03 May Managing ASC 606 in a Subscription Business
If you read our previous blog post, ASC 606: When Even Google Is Afraid, you know how important ASC 606 compliance is for your business. You realize that if you don't have an ASC 606 compliance strategy, or you haven't yet implemented it, you are behind in the game.
The rules are comprehensive, spanning your end-to-end processes, including contracts, pricing, quotes, orders, and revenue recognition. They involve myriad factors for subscription business, including upselling, bundling, downgrading, usage, equipment, rebates, warranties, shipping costs, and early termination fees, to name a few.
And, failure to achieve compliance can cost you money, damage your reputation, incur SEC fines, and/or land you in jail. So, how do you manage ASC 606 compliance effectively?
Managing ASC 606 With Your Business Teams
ASC 606 impacts many areas of your business. This affects the roles and responsibilities of your core business teams. And, now that ASC 606 is here to stay, it is more important than ever for your core teams to work together strategically to ensure your customer contracts are optimized for your top-line revenue. Your teams may need new tools and systems to effectively track and manage the pathways from prospective customer to signed contract and revenue recognition. It may be time for you to automate. BluSynergy may be just the solution you need.
ASC 606 will affect your finance team's daily tasks, so they need to understand the rules inside and out. They may need new skills and systems to calculate and forecast your revenue accurately as well as to find the best strategies for managing your contracts. Quote-to-Cash technologies will be more important now. Your product catalog or quote sheets need to integrate the revenue recognition rules so that your sales force can sell with optimal revenue outcomes while staying ASC 606 compliant.
More than ever, your sales team will rely on finance to provide product or service information that accommodates for the ASC 606. Otherwise, your sales team will not know if a negotiated change in the contract terms is better or worse for your top-line revenue. It may be more costly to your company to have your sales team “sweeten the pot” to close a sale now that ASC 606 is here. This applies to subscription services, bundling, up-selling, cross-selling, and downgrading as well. And it applies to sales incentives like commissions and bonuses.
Your legal department manages your risk; they used to get involved at the end of the sales process. With ASC 606 in force, the legal terms of a contract can affect the revenue valuation of the deal. This includes things like free consulting services, marketing exposure, and shipping fees. The top-line revenue value of a contract is more than the selling price. Your legal team needs to be knowledgeable about the implications of ASC 606 for your business and they may need to be more engaged in the contract process earlier on.
Using the ASC 606 Five Step Method
ASC 606 may make your accounting more cumbersome, but the regulation outlined a Five Step Process to help you streamline your compliance strategy. We've summarized it here; the article provides much more detail and great resources.
- Identify the contract with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
Step 1: Identify the Contract With a Customer
According to the ASC 606, a contract is an agreement (written, oral, or implied) between two or more parties that creates enforceable rights and obligations identified by the following attributes:
- All parties have approved the agreement. A contract that has not been approved by all parties is not enforceable.
- All parties are committed to fulfilling their obligations. Carefully consider termination clauses. If each party has unilateral rights to end an unperformed obligation, then by law no contract exists.
- Each party's rights are identifiable. The contract must specify the goods or services to be provided. .
- Payment terms are identified. Contracts must include sufficient details so that the price can be estimated.
- The contract has commercial substance. In other words, risk, timing, or cash flows must change as a result of the contract.
- Collectibility is probable, meaning that customers are credit worthy and likely to pay on time.
Step 2: Identify the Performance Obligations in the Contract
Performance obligations are promises to deliver goods or services to your customer. Businesses under ASC 606 must explicitly define obligations in the contract as well as any obligations a customer may expect based on a previous or existing business relationship. For example, if an existing customer has always received free shipping, then that is a performance obligation for that customer; however, free shipping may not be a performance obligation for a new customer who expects to pay for shipping.
Step 3: Determine the Transaction Price
The transaction price is the cost of goods or services to be paid by the customer to the business. Transaction prices may be fixed, variable, or both. It is identified in the contract as a performance obligation. When the performance obligation is fulfilled, the cost is recognized as top-line revenue. Transaction price does not include future options or money collected by third parties such as tax authorities.
Step 4: Allocate the Transaction Price
Businesses must accurately allocate the transaction price for each performance obligation using its standalone selling price. The standalone selling price may be estimated using an adjustment market assessment, expected cost plus margin, and/or residuals. Special guidelines cover discounts, variable considerations, and contract modifications. Again, the article referenced above details these special guidelines.
Step 5: Recognize Revenue When or as Performance Obligations Are Satisfied
Revenue must be recognized when or as performance obligations are satisfied. For single-point-in-time performance obligations, revenue is recognized at the point of fulfillment. For period-of-time performance obligations, companies must decide how to measure progress in relation to the completed performance obligation; revenue is recognized proportionate to that progress.
ASC 606 Inaction Is (Still) Not An Option
With BluSynergy, you are never alone! Our qualified sales team can help you rethink your accounting practices to include the factors and processes you need to track for ASC 606 compliance. We can help you automate and implement the ASC 606 Five Step Method. We can help you understand how future decisions about and strategies for your subscription models will impact your top-line revenue recognition.
Curious about Quote-to-Cash solutions? Confused about how to automate or how to adapt your current automation to manage the Five Step Method? Give one of our BluSynergy sales consultants a call today at 731-INVOICE (731-468-6423).
At BluSynergy, your success is our success. And, don't forget to read our upcoming blog on unique evergreen subscription models, coming in May.