ASC 606

ASC 606 requires entities to apply a five-step model to determine when and how much revenue to recognize: (1) identify the contract, (2) identify performance obligations, (3) determine the transaction price, (4) allocate the transaction price, and (5) recognize revenue when (or as) performance obligations are satisfied.

There are five questions you answer in order: Do we have a real deal? What did we promise? How much will we get paid? How do we split the price across our promises? When did we deliver on each promise? Revenue is recorded when you answer that last question for each promise.

Imagine you agree to make someone a birthday cake AND deliver it for $30 total. Step 1: You shook hands on the deal. Step 2: You promised two things (make it + deliver it). Step 3: The total price is $30. Step 4: Maybe making the cake is worth $25 and delivery is worth $5. Step 5: You earn the $25 when the cake is done, and the $5 when you deliver it.

TechCo sells a software bundle: perpetual license ($60,000), implementation services ($25,000), and 2-year support ($15,000). Total contract: $100,000. Step 1: Valid contract exists. Step 2: Three performance obligations (license, implementation, support). Step 3: Transaction price = $100,000. Step 4: Allocate based on standalone selling prices. Step 5: License revenue at delivery, implementation over the service period, support ratably over 24 months.

Before ASC 606, different industries used different rules. A software company, a construction company, and a retailer all recognized revenue differently - even for economically similar transactions. This made comparisons difficult and created opportunities for manipulation.

Assuming ASC 606 and IFRS 15 are identical. While substantially converged, differences exist in areas like licensing (functional vs symbolic IP), collectibility threshold, non-cash consideration measurement, and interim disclosure requirements.

A performance obligation is a promise to transfer a distinct good or service (or a series of distinct goods/services). A good or service is distinct if the customer can benefit from it on its own or together with readily available resources, AND the promise is separately identifiable from other promises in the contract.

Look at everything you promised in the contract. Each separate promise that the customer could theoretically buy on its own counts as a separate performance obligation. If two promises are so intertwined that they only make sense together, they are one combined obligation.

If you sell someone a bicycle AND a helmet, those are two separate promises because they could buy each one separately from different stores. But if you promise to build a custom treehouse, the wood and the labor are not separate - nobody wants just a pile of wood or just labor with no materials.

A telecom company sells a phone ($800 retail) bundled with a 2-year service plan ($50/month). Are these one or two obligations? The phone is distinct (customer could use it with another carrier). The service is distinct (customer could get service without buying a phone). Result: two separate performance obligations, each recognized on its own timeline.

Treating every line item on an invoice as a separate performance obligation. The test is whether the item is distinct - not whether it appears as a separate line. Installation that significantly customizes a product may not be distinct from the product itself.

When the transaction price includes variable amounts (discounts, rebates, refunds, incentives, penalties, or performance bonuses), an entity must estimate the variable consideration using either the expected value method (probability-weighted) or the most likely amount method, subject to a constraint that limits recognition to amounts not expected to reverse.

Sometimes you do not know the exact final price when you start. Maybe there is a bonus if you finish early, or a penalty if you are late, or the customer might return the product. You have to estimate what you will actually receive and only count amounts you are reasonably sure will not be taken back later.

Imagine you agree to mow 10 lawns for $10 each, but the deal says if any customer is unhappy, you give the money back. You cannot say you earned $100 on day one. You have to guess how many might want refunds. If you think maybe 1 out of 10 will complain, you can only count $90 as earned until you know for sure.

A pharmaceutical company sells drugs with a right of return (historically 3% return rate). It ships $10 million of product. Expected value method: recognize $9.7 million as revenue and record a refund liability of $300,000. The constraint: only include variable consideration to the extent it is highly probable that a significant reversal will not occur.

Ignoring the constraint on variable consideration. Even if your best estimate is $1 million in performance bonuses, you cannot recognize that amount if there is a significant chance it could reverse. The constraint is designed to prevent premature revenue recognition.

What is the difference between ASC 606 and ASC 605?

ASC 605 was the old revenue standard with industry-specific guidance scattered across dozens of topics. ASC 606 replaced all of it with a single principles-based 5-step model applicable to all industries. The biggest change: companies must now identify distinct performance obligations and allocate revenue to each one.

Is ASC 606 the same as IFRS 15?

They are substantially converged - both use the same 5-step model and were developed jointly. However, differences exist in licensing guidance, collectibility thresholds, interim disclosure requirements, and certain practical expedients. Most transactions will produce the same result under both standards.

When did ASC 606 become effective?

ASC 606 became effective for public companies for annual periods beginning after December 15, 2017 (calendar year 2018). Private companies had an additional year (2019). Early adoption was permitted.