How Do You Identify a Contract Under ASC 606 and IFRS 15?

ASC 606/IFRS 15 is one of the most profound compliance changes in corporate finance since the release of the Sarbanes-Oxley regulations over 20 years ago. This new compliance standard has reshaped how businesses recognize revenue and has proven to be incredibly challenging to navigate in today’s fast-paced digital, subscription-based economy. Adopting these standards has been a significant undertaking for public and private companies in terms of their complexity, the level of judgment and estimates involved, and data availability.

What are the transition methods available for companies adopting ASC 606 and IFRS 15?

Companies transitioning to ASC 606 have two methods at their disposal. The first, the full retrospective approach, requires companies to delve into their past financials and revise them as though ASC 606 had always been the guiding standard. The alternative, the modified retrospective approach, simplifies the transition by only adjusting the opening balance of retained earnings to reflect the cumulative impact of the new standard.

Similarly, under IFRS 15, companies also face a choice between two distinct paths. They can embrace the full retrospective method, which mandates adjusting all previous reporting periods to conform to the new standard. On the other hand, they might opt for the modified retrospective method, which eases the transition with practical expedients, applying the standard solely to contracts that were still open at the beginning of its implementation.

The first and very crucial step of ASC 606/IFRS 15 is to identify the contract with a customer.

Why is this step so important? What is technically considered a contract under ASC 606/IFRS 15? What criteria must be met to qualify for a contract? How can subscription/SaaS businesses effectively and efficiently complete this step? In this blog, we’ll answer these questions and explore the revenue recognition technology and solutions available for subscription companies to meet the new revenue standard.

The Five Steps of ASC 606/IFRS 15

The standards outline five specific steps for businesses to recognize revenue:

1. Identify the contract with a customer

A contract can be either written or verbal but should have commercial substance with enforceable rights and obligations.

2. Identify the performance obligation in the contract

Performance obligation simply means a promise to transfer goods or services to the customer. In this step, any separate and distinct performance obligations to the customer need to be identified.

3. Determine the transaction price 

The transaction price refers to the cash and non-cash consideration that an entity is entitled to receive from the customer in exchange for goods and services provided.

4. Allocate the transaction price

When offering multiple products and services as part of a subscription business model, companies are required to allocate the arrangement fee to each separate and distinct performance obligation based upon a standalone selling price (SSP) methodology. SSP is the price that a vendor would charge if the product or service was offered separately.

5. Recognize revenue when or as the entity satisfies a performance obligation

Revenue can be recognized as the business meets each performance obligation. This step specifies when revenue should be recognized either at a point in time or over time.

How is revenue presentation different under ASC 606 and IFRS 15?

The presentation of revenue under ASC 606 and IFRS 15 diverges significantly, primarily in how revenue is characterized on income statements. ASC 606 insists that revenue should be portrayed in a manner that truly captures the essence of the transaction—specifically, the genuine transfer of control of goods or services from a company to its customers. It’s about clarity and precision in financial reporting. In contrast, IFRS 15 introduces flexibility, allowing revenue to be shown either on a gross or a net basis. This choice hinges on the role of the reporting entity in the transaction: are they the principal decision-maker or merely an agent? This distinction adds a layer of strategic consideration to financial disclosures, influencing how companies reflect their market operations.

What are the disclosure requirements for revenue recognition under ASC 606 and IFRS 15?

The disclosure requirements for revenue recognition under ASC 606 and IFRS 15, while largely aligned, hold their own distinctive nuances. Both standards passionately advocate for transparency and comparability, compelling entities to unveil a wealth of information about how they recognize revenue. This includes detailed disclosures on their accounting policies, and the nature, amount, timing, and uncertainties related to revenue and cash flows arising from contracts with customers. However, IFRS 15 takes this transparency a step further, with an even deeper commitment to clarity. It demands that entities not only share detailed information but also delve into the factors that affect the nature, timing, and uncertainty of these financial figures. This additional layer of disclosure ensures that stakeholders gain a more profound understanding of contract dynamics and their financial impacts, promoting a higher level of trust and insight into the financial workings of companies.

