FASB ASU 606: Use Practical Expedients to Ease Revenue Recognition Effort
The suggestions contained herein are likely to be considered aggressive by many public accounting firms. However, if your contract terms fit within these narrowly defined characteristics, these practical expedients could dramatically reduce your calculation and disclosure requirements.
ASU 606 implements new, more complex analyses to determine the amount and timing of revenue recognition for contracts. These new regulations give rise to recognition of significant assets and will cause more periodic cost accounting and financial statement disclosure. The standard provides four practical expedients to ease accounting and disclosure requirements.
1. The existence of a significant financing component
An entity should adjust the promised amount of consideration for the effects of the time value of money if the timing of the payments agreed upon by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing for the transfer of goods or services to the customer.
2. Incremental Costs of Obtaining the Contract
An entity should recognize as an asset the incremental costs of obtaining a contract that the entity expects to recover. Incremental costs are those costs that the entity would not have incurred if the contract had not been obtained.
Sales commissions are one of the simplest examples of and incremental cost of obtaining a contract. The standard calls for the capitalization and recognition of the sales commission over the life of the contract, or the average period of customer retention if either is over 12 months. See more about this in the section about contracts with large upfront fees.
3. Accounting for a portfolio of individual contracts or performance obligations
Many contracts have common provisions for returns, exchanges, or standard warranties. These type of liabilities have typically handled with a balance sheet reserve that is not contract specific. The following practical expedient may allow that practice to continue these accounting practices providing the terms are common across contracts and customers and that the cost experience is similar across contracts.
4. Simultaneous Receipt and Consumption of the Benefits of the Entity’s Performance
Many common contracting activities such as support calls or training sessions are examples of performance obligations that are simultaneously performed and consumed. This practical expedient allows for the revenue for these activities to be recognized when invoiced; providing the services are priced at standard amounts per unit. If the performance obligations are part of a larger contract that may have a discounted price, the revenue may still be recognized when invoiced, but the unit price will need to be adjusted to the allocated sale amount.
Contracts with upfront payments and the push to subscription pricing
Many contracts call for upfront payments and a periodic maintenance fee. An example is the sale of a software program. Historically most call for an upfront purchase and require an annual maintenance fee. This fee structure allows for enough upfront payment to satisfy sales commissions and the vendor’s startup costs. The standard now requires that the additional sales expenses and the upfront payment be capitalized and recognized over the term of the contract or the average expected life of the customer’s use of the program.
The only way to simplify this requirement is to convert to subscription pricing without minimum contract periods, and to make the sales commission not contingent on any future event and has no claw-back provisions. (Even then some public accounting firms will argue that the sales commission should be capitalized and the cost recognized over time.)
Practical Expedients Disclosure
An entity that adopts use of a Practical Expedient, will need to disclose the use of the practical expedient, and apply it universally to all contracts with similar characteristics and similar Circumstances.
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More Background & Discussion