Last editedNov 20212 min read
If your business uses the accrual accounting method, you’ll need to follow the rules of revenue recognition. This basic principle ensures that any revenue is listed on the income statement in the same accounting period when it’s realized. The ASC 606 standard helps provide more detailed guidelines when it comes to revenue recognition, but what does ASC 606 stand for, and does it apply to you? Keep reading to find out.
What does ASC 606 stand for?
The acronym ASC stands for Accounting Standards Codification. ASC standards are outlined by the Financial Accounting Standards Board (FASB), which develops and maintains best accounting practices for businesses following the generally accepted accounting principles (GAAP). The “606” refers to Topic 606 of the Accounting Standards Codification, a recent update to these standardized principles.
What is ASC 606?
ASC 606 is a recent change in FASB standards specifically pertaining to revenue recognition. It helps clearly outline and define how you should deal with revenue received from contracts. If your company enters sales contracts or agreements with your customers, you’ll need to pay attention to the ASC 606 guidelines for accounting consistency.
With ASC 606 revenue recognition, companies will be able to:
Streamline financial statement preparation
Compare revenue across different departments and industries
Create a more efficient revenue tracking system
Identify reporting inconsistencies more rapidly
How does ASC 606 work?
How exactly will following ASC 606 achieve these goals? There are several different methods you can use for revenue recognition, including:
Sales basis method
Percentage of completion method
Completed contract method
To put ASC 606 to use, you’ll first need to choose the appropriate method and then follow the five steps involved, which we’ll outline below. The main difference between these new standards and version 605 is that 606 is more comprehensive. It breaks down revenue streams into separate categories, including distinct performance obligations.
What are the ASC 606 steps?
According to ASC 606 revenue recognition principles, there are five steps to recognize revenue during the contractual process. These can be broken down into the following:
Step 1: Identify the contract
Outline the specific criteria your business will use when drawing up a contract with a customer to sell them goods or services. Under ASC 606, a contract must involve two or more parties. Qualifying criteria include:
The contract is approved by all parties
The goods and services are clearly defined
Payment terms are clearly defined
The vendor believes they will receive payment
Step 2: Identify the contract’s obligations
The second step in any ASC 606 examples will focus on how specific performance obligations will be met. A performance obligation simply means whatever services or goods the vendor has included as part of the contractual agreement. For example, it could be free installation included with the delivery of an appliance.
Step 3: Identify the transaction price
This step defines what you should think about when establishing the price for your contract transaction. In other words, it’s the amount your business expects to receive as compensation for transferring the goods or services.
Step 4: Allocate the transaction price
With the price already defined, ASC 606 examples move on to guidelines for allocating the price across the contract’s performance obligations. This step gives the customer the information needed for payment.
Step 5: Recognize revenue when performance obligations are met
As the business hits each target or obligation, revenue can then be recognized on the financial statements. Your business has delivered on its promises, and now it can reasonably expect to receive payment and can thus recognize the revenue.
What does ASC 606 mean for your business?
ASC 606 needn’t be overly complicated; it simply provides a fresh set of guidelines for breaking down your business contracts, step by step, and only recognizing qualifying revenue. The overarching goal is to eliminate any variation in accounting across industries, providing a standard framework for comparison. The latest versions of accounting software will be able to handle the ASC 606 steps automatically, for even faster processing times.
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