In our last blog, we discussed the basic concepts of ASC 606, the new revenue recognition standard. Today, let’s dig in a little deeper to see what exactly the five-step model of the new standard is and how to apply it step by step.
As mentioned in our last article, all businesses and organizations that enter into contracts with customers will be affected by ASC 606, no matter if it’s a public company, private company, or a nonprofit organization. In other words, basically none of us will be left out of this transition. To make sure you are getting off on the right foot with your company, ask yourself the following questions while we walk you through the five steps in the new revenue recognition model:
- Identify the contract with a customer
Can you identify the contract? This means, the new revenue recognition model is based on the existence of a contract with a customer.
Tips: As defined in the standard, a contract is an agreement between two or more parties that create enforceable rights and obligations.
- Identify the performance obligations in the contract
Can you identify the performance obligations? This means taking a look not only at the actual deliverables and terms in the contract but also at the implied promises. This step can get complicated as the contract may require significant analysis to identify the obligations you have to the customer.
Tips: A performance obligation is a promise to transfer goods or services to a customer. The standard requires an entity to identity all distinct performance obligations in a contract.
- Determine the transaction price
Have you determined the transaction price? This means evaluating the terms of the contract to determine the amount, nature and timing of the exchange of goods and services.
Tips: Although this step seems straightforward, this step actually includes a lot of considerations such as variable consideration, noncash consideration, and the existence of financing components in determining the transaction price.
- Allocate the transaction price
Have you allocated the transaction price? If you identified more than one performance obligation in step 2, you will need to allocate the transaction price to those obligations based on their relative standalone selling price. This step may involve significant estimates by management if the performance obligations identified in step 2 are not typically sold on a standalone basis. In this scenario, management will need to determine the estimated selling price of the performance obligations.
Tips: The transaction price should be allocated to the performance obligations identified in step 2.
- Recognize revenue when or as the company satisfies a performance obligation
Can you recognize revenue as performance obligations are satisfied? Now that the previous 4 steps are completed, it is time to recognize revenue. Under ASC 606, revenue is recognized at a point in time or over a period of time, depending on how the performance obligation is satisfied. This step may involve significant estimates by management in measuring the progress made to date.
Tips: This is the final step in the new revenue recognition process.
This is still a basic introduction to a complex series of new requirements. To make sure you are in compliance from the start, please give us a call to see how we can help you get ready for the new revenue recognition standard.