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A new accounting standard for recognizing contract revenue in a standardized way regardless of industry, ASC 606 took effect in December, 2016. The goal of the new standard is to provide guidance for accounting staff in preparing financial statements. Although non-public companies will also be asked to implement the rule, it is primarily geared toward public corporations and covers any type of contract the company has with a customer, except for leases, financial instruments, and insurance contracts, which are already covered by other generally-accepted accounting principles (GAAP). These types of contracts continue to be accounted as they were previously.
Unit of Account and Performance Obligations
The new accounting standard is meant to clarify and standardize the financial impact of contracts with customers across a variety of industries. The unit that must be recognized in financial statements under the new rule is a performance obligation: the value of either a good or service that is committed under the contract. A commonly-used term is also a contract “deliverable.” Performance obligations should be accounted for separately from a contract only if they are distinct; if not, they may be bundled or grouped together for accounting purposes.
Transaction Price and Revenue Recognition
The complex nature of contract relationships comes into play when calculating the price or value to be paid for each separate performance obligation. Transaction price may be estimated, and can include variables in expectations, for example, cancelled orders or unforeseen adverse situations. Financing components will also be recognized, and others excluded, such as third party collections like sales tax. Revenue should be recognized when the corporation satisfies each performance outcome or deliverable within a contractual arrangement.
Cost Recognition
Whatever it costs to obtain a contract, the corporation can capitalize those costs in increments, if they are expected to be recovered. The same recognition applies to costs that are incurred during the course of fulfilling a contract, or to satisfy future performance requirements. If these costs will be recovered, then they will be recognized as capital expenditures.
Timing Considerations
The new rule took effect December 31, 2016. The first accounting period where statements will be issued using this new form of contract recognition for public companies will be years beginning after December 15, 2017. The rule was developed jointly by the two accounting boards, FASB and IASB. The FASB standard began December 15, 2016, and the IASB standard began January 1, 2017. Publicly-traded corporations are expected to implement the new standard first, while privately-owned companies have another year to work with their accounting firms and financial administration to change methods.
One significant impact of the standard will be on the construction industry. Traditionally, the industry recognized revenue based on percentage of completion. Now, a five-step process is involved, which starts with identifying and understanding the contract and its deliverables. The cost of meeting the terms of the contract will now be considered, along with the transaction price, or amount provided in exchange for meeting the contract milestones. These methods are a genuine change in accounting practices. ASC 606 is a new accounting rule that has been discussed by the major accounting official bodies for years and is now being implemented.