INTRO
ASC 606 is the new revenue recognition standard that affects all US businesses that enter into contracts with clients or customers for goods or services. ASC 606 is required, regardless of whether a business has private, public, or non-profit status.
With the ASC 606 guidelines drastically changing the revenue recognition standard in the US, it can be difficult to adapt without sacrificing efficiency to ensure compliance. Since subscription-based companies are primarily composed of recurring revenue streams, they are especially affected by these changes—but with a few tricks, compliance can be a breeze.
ASC 606 AND ITS 5 STEPS
The 5 basic steps outlined below are deceptively simple: this is especially true for subscription-based companies where our pricing tools and sales strategies may not fit neatly into these steps.
Step 1: Identify the contract with a customer
This step refers to the criteria of an individual contract being identified with a specific customer. Not too difficult on the surface, but in the subscription world contract changes are ubiquitous and what’s recorded on paper is rarely what is done in practice. For example, there are several components to keep in mind from order date vs effective start date, payment terms, initial periods, renewal notice periods and billing periods. Being deliberate and consistent about how you identify contracts and manage complex timelines is key to easy ASC 606 compliance.
Step 2: Identify the performance obligations in the contract
This step refers to whatever obligations are in the contract (goods or services) that must be fulfilled by the company. Similar to the complications in step one, obligations often shift when contracts are upgraded or downgraded, so take extra care to track changes in performance obligations with contractual changes. Furthermore, it’s also helpful to categorize the obligations separately in terms of recurring services, one-off fees (e.g. implementation, consulting), and fees (usage-based). This makes allocating specific transaction costs to their specific obligation go smoothly for step 4.
Step 3: Determine the price of goods and services
This step refers to the price that the consumer is obligated to pay for the exchange of goods and services. This can be difficult in the B2B world as with many sales tactics typically involve evolving pricing strategies, it can be incredibly time-consuming to track these manually. These complex pricing models in B2B such as usage-based ones can make it even more confusing to mark down an exact price, not to mention that the final prices are often determined through negotiated deals. In other words, a lot more work for B2B subscription-based companies given our prices are typically non-uniform.
Step 4: Allocate the transaction price to performance obligations
This step simply refers to allocating how the transaction price is attributed to distinct performance obligations. This gets confusing for recurring and usage-based fees given that they are obligations that evolve over time. Recurring charges are relatively straightforward, whereas usage-based fees can be tricky as it is directly correlated with the customer’s use which is typically volatile. But, if you follow the advice mentioned above in step 2, and measure the customer's usage of your service properly, the legwork for this should be mostly complete.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation
This step refers to recognition of revenue at the point when the service is provided. Based on how we differentiated the revenue types in step 2, you can then decide how each of the types will be recognized. This simply consists of determining conventions for which revenue recognition rules to use when recognizing one-time, recurring and usage fees. Also take care to correctly recognize revenue for when there are changes to the subscription that occur in the middle of a service period.
HOW TO SOLVE?
The gist is that not only can doing this manually risk human error, but that it’s incredibly time-consuming and cumbersome to comb through these details. Thus, it’s best to automate how each of these problems are handled. To be compliant with ASC 606, we recommend using a subscription management system that is purposely designed for B2B subscription-based companies giving you tailor-made tools for your business model to document each step appropriately, automate your processes, and minimize risk of errors. This way you can save time and ensure accuracy in your revenue accounting.
LOOKING TO THE FUTURE
As the Financial Accounting Standards Board (FASB) continues to review and evaluate the feedback on this new standard, we can anticipate future changes and improvements that may come in the future. There is a noticeable push toward increasing information transparency and disclosures which has in turn improved company evaluations by enabling more accurate entity comparability. Thus, we can expect the need for systems that categorize and track the details and steps of all transactions to be more relevant in the future if not the new norm in upcoming revisions by the FASB.
Our advice is that it is best to adapt to a system that splits up the accounting process into multiple steps to ensure compliance and future adaptability in case the guidelines change again and head toward the need to recognize more individual steps. Also, it’s key to have a platform that streamlines this all for you; that way the shift to new compliance standards is not only seamless but also happens quickly and efficiently. No more fat fingers from manual calculations or entries!