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As we’re rounding third base on the implementation of ASC 606, Revenue from Contracts with Customers, there are a number common themes that we are seeing. While no implementation is the same, included below are five areas of struggle that have continued to arise in practice, as well as corresponding implementation and adoption considerations.
#1 – Combination of Contracts and Contract Modifications
Under legacy guidance, companies were required to treat multiple contracts as one revenue arrangement in certain circumstances. Companies should evaluate their internal policies to determine if any of the revised criteria impact the scenarios in which they combine contracts.
The more critical consideration that may have a significant impact in this space is contract modifications. For example, while two separate contracts may not be combined as one revenue arrangement, a subsequently issued contract may be considered a contract modification under the new guidance and therefore impact the accounting of the original contract. Companies should have a policy in place for identifying contract modifications and be able to document and support their conclusions.
#2 – Practical Expedient for Immaterial Goods and Services
Under legacy guidance, there was not a specific definition as to what was considered a deliverable impacting the determination of the units of accounting in an arrangement. The new guidance allows for companies to exclude immaterial goods and services from the performance obligation analysis. However, the analysis needs to be performed at the contract level. As such, while certain items may be immaterial in one contract, those same goods or services may be material in another contract and would thus be incorporated into that contract’s performance obligations analysis.
#3 – Milestone Payments
Milestone payments are typically considered variable consideration whose impact will need to be continuously evaluated to determine when they should be incorporated into the transaction price. Companies have often been able to apply a constraint on the amount recognized by highlighting the susceptibility of the payments to outside factors, as well as the lack of experience (at the company and within an industry) for estimating milestone payments. As milestone payments become more certain, companies will need to incorporate such payments into their transaction price as the constraints are lifted (i.e., when factors indicate that a significant revenue reversal would not occur). Given the typical magnitude of milestone payments, Companies should take a fresh look at their budgeting and planning process to ensure that they are reflecting not only when milestones will be legally achieved, but also when they will be recorded as revenue and impact earnings.
#4 – Allocating Variable Consideration
In general, entities must use the relative standalone selling price for allocating the consideration. However, with variable consideration, there are certain instances where that variable consideration may be allocated to a specific part of the contract or performance obligation. For this to occur, the terms of the variable consideration must relate specifically to an entity’s effort to satisfy the performance obligation and allocating the amount meets the allocation objective of the standard. For arrangements with multiple performance obligations, this determination is challenging; companies must clearly document which activities give rise to the variable consideration and whether or not they are specifically related to one performance obligation or multiple performance obligations within the arrangement.
#5 – Enforceable Right to Payment
An entity recognizes revenue as performance obligations are satisfied. Performance obligations may be satisfied over time if they meet certain defined criteria. If an entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for their performance completed to date, a performance obligation is considered satisfied over time. Determining whether an enforceable right to payment exists for performance to date may be challenging as: 1) the right to payment is required to include a portion of or the expected profit margin of the contract or a reasonable return of the entity’s cost of capital and 2) the contract must be legally enforceable.
Entities operating in many jurisdictions and without standard contracts may find it challenging to determine what the terms of payment are and if they include a margin. Companies may also need to obtain a legal letter to opine on whether a particular provision is considered enforceable. This is also an area that should be monitored closely after adoption to ensure that new contracts or future amendments do not impact the previous conclusion surrounding point in time/over time determination.
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With offices in Boston and New York, WilliamsMarston LLC is comprised of former Big Four accounting experts. We routinely advise pre-IPO and public companies on the accounting and reporting for complex transactions, including initial public offerings, mergers and acquisitions, revenue recognition, debt and equity instruments, variable interest entities, and stock based compensation amongst many others. Chief Financial Officers and Controllers rely on WilliamsMarston’s professionals for assistance with their most complex accounting and reporting initiatives.
Revenue recognition is complicated and dependent on the terms and conditions of the arrangement. This whitepaper contains general information only. By virtue of this whitepaper, WilliamsMarston LLC is not rendering business, accounting, financial, investment, legal, tax or other professional advice or services. The statements contained in this whitepaper are not intended to be a substitute for any accounting literature or SEC regulations. Companies applying U.S. GAAP or filing financial information with the SEC should apply the relevant laws and regulations and consult a qualified accounting advisor.