ASC 606 and IFRS 15 are two standards for Revenue Recognition. One was issued by the International Accounting Standards (IAS) Board, and the other standard was issued by the Financial Accounting Standards (FAS) Board, respectively.
The core concept behind ASC 606, IFRS 15 is
An entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled for those goods and services.
ASC 606 and IFRS 15 replaces ASC 605 and IFRS 18, respectively with the following enhancements:
- Expected Consideration. One key principle in the new revenue principles is expected consideration. This means that we have one common revenue definition for all industries, regardless if it's a telecommunications industry, the software industry, it needs a revenue recognition standard.
- Performance Obligation. Introduced the concept of the performance obligation. The concept of the performance obligation replaces deferred revenue.
- Deals are valued at inception. This doesn't necessarily mean deals are only valued when the billing happens.
- Point in Time and Over time Recognition of Revenue. Revenue is now recognized point in time and over time, depending on the product or service that's being provided.
- Contract Revision Tracking. Enables tracking of corrections or modifications made to the contract
- Seven Tests for the Transfer to Customers
- No Dependency on Billing
Who must adopt and when must you adopt the new revenue standard?
- Covers all commercial public companies in the USA and all the IFRS countries. If we look at IFRS countries, we can see that there are about 150 jurisdictions or countries that should comply with the International Financial Reporting Standards.
- Covers all industries
- You must adopt the effective first day of the new fiscal year after January 1, 2018. In terms of date, you must adopt the effective first day of the new fiscal year after January 1, 2018. The actual adoption date depends on whether your organization is using a fiscal year versus a calendar year. If it is a calendar year, then that means you're looking at January 1, 2018, and if it's a fiscal year, then it depends when the fiscal year of your organization starts. For Example: Oracle Corporation uses a fiscal year that starts June 1. So June 1, 2018 will be the day that Oracle would have to comply with a new standard, because we are using a fiscal year to report our results, not a calendar year.
What has changed between the old and new standards?
Below are some key points that has changed between the new standard versus the former standard.
| Obsoleted Deferred Revenue Accounting | Adopted Performance Obligation Accounting |
| You defer that part of a sales invoice you can't recognize as revenue | You accrue for goods and services that you owe to customers because either you or they have relied in the contract. You no longer defer revenue. |
| You value the deferral at fair value and it is non-monetary | You value the accrual at estimated consideration and it is a monetary debt. |
| You Calculate and book liability when you issue invoices | You calculate the liability at inception and book it when either party acts. An "act" could be shipping or invoicing. |
| Liability is a list of invoices not yet posted to the Profit and Loss (P & L) in full or in part for future release to the P & L | Liability is a list of good and services you actually owe to customers for future satisfaction via a transfer. |
| You book the invoiced amount to the P & L when you meet the regulatory definition by industry | You book revenue to the P & L when you satisfy the customer with no industry-specific rules bill or not billed. |
You defer revenue in the old standard you accrued for goods and services that you owe to the customer, because you haven't delivered the service/product yet. Under the new standard, you no longer defer revenue.
The third entry in the table is a major departure from the old standard. Under the old standard you calculate and book liability when you issue invoices. Under the new standard, you calculate the liability at inception. You calculate that liability at inception and book it when either party acts. An act could be shipping a product, invoice issuance or deploying a consultant to provide services to an organization.
Under the old standard, liability is a list of invoices that have not posted to the GL. Under the new standard, liability is the list of goods and services that you owe to your customers for future satisfaction. You haven't transferred that service or delivered the good yet, so you're not really at a list of invoices.
Example of Calculating Liability
Take the example below:
In this use case, if the deployment of the sales consultant is not in a capacity to provide services that were offered as part of the contract, then you should not consider calculation of liability. In the provided example, the sales consultant was only providing a demonstration of the Product, and therefore, there was no "signed" agreement yet. This is not yet part of the contract and is not tracked as a liability.
However, if the deployment of a sales consultant IS part of a contractual agreement, then it is considered as a performance obligation, and therefore, will already be tracked as a liability.
Accounting Differences of the Performance Obligation between the old and new standard
A performance obligation is a promise in a contract with a customer. When you enter into a contract with a customer, then that means that you are obligated to provide a service or deliver goods. Below, we have also a comparison of Performance Obligations from an accounting perspective, showing you the debits and credits.
The third entry in the table is a major departure from the old standard. Under the old standard you calculate and book liability when you issue invoices. Under the new standard, you calculate the liability at inception. You calculate that liability at inception and book it when either party acts. An act could be shipping a product, invoice issuance or deploying a consultant to provide services to an organization.
Under the old standard, liability is a list of invoices that have not posted to the GL. Under the new standard, liability is the list of goods and services that you owe to your customers for future satisfaction. You haven't transferred that service or delivered the good yet, so you're not really at a list of invoices.
Example of Calculating Liability
Take the example below:
A sales consultant was deployed to assist customer X on May 10, 2019 and provide a demo of the product. Customer X has agreed to the purchase and a sales order was booked on May 15, 2019. The Product was shipped on May 18, 2019 and the Invoice was issued on May 19, 2019. When will liability start to be tracked? Will it be during the deployment of the consultant, or when Customer X has agreed to purchase the product?According to the new Standard: "you calculate the liability on inception and book it when either party acts. An act could be shipping or invoicing. However, an act could also be deploying a consultant to provide services to an organization according to a contract."
In this use case, if the deployment of the sales consultant is not in a capacity to provide services that were offered as part of the contract, then you should not consider calculation of liability. In the provided example, the sales consultant was only providing a demonstration of the Product, and therefore, there was no "signed" agreement yet. This is not yet part of the contract and is not tracked as a liability.
However, if the deployment of a sales consultant IS part of a contractual agreement, then it is considered as a performance obligation, and therefore, will already be tracked as a liability.
Accounting Differences of the Performance Obligation between the old and new standard
A performance obligation is a promise in a contract with a customer. When you enter into a contract with a customer, then that means that you are obligated to provide a service or deliver goods. Below, we have also a comparison of Performance Obligations from an accounting perspective, showing you the debits and credits.
A Sales contract is initiated to deliver $1,000 of services over time at $100 per month. Billing occurs quarterly upon satisfaction in arrears. After initial Successful deliveries, customer agrees to pay $300 for delivered services, plus $300 in advance.
In the obsoleted accounting standards, nothing really happens until you bill. Everything starts with the billing process. We only recognize revenue by the end of the quarter. In the new, adopted accounting standards, Liability and Assets change as we satisfy the performance obligations over time.
Let's take a look at the April 4 entry. What we see here is that there is an obligation accrual, and there is basically the obligation accrual and the right to bill. So when we net these asset and liability balances, we get 0 because we haven't delivered anything yet.
If we go on and look at April 30 and May 30 entries, we can see here that things are moving along. The liability is being reduced independently of billing. When we get to May 30, we can see that the net asset amount is 200. If we net the 1,000 on the debit side, the 800 on the credit side, we get to the net number of 200.
By June 30, the organization then bills the customer for $300 and gets another $300 in receivable as mentioned in the scenario.
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Let's take a look at the April 4 entry. What we see here is that there is an obligation accrual, and there is basically the obligation accrual and the right to bill. So when we net these asset and liability balances, we get 0 because we haven't delivered anything yet.
If we go on and look at April 30 and May 30 entries, we can see here that things are moving along. The liability is being reduced independently of billing. When we get to May 30, we can see that the net asset amount is 200. If we net the 1,000 on the debit side, the 800 on the credit side, we get to the net number of 200.
By June 30, the organization then bills the customer for $300 and gets another $300 in receivable as mentioned in the scenario.
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