Revenue Recognition: Private Company Implementation

What private companies can learn from public companies’ implementation of Accounting Standards Update (ASU) No. 2014-09

As 2019 winds down and private companies are finalizing the implementation of the new guidance, there are several things that can be learned from public companies’ implementation. (Run a not-for-profit organization? See how the ASU No. 2014-09 revenue recognition standard impacts you.) Below is a brief overview of the standard and the main issues and areas of focus that public companies noted were where a significant portion of time was spent during implementation.

Capturing all contracts and assessing impact.

Capturing all contracts and assessing impact. As required by the five-step standard, you must consider all revenue streams and how the steps apply to each one.

Demystifying ASC 606’s Five-Step Process

1. Identify the Contract

At the core of ASC 606 lies the identification of contracts. This initial step is not merely administrative; it’s a strategic process that involves thoroughly comprehending the terms and conditions of each agreement. By gaining a deep understanding of the contractual arrangements, companies can ensure that they capture all relevant elements that might impact revenue recognition later in the process.

2. Identify and Separate Performance Obligations

Breaking down the components of the contract into distinct performance obligations is the next step. This process is akin to dissecting the value exchange between the parties involved. By doing so, companies can not only ensure accurate revenue allocation but also create a transparent framework for assessing whether these performance obligations are distinct and should be accounted for separately or bundled together.

3. Determine Transaction Price

Determining the value of the transaction involves considering various factors, ensuring a comprehensive evaluation. This meticulous evaluation extends beyond a superficial consideration of the monetary figure; it requires a nuanced analysis of potential variable considerations, non-cash components, and any potential changes that might occur due to uncertain events. A well-defined transaction price ensures that revenue recognition aligns with the actual economic substance of the transaction.

4. Allocate Transaction Price

Once the transaction price is known, allocating it to the different performance obligations within the contract is crucial for proper recognition. This allocation is not a mere mathematical exercise; it’s a strategic decision-making process. Companies need to assess the standalone selling prices of each distinct performance obligation, considering market conditions, customer preferences, and other relevant factors. This step’s accuracy directly impacts the faithful representation of the value delivered to the customer.

5. Recognize Revenue

The final step involves recognizing revenue as the performance obligations are satisfied. This is where the theoretical aspects of ASC 606 translate into real-world accounting practices. Recognizing revenue at the right time ensures that a company’s financial statements accurately portray the progression of value delivery over time. Aligning revenue recognition with the value delivered emphasizes transparency and consistency in financial reporting, enhancing stakeholders’ confidence in the company’s financial performance.

Of these steps, identifying the performance obligations and allocating the transaction price have been where most public companies have spent their time.

For instance, performance obligations must be determined, and depending on those determinations, the new standard could impact timing of when revenue is recognized, especially if those performance obligations have no standalone selling price. Identifying performance obligations could vary from company to company. For example, for many healthcare contracts, there is a single performance obligation—i.e. a bundle of healthcare services to treat a patient’s diagnosis. While the patient may receive benefit from individual services provided during the continuum of care, those services generally are integrated and are part of a bundle of services that represents the combined output for which the patient has contracted. Each service is highly dependent/highly interrelated.

Companies must assess if changes to a contract represent a new contract or a modification of an existing contract. The difference could affect how revenue is recognized over the term of that contract. For example, if an additional service is provided to a patient, is that additional obligation distinct and does it reflect a standalone selling price? If so, that additional service may be considered a separate contract. If it is not distinct or does not reflect a standalone selling price, this may be a contract modification that either modifies the original contract or may result in termination of the original contract and the formation of a new contract.

When assessing the transaction price of a contract, you must consider credit risk on the front end. Many companies would record revenue at the gross amount and consider writing off any uncollectible balances after the contract is complete and final billings have been done or after the balance has aged out a certain number of days. Under the new standard, however, these credit risk considerations must be done at the time revenue is recorded based on historical collections analysis and then incorporated into the transaction cost. For healthcare companies, there is a practical expedient that allows a portfolio approach to be used to account for patient contracts as a collective group rather than individually. Examples of the groupings within the portfolio can be based on 1) type of service (inpatient, outpatient, skilled nursing, etc.), or 2) type of payors (commercial, governmental, self- pay, etc.).

Before a company can begin implementing changes due to ASC 606, consideration of each revenue stream and how the new standard may impact the recognition of those revenue streams must be assessed. Each of the five steps must be reviewed during implementation, and documentation should be created to walk through each step.

Industry Specifics

ASC 606: Modernizing Construction Revenue Recognition in Five Steps

ASC 606 for Construction

ASC 606 Changes for Private SaaS – What You Need to Know

The introduction of ASC 606 has sent ripples of change across organizations worldwide. This shift necessitates a thorough restructuring of revenue recognition processes. If your business deals with subscription software or Software as a Service (SaaS), it’s crucial to grasp the upcoming alterations to ensure accurate implementation.

