The premise of the new ASC 606 accounting standards is pretty straightforward: businesses can recognize their revenue only when and as its value is received by customers.
But as many businesses have come to realize, moving into compliance is anything but simple.
Take telecommunications giant Verizon, for example. The company—which serves more than 100 million customers—began working on its ASC 606 project several years before the standards took effect. While it used to rely on its software to automatically log information for each of its contracts on its financial statements, Verizon has had to reprogram its software entirely to accommodate new ways of accounting for its revenue.
The project has cost the company thousands of work hours for both its finance and IT teams.
This is just one of many stories that show how even large companies are struggling to adopt the new guidelines—and experiencing huge business costs and disruptions as a result.
What is ASC 606 and how are compliance requirements impacting businesses?
Becoming ASC 606 compliant can be a complicated process, and a lot of subscription-based businesses are still struggling to meet the requirements. In fact, more than half of all businesses impacted by the new standards are unprepared for it, according to PwC.
ASC 606—which stands for Accounting Standards Codification as Topic 606—is the revenue recognition standard that took effect for public companies on January 1, 2018, and private companies a year later.
These rules—considered by many to be the biggest change in accounting standards in the last century—affect all businesses in the U.S. that collect revenue from contracts with customers.
The update addresses revenue recognition inconsistencies that previously existed across industries and between U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). It also introduces improved disclosure requirements and provides businesses with a better framework for addressing their revenue issues.
How are companies affected by ASC 606?
While ASC 606 affects all types of businesses, it’s particularly demanding on SaaS and any other subscription-based business for a number of reasons.
First and foremost, these businesses bill their customers for services over a period of time—which could mean regular monthly or even yearly payments. But to remain ASC 606 compliant, the revenue from these payments cannot be recognized immediately. Instead, it must be deferred over the length of the subscription period. This is because the business hasn’t yet delivered the service in full.
Subscription-based businesses also now need to have the ability to keep track of their earned and deferred revenue over the entire period of their subscriptions. This can be challenging due to the complexity of subscriptions.
Subscription-related revenue tends to change frequently because of customer upgrades, downgrades, and various other contract modifications. And in some cases, separate contracts might be created for single customers.
Each of these contracts can have differing impacts on a business’s revenue recognition, making something as simple as identifying the contracts for compliance a difficult task.
Subscription-based business can involve complexities of many kinds with regard to revenue recognition. A fundamental challenge is accurately tracking contracted, recognized, and unbilled deferred revenue.
For example, should revenue from non-refundable upfront fees be recognized now or deferred until later? How should the revenue from evergreen subscriptions be recognized over time? And how do you determine the transaction price if your subscriptions involve usage-based pricing?
Mid-term subscription changes present an even bigger challenge in terms of ASC 606 compliance. These changes involve a complex process of altering settings to replace one plan with another, accompanied by a whole slew of accounting adjustments.
Charges may need to be prorated, charges may need to be cancelled or partially reversed on the old subscription, and changes need to be made to the ledger to reflect deferred and earned revenue, as well as tracked monthly recurring revenue contraction and expansion. It can easily become overwhelming.
As subscription-based businesses endeavor to meet ASC 606 standards, they may shy away from potentially lucrative revenue opportunities for fear of falling out of compliance. New pricing models and innovative contract designs may be put on the back burner, which could result in these businesses trailing behind their competitors and the demands of the market.
And these aren’t the only stakes as businesses work toward compliance.
What are the consequences of being unprepared and non-compliant with ASC 606?
Failing to bring your business’s accounting standards in line with ASC 606 is a huge risk that can result in a number of consequences—mostly stemming from inaccurate reporting. Businesses may have to incur the cost of restating earnings, which could lead to not only a blemished reputation, but potentially also audits, firings, and even litigation.
Toward the end of 2018, Oracle—the integrated cloud applications and platform service provider—announced its quarterly earnings. The very next day it restated its revenue with close to half a billion dollars erased from its top line.
No, the $457 million didn’t go missing. The company apparently failed to release its ASC 606 results during its first announcement. And while it was compliant the second go around, analysts were understandably confused, and Oracle ended up taking a hit to its earning estimates. Its stock took a tumble as well.
Uber was another potential casualty of ASC 606. The car-sharing company had first-quarter revenue of $3.4 billion in 2017—but that was under the old accounting standards. Adopting the new standards would see its reported revenue dropped by more than half.
Getting ready for ASC 606
Becoming ASC 606 compliant requires a lot of research and planning, and it can take valuable human resources away from running a business.
If your team has yet to get started on becoming ASC 606 compliant, you shouldn’t underestimate the enormity of this undertaking.
It isn’t a task that will be accomplished quickly, and it isn’t a project that can be managed by just a handful of people in accounting whose plates are likely already full.
Finance teams should start by gaining executive support along with a proper line-item budget. They should also consider bringing in external or internal talent who can focus their attention on the project and bring it forward to completion.
Common ASC 606 implementation mistakes to avoid
When embarking on the process of working toward ASC 606 compliance, businesses shouldn’t wait until the end of the project to get feedback from their auditor. These professionals can offer valuable insight and advice. Put together a draft framework for how you’ll account for revenue and bring it to your auditor early in the process.
You should also be sure to consider various other stakeholders who may be relevant to your compliance planning. For example, if your business uses the rate of technological obsolescence to determine its amortization periods, consider involving a team member from engineering or product development.
Finally, if your business is used to working with legacy financial processes, it may be tempting to continue using manual methods and Excel spreadsheets to determine how your revenue should be capitalized and amortized. But this isn’t a practical solution over the long term.
Consider leveraging software to automate the process and help your business move into compliance.
Getting started with the right subscription billing management software
Revenue needs to be recognized each day in a subscription-based business, and this can be a significant challenge. New subscriptions continually roll in—each with their own unique revenue recognition calculations. And to complicate the matter, subscriptions often change over time, requiring real-time adjustments to keep up with accurate revenue recognition.
Many subscription-based businesses still use legacy billing systems that require manual processes and adjustments. Timeliness and accuracy are always an issue of concern whenever humans are in charge of a task. And when regulatory compliance is in question, your business can’t afford to waste time and make mistakes.
The right subscription billing management software can make all the difference when it comes to producing accurate financial statements that clearly differentiate between deferred and earned revenue.
Stax Bill is one of few cloud-based agile billing software solutions built on a double-entry accounting system and general ledger support. The dynamic billing solution can also integrate seamlessly with any accounting system to handle the complex billing scenarios and revenue recognition needs of businesses. This is important from more than just a regulatory perspective.
Accurate financial statements are meaningful to banks and business advisory boards, and accurate revenue recognition is a key factor used by potential investors to determine the value of a business.
Furthermore, being able to report accurately on your revenue will give your business clear insight into your cash-flow situation. This enables your team to make better decisions and more calculated strategies for the future.
Accounting with compliance will reduce your risks
ASC 606 is forcing businesses to rethink and rework their accounting practices. And subscription-based businesses need to be especially mindful of these new standards and what they mean in terms of revenue recognition requirements.
There’s a lot at stake, but with the right information, the proper resources, and an intelligent software solution, businesses can clean up their compliance issues while also creating countless efficiencies across their finance departments and organizations as a whole.