selling price of each unit. An example of a selling price that is standalone is the charges for an agency for the services or the goods (Singh, 2018,). Some of the suitable methods for allocating the expenses for transactions include the residual approach, the approach for market assessment which has been adjusted, and also the approach which totals the margin to the expected costs.
ASC606 clearly states that the prices should be allocated to every performance obligation individually. The prices that are difficult to identify and also allocate prices during the inception of a contract are addressed in the variable consideration. It should also be made clear to the clients that the prices are estimates to avoid putting out the customers if the amount billed is different from the estimated costs in the contracts.
The standard also provides for discount allocations. An agency that is giving a discount to the customer should not allocate the premium to the whole performance obligation but should do that in one or a few performance obligations. ASC 606-10-32-37 has provided measures through which each agency should apportion the discount.ASC606 require that each performance obligation should have a price allocated to the requirement remains even if the responsibility is not separately sold. The price could either be a reasonable estimate or determined on a proportional basis. The main objective of this stage is to ensure that the amount allocated reflects the consideration expected by the business after the good or service has been transferred.
Recognize revenue when the entity satisfies a performance obligation
The last steps involve revenue recognition as the business meets the obligations that were to be performed. The steps explain the procedure for recognizing the revenue. ASC 606, provides that entities should record the income received from every performance obligation as customers make them. Revenue recognition recognizes timing as an essential element. The business should determine at the beginning of the contract if the performance obligation are to be fulfilled on a specific time or ongoing basis (Singh, 2019,). Revenues are recognized over time if an agency's performance does not involve the creation of an asset that has an alternate use, and the business has a right to receive payment that is enforceable after a performance at the completed dates. Revenue recognition can also be over a given period of production of the obligation increases or enhances the control of the customers as the process is created. Additionally, if a customer consumers and receives the benefits as the business provides them, then the revenue should be recognized over a given period.
Summary
The five significant steps in the ASC 606 models, therefore, includes contract identification with the customers, identification of the obligation to be performed in the contract, transaction price determination, allocation of the determined transaction price as well as revenue recognition. ASC 606 has simplified and standardized the process in which business records its revenues that are gained from the contracts with customers. This includes the timing for reporting the taxes, the amounts as well as nature (Riccardi, 2015,). Companies that offer recurring services such as licenses and subscriptions will improve their results after implementing the standard. Meeting the ASC606 standard has an impact on the finance department, policies in human resources as well as the information technology system among another department.
Requirements
Implementation and compliance of the new revenue rule will bring about some changes in the regular operation of the business. Organizations will be required to automate their calculations, reduce the closing period for the business as well as have a clear image on the revenue of an organization which includes both the deferred and the recognized revenue. The businesses are also required to deliver relevant reports, both externally and internally, to pass the audit.
Opinion
Complete implementation of the new rule requires technological solutions that are robust such as the cloud application for revenue recognition, as well as technology for revenue recognition that are flexible and automated. Right technological solutions are essential in tracking different streams of revenue, automating the calculations and allocations, and also in configuring various templates and rules that are used in the calculations (Riccardi, 2015,) The solution will be essential in the elimination of all the complicated procedures, such as the complex spreadsheets that were used previously. The use of the correct systems will help in the production of the clear trails in audit as well as attaching the supporting document. Policies, internal systems, as well as procedures, are all vital elements for implementation.
The five steps in the revenue recognition model have eliminated all weakness as well as inconsistencies as the model is comprehensive and can be used in different industries and for various transactions. Additionally all the stakeholders who have interest with the financial statements can now have access to sufficient information as required by the standard and can therefore comprehend all the revenues that come from engaging the customers with contracts. The standards are also simple and have thus eliminated the complexity that existed in the previous GAAP standards. The standards have provided a framework that is important in solving all the problems that comes from revenue recognition, have enhance the analysis of different practices of revenue recognition in different jurisdictions, business, capital markets and industries and has also simplified the process of preparing financial statements. The financial statement users can now understand the amount, uncertainty, timings and also the revenue recognized in a better way
Importance of ASC 606 rule.
ASC 606 has provided an alignment in the process of revenue recognition that is generated from contracts with different customers. The standard will ensure consistency across various industries in the ways that revenue is being recognized. ASC 606 has provided solutions to the problems that existed in accounts due to revenue recognition. Implementation of the standards has impacted the investors in that they can now effectively use the different financial reports from various industries to make their analysis and make the variable decision in regards to the investments. ASC 606 has a direct impact on the daily business tasks of companies.ASC606 financial resources to be more straitening in terms of time while handling the contracts. This may require additional skills (Riccardi, 2015,). The new standards also require the technology of cash technology, which is essential for business.
ASC 606 has also resulted in significant changes in organizations' sales recognition. Solutions for incentive compensation will help in aligning the incentives as well as drive the performance of sales. ASC 606 is essential for the optimal outcomes of the business. In addition to this, ASC 606 has enhanced legal works, sales and also finances to be joined for strategically on the contracts for customers.
