Identifying performance obligations: The revenue recognition standard calls for determining whether the promises made to your customers are distinct within the context of the contract. If it’s capable of being distinct (when it can be used, consumed, sold, or held for economic benefit on its own), you will likely have a more straightforward determination, but figuring out things like the interdependence of promises on other goods and services can be a challenge.
This effort can begin by identifying all the promises being made to customers (e.g., warranties and indemnification provisions). Evaluate the nature of each promise (a milestone payment could be a promise or it could be an incentive payment, which would be a variable consideration). And consider whether the promises are distinct. What are the bare minimum performance obligations vs. optional elements in the contract?
Knowing when transfer of control happens: For physical products, this is an easy determination—an item can be recognized when a delivery driver drops a package on the customer’s porch, for example. But the pattern of transfer is not obvious for some performance obligations. If you’re constructing a building, for instance, the performance obligations may be satisfied over time—you are transferring control as the job progresses. You would not wait until the building is done to recognize revenue on that construction.
Evaluating contract costs: The standard changes how incremental costs involved in acquiring and fulfilling a contract are recognized. A salesperson’s commission could be considered an incremental cost. Recognition of the cost will need to align with recognition of the revenue.
Preparing for the Transition and Minimizing Audit Risk
The effort involved in making an accounting change like the revenue recognition standard can easily be underestimated. In addition to understanding ASC 606, there’s the constant concern over whether proper documentation is being kept that will meet auditors’ expectations. Companies need to keep notes on the thought processes behind their decisions.
For instance, judgment is needed to estimate the standalone selling price for each distinct performance obligation. Companies may rely on internal historical figures, see what’s happening in the marketplace, or come up with a new model, but they will need to provide backup for why one approach was selected over another. In addition, revenue recognition in accounting calls for proper disclosures related to significant judgments made in identifying performance obligations.
Rely on the expertise of RoseRyan finance and accounting experts who will take your team through the changes and make sure the company is prepared, with efficient processes and systems in place, to comply with the standard going forward. We’ll also support the company through the transition, which may involve process changes and training of the team.