ASC 606 is the accepted revenue standard in the US, and it is here to stay. It will affect all of your existing contracts with customers, and it promotes flexible and robust guidance through the entire process of revenue recognition and its changes that can affect the financial performance of a company.
But what exactly is ASC 606, and how does it apply to your business? This is what we’re tackling today.
Ready to learn more? In this guide, we’ll take you through:
WHAT IS REVENUE RECOGNITION?
Revenue recognition is an accounting principle that identifies the specific conditions under which a business can record a sale transaction as revenue. Only when revenue is earned, can it then be ‘recognized’. Revenue is typically recognized when a critical event occurs, such as the product being delivered to a customer, and the dollar amount is measured easily by the company.
WHAT IS ASC 606?
ASC 606 is the new revenue recognition standard affecting all businesses that enter into contracts with customers to sell goods or services. It is a recent change in standardized accounting principles for revenue recognition and the document explains in a step-by-step manner, how you should account for revenue earned from your business operations.
While the previous system was industry-specific, the new and improved structure is industry-neutral. Its goal is to encourage transparency in revenue recognition, address revenue issues when they pop up, and create a standardized ecosystem where all businesses can recognize revenue across multiple industries.
The term ASC stands for Accounting Standards Codification, defined by the Financial Accounting Standards Board.
FIVE STEPS TO ASC 606
When it comes to SaaS businesses, the payment for a promised service is made by the customer upfront, and this new ‘cash’ can only be considered as revenue as it is earned over the contract period of the customer.
ASC 606 has a simple 5-step process to ensure effective revenue recognition.
1. Identify contract with a customer
The first step outlines the criteria that needs to be met when establishing a contract with a customer to supply your services. Under ASC 606, a signed contract is not needed, but any contract can be valuable with enforceable rights and obligations.
Every contract has a few essential parts:
All parties involved have willingly approved the agreement
All parties are committed to fulfilling their obligations
The rights of each party are identifiable
Terms of payment are established
Collectibility is probable
2. Identify performance obligations in contract
It is important to then specify how distinct performance obligations in a contract must be handled. Simply put, the term performance obligation means a promise to transfer goods or services to the customer. In this step, any and all distinct services provided to the customer need to be outlined. A service can be defined as:
The customer will benefit from the service itself
It can be transferred independently of other performance obligations in the contract
3. Determine transaction price
The purpose of this next step is to delineate what needs to be considered when defining the transaction price. The transaction price means the cash and non-cash payment that an organization is entitled to receive from the customer. This will include any variable considerations like volume discount and price concession.
4. Allocate transaction price
Once the transaction price has been set, it’s important to then allocate it across the contract’s separate performance obligations, and is what the customer agrees to pay for your service.
In SaaS, the service provided is naturally recurring, so there will always be a continuous performance obligation. This can be overcome by the seller splitting the total amount of consideration to be recognized as revenue for each performance obligation.
5. Recognize revenue when the entity satisfies a performance obligation
Revenue can be recognized once your organization meets each performance obligation. This step is useful as it allows you to specify how that should happen, and then you’re done! The revenue is recognized when the performance obligation has been fulfilled.
The need for each step will vary from business to business, but these steps can help the lion’s share of companies identify how to correctly recognize revenue.
HOW ASC 606 IMPACTS YOUR BUSINESS
The “Revenue from Contracts with Customers” rule helps to standardize the way in which companies record revenue in customer contracts. ASC 606 has been implemented since December 2017, and it covers how businesses report on the timing, amount and nature surrounding their customer contracts.
For retail companies and the like, that sell their goods and receive the revenue in one instant transaction, the impact of ASC 606 will not be as significant. For many SaaS companies that operate using a subscription-based model, this rule may lead to better results.
Before this ruling was implemented, if a SaaS company sold a 12-month license, only six months of revenue could be applied to its records. The following six months of revenue could not be counted until the year after. This however is a thing of the past with ASC 606.
HOW PRECURSIVE CAN HELP
No matter your position on ASC 606, it’s here to stay, and we’re here to help. With Precursive’s smart revenue recognition software, we can help you to:
Customize revenue recognition tracking to your business needs
Recognize revenue based on project tasks, timesheets or milestone completion
Import or export revenue transactions into your financial system
Forecast and recognize revenue on both fixed price and T&M projects
With Precursive, you can be sure you’re getting valuable insight into how you are spending your money and making revenue, and give you the tools to ensure you are managing recurring billing, reducing revenue leakage, and keeping your cash flow healthy.
WHAT NEXT?
You should now have a better understanding of ASC 606 and how this new rule may affect your organization. The added requirements can be slightly overwhelming, which is why you should turn to revenue recognition software to take some of the load off your plate.
Find out how PSA solutions and revenue recognition features compliment each other by booking a Precursive demo today!
Want to learn more about revenue recognition? You can do this by looking at our revenue recognition field guide, the one-stop shop for you to master this topic.
