Revenue recognition under ASC Topic 606 includes new and extensive disclosure requirements that will significantly impact revenue-generating companies, whether publicly traded or privately held.
The disclosure requirements in ASC Topic 606 were developed to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Significant judgment may be involved. There are a number of qualitative and quantitative disclosures that are meant to help achieve that goal, which represent a drastic expansion compared to previous requirements.
The required annual disclosures consist of qualitative and quantitative information regarding the following high-level areas:
- Contracts with customers
- Significant judgments made in applying the guidance in ASC Topic 606
- Assets recognized from costs to fulfill a contract
1. Contracts with Customers
The majority of required disclosures under ASC Topic 606 relate to contracts with customers. First, entities should disclose revenue recognized from contracts with customers, presented separately from any other sources of revenue.
Disaggregation of revenues
Entities should also disclose a disaggregation of revenue into categories that best depict how the nature, amount, timing, and uncertainty of revenues and cash flows are affected by economic factors. The extent to which an entity's revenue is disaggregated for the purposes of this disclosure depends on the facts and circumstances that pertain to the entity's contracts with customers. For example, some entities may need to use more than one type of category, while other entities may meet the objective by using only one type of category to disaggregate revenue.
When selecting the type of category (or categories) to use to disaggregate revenue, an entity should consider how information about the entity's revenue has been presented for other purposes, including the following:
- Disclosures presented outside the financial statements (for example, in earnings releases, annual reports, or investor presentations)
- Information regularly reviewed by the chief operating decision maker for evaluating the financial performance of operating segments
- Other information that is used by the entity or users of the entity's financial statements to evaluate the entity's financial performance or make resource allocation decisions
In addition, to the extent an entity has used the portfolio approach to apply the five-step method, consideration should be given to how the portfolios (revenue streams) would align with the disaggregated disclosure.
Examples of categories that might be appropriate include, but are not limited to:
- The type of good or service (for example, major product lines);
- Geographical region (for example, country or region);
- Market or type of customer (for example, government and nongovernment customers);
- Type of contract (for example, fixed-price and time-and-materials contracts);
- Contract duration (for example, short-term and long-term contracts);
- Timing of transfer of goods or services (for example, revenue from goods or services transferred to customers at a point in time vs. over time), and;
- Sales channels (for example, goods sold directly to consumers and goods sold through intermediaries).
If applicable, the entity should disclose sufficient information to enable users of financial statements to understand the relationship between the disclosure of disaggregated revenue and revenue information disclosed for each reportable segment.
A revenue contract between a vendor and customer, where only one of the parties has performed, results in the recognition by the vendor of either a contract asset or contract liability. For example, if the customer prepays the transaction price before completion of the performance obligation, the vendor records a contract liability. The contract liability would be settled and revenue recognized when the vendor satisfies its performance obligation. Conversely, if the vendor satisfies a performance obligation prior to being unconditionally entitled to payment, a contract asset is recorded. Contract assets are presented separately from accounts receivable, the latter being recorded when the vendor has an unconditional right to payment, subject only to the passing of time.
There are a few additional items that entities should disclose with respect to contracts balances. Entities should disclose the opening and closing balances of contract assets, contract liabilities, and receivables from contracts with customers, as well as revenue recognized during the period that was included in the contract liability at the beginning of the period. Additionally, entities should provide an explanation, using qualitative and/or quantitative information, of how the timing of satisfaction of performance obligations relates to the typical timing of payment and the effect that those factors have on the contract asset and the contract liability balances.
Using qualitative and quantitative information, entities should describe changes in the contract asset and contract liability balances due to significant events, such as business combinations, cumulative catch-up adjustments to revenue, impairment of a contract asset, a change in the time frame for a right to consideration to become unconditional, or a performance obligation to be satisfied.
