ASC 606 Compliance

The new ASC 606 standard for revenue recognition will change how companies book revenue and expenses. This came into effect for private companies in the US beginning December 15th, 2018. In the past, revenue recognition standards differed between US and international organizations. These rules needed to be updated due to the varying ways they were being implemented.

The objective of the new ASC 606 revenue recognition standard was to adopt an international standard and outline a common way to recognize the revenue. The new standard provides framework to drive consistency in financial reporting, improve comparative analysis, and reporting.

These accounting standards provide guidelines for revenue processes such as contracts, quotes, orders, etc. The primary changes related to this standard occur, when there is a contract involved with long duration or with performance obligations. This results in many companies needing to re-evaluate when and how they account their revenue and whether sales and its related expenses need to be booked differently.

ASC 606 breaks down the contract process into the following 5 steps:         

• Identify the contract with a customer
• Identify the performance obligations in the contract
• Determine the transaction price
• Allocate the transaction price
• Recognize revenue and expense when or as the entity satisfies a performance obligation 

The new standard impacts various costs associated with contracts such as legal fees, preparation costs etc. More importantly for us, the new standard directly impacts sales commissions.  Companies paying sales commissions implement the following changes in order to remain ASC 606 complaint: 

• Sales Commissions Tracking: Previously, keeping track of commissions at the rep level was enough. With the new standard, the transaction level as well as the customer level need to be tracked as well.
• Commissions Expense Timing: Previously, commission used to be tagged as an expense when it was paid out. With the new standard, commissions need to be tagged as an expense over a time period matching the delivery of services to customers.
• Types of Commissions and Capitalization: Not all sales commissions/incentives qualify for capitalization. The pre-condition for capitalization is that associated costs should be ‘incremental’ and ‘recoverable’.
• Contract Duration and Amortization: The sales commissions should be amortized based on the entire expected duration of the contract (not just initial period). This requires an estimation of the average lifetime of the contract.
• Recognizing as Immediate Expense: Commissions for the contracts that have a duration of one year or less can be booked for immediate expense rather than as an amortization. 

Sales Commission Expense Recognition

Sales Commission expenses are recognized based on a few models:

• Immediate Expense recognition – for immediate and full sale of products or contracts below one year
• Monthly amortization recognition – for longer service contracts providing regular recurring service
• Milestone-based recognition – for milestones specified in contract and achieved
• Services as rendered recognition – for contract where services are rendered variably month to month

Immediate Expense recognition

This is very simple and is essentially the same as how sales commission is recognized today. Hard goods commissions and contracts within one year will be recognized this way. 

Monthly amortization recognition

This recognition is common for contracts more than one year in duration for services that generally are consistent month to month. The monthly recognition is typically:
Total commission against contract / number of months
Maintenance contracts and subscription license contracts will typically be recognized this way.