Revenue is one of the core elements of an entity’s financial statements; it is used as the basis of many financial measures to compare companies to one another and to analyze a single company over time. The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) recognized that existing revenue recognition literature differed between their jurisdictions and that both systems needed improvements. The two organizations collaborated and Accounting Standards Update (ASU) 2014-09 was produced as the result of their joint efforts. This update is part of the Accounting Standards Codification (ASC) as Topic 606: Revenue from Contracts with Customers (ASC 606), and supersedes the existing revenue recognition literature in Topic 605. The goals of ASU 2014-09 are as follows:
- Remove inconsistencies and weaknesses in revenue requirements
- Provide a more robust framework for addressing revenue issues
- Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets
- Provide more useful information to users of financial statements through improved disclosure requirements
- Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer
(ASU 2014-09 Summary)
The standard setters hope to achieve these goals by introducing a five-step approach that should help entities recognize revenue in a way that better reflects the consideration that the entity expects to receive in return for the transferred goods or services.
This article provides a basic overview of ASC 606 and highlights major topics that an entity should consider when applying the standard. The RevenueHub site publishes other articles that (1) summarize the major issues of each of the five steps, (2) provide a detailed analysis of some of the nuances of ASC 606, and (3) show proper implementation of ASC 606 through relevant case studies.
ASC 606 applies to contracts with customers in all industries except for those excluded in ASC 606-10-15-2:
- Leases (ASC 840)
- Insurance contracts (ASC 944)
- Contractual obligations within certain financial instrument guidance
- Receivables (ASC 310)
- Investments (ASC 320, 323, 325)
- Liabilities (ASC 405)
- Debt (ASC 470)
- Derivatives and Hedging (ASC 815)
- Financial Instruments (ASC 825)
- Transfers and Servicing (ASC 860)
- Guarantees other than product or service warranties (ASC 460)
- Nonmonetary exchanges between entities within the same line of business used to facilitate sales to customers
When an entity enters into a transaction that is subject to guidance from multiple topics in the codification (like the topics listed above), the entity must exclude from the transaction price the amount of consideration tied to revenue subject to the other topic(s). The remaining consideration is allocated to the other performance obligations according to guidance in ASC 606 (ASC 606-10-15-4). For more information, please refer to Scope and Interaction with Other Guidance.
The Five-Step Approach
ASC 606 directs entities to recognize revenue when the promised goods or services are transferred to the customer. The amount of revenue recognized should equal the total consideration an entity expects to receive in return for the goods or services. The Boards created a five-step approach that entities should apply when determining the amount and timing of revenue recognition.
- Step 1: Identify the contract with a customer
- Step 2: Identify the performance obligations in the contract
- Step 3: Determine the transaction price
- Step 4: Allocate the transaction price to the performance obligations in the contract
- Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation
These steps are addressed more fully in the The Five-Step Method.
Adoption and Transition
For public entities, certain not-for-profits, and certain employee benefit plans, ASC 606 will take effect for fiscal years beginning after December 15, 2017. Early adoption is permitted for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. An entity that does not fall into any of these categories is considered nonpublic under ASC 606. Nonpublic entities are required to observe ASC 606 for fiscal years beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. Early adoption is also permitted for nonpublic entities. For more detailed information about transition dates, please read Transition Dates and Methods. For more information regarding transition plans, refer to Connor Group and RevenueHub’s recent study of US public companies’ ASC 606 transition disclosures.
Full vs. Modified Retrospective Adoption
The Boards decided to allow entities to choose one of two adoption methods: full or modified retrospective. (ASC 606-10-65-1(d)). Under the full retrospective method, entities apply the standard retrospectively to all reporting periods represented on the financial statements. Entities who use the full retrospective method are allowed to use any or all of three practical expedients in order to ease the burden of transition. Under the modified retrospective method, entities apply the standard in the year of initial application—comparative periods are not restated—while recognizing the cumulative effect of adopting ASC 606 with an adjustment to beginning retained earnings. For more information on the two transition methods and the various allowed practical expedients, please refer to Transition Dates and Methods.
ASC 606 supersedes most existing industry- and transaction-specific guidance. Its purpose is to improve the revenue recognition portion of financial statements and increase the consistency of financial reporting globally. Standard setters hope to achieve this with a five-step approach to recognizing revenue from contracts.
Public entities are expected to adopt ASC 606 in their first reporting period after December 15, 2017. However, they have the option to adopt one year earlier than the requirement. For most public companies, financial statements released in 2018 will be the first in compliance with ASC 606. Nonpublic companies must adopt the standard for the following year. In order to ease the transition, the Boards allow entities to choose between two adoption methods (full- and modified-retrospective) and use practical expedients when they first apply ASC 606.
- ASU 2014-09, “Revenue from Contracts with Customers.”
- ASU 2015-14, “Deferral of the Effective Date.”
- EY, Financial Reporting Development: “Revenue from contracts with customers.” Revised August 2017. Section 1 “Overview, effective date and transition” and Section 2 “Scope.”
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” September 2014. Section 4.1 “Scope”, Section 5 “The model”, and Section 13 “Effective date and transition”.
- PwC, “Revenue from contracts with customers.” August 2016. Section 1.6 “Transition and effective date” and Section 2.2 “Scope”.