Understanding the Converged Standard on Revenue Recognition

Whether you’re ready or not, the converged standard on revenue recognition is now fully upon us. Also known as ASC 606, this converged standard on revenue recognition was announced in 2014 and is now close to full implementation. The standard was introduced to simplify the way revenue is realized between companies and customers. While it has simplified much, the new revenue recognition standard has also forced many companies to change their revenue recognition process. The many benefits of the new converged standard are apparent, yet adopting a new process and adapting to the new regulation has proven difficult for some organizations. In this post, we’ll dig deeper into what exactly this new converged standard on revenue recognition is, why and how it came about, and how you can ensure you are complying with it.

The converged standard on revenue recognition is an accounting standard that deals specifically with how companies recognize revenue from contracts with customers. Also known as revenue realization, revenue recognition has to do with when and how a company records revenue. Accurate revenue recognition is critical because it guides a company’s financial planning and helps determine how many funds to allocate and to which areas of the business. Without an accurate picture of revenue, it’s difficult to plan for the future and grow effectively. Not only that, revenue recognition affects everything from compensation structures to sales commissions, product plans, and go-to-market strategies. In the past, the way revenue was recognized often differed by industry and country, with organizations in different countries adhering to distinct rules under different regulatory bodies. With the new revenue recognition standard, that is no longer the case.

To consolidate and simplify the way revenue is recognized, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) banded together to create a new standard, often referred to as ASC 606. Previously, the IASB regulated the International Financial Reporting Standards (IFRS), while the FASB was responsible for similar, but distinct United States Generally Accepted Accounting Principles (U.S. GAAP). This new converged standard brings together the principles outlined in the IFRS and the U.S. GAAP all under one uniform formula. The new standard lays out five guidelines that companies must follow when recognizing revenue.

The new revenue recognition standard (ASC 606) involves the following five steps:

1. Begin a contract with a customer and establish a valid agreement between the two parties.

2. Identify the performance obligations in the contract. The promises within the contract must be deemed capable of being distinct and also be distinct within the context of the contract.

3. Determine the transaction price. This means estimating all of the variable considerations in the contract on day one. It also means constraining them so that a significant revenue reversal is not probable. Also included in the transaction price under ASC 606 is a list of noncash considerations.

4. Allocate the transaction price to the individual performance obligations identified in step two based on the standalone prices. If standalone prices are not available, allocation can be done based on third-party evidence (TPE), all the entities’ cost plus standard margin, or by the residual approach if the prices of other performance obligations are known.

5. Recognize the revenue when or as the entity satisfies a performance obligation. This entails determining whether the performance obligation will be satisfied over time or at a point in time. The new set of criteria for “over time” might move some products from one category to another. If revenue cannot be recognized over time, it will have to be recognized at the point in time when control of the product gets transferred to the customer.

Many wonder why there was such a need for a new converged standard of revenue recognition. Quite simply, the new standard is meant to simplify and standardize. It’s meant to make a complex system more uniform across industries and nations, facilitating a clearer picture of a given company’s financial standing, and offering a clearer way to consistently compare companies all across the world. Plainly, as the global economy continued to grow in complexity and depth, a simplified revenue recognition standard was required.

Before the standardization under the new ASC 606 converged standard, the way revenue was recognized across industries was often different and complex. The new principle-based approach under ASC 606 does leave some room for interpretation, but it is meant to provide a simple framework for standardization across the globe.

The decision to unify revenue recognition under one simple standard was not made hastily. In fact, it is said that it took over 12 years to arrive at the decision. The converged standard on revenue recognition was the result not only of talks between the FASB and the IASB, but also of communication between the entities and interested parties. This communication was frequent through the entire process of the project, and the boards sought comment at every stage of development. The standard was continually refined in response to feedback from the interested parties. The FASB claims, in fact, that it got as many as 1,500 comment letters responding to their work on the new standard.

The new converged standard was announced way back in May of 2014. With the understanding that complete compliance would take considerable time, companies were given significant warning and ample time to fully implement and apply the new standard. Public entities that reported under the U.S. GAAP were required to become compliant after December 15, 2017. Private companies in the U.S. were given more time, being required to show compliance after December 15, 2018. International companies that report under IFRS are required to comply on or after January 1, 2018.

Yes. In fact, the FASB and IASB have together formed something called the Transition Resource Group (TRG). This group meets every so often to publicly discuss issues that emerge as the new standard is implemented. The group serves as the middle man between concerned parties and the FASB and IASB in taking into account common implementation concerns and taking any necessary action regarding the standard. The TRG also strives to provide a forum where those implementing the new standard can learn from others who have also grappled with the complexities of implementation.

The TRG is happy to field questions and accept concerns over issues of implementation via an emailed submission form. Questions made to the TRG must be related to ASC 606/IFRS 15, represent diversity in practice, and concern an implementation issue that is likely to be pervasive or to apply to a large group of people.

Compliance is key if you want to avoid negative fallout from an audit or a decreased corporate valuation. There is little doubt that the new standard has caused companies to rethink a number of their processes, and implementation for many organizations has not been a simple process. Many are behind. It was estimated, in fact, that as many as 70% of companies were on track to miss the ASC 606 deadline. The good news is that many others have been through the process of becoming compliant. Additionally, there are a number of tools available to help you in the process. One of these tools is CPQ software combined with a CRM solution.