Guide: ASC 606 Revenue Recognition Examples
In our last blog post, we discussed the 5-step process companies must follow to implement the new revenue recognition guidance under ASC 606. Companies must also understand the financial reporting impacts of ASC 606 and how to properly recognize revenue from contracts with customers.
This article explains the accounting treatment of implementing the revenue recognition steps including how to allocate transaction prices and record journal entries.
How to Allocate the Transaction Price of Each Performance Obligation
Once you’ve identified the contract with a customer and specified performance obligations, payment terms, and rights of the buyer and seller, the next step is to determine the transaction price of each performance obligation.
Suppose your firm charges customers for consulting services and workshops. All parties have agreed on a one-year contract that includes (1) consulting fees of $50,000, (2) an onboarding fee of $2,500, and (3) a workshop scheduled 6 months from now for $10,000. The sum of the 3 performance obligations is $62,500.
The next step is to allocate the transaction price amongst the performance obligations. Instead of individually pricing the 3 services to your customer, you offer a package deal for the one-year of consulting, onboarding, and a workshop for $50,000. In this case, the transaction price is allocated as follows:
ASC 606 provides guidance for estimating standalone pricing when needed. It also includes guidance for allocating discounts and accounting for changes in contract terms.
How to Record ASC 606 Revenue Recognition Journal Entries
Revenue is recognized when the entity satisfies the performance obligations, regardless of when payment is received. Typically, payments are received upfront for obligations that will be fulfilled over multiple periods.
In the example above, your customer paid $50,000 in advance of receiving promised goods or services. Even though revenue has not been earned yet, you must record the receipt of cash with the following journal entry:
Record payment received on 12-month contract for all services.
Because you’ve received payment for services you haven’t yet provided, revenue is deferred until you have fulfilled your contractual obligations. The deferred revenue account is used to “park” the payment until you’ve actually earned it through performance. Each month the accountant must reclassify deferred revenue from the balance sheet to service revenue on the income statement as it’s earned.
For each of the 12 months that you provide consulting services, you will record revenue equal to 1/12th of the deferred balance. This entry will be recorded monthly to recognize the earned portion of consulting fee revenue:
Record monthly consulting services revenue earned on 12-month contract ($40,000/12 = $3,333).
The onboarding fee is a one-time, upfront fee for set up and training and recorded when the contract begins:
Record onboarding fee revenue earned on 12-month contract.
Depending on the structure of your chart of accounts, this may also be recorded to a separate Fee Revenue account.
The workshop performance will be recorded 6 months from now after your company has fulfilled your performance obligation by completing the workshop:
Record revenue earned for consulting workshop.
The balance of the Deferred Revenue account will gradually decrease to zero and Service Revenue will gradually increase to equal $50,000 at the end of the one-year contract after all revenue has been earned.
Under ASC 606, not all of the contract revenue will be recognized upfront even if the company has been paid in full.
How to account for free services or waived fees
Free service doesn’t mean no revenue is earned; it means that the total transaction price would be reallocated to incorporate the additional months.
If your company gave a client one additional month of free consulting services, the $40,000 consulting fees would be allocated over 13 months instead of 12 months, even though no payment is received.
The company would record this entry:
Record monthly revenue earned on 13-month contract ($40,000/13 = $3,076.92).
If your company agreed to transfer goods and services first and bill later for payment, you would record a receivable as long as you are unconditionally entitled to payment and collectability is assured per the contract. Instead of debiting Cash and crediting Deferred Revenue then reclassing Deferred Revenue to Service Revenue, you would record this entry:
Record monthly revenue earned on 13-month contract.
The company now has an asset (Accounts Receivable) instead of a liability (Deferred Revenue).
Because no upfront payment was received for consulting services, there is no impact on deferred revenue in the financial statements. ASC 606 also requires extended disclosures in the financial statements and companies must provide details around performance obligations and the associated assets and liabilities.
Failure to record and understand the ASC 606 impact of these entries could result in a company overstating liabilities and understating revenue. To ensure accurate financial reporting, leadership must take action on these knowledge gaps by either training staff, outsourcing, or investing in high-performing employees.