Adapting to the SaaS Landscape

Within the SaaS realm, diverse aspects come into play, including subscription services, implementation, fees, service agreements, and consulting services. Under the current ASC 606 guidelines, software revenue is evenly spread over the contract duration. However, contingent revenue caps exist, which limit recognition. For instance, if a client has a three-year subscription with escalating fees, the cap restricts recognition beyond earned revenue.

Transitioning to the Future

With impending changes, the concept of contingent revenue caps is fading. This means that revenue recognition will adapt to the evolving terms. For example, in a three-year subscription scenario, if year one generates $7,000 and year two produces $9,000, the entire amount will be recognized, but a contract asset of $2,000 will arise.

Challenges Faced by the SaaS Industry

1. Data Volume Surge

Overlooked by many, the expansion of data volumes accompanies the new standard’s implementation. Managing commissions manually amidst this data surge becomes a significant challenge.

2. Consistent Month-End Closures

Complying with ASC 606 requires commission capitalization and amortization. Meeting month-end closure deadlines, already aggressive, becomes even more daunting without additional resources.

3. Sales Value Sensitivity

Changes to customer characteristics now influence sales value. The standards go beyond accounts receivable and delve into the realm of the overall company status.

Stay ahead of the curve. Embrace ASC 606 and harness its transformative power for your SaaS endeavors.

Re-evaluating internal controls and processes.

Re-evaluating internal controls and processes. Regardless of the industry, one inevitable effect of the new standard is assessing your company’s controls and processes around revenue recognition to ensure all aspects of the contracts are being captured. This must be done after all performance obligations are considered to ensure the transaction price is being allocated accordingly.

By referencing public filings, look at internal control processes for public companies in your industry to see how they’ve had to change their processes and controls in order to capture the relevant information (performance obligations, transaction price, etc.).

While looking back at the implementation process, most of the financial reporting accountants from public companies we talked to agreed that while the impact to net revenue was not significant, the implementation process was more time-consuming than expected. There were numerous trainings held throughout the year leading up to the implementation to make sure their internal controls are adequately capturing and their financial reporting is accurately reflecting any changes identified from the ASC 606 implementation. Other financial reporting accountants discussed how they noticed changes on the front end when the standard was first adopted – for instance, different accounts being used now such as “Implicit Price Concessions” vs “Bad Debt Expense” and how those accounts are now mapped differently on the income statement.

Internal auditors agreed that most of the work is on the front end – making sure any changes required as a result of ASC 606 is being captured in the internal control processes. Changes could vary depending on the industry and what was determined when assessing the five steps for each revenue stream (transaction price, performance obligations, etc.). It was noted that while many public companies had minimal income statement impact as a result of the adoption of this standard, there was significant time incurred to arrive at that conclusion as well as significant time devoted to gathering the information needed for drafting the necessary disclosures.

Your processes and controls will have to be revised to ensure all relevant data is captured. Use this opportunity to streamline processes and make sure your team is prepared/trained.

Disclosures.

Disclosures. Since financial statement disclosures will inevitably change after implementation, take advantage of the public companies in your industry by reading through those 10-k’s and other public company filings.

Review quantitative information in that public company’s footnote, and make sure any similar information has been captured in your internal controls and processes. In addition, review qualitative information from that footnote and ensure contracts have been evaluated for key components (will a portfolio approach be used, are all performance obligations within customer contracts have a duration of one year or less, etc.).

While private companies have fewer disclosure requirements, reviewing public company filings is a great place to start. As an example, some of the disclosures that are required for public companies but not for private companies are

disclosure of the amount of current period revenue included in any opening contract liability balance, and
disclosure of the judgments used to determine the amount of costs incurred to obtain or fulfill a contract as well as disclosure of the amortization method used for those contract costs.

While speaking with financial reporting managers of public companies, they noted it did take more time than they had anticipated to gather the information needed for the required disclosures. There was time spent with their internal IT teams to ensure the correct reports could be run from their systems. For example, reports had to be run for the current and prior years related to certain types of revenue streams in order to properly disclose the impact of adoption.

Preparing for ASC 606’s Arrival

As the ASC 606 deadline looms, organizations are urged to ready themselves. Surprisingly, a substantial percentage (approximately 70%) of respondents, as reported by CPA Practice Advisor, are not yet prepared. If your business seeks to automate processes and seamlessly adapt to ASC 606, reach out to us today. We’re dedicated to easing the transition and ensuring a smooth implementation journey.

When preparing financial statements under the new standard, leverage the work of public companies by considering their disclosures and determine what can be utilized in yours.

While the implementation of 606 could seem daunting, there are valuable takeaways that can be learned from public companies’ implementations over the last year. Private companies can benefit from lessons learned and the “what we wish we had known” from public companies.

If you have any questions, please contact one of LBMC’s accounting and audit experts:

Michelle Schmidt, Senior Manager
mschmidt@lbmc.com
615-309-2439