Identifying a Customer Contract Under ASC 606/IFRS 15

Let’s take a closer look at the first of the five steps of revenue recognition under these standards. How can businesses ensure that arrangements meet all the conditions of a valid contract for revenue recognition? Typically, a contract is an agreement between two or more parties that creates enforceable rights and obligations.

The essential criteria for a contract under ASC 606 are:

• All parties have approved the agreement (verbal or written agreement)
• All parties are committed to fulfilling their obligations
• Each party’s rights are identifiable
• Payment terms are identified
• The contract has commercial substance
• Collectibility is probable

How can subscription companies effectively identify customer contracts under ASC 606/IFRS 15? 

The impact of adopting the ASC 606/IFRS 15 standards for subscription/SaaS businesses may be greater due to the complexity and volume of customer contracts. Subscription-based businesses rely on detailed contracts with terms that are generally one year or longer and include services such as the right to access software, hosting, upgrades, enhancements, and support. Due to their long-term nature, customers frequently seek to modify subscription plans and underlying products and services during their term.

Under ASC 606/IFRS 15, all customer transactions negotiated at the same time or in contemplation of each other need to be treated as a single arrangement, therefore, creating challenges for companies to track multiple contracts for this purpose. In addition, reviewing and analyzing all contract types and clauses for the identification of performance obligations for proper revenue recognition can be daunting. 

Here are some tips to help subscription businesses identify and understand customer contracts in order to effectively streamline their revenue recognition process: 

Understand your Contracts

Start performing an in-depth review of all customer contracts. Collaborate across the organization (e.g., sales, product, professional service, accounting, legal, compliance teams) to:

• Obtain a comprehensive view of the contracts and modifications to assess the potential revenue impact
• Identify any interdependent performance obligations across contracts
• Evaluate common business practices or verbal commitments to determine if they also represent performance obligations
• Establish and document a detailed revenue recognition policy that covers all revenue streams

Streamline or Integrate Data Sources

Revenue recognition under ASC 606/IFRS 15 is heavily dependent on multiple data points and sources such as contracts, customary business practices, oral agreements, and invoice/payment data. Understanding and organizing all the relevant data is critical for accurate revenue recognition and reporting. Seamless integration of source systems overcomes the challenge of disparate data sourcing and streamlines the revenue recognition process. 

Automate Revenue Recognition 

Automating revenue recognition avoids costly errors and eliminates inefficiency, providing businesses with a predictable, auditable, GAAP-compliant process. Chargebee RevRec’s  revenue recognition solution does just that while scaling with your business by:

• Eliminating manual processes and providing end-to-end automation of ASC 606 /IFRS-15’s five-step model to recognize revenue
• Unburdening finance teams and creating more time to focus on value-added activities for their business
• Equipping businesses with accurate, reliable insights to make strategic decisions with business growth in mind

What functionalities does Chargebee Revenue Recognition offer for businesses using subscription-based revenue models?

Chargebee Revenue Recognition offers a suite of functionalities tailored to the unique demands of businesses that operate on subscription-based revenue models. This tool is a game-changer, particularly when it comes to managing the complexities associated with such business structures.

Firstly, the advanced reporting tools embedded within Chargebee Revenue Recognition provide deep and insightful views into financial data. This feature is crucial for businesses that need to track and analyze their recurring revenue streams meticulously. By offering such comprehensive insights, Chargebee Revenue Recognition empowers companies to make informed decisions that are crucial for sustaining and scaling their operations.

Furthermore, the platform’s automatic updates feature is a massive relief for financial teams. This functionality ensures that financial data is always up-to-date, significantly reducing the burdensome task of manual data entry. This not only saves valuable time but also minimizes the risk of errors, ensuring that the financial reporting remains pristine and reliable.

Chargebee Revenue Recognition also excels in offering expanded controls, which grant businesses enhanced command over their financial processes. This level of control is vital for maintaining accuracy and flexibility, allowing businesses to adapt quickly to changes or new information. Additionally, its seamless integration with other Chargebee products like Chargebee Billing and Chargebee Invoicing streamlines the financial management process. This integration ensures that setting up a robust financial management system is straightforward and doesn’t require extensive IT support, making it accessible even to those who may not be tech-savvy.

