By Daniel A. Rudio, CPA
As private companies gear up to implement the new revenue guidance in Accounting Standards Codification (ASC) Topic 606, many can benefit from the experiences of public companies that implemented the standard last year. Top among all lessons, though, is that implementation of the standard demands considerable time, resources, and expertise, as well as a focused team working to meet a tight timeframe.
ASC 606, which goes into effect next year, requires private companies to recognize revenue based on the amount the company expects in exchange for those goods and services. The new rules are principles-based, meaning that various judgments, assumptions, and estimates may be required, which may result in a change in the amount or timing of the revenue recognition.
The new guidelines also add significant new disclosure requirements that will be unique to every company. It will be difficult to use boilerplate disclosures and to satisfy the requirements in ASC 606.
Keep in mind that implementing the new standard may result in operational changes to your company, resulting in new policies and procedures for 2019 and onward. ASC 606 will impact most businesses in ways that go beyond the balance sheet and income statement. Coupled with tax reform that passed in late 2017, the adoption of ASC 606 could affect the amount of cash taxes a company has to pay in a given period. The adoption of ASC 606 also could affect incentive compensation programs, such as sales commissions and management bonuses.
The effective date of ASC 606 is imminent, so implementing ASC 606 should be a priority for private companies.
Challenges to Implementation
ASC 606 contains a new five-step process for recognizing revenue from contracts, which requires businesses to identify the contracts, identify performance obligations, determine the transaction price, allocate the transaction price to the performance obligations, and recognize revenue when performance obligations are met. The new rules are principles-based, and determining whether certain business arrangements — such as verbal agreements or contracts that contain “termination for convenience” clauses — meet the definition of an enforceable contract under ASC 606 will be a formidable first step. In some cases, determination might require legal opinions. In addition to ASC 606, FASB issued ASC 340-40, which requires companies to capitalize and amortize “incremental contract costs” and “costs to fulfill” a contract. Many of these costs are currently expensed as incurred. However, they may now be required to be capitalized and amortized over the life of the customer, which can present challenges with contracts that offer renewal options, among other situations.
Auditors understand that many companies won’t be able to analyze every contract. They do expect, however, that private companies will select a representative sample of contracts to review to ensure all revenue streams are reviewed for impact. Once decisions are made on how to apply ASC 606 to those specific contracts, private companies will need to apply any conclusions reached to all similar contracts.
In our experience, even if a company evaluates 20 percent of its outstanding contracts, the process will likely consume a surprising amount of time and resources. If you think about it, this shouldn’t be surprising. A single contract can stretch to 25 pages or more, and carefully reviewing a document of this length can take hours. The review will also require, as public companies learned, highly qualified workers who understand the legal and accounting impacts of the contracts, including issues like material rights, termination provisions, and enforceability.
For each of the five steps in the revenue recognition process, there may be 25 or more key accounting issues to consider. If you tally it up, companies may need to review as many as 125 factors or data points for each contract. Compounding matters, as many as one-quarter of these issues may be subject to interpretation, and may require input from sales, operations, legal, and audit teams.
Huddle with the Auditors
The importance of working with auditors early on cannot be overstated. External auditors with experience in ASC 606 can offer guidance on creating a comprehensive, compliant implementation plan. An ongoing dialogue with the auditors also can help businesses understand how auditors will interpret the standard and what compliance practices they will — or will not — sign off on.
Unlike some previous standards, ASC 606 requires significant knowledge and judgment to ensure that disclosures in the financial statement are accurate and complete. Most businesses, however, will not have internal ASC 606 expertise, since the standard is new and experienced experts are few and far between.
Daniel A. Rudio, CPA, is managing director at Pine Hill Group, an accounting, financial reporting, and transaction advisory firm headquartered in Philadelphia. He can be reached at email@example.com.