Revenue Recognition Under ASC 606
Revenue recognition can be complex. Make sure you get it right using BDO's "Blueprint" publication.
BDO's Professional Practice publication (Blueprint) guides professionals through the application of FASB’s Accounting Standards Codification Topic 606, Revenue Recognition (“ASC 606” or the “revenue standard”) with practical examples and interpretive guidance. Summarizing key aspects of ASC 606, this Blueprint helps all companies, public and private, understand and continue to comply with the revenue standard as business models, service lines, and pricing practices change.
ASC 606 in a Nutshell – The Five-step Revenue Recognition Model
The revenue standard establishes a single, comprehensive framework to determine how much revenue is recognized, and when. The core principle is that an entity recognizes revenue to depict the transfer of promised goods or services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. An entity recognizes revenue when or as control over the goods or services is transferred to the customer. The core principle is applied in five steps; explore the steps below.
An entity identifies the contract with a customer for accounting purposes, which may not be the same as the contract(s) for legal purposes. A contract is an agreement (written, oral or implied by an entity’s customary business practices) that creates enforceable rights and obligations between an entity and its customer.
An entity identifies performance obligations in the contract by analyzing its promises to transfer goods or services to the customer. A performance obligation is a ‘distinct’ good or service (or a bundle of goods or services). A good or service (either individually, or in combination with each other in a bundle) is distinct if the customer can benefit from that good or service on its own or in combination with other readily available resources and that good or service is separately identifiable from other promises in the contract. An entity also considers the applicability of the series guidance.
An entity determines the transaction price, including an estimate of variable consideration if appropriate. The transaction price is the amount recognized in revenue in Step 5. The entity must also identify and adjust the transaction price, if appropriate, for a significant financing component, noncash consideration, or consideration payable to a customer.
An entity allocates the transaction price among the performance obligations in the contract. The allocation generally is based on the relative standalone selling price of each performance obligation with exceptions for certain discounts and variable consideration; the allocation must be consistent with the allocation objective in ASC 606. Determining the standalone selling price of each performance obligation is a key aspect of this step.
An entity assesses when it satisfies each performance obligation (which may be at a point in time or over time) by transferring a promised good or service to the customer and recognizes revenue allocated to each performance obligation when (or as) that performance obligation is satisfied. A good or service is transferred to the customer when (or as) the customer obtains control over that good or service.
Other Key Concepts
Principal Versus Agent Considerations
ASC 606 provides guidance on principal versus agent assessments when a third party is involved in providing goods or services to a customer. An entity is a principal, and thus recognizes revenue on a gross basis, if it controls a good or service before transferring the good or service to the customer. An entity is an agent, and thus recognizes revenue on a net basis, if it arranges for a good or service to be provided by another entity. The standard contains indicators and examples to assist with this analysis.
Contract Modifications
ASC 606 includes a comprehensive model to account for modifications of contracts with customers. A contract modification is a change in the scope or price of a contract approved by parties to the contract. This might be referred to as a change order, variation, or an amendment. An accounting adjustment is only recognized for a contract modification when either new enforceable rights and obligations are created, or existing ones are changed.
Customer Options for Additional Goods or Services
Customer options to acquire additional goods or services for free or at a discount come in many forms, including, sales incentives, customer award credits (or points), contract renewal options, or other discounts on future goods or services. ASC 606 provides guidance on accounting for a customer option to acquire additional goods or services based on whether it is a material right, a renewal option or neither.
Contract Costs
ASC 340-40, Other Assets and Deferred Costs — Contracts with Customers, includes specific guidance on accounting for the incremental costs of obtaining and the costs incurred in fulfilling a contract with a customer within the scope of ASC 606. Certain contract costs are initially recognized as an asset (that is, deferred) and subsequently expensed on a systematic basis that is consistent with the pattern of transfer to the customer of the good or service to which those costs relate.
Onerous Contracts (Loss Contracts)
This Blueprint also discusses the accounting for onerous (loss) contracts with customers in accordance with U.S. GAAP.
Licensing
ASC 606 contains special rules for recognizing revenue from licenses of intellectual property (IP). ASC 606 specifies that there are two types of licenses of IP, symbolic IP license and functional IP license, with different patterns for revenue recognition based on the nature of the license.
Presentation and Disclosures
Presentation
ASC 606 includes guidance on presenting contract assets, contract liabilities and receivables in the balance sheet for contracts with customers. When either party to a contract has performed, an entity presents the contract in the balance sheet as either a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity presents any unconditional rights to consideration separately as a receivable.
Disclosure Objective
ASC 606 includes an overall disclosure objective, which is for an entity to disclose information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
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