ASC 606 Step-by-Step Step 5: Recognize the Revenue When/As a Performance Obligation is Satisfied

We’re entering the home stretch—in more ways than one. As we enter the Fall, private companies now have one year and one quarter to complete their transition to the new ASC 606/IFRS 15 standards pertaining to the way that all contracts are managed and accounted for. Additionally, we are entering the home stretch for this blog series, which took an in-depth look at the changes that are being made and the processes that will need to be changed as organizations get closer and closer to the effective date.

Today, we will close out our Step-by-Step Series, which looked to break down the 156-page standard and provide key takeaways, including who ASC 606 affects, a brief overview on the five steps, and a look at how ASC 606 will affect different industries. For more information, see each step in detail below.

1. Identify Contract(s) with a Customer
2. Identify Performance Obligations in the Contract
3. Determine the Transaction Price
4. Allocate the Transaction Price to the Performance Obligations in a Contract
5. Recognize the Revenue When (or as) the Entity Satisfies a Performance Obligation

ASC 606 Deep Dive Step 5: Recognizing Revenue

Biggest Impact: Aerospace & Defense, Asset Managers, Construction/Building/Engineering, Manufacturers, Licensors, Real Estate, Software

The last step in the revenue recognition process is to recognize the revenue after the performance obligations are fulfilled by the supplier. With certain rule-changing regarding costs to obtain a contract and specific disclosure requirements, the new rules pose large changes to the accounting practices for nearly every industry, with the exception of asset managers, healthcare, and telecommunications.

Recognizing Revenue

For many contracts, in which a performance obligation is satisfied when a good or service is transferred to a customer, revenue recognition is a simple process—transferring the promised good and recognizing revenue after it is transferred:

• An entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer.
• A good or service is transferred when (or as) the customer obtains control of that good or service.

Performance Obligations Satisfied Over Time

The process for recognizing revenue differs slightly in the event that an entity satisfies a performance obligation over time. In order for performance obligations to be met over time, and revenue to be recognized in this way, one of the following three criteria must be met.

1. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs. (A weekly recurring service: Cleaning)
2. The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced. (building an asset on a customer’s site)
3. The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date. If a performance obligation is not satisfied over time, an entity satisfies the performance obligation at a point in time. (building a customized or specialized asset that only the customer can use)

Measuring Over-Time Progress: Input and Output Measurements

For these, companies take a different approach, in which a provider will measure progress using one of the following two methods, output and input.

• Output Method: Based on direct measurements of the value to the customers of goods or services transferred to date, relative to the remaining goods or services promised. Examples include milestones reached, time elapsed, etc.
• Input Method: Based on an entity’s efforts toward satisfying a performance obligation, relative to the total expected inputs to satisfy the obligation. Examples could include labor or machine hours used, resources consumed, costs incurred, etc.

Satisfying Performance Obligations at a Point In Time

The alternative to over-time satisfaction of performance obligations is the satisfaction of performance obligations at a point in time.

Point in Time Consideration: Transfer of Control

To determine the point in time at which a customer obtains control of a promised asset and an entity satisfies a performance obligation, the entity would consider indicators of the transfer of control. Control, and therefore transfer of control, is explained as the following:

• The Ability of the Customer… (the customer has present right to an asset)
• …To Direct the Use of… (the customer can deploy the asset, or can allow or prevent another entity from deploying the asset)
• …And Obtain Remaining Benefits from… (the customer can obtain potential cash flow—directly or indirectly—through use, consumption, sale, pledging, or holding the asset)
• …An Asset

Additional Issues to Look At

In addition to the issues regarding transfers, there are certain practices that need to be heeded regarding things like repurchase agreements, consignment agreements, bill and hold agreements, customer acceptance, and more, as discussed in the full text and KPMG Revenue Issues In Depth Article.

Conclusion: Time to Get Moving

15 months may seem like a long time (it’s only three if you’re a public entity), but many organizations are seeing challenges in making the move to implement new processes and systems to meet the requirements of the new standard.

Even if we’re posting monthly blogs leading up to the effective date, you should already be looking at transition methods and other industry-specific considerations that you need to make. To address this, we’ve compiled a list of resources for companies looking to prepare for the upcoming standard:

• Analyst Report: Intacct Leads the Way in ASC 606 and IFRS 15 Revenue Recognition
• Six Rules for ASC 606 Readiness
• ASC 606 and Subscription Businesses—Why Compliance Can’t Wait

On Demand Webcasts: ASC 606/IFRS 15

Sage Intacct recently presented a three-part series on the new standards, which you can view on-demand.

• Part 1: New FASB Rev Rec Standards, Actions You Should Take Now!
• Part 2: The Impending Impacts of ASC 606 on Subscription Businesses
• Part 3: Master Your Transition to ASC 606 and IFRS 15

We welcome you to peer through the full text, the AICPA guidance, and to get in contact with us to learn more about preparing for ASC 606 with outsourced accounting services and/or a new accounting software designed with new RevRec Standards in mind.