The History of Federal Regulations
The first regulations were implemented by the IRS to improve tax collections on long-term or multiple year contracts.
The second push came after our military leaders became intolerant of the pricing policies of major contractors. The policies would be considered fraudulent in today’s environment.
The new standards wish us to:
- Use performance obligations to trigger revenue recognition
- Allocate contract revenue fairly to performance obligations
- Adhere to standardized revenue recognition profiles
- Financial Statements that are more comparable and standardized across industries and geographies
- The changes initiated by ASU 606 were initiated by Wall Street to provide investors with more consistent published financial information
- Performance Obligations
- Allocate Revenue
- Revenue Recognition Profiles
- Capitalize Additional Sales Cost
- Capitalize Variable Consideration
Now that we know what the regulations require us to do, let’s look at what the regulations are trying to control.
ASU 606 wants concise and transparent math and no delays that would affect revenue recognition timing.
What are the key impacts and how do they pertain to you? We have outlined them below.
The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
- ASU 2019-08, Shared-based consideration payable to a customer
- ASU 2018-18, Targeted improvements for collaborative arrangements
- ASU 2018-08, Clarifying the scope and accounting guidance for contributions received and contributions made
- ASU 2018-07, Improvements to nonemployee share-based payment accounting
- ASU 2016-20, Technical corrections and improvements to ASC 606
- ASU 2014-09, Revenue from contracts with customers
- ASU 2016-11, ASU 2017-13, and ASU 2017-14, Amendments to SEC guidance related to ASC 606
The revenue recognition standard explains that to achieve the core principle of Topic 606, an entity should take the following steps below.
5 Revenue Recognition Steps:
- Identify the contract with the customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when the entity satisfies a performance obligation
The 606 applies to every company except 2 types: insurance and leases
One of the most common examples in our industry as it pertains to the ASU 2014-09, revenue from contracts with customers is professional services and software sales type of scenarios. Here is an example.
The ASU 606 wants:
- No games with unit prices
- Consistent revenue timing
- Recognize revenue when certain
To Sum It All Up
Treat revenue recognition like performance obligations, using consistent methods across contracts. Additional sales costs are costs incurred to obtain or prepare to meet contractual performance obligations. They are costs that would not be incurred if the contract was not awarded.
The purpose of this update is to provide insights and a better understanding of these changes and how they can affect your business.
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