The Experts’ Take on ASC 606 Revenue Recognition (and How You Can Accelerate Compliance)
Oct 31, 2018 | By Blake Oliver
Although it’s tempting for private companies to hide their heads in the sand when it comes to complying with ASC 606, the reality is that putting it off will only increase the challenge. The standard is already in effect for calendar year end public companies, and it takes effect for private companies at the end of the year. There’s much to do to prepare, so the time is now to get started.
We sat down with two experts from CFGI, a financial consulting firm that assists organizations with operational finance and technical accounting challenges: Lindsi Scanlan and Xavier Sanchez. Scanlan is a Senior Manager with CFGI and has a successful track record of technical accounting support, SEC reporting, SOX compliance, and process optimization. Sanchez is also a Senior Manager with significant experience at CFGI, providing both technical accounting services as well as IT risk advisory services.
ASC 606 Affects a Wide Variety of Businesses
It’s not only a few types of businesses that the new revenue recognition standard is causing difficulty for. Scanlan explains, “Software companies, service providers, those who are bundling a product and a service together, and product-based businesses that offer discounts are all going to be affected. It even affects companies with no impact on a period-over-period basis of the revenue that they're reporting because the amount of work that goes into proving that out is significant. It's impacting everybody, across the board, from that standpoint.”
ASC 606 Requires a Thorough Understanding of Your Revenue Streams and Your Customer Base
You won’t be able to comply with the new rev rec standard if you don’t know exactly what’s in your customer contracts and how the promises you make to your customers in those contracts should be accounted for. ASC 606 incorporates some potentially significant changes for certain common contractual features – especially if you have been applying industry-specific accounting guidance historically. To streamline your scoping assessment, Scanlan recommends using a bucketing strategy: “Are there certain portfolios where customer contracts are operating similarly? If so, you can bucket them and do your analysis at a higher level using representative contracts rather than looking at every individual contract.”
She also recommends designating a project lead within your technical accounting or financial reporting group. Then assign your revenue or billing manager to co-lead. “You're really tackling it from both aspects — the process side of, ‘This is how we're used to reporting revenue, invoicing our clients, and so on.’ Then, on the accounting side, saying, ‘Okay, let's talk through this on a practical standpoint.’ Then think about what you need to do from a technical accounting standpoint to bridge the gap between where you are now and where you need to be."
Automation can dramatically simplify compliance. FloQast recently introduced multi book accounting to help companies adjust to the new standard, and there are a a number of other software solutions that offer assistance. Sanchez advises, “There should be a lot of upfront diligence on choosing your revenue recognition software. For successful implementation, you need to make sure the business is involved and the accountants are involved. Also, loop in the IT department to make sure that your choice is a viable solution.” A checklist can be helpful with compliance. Sanchez says, “When you enter into your contracts, make sure that you are going through a checklist of the things that impact rev rec compliance. Different industries are going to be impacted differently. Build that into your controls, where you're either reviewing at the contract level, or order-by-order standpoint, or if it's a quarterly review.”
How to Sell Your CEO on the Necessary Resources for Compliance
Since the deadline is rapidly approaching, you’ll need to devote resources both in the form of staff, technology, and perhaps outside advisors. Convincing your CEO that you need additional resources could be a challenge, since the complexity of implementation can be difficult for those not immersed in the finances of the business. And some of those new resources will need to be ongoing.
But compliance isn’t simple. Scanlan says, “From my perspective, if you’re not prepared, you're risking getting a material weakness when you report to The Street. I think that's motivation enough for CEOs to get behind approving the resources you need.”
She adds, “Even as a private company, the likelihood that you'll stay a private company forever, or that you won’t have a new investor come in, is small. If they see a material weakness in the audit opinion, or if you see an audit opinion that basically says you weren't able to adopt on time, that might call into question the reliability of your financial statements as a whole. If your company wasn't able to tackle this in a timely manner, then that leads to the question, ‘Are these financial statements reliable?’”
What Controllers Should Be Looking for When Switching to ASC 606
There are a two key mistakes that controllers will want to avoid when adopting ASC 606. Scanlan advises, “I have seen clients—those where we've come in at a later stage—who have missed something in their upfront data-gathering phase. This can have a significant downstream impact, since you're going backwards and starting over. I'd say that would be an area that causes a lot of rework. Also, not implementing in time.”
Sanchez emphasizes the importance of controls: “Getting up to the standards is important, but you also need to be thinking about how you’re going to keep it going as the new contracts come in.”
FloQast’s Take on ASC 606
The new rev rec standard is causing challenges for the accounting and finance team at FloQast, too. In some cases, it may be less accurate than the old standard, particularly when it comes to services revenue related to our software implementations. For example, if you’re a relatively young startup like us, it’s difficult to determine how long your average contract is. You’ll need to make an educated guess. In our case, we’re assuming that customers will stay on for an average of five years, but we could be overestimating or underestimating.
Under ASC 606, we’re required to amortize our setup fees over that five year term, when previously we recognized it all in month one or two (since our setups typically take only a month). Now if a customer churns, we have to accelerate all that services revenue and book it in the month the customer leaves us, which recognizes more GAAP revenue than we expect.
This seems to violate the matching principle of accounting, which says that revenue should match the expense associated with it. If the majority of your service expense is outlaid on the front end of a contract, that’s when you should recognize the expense. It doesn’t make sense to recognize that expense later on, when the services were completed months or years prior.
That said, the new rev rec standard is what it is. And FloQast is dedicated to helping accounting teams automate and ease the pains of compliance whether or not FASB’s pronouncements make sense. Learn more about how we’re helping companies achieve ASC 606 compliance ».
To find out more about CFGI and how they’re assisting clients with adopting ASC 606, visit CFGI.com.