Understanding ASC 606 and What it Means for Recurring Revenue

Did you know ASC 606 has been in effect for five years now? In fact, the new accounting regulations for revenue recognition are part of US GAAP (Generally Accepted Accounting Principles) and went into effect in 2018 for public companies and 2019 for nonpublic organizations. The ASC 606 rules were created by the FASB (Financial Standards Accounting Board) to standardize revenue recognition for customer contracts, bringing US GAAP in line with the IFRS (International Financial Reporting Standards).

While ASC 606 has created more flexibility in how companies recognize revenue. It has also generated a new set of compliance concerns. Part of the challenge is that ASC 606 isn't static but continues to evolve to address new revenue strategies, such as subscription billing.

ASC 606 Basics

ASC 606 defines revenue recognition as related to contracts with customers for goods or services. The aim of ASC 606 is to standardize financial reporting and eliminate variations in how businesses in different industries handle accounting. With standardized accounting and revenue recognition practices, it’s easier for investors, partners, and others to compare apples-to-apples fiscal performance.

The ASC 606 framework consists of five steps:

1. Identify the customer contract – Multiple terms, agreements, and verbal promises often cover customer relationships. Under ASC 606, they all fall under one agreement. For example, a vendor may have different contracts for equipment lease or purchase and ongoing maintenance. They are considered a single agreement that includes essential elements, such as:
   1. Approval and commitment of both parties
   2. Each party’s rights relating to the goods or services in the contract
   3. Payment terms and collectability
   4. Commercial substance or the change in cash flow
2. Identify the performance obligations – These are promises to the customer, such as the delivery of services, updates, training, etc. Fees for specific performance obligations must be tracked and reported.
3. Determine the transaction price – Determining the price of the contract requires estimating the revenue from the contract term. Determining revenue can be challenging if there are volume discounts, rebates, and other contract variables.
4. Allocate the transaction price – Besides identifying fees, those payments may need to be allocated across separate performance obligations. For example, for subscription contracts, a portion of the overall performance price is recognized over a subscription period.
5. Recognize revenue as the performance obligation is satisfied – Satisfying a contract obligation can occur either at one point or, in the case of subscription revenue, over time. Organizations that continue to maintain manual business processes often have issuers with this step if they must estimate delivery dates or manually track the progress of a project.

ASC 606 Compliance and Recurring Revenue

Recurring revenue business models can be complex, especially regarding revenue recognition. Revenue can be tracked by scheduled subscription payments or metered consumption, which can lead to complications that result in billing errors.

As more businesses adopt recurring revenue, they encounter issues that complicate ASC 606 compliance, such as high transaction volumes and changes in contract performance due to volume discounts, upgrades, and service changes. Multiple performance obligations, such as installation, deployment, and training, may exist.

The biggest difference between ASC 606 and ASC 605, the previous standard, is how sales commissions are reported. Under ASCX 605, commissions could be reported as immediate income, capitalized, or amortized. Under ASC 606, sales must be capitalized, so if a sales rep earns a $240 commission for a subscription service, it must be reported as a $20 monthly cost for the year.

Automating ASC 606 Revenue Recognition

To simplify ASC 606 revenue processing, the easiest solution is to automate it. Gotransverse manages ASC 606 compliance for you as part of intelligent billing, including:

• Managing the complexities of deferred revenue and performance agreements with multiple elements.
• Allocating revenue to performance obligations based on the relative value of standalone selling prices.
• Recognizing allocated revenue as products and services are delivered.
• Handling estimates of quantity-based products, such as subscription services.
• Supporting multiple general ledgers to simplify financial statement disclosure compliance.
• Handling mid-term changes and revisions of contract terms.
• Adding future-based-billing elements, such as discounts for early payment or performance bonuses.

Gotransverse is designed to support recurring revenue and consumption-based pricing, and ASC 606 support is built in. Our mission is to provide a flexible billing solution tailored to handle revenue recognition your way and still keep you compliant with the latest regulations. To see how Gotransverse can help you address ASC 606 compliance, learn more about our support for ASC 606, or contact us to get more details or schedule a demonstration.