Non-public Entity Pro-Tip
Most non-public entities can elect to forgo the full Disaggregation of revenues and Contract balances disclosures discussed above. If elected, an entity discloses, at a minimum, revenue disaggregated according to the timing of transfer of goods or services (for example, revenue from goods transferred at a point in time vs. over time), qualitative information about how economic factors (such as type of customer, geographical location of customers, and type of contract) affect the nature, amount, timing, and uncertainty of revenue and cash flows, and, the opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed.
Entities are also required to disclose information about their performance obligations in contracts with customers, including a description of when the entity typically satisfies its performance obligations (for example, upon shipment, upon delivery, as services are rendered, or upon completion of service), significant payment terms (for example, when payment typically is due, whether the contract has a significant financing component, whether the consideration amount is variable), nature of the goods or services that the entity has promised to transfer, obligations for returns, refunds, and, types of warranties and related obligations, as applicable.
Revenue recognized in the reporting period from performance obligations satisfied in previous periods will also need to be disclosed.
Transaction price allocated to remaining performance obligations
Regarding remaining performance obligations, entities should disclose the amount of transaction price allocated to remaining performance obligations at the end of the reporting period, with a quantitative or qualitative explanation of when the entity expects to recognize the related revenue. Notably, this information is not required for contracts that have an original expected duration of one year or less or that apply the value-based invoicing practical expedient.
2. Significant Judgements
Entities should plan to disclose the significant judgments made that affect the determination of the amount and timing of revenue from contracts with customers, including the timing of satisfaction of performance obligations, determining the transaction price and the amounts allocated to performance obligations.
For performance obligations that an entity satisfies over time, an entity will need to disclose the methods used to recognize revenue (for example, a description of the output methods or input methods used and how those methods are applied) as well as an explanation of why the methods used provide a faithful depiction of the transfer of goods or services.
For performance obligations satisfied at a point in time, an entity should disclose the significant judgments made in evaluating when a customer obtains control of promised goods or services.
Lastly, regarding the transaction price, entities shall be required to disclose information about the methods, inputs, and assumptions used to:
- Determine the transaction price, including estimating variable consideration;
- Allocate the transaction price in an arrangement with more than one distinct performance obligation, including estimating standalone selling prices of promised goods or services; and
- Measure obligations for returns and refunds.
Non-public Entity Pro Tip
Most non-public entities can elect to forgo disclosures related to the following related to significant judgments:
- For performance obligations delivered over time, the explanation of why the methods used provide a faithful depiction of the transfer of goods or services.
- For performance obligations satisfied at a point in time, the significant judgments made in evaluating when a customer obtains control of promised goods or services.
- Methods, inputs, and assumptions used to determine the transaction price, estimating variable consideration, allocating the transaction price and measuring obligations for returns and refunds.
3. Assets Recognized from Costs to Fulfill
If applicable, publicly traded entities should disclose information about capitalized costs, including the amount and a description of the costs capitalized, along with the amortization method and amount of amortization.
Those responsible for disclosure and reporting functions in publicly traded companies should be aware of the Securities and Exchange Commission (SEC)'s expectation of pre-adoption disclosures to help users of the financial statements understand the entity's progress in assessing the impact of the adoption of ASC Topic 606.
Pre-adoption disclosures should encompass the following quantitative and qualitative aspects:
- Description of impact
- Expected changes in accounting policies
- Status of assessment including aspects not yet addressed, if applicable
- Quantitative impact, unless not reasonably estimable
The extent of required disclosures for publicly traded or privately held companies can appear to be overwhelming, and will be, in some cases. Even if the accounting impact of adopting ASC Topic 606 would not be significant, management should be aware the disclosure requirements alone could be taxing. It would be prudent for management to proactively work on understanding the extent of the requirements as well as the information investors would expect to see, identifying the information technology and other resource needs, as well as training and involving the correct representatives within the organization that would be required to help facilitate and support accurate and adequate disclosures. We recommend creation of a "straw-man" disclosure in preparation for the adoption so that management can get a comprehensive view of changes to data, systems, and the associated internal controls.
Related Reading: MHM's Revenue Recognition Serial
For More Information
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Published on July 07, 2017