February 3, 2020
ASC-606 Revenue Recognition from Contracts
Revenue from Contracts with Customer
ASU 2014-09 standard is effective for nonpublic entities for annual reporting periods beginning after December 15, 2018. This means that entities with a calendar year-end need to adopt the standard for the year ended December 31, 2019. Under the new guidance, there are five steps in the revenue recognition process, which reflect the transfer of promised goods or services to customers in an amount that determines the consideration to which the entity expects to be entitled. Revenue recognition is considered contract specific, as the applicable criteria are based on the terms of the contract with the customer, whereas it was previously industry-specific.
Five-Step Process of the Revenue Recognition Process:
Step 1: Identify the contract with the customer. A contract exists if all of the following criteria are met:
• Approval and commitment of the parties exists
• The rights of the parties have been identified
• The payment terms have been identified
• The contract has commercial substance
• Collection of the consideration to which an entity is entitled is probable.
Step 2: Once the contract has been identified, the performance obligations within the contract need to be identified. A performance obligation is a promise to transfer either distinct goods or services or a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. Options to acquire additional goods or services for free or at a discount, (for example sales incentives, customer award credits (or points), and renewal options), also need to be considered when determining performance obligations. Distinct goods or services are accounted for separately under the standard because they are considered separate performance obligations.
Step 3: Determine the transaction price, which is defined as the amount of consideration to which the entity expects to be entitled. The transaction price is affected by the following:
• Variable consideration
• Significant financing
• Non-cash consideration
• Consideration payable to the customer.
Step 4: Allocate the transaction price. The price should be allocated to each performance obligation on the basis of the stand-alone selling price. This is done using the observable price or estimated using an approach to maximize the observable inputs, such as the adjusted market assessment, the expected cost-plus margin, or the residual approach.
Step 5: Finally, revenue is recognized when (or as) performance obligations are satisfied. A performance obligation is considered to be satisfied when the customer obtains control of the goods or services. Control is defined as the ability to direct the use of and obtain substantially all of the remaining benefits from, the asset. Transfer of control can take place over time or at a point in time.
For example, A high school receives $2,000,000 from a corporation. In exchange, the school agrees to name its new football stadium in the corporation’s name. The name must be prominently displayed on the stadium to certain specifications contained within an agreement between the high school and the corporation. The stadium is located next to a heavy traffic area in the heart of the city where the school is located. The term of the agreement is five years.
Step 1: Identify the contract
This is considered a reciprocal contract. The high school and the corporation approved the agreement and committed to satisfying the terms. The high school has the obligation to name the stadium in the corporation’s name and display that name per specification in the contract. The payment terms were identified. The contract has commercial substance since the corporation is receiving value in the form of advertising. The high school determines that the collectability of the consideration is probable.
Step 2: Identify the performance obligations
The high school must exclusively name the stadium after the corporation and maintain signage in accordance with the terms of the contract.
Step 3: Determine the transaction price
The transaction price is $2,000,000.
Step 4: Allocate the transaction price
There is one performance obligation; therefore, the allocation of the transaction price between performance obligations was not considered necessary.
Step 5: Recognize revenue
Revenue is recognized when a performance obligation is satisfied. In this example, the naming right for the stadium lasts five years. It is reasonable to conclude that the corporation receives and consumes the benefits over the term of the contract. Therefore, revenue is recognized pro-rata over the term of the contract ($400,000 per year).
ASU 2014-09 may be adopted using either the full retrospective or modified retrospective method. Disclosure requirements for both methods in order to understand the nature, amount, timing, and uncertainty of revenue and cash flows include the following:
• Contract balances: receivables, assets, and liabilities
• Performance obligations: timing of satisfaction and transaction price allocation
• Significant judgments
• Costs to obtain or fulfill a contract
• Breakdown of revenue
An emphasis of a matter paragraph for the change in accounting principle should be added to the report.
Within the accounting policies footnotes, the following disclosures should be included:
• Adoption footnote: standard, description of the standard, adoption date, nature and reason for change in accounting principle, method of adoption, the effect on the financial statements, significant judgments, and adoption option elections including practical expedients
• Change in accounting principle describing the old and new GAAP
• Revenue recognition policy: provisions of the standard and industry guidance.
Written by Amy Kletch, CPA.
Amy is a manager with over 20 years of audit experience in various industries; including public companies, non-profits, manufacturing, distribution, construction, government, oil and gas, pension plans, and transportation.