Accounting Standards Codification (ASC) 606 provides scope considerations that an entity must first consider to determine whether to apply the remainder of the topic. Additionally, transactions that are partially within the scope of other guidance and partially within the revenue guidance must be divided into their respective portions, which will then be accounted for separately. To divide these transactions, separation and measurement guidance from ASC 606 is only followed if the other standard does not provide specific direction.
ASC 606 applies to transactions with customers, defined as “parties that contract with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.” Consequently, one scope consideration is whether the counterparty to a transaction is a customer (for additional guidance, see Definition of a Customer).
Additionally, ASC 606-10-15-2 provides the following explicit list of transactions with customers that are not in scope:
- Lease contracts within the scope of Topic 840.
- Insurance contracts within the scope of Topic 944.
- Financial instruments and other contracts within the scope of the following:
- Topic 310 – Receivables
- Topic 320 – Investments, Debt and Equity Securities
- Topic 323 – Investments, Equity Method and Joint Ventures
- Topic 325 – Investments, Other
- Topic 405 – Liabilities
- Topic 410 – Debt
- Topic 815 – Derivatives and Hedging
- Topic 825 – Financial Instruments
- Topic 860 – Transfers and Servicing
- Guarantees (other than product or service warranties) within the scope of Topic 460
- Nonmonetary exchanges between two or more entities in the same line of business – Topic 845 may apply to these transactions
Contracts can be partially within the scope of ASC 606 and partially within the scope of another standard. In these cases, if the other topic provides direction for separation and measurement then that guidance should be followed first, with the remaining portion of the transaction being accounted for under ASC 606. Alternatively, if the other topic does not provide direction, then the guidance from ASC 606 on allocating transaction prices will be followed. The following flowchart summarizes the process for separating a transaction.
This approach is designed so that any discount in the overall arrangement will be allocated to the portion that is within the scope of topic 606.
Guarantees & Derivatives (Topic 460, Topic 815, and Topic 310)
Non-warranty guarantees are outside of the scope of ASC 606. In transactions that contain both guarantee and revenue elements, the guarantee must be recorded following the guidance in ASC 460, with the remaining portion of the transaction price allocated according to the revenue standard. Guarantees should generally be recognized as a liability at an amount equal to the estimated fair value. Because guarantees also meet the definition of a contingency, in some instances the probable contingency could potentially be larger than the estimated fair value. Although this is generally not the case, this exception may occur when a guarantee has a high probability of having a large impact, with a small probability of zero impact. As a result, the contingency amount would be greater than the fair value of the guarantee, and the larger amount of the two must be recognized.
Similarly, derivatives must be measured at fair value with the excess allocated according to the revenue standard. After the initial allocation, any subsequent accounting change for elements recorded at fair value is accomplished according to relevant Generally Accepted Accounting Principles (GAAP). These adjustments will have no impact on the other performance obligations or the way revenue is recognized.
For certain loan guarantees in which an entity lends its creditworthiness to another party for a fee it is unclear whether ASC 460 or ASC 606 should be applied. Pending content in ASC 310-10-60-4 directs that for guidance on loan guarantees an entity should see topic 606. However, topic 606 states that guarantees within the scope of Topic 460 (other than product or service warranties) are outside the scope of ASC 606. Loan guarantees are an output of banks’ ordinary activities, but are also guarantees. Consequently it is unclear if ASC 310-10-60-4 should instead reference ASC 460 directly, or if loan guarantees in exchange for a fee should be treated as revenue transactions under ASC 606.
Leases (Topic 840 & 842)
Both ASC 840 and the recently released ASC 842 specifically refer to ASC 606 for direction on allocating the transaction price for lessors. Consequently, contracts that contain both lease and revenue elements should be allocated based on relative selling price (for additional guidance, see Standalone Selling Prices).
Example (Contract with sale and a non-warranty guarantee)
Blendit Company (a manufacturer of high-end blenders) is interested in opening a smoothie shop in a new location near its remote corporate headquarters so they can provide employees with complementary smoothies. Additionally, Blendit sees this as a means of developing a relationship with a new sales channel to sell its Pro3 blenders.
Sumptuous Smoothies is willing to open a new location and purchase 200 Pro3 blenders for its various locations if it can also purchase a minimum revenue guarantee from Blendit to guarantee the revenue of the new location for 2 years. The total transaction price is $150,000, with the standalone selling price of the blenders and the fair value of the guarantee being $80,000 and $100,000, respectively. When the guarantee is considered as a contingency, the amount that provides the best estimate within the range of possible losses is $60,000.
Because ASC 460 provides direction for measuring the guarantee at the greater of fair value or the contingency amount, the greater of these amounts ($100,000) of the transaction price is allocated to the guarantee and recorded as a liability, with the remainder ($50,000) allocated to the sale of the blenders.
Comparison to 605
One primary reason for the issuance of ASC 606 was to eliminate industry-specific revenue guidance, and create converged revenue guidance based on common principles. Under ASC 605 there were more than two-dozen different areas of guidance for industries ranging from agriculture to health care. Whether or not a transaction was accounted for using one standard or another could have a major financial statement impact, and each standard had a separate scope. This is in contrast to ASC 606, which provides guidance for all transactions with customers except for five exceptions (leases, insurance contracts, financial instruments, certain guarantees, and nonmonetary exchanges).
There are two primary considerations for whether a contract is subject to ASC 606. These include (1) whether the counterparty to the transaction is a customer and (2) whether the contract is within the scope (entirely or partially) of one of the exceptions listed. For transactions that are partially within scope of ASC 606, other guidance should be used to the extent it provides specific measurement or separation guidance. This will result in any discount being allocated to the revenue portion of the transaction. However, when other relevant guidance provides no direction, then ASC 606 should be used to allocate the transaction price.
- ASC 460-10-15-4 to 15-7, 30-1 to 30-4
- ASC 606-10-15-1 to 15-4
- ASU 2014-09: “Revenue from Contracts with Customers.” BC64-BC66.
- EY, Financial Reporting Development: “Revenue from contracts with customers.” August 2017. Section 2.3, Section 6.6.
- Deloitte, “A Roadmap to Applying the New Revenue Recognition Standard.” February 2015. Section 3.2.
- KPMG, Issues-In-Depth: “Revenues from Contracts with Customers.” May 2016. Section 4.3.
- PWC, “Revenue from contracts with customers.” August 2016. Section 1.3.1.