A Complete Guide to ASC 606, Commissions and Revenue Recognition

Accounting for revenue can be one of the most difficult aspects of implementing the revenue recognition standard ASC 606.

Although many businesses have already adopted these new guidelines and regulations, some are still struggling and can benefit from the insights others have gained.

While companies see additional accounting regulations as a hassle, the reality is that with help from the right sales compensation software, many could stand to benefit from this transition.

What is ASC 606? 

ASC 606 is a new accounting standard that outlines how revenue is recognized for accounting purposes within private, public, and non-profit organizations. The standard affects how revenue is recognized when companies contract with customers to deliver goods and services.

Related article: A Simple Guide to Sales Commission Structures

ASC 606's subsection, ASC 340-40, requires that when a company is accounting for contract fulfillment, any sales commission payments or incremental costs of obtaining the contract must be capitalized as an asset and amortized over the contract term. Amortization is the spreading out of costs accrued from loans or intangible assets.

Why did authorities implement ASC 606?

ASC 606 is a joint product of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). Previously, standards for recognizing revenue set by the FASB used Generally Accepted Accounting Principles (GAPP) in the US that differed from those set internationally.

In 2014, the two organizations jointly published "Topic ASC 606: Revenue from Contracts with Customers." It outlined the new synchronized framework for recognizing revenue that provided a more consistent framework for businesses across all industries globally to recognize revenue.

The core principle of the guidance in Topic 606 is that an entity should recognize 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 in exchange for those goods or services.
FASB, No. 2016-10, Topic 606

By simplifying this accounting process, investors and analysts can more easily interpret revenue when reviewing financial statements, regardless of the industry.

How does ASC 606 impact the accounting process? 

ASC 606 standardizes how companies report revenue, specifically the type, amount, and scheduling of contracts with customers.

The ASC 606 standard requires companies recording revenue from customer contracts to adhere to the following five steps:

1. Identify the contract with the customer
2. Identify the separate performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price
5. Recognize revenue when each performance obligation is satisfied

Recognizing Revenue 

GAAP has historically used the revenue recognition principle. It states that revenue is only recorded when earned, not when the money is received.

For example, a landscaping company mows the lawn of a local church for $200. Even if the landscapers don't get paid for another month, they can recognize the revenue now. That is also known as an accrual.

However, suppose the landscaping company enters into a six-month contract to mow the lawn and is paid $1,200 in advance. In that case, revenue will be recognized in increments over six months in a process known as amortization. Recognizing revenue in this way allows the company's financial statements to reflect the revenue as the work is completed. 

How does ASC 606 impact the sales compensation team?

ASC 606 has implications for costs amortized over the contract term. Before ASC 606, commission expenses were recognized when a contract was executed and the payout offset revenue was received.

Related article: The Illusion of Control in Enterprise Sales Compensation

Now, variable compensation (in the form of sales commissions) must be identified and tracked according to the new regulation. That significantly affects how commissions will be calculated and how spreadsheets are maintained.

Steps to Prepare for ASC 606

To implement ASC 606, first ensure you have the historical commission data you need to get an overview of how commissions are normally paid. You will also need access to contract and transactional details to understand if their costs are incremental.

Determining the Amortization Period

Whether contract costs are amortized over the contract's life or the life of the customer will depend on the business and the length of the contract.

For example, for one-year or longer contracts, commissions for individual (non-manager) salespersons must be amortized over the expected customer life.

When a contract's term is less than one year, companies may use a practical expedient to expense commissions when they were incurred. That requires administrative and sales teams to be aligned with the accounting team to ensure that the right approach is being used to comply with the new regulation.

Existing Incentive Compensation Management (ICM) calculations will need to be adjusted with layers of new data to be ASC 606 compliant. They may not be enough to keep up with changing revenue recognition standards. In this case, using your existing Excel spreadsheets may no longer be viable.

The Future of Sales Compensation

Forma.ai provides sophisticated sales commission solutions for large businesses. Forma.ai can automate the most complex compensation plans, reducing the burden on sales comp teams and eliminating payroll errors, saving your company time and money.  

Sales compensation software is more efficient and effective than ever, and the smartest businesses are moving away from traditional methods of executing sales compensation. Reach out to our team for a demo of our game-changing software and see up on the future of sales compensation software.