The time to ensure you have the right processes in place to comply with the ASC 606 revenue recognition rules is now, especially if you sell direct to consumers and expect to generate a lot of income during the holiday season, accounting pros said last week in a CFO.com webinar.
The Financial Accounting Standards Board (FASB) adopted Accounting Standards Codification (ASC) 606 in 2014 to tie revenue to when control of a good or service transfers to a buyer under a contract rather than when the supplier satisfies its obligation. The change, on its surface, seems modest. But it requires companies to exercise more judgment on when revenue, and expenses to generate them, is recognized.
The rules took effect for public companies last year. The requirements kick in for private companies at the end of this year.
700 pages of guidelines
Because of the complexity embedded in the 700 pages of guidelines, it's a good idea for your accounting team to work through your processes with your outside auditors as a kind of trial run if you haven’t already done that, said Sarah Blake Semendinger, controller for The Great Courses, an education company.
"You do not want something like this to be the holdup to a clean opinion," she said. "By working with them in the interim, you can ensure a smoother audit."
The guidelines outline a five-step process for recognizing revenue:
- Identifying your contract with a customer
- Identifying your performance obligations under a contract
- Determining the transaction price
- Allocating the transaction price
- Recognizing revenue
More than under current procedures, you’ll need to work with the heads of your IT, legal, sales and other departments, because the decisions they make can affect how you recognize expenses and revenue, said Christophe Cantenot, director of revenue and financial reporting for Dexcom, which provides a way for people to use their phones to monitor their glucose levels.
How contract terms are written can make a significant difference in how you recognize money coming in or going out. And if you don’t coordinate well, you can face a big drop in revenue in one reporting period versus another, he said.
"In sales, you want to work with those in charge of the relationship with your clients and those in charge of the contracting side," he said. "You need to have someone with revenue knowledge review the agreements with your customers before executing."
The rules affect how the sales team expenses its acquisition costs and applies its commissions.
"We had to go through a deep dive assessment on whether those sales commissions should be considered like contract acquisition costs," he said. "In the past, we were expensing those sales commissions. ... If the expected amortization period of those costs is less than a year, then you can continue to expense them as you incur the expense. So it did change the way we were looking at the business, forced us to spend more time with HR, the sales team, and look at the way they were compensated."
For a company that sells to consumers, how those goods or services are distributed makes a difference in how revenue is recognized.
Semendinger’s company, which sells education courses, distributes their products in two ways: directly to consumers, and through a distribution arrangement with Amazon’s Audible. It also produces courses exclusively for Audible and sells a subscription product through an app.
"You can’t always assume the relationship is the same as last year," she said. "Look at your net versus gross or principal agent relationship. Look at those contracts each year when they get renewed."
Semendinger has to look at whether the digital subscription product is distributed through iTunes or Google Play Store. "So, we’re looking at how those contracts are renewed, when terms and conditions change, from Apple or Android. We have to analyze to ensure the whole net versus gross or principal agent hasn’t changed."
Because decisions made by the legal team on how contract terms are written and how sales are recognized, it’s imperative your finance team works with leaders in legal and sales so they understand how their decisions affect your assumptions. IT needs to be involved, too, because it needs to set up systems so team leaders can collaborate.
"Marketing is probably the biggest impact for me," Semendinger said. "We design our campaigns so far out in advance. I need to remind them to keep us in the loop, especially on these holiday catalogs. We still look at things on a quarterly basis and how campaigns change from one year to another as far as timing. So, when we’re comparing revenues and expenses, from, say, the second quarter last year to the second quarter this year, if they make a change by just a few days, on when a campaign would go live, that could have a huge swing from quarter to quarter. Especially coming into the holiday season, as you can imagine being a retail company, a lot of our sales are done from Black Friday through the Christmas holiday, and the timing of when we start those campaigns” determines how much revenue we can recognize and when.