Article written by:
Mike Purcell, CPA
Senior Manager, Assurance & Business Advisory Services
Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers, has dominated accounting and finance literature, including our very own Bottomline, for the past number of years. Consistently touted as one of the most significant changes in accounting literature in decades, ASC 606 has eliminated industry-specific guidance and introduced a single, principle-based standard to improve comparability, as well as provide information that is more useful to financial statement users. For public company filers, the standard became effective for the calendar year 2018. Following adoption in 2018, the SEC has been busy reviewing issuer statements and providing comment letters regarding the issuers’ adoption of the new standard.
As a quick refresher, ASC 606 introduces a five-step model to account for contracts with customers. SEC comment letters have largely focused on Step 2 (identify performance obligations (promises) in the contract) and Step 5 (recognize revenue as performance obligations are satisfied). Interestingly, nearly half of comment letters were sent to issuers who disclosed in their filings that adoption of ASC 606 was immaterial.
Step 2 requires the identification of contractual promises by the entity, to transfer to a customer distinct goods or services, either individually, in a bundle or as a series over time. In identifying performance obligations, goods or services are considered distinct if they are a) capable of being distinct, and b) distinct within the context of the contract. This evaluation includes not only evaluation of identified goods and services, but also implicit promises within the context of the contract. The SEC has focused on issuers and their identification of performance obligations, as well as whether certain obligations should be combined. Additionally, issuers have struggled with identifying implicit performance obligations, including material rights, or future discounts available to customers. Step 2 identifies the units of account that affect the allocation of the transaction price and timing of revenue and requires significant judgment.
To the surprise of some, Step 5 has also been a hot button topic with the SEC, which is the recognition of revenue when each performance obligation is satisfied. Under ASC 606, the presumption is revenue is recognized over time (the contract), versus at a specific point in time, unless the contract fails to meet certain criteria. For many industries, this could represent a significant shift from legacy recognition rules. The SEC has been focused on control transfer to customers and the timing of the control transfer, ultimately affecting when revenue is recognized in the financial statements.
For organizations that are privately held, these lessons from issuers and the SEC should be carefully considered given the historical “trickle down” effect from the public environment. As privately held organizations continue to evaluate and implement ASC 606 for the calendar year 2019, we encourage specific and focused conversations with all in the organization (including accounting, counsel, sales and marketing, etc.) to assist with identification of performance obligations and review of transfer of control for your contracts.