Implementation of ASC 606.
Some of the companies consider a complete transition of the programs for revenue allocations, which are automated. In other business, the use of technological tools that enhance the disclosure and the tracking of the customer services have strengthened the implementation of the standards. The new standard for revenue has also eliminated many rules that were recognized in the previous GAAP US legacy (Riccardi, 2015,). The five-step model recognition can be applied in a straight forwards way. In other cases, the application of the new rule will need guidance, a judgment as well as an increase in the compliance complexity. The process of applying the rule should include a commentary review as well as attendance of the training courses. The process will also require taking an inventory of all the revenue streams in the organization. This can be done by creating a spreadsheet that has all the lists of the revenues and their sources. The inventory list should be used in assigning the team members the responsibility of applying the ASC 606. Additionally, the revenue recognition process can be documented, and then the relevant sections, as provided in ASC606 identified. The officer, in terms of implementing, should have specific reasons as to why a given a choice was made (Flood, 2020). It is essential for an organization to support all decisions with facts and also review all the conclusions made with the peers, external auditors as well as the team members. They are well versed in the standards as well as the required technology.
The final stage of applying the policy includes finalizing as well as approving the system for the new standard of revenue recognition. Organizations should also train their staff on the plans and the procedures to ensure that there is the communication of the necessary changes between the organizations (Riccardi, 2015,). When applying the standard, it is also important to notify and involve the internal auditors, and other staff who are responsible for the execution of contracts.
Application of the standard, therefore, involves reviewing all the commentary from resource groups and the accounting firms, taking inventory of the revenue streams, assigning the responsibilities to the team members, approval and finalization of the revenue recognition policies and finally communication with the relevant staffs and the stakeholders involved in the contract process.
It is also important to note that the process of applying the standard for revenue recognition at any organization differs depending on the uniqueness of the situation (Flood, 2020). It is, therefore, crucial that once the organization has determined the existence of a contract, which provides a good deal for the company, the organization should accurately analyze the existing factors that resulted in revenue recognition compliance, the thought, and the time. This makes the application less challenging as more and more of it is practiced. Additionally, housing and tuition are sources of primary revenues are institutions such as higher education has more bulk activities for revenue recognition.
Companies can apply ASC 606 in two ways, which includes a full retrospective approach or a modified retrospective approach. In the comprehensive retrospective approach, the entities use the standard by revenue recognition through retrospective guidance on every previous reporting period that has been presented in a financial statement (AICPA, 2019). Many entities prefer the full retrospective approach for the transition of the financial statements for the users. This is because the approach enhances comparability, is consistent, and also provides useful information. However, the method can excessively burden the companies by involving contracts that are long term. The use of modified retrospective enables the companies to apply the standards to use the initial year of application. In such cases, the company will not restate the comparative periods will instead recognize the cumulative effect in the adoption of the ASC 606 having the adjustment of the retained earnings at the beginning.
The new revenue core principle is, therefore, to recognize revenue to reflect the process of transferring the services or goods promised in the amounts that indicates the considerations. The consideration is the expected returns in exchange for delivering services and products as per the contract. The standard involves five steps, which are contract identification, performance obligations identification, transaction price determination, allocation of the transaction price, and also revenue recognition as the performance obligation is being met (Singh, 2019). New revenue recognition standard compliance has the potential of overhauling the processes, the systems as well as the controls completely across the various departments of the organization. The new rule has and will continue changing revenue recognition approaches for organizations, impact company expenses as well as how organization obtains and fulfill their contracts with the customers.
The main objective of the rule is to have a single standard that is principle-based for revenue recognition. The standard further aims at improving the process used by companies to account for contracts with their customers through the provision of a framework that is robust to address all the revenue issues that come up increased regulation of better disclosure, and also increase the comparability. The new standard scope includes all the customer contracts apart from those that involve financial statements, exchanges that are no-monetary, guarantees, insurance contracts as well as the lease contracts.
Literature review
References
AICPA. (2018). Life and health insurance entities in 2018. Wiley.
AICPA. (2019). Audit and accounting guide: Revenue recognition 2019. Wiley.
Flood, J. M. (2020). Wiley GAAP 2020: Interpretation and application of generally accepted accounting principles. John Wiley & Sons.
The new revenue recognition standard: FASB ASC 606. (2018). Audit and Accounting Guide, 549-557. doi:10.1002/9781119563976.app9
Riccardi, L. (2015). Accounting standards for business enterprises No. 38—Initial implementation of accounting standards for enterprises. China Accounting Standards, 299-305. doi:10.1007/978-981-10-0006-5_42
Singh, A. (2019). Welcoming the new revenue recognition standard: ASC 606 revenue from contracts with customers second edition. Independently Published.
Singh, C. A. (2018). Welcoming the new revenue recognition standard: ASC 606 - Revenue from contracts with customers. Independently Published.
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