Understanding the significance of ASC 606 Revenue Recognition for product based companies
With the rise in cloud and more companies revamping their existing business model, the processes and controls of ASC 606 (equivalent to IFRS 15) are gaining higher significance. For companies which are highly regulated with exchange commissions, any misrepresentation of revenue would attract heavy penalties, unwanted scrutiny and diminution in the value for stakeholders.
I want this article to be focussed on companies which are operating on SaaS platform and/or selling their product based services. We are aware that this pandemic has generated tremendous gain for tech companies in terms of market capitalisation and has given them opportunities to venture into new products (and segments) with 'work from home' regime.
1. Microsoft Inc has grown its cloud computing based services by more than 25%;
2. UK/Europe's biggest software provider (SAGE and SAP) has moved their business model from licensing to subscription model;
3. Apple Inc is expecting growth from growing sale of devices with launch of 5G directly giving an incremental growth to its services;
4. Salesforce has experienced more than 25% growth in their Client Relationship Management subscription revenue;
5. Zynga/Amazon has realised potential of selling games over cloud in coming years.
Important to note, this year has registered the biggest number of deals/acquisitions by the amount of investment.
This year has also marked two big scandals sparking increased vigilance and regulations due to the failure of Wirecard AG (Germany based payment processing company) and Luckin Coffee which were both listed on US Stock Exchange. It was to the disappointment that both the companies reported billions of dollars of revenue with no cash in their bank accounts.
As per globally accepted auditing standards, every material account in the Balancesheet and Statement of Profit & Loss must have their standardised processes with multiple set of controls established to avoid any misstatements and/or identify fraudulent acts.
Identifying revenue as one of the most material item, we will look at the depth of understanding that needs to be developed for changing businesses and environment, with new innovative products and pricing being offered.
"Is this right time to look back and re-interpret ASC 606 in the new business environment?"
For ASC 606, a systematics analysis, documentation and review of the following is required for reporting:
1. Identify the contract
Review the transfer of control at the inception of signing the agreement. The rights of parties needs to be clearly identified.
Segregate the fixed and variable component of the payment term. Document and agree the understanding of additional/flexible services offered on demand.
Document the probable events that can affect the collection i.e identify the risks.
2. Identify the performance obligation of the contract
Assess the component of good and services in the business model and its significance to completion of the obligation.
Assess and document the event when the customer obtains control of the good.
3. Determine the transaction price
Determine the price for good and/or services with other elements of taxes, discount, rebates.
Identify the fixed, variable, non-cash considerations and contingent fee agreed with customer.
4. Allocate the transaction price to the performance obligations of the contract
Formulate a mechanism to allocate the consideration to the customer for various stages based on transfer of control.
5. Recognising revenue when the entity satisfies performance obligation
Recognise the revenue based on the event when customer obtains the control. Note there is a separate guidance for 'control' mentioned in ASC 606 which earlier focussed on risk and rewards.
For the next blog, let's stay excited to explore the real world complexities and simplify them with real solutions.