Lastly, the compliance support provided by Chargebee Revenue Recognition is indispensable. It supports compliance with major accounting standards such as ASC 606 and IFRS 15, delivering audit-ready financial statements. This comprehensive support is designed to keep businesses in line with international financial regulations, helping them meet global compliance standards efficiently and without hassle.

In essence, Chargebee Revenue Recognition is not just a tool but a strategic partner that supports the dynamic needs of subscription-based businesses. It offers much more than just functionality; it provides peace of mind and a foundation for businesses to thrive on a global scale.

How does Chargebee Revenue Recognition support compliance with standards like ASC 606 and IFRS 15?

Chargebee’s Revenue Recognition tool is meticulously crafted to help businesses navigate the often daunting waters of international accounting standards, providing them with thorough, audit-ready financial statements. This invaluable feature is a beacon for companies striving to comply with intricate regulations set by standards such as ASC 606 and IFRS 15. It not only simplifies the compliance process but also enhances the accuracy and transparency of revenue reporting. This fosters a deep sense of trust and reliability among stakeholders, reassuring them of the company’s financial integrity and dedication to transparency.

To learn more about how Chargebee RevRec provides end-to-end automation of ASC 606/ IFRS 15’s five-step model, download our detailed guide on identifying a contract.

Frequently Asked Questions (FAQ)

1. What is ASC 606 and IFRS 15?

ASC 606 and IFRS 15 are accounting standards that provide a framework for revenue recognition. They help ensure that revenue from contracts with customers is recognized accurately and consistently across industries.

2. Who needs to comply with ASC 606 and IFRS 15?

All companies that enter into contracts with customers to transfer goods or services — public, private, and nonprofit — must comply with these standards. Specific compliance dates vary by region and entity type.

3. What are the major differences between ASC 606 and IFRS 15?

While ASC 606 and IFRS 15 are largely aligned, there are nuances in how revenue is presented and disclosed. ASC 606 requires revenue and cash flows to be disclosed in a way that reflects the entity’s performance, whereas IFRS 15 offers more flexibility in presenting revenue either on a gross or a net basis.

4. How do I identify a contract under ASC 606 and IFRS 15?

A contract under these standards is identified when it has approval from all parties, specifies payment terms, has commercial substance, and the collectibility of payment is probable. Both written and verbal agreements can be considered contracts.

5. What are the transition methods available for adopting ASC 606 and IFRS 15?

There are two primary transition methods: the full retrospective method, which applies the standard to each prior reporting period presented, and the modified retrospective method, which applies the standard only to contracts not completed as of the date of initial application.

6. How can technology help with compliance with ASC 606 and IFRS 15?

Technology, such as automated revenue recognition platforms like Chargebee Revenue Recognition, can streamline data integration, ensure accuracy through automation, and provide robust reporting tools to manage and analyze revenue data effectively, ensuring compliance with these complex standards.

7. What are the consequences of non-compliance with these standards?

Non-compliance can lead to legal and financial repercussions, including fines, restatements of previously issued financial statements, and potential damage to a company’s reputation.

8. How do subscription-based businesses uniquely manage revenue recognition under these standards?

Subscription businesses must carefully evaluate their contracts to identify performance obligations and allocate transaction prices accordingly. Automated tools can help manage the complexities of subscription contracts, especially when modifications and customer interactions frequently occur.

9. Where can I find more resources about ASC 606 and IFRS 15?

Resources are available through financial regulatory bodies like the Financial Accounting Standards Board (FASB) for ASC 606 and the International Accounting Standards Board (IASB) for IFRS 15. Many educational platforms and industry blogs also provide in-depth analysis and guidance.

10. What are some best practices for ensuring compliance with ASC 606 and IFRS 15?

Best practices include thorough contract review, regular training for compliance teams, deploying robust accounting software, and maintaining clear and detailed documentation of revenue recognition policies and decisions.