There are only five requirements needed for accounting teams to successfully perform revenue recognition, and ASC 606 lays them out like a yellow brick road.
- Identify the contract
- Identify performance obligations
- Determine transaction price
- Allocate transaction price
- Recognize revenue
It’s just five steps. They are clearly worded. Nothing complicated or fancy. Seems simple enough, right?
Let's break it down a bit.
Assume you're a typical SaaS company. You take payment via credit cards and occasionally offer trial periods or discounts to boost sales.
ASC 606 Step 1: Identify the contract
This sounds simple until you dive into:
- Is the contract customized for any market? Customer?
- What version of the contract was it?
- What are the dates?
- What if the contract has auto-renewal?
- What if the contract has an opt-out or cancellation clause?
- Modification clause (like upgrades or downgrades)?
- Is the contract more than one year?
- What about data retention on any data the customer might own if they cancel?
Identifying a contract means you have to painstakingly sift through these nuances and ensure you’ve accounted for every detail. Missing a single clause could lead to revenue recognition errors or compliance issues. No pressure.
ASC 606 Step 2: Identify performance obligations
Sure, it's just access to software, professional services, and support. But:
- What are the trigger mechanisms around the performance obligations?
- Are there multiple performance obligations? If so, how do they relate to each other?
This step requires you to meticulously map out every performance obligation and ensure they're distinct and measurable. One misstep and you're in hot water with your auditors.
ASC 606 Step 3: Determine transaction price
Sounds straightforward, but consider:
- What if you discount at the invoice and not the line items?
- What about “free” items?
- How do you handle returns? Partial returns?
- How do you handle disputes? Partial disputes? Second disputes?!
Setting the transaction price involves complex calculations and justifications, especially when discounts and freebies come into play. Get ready for some Excel wizardry.
ASC 606 Step 4: Allocate transaction price
Consistency is key, but...
- How do you ensure you are consistent across various contracts and performance obligations?
Allocating the transaction price means you need a robust system that ensures consistency and accuracy. Manual errors? Let's hope not.
Agility is becoming a must-have, too. For example...
- If you’re at a public company, your allocation mix will need to be reviewed quarterly at a minimum. Consider that you start giving away support services for free (maybe if there’s some internal push or campaign, or a change in your strategy or model), then your mix and allocation methodology needs to be able to digest and adjust that easily and systematically. You don’t want to add this to the list of monthly manual tasks, especially across hundreds or thousands of customers (or tens of thousands, or hundreds of thousands, or millions… sweating yet?)
ASC 606 Step 5: Recognize revenue
High volume? No problem! Oh, wait:
- How do you ensure you are not missing revenue (from new SKUs, data reconciliation to reports, etc.)?
- Still have those returns and partial returns accounted for consistently?
- And here come disputes, partial disputes, and second disputes again. Some PSPs even allow for second chargebacks (ahem, Adyen). Is your policy for these still locked in?
- How do you account for credits?
- How do you account for upgrades/downgrades?
- How do you account for multiple currencies and FX?
- How do you account for bad debt?
- Do you have documented internal controls around these processes?
Recognizing revenue is where the fun really begins. You must meticulously record every transaction and account for every anomaly. One wrong entry and your financial statements will be off.
Conclusion
In summary, while the five steps of ASC 606 for revenue recognition seem easy on paper, each step is laden with intricate details that require expertise, documentation, processes, and data to make everything accounting-ready. It’s not just a process, it’s a journey through the labyrinth of compliance and accuracy. So, next time someone says rev rec looks easy (probably a marketer or engineer), just smile and nod. They clearly haven't lived it.
Learn how to automate compliance with ASC 606 in this special webinar created exclusively for accountants at subscription businesses: 3 Things Subscription Companies Gain With Accounting Automation (and 3 Things They Lose)
