Revenue recognition under Accounting Standards Codification Topic 606 (“ASC 606”) significantly changed accounting requirements by standardizing how revenue is identified, measured, and reported. While this standard has been in place for several years, its practical application for companies will constantly evolve as business changes. Let’s review the five-step model of ASC 606. Each step requires careful analysis and judgment, particularly when handling complex contracts or bundled goods and services.

ASC 606-10-20 defines revenue as, “Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.” It is important to note that this standard excludes other types of income, such as gains.

In this article, we revisit the five-step model and share key insights from our experience as a certified public accounting firm helping clients navigate these requirements as part of our experience in auditing private and public companies.

The main principle of this revenue model requires a reporting entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services. The standard lays out the following five-step model for revenue recognition:

The foundation of revenue recognition lies in identifying whether a valid contract exists with a customer involving provision of goods or services that are an output of the entity’s ordinary activities in exchange for consideration. A contract must meet specific criteria:

Let’s look at some challenges and examples:

Key Challenges: Companies sometimes overlook the need to evaluate whether multiple contracts should be combined. When contracts are entered into near the same time with the same customer, they may need to be treated as a single arrangement if they share a commercial objective. In addition, ambiguity in contract terms can complicate recognition, such as unsigned agreements or vague performance obligations. Additionally, companies must consider customary business practices or industry standards, which may not always be explicit in contracts.

Example: A software company agrees to deliver a custom platform but does not finalize payment terms until development is underway. Without clearly defined rights and payment terms or established business practices, this agreement may not initially qualify as a contract under ASC 606.

Under the model, a performance obligation is defined as an explicit or implicit promise to provide either (i) a distinct good or service, or (ii) a series of distinct goods or services as defined by the revenue standard. This step often proves challenging because it requires careful analysis to determine whether goods or services are distinct.

Each distinct performance obligation must be:

Determining whether a contract has one or multiple performance obligations requires understanding of the interdependence of deliverables.

Example: A construction company agrees to build a house, supplying both materials and labor. Is this a single obligation (construction of a finished house) or multiple obligations (e.g., supply of concrete, lumber, and electrical systems)? If the deliverables are highly interdependent, they are treated as a single performance obligation. However, if sold separately, they might need distinct allocation.

This step establishes the total consideration expected to be received in exchange for fulfilling the performance obligations. The transaction price calculation must consider:

Once the total transaction price is determined, it must be allocated to each performance obligation. This allocation is based on the standalone selling price (SSP) of each deliverable, adjusted for discounts or variable pricing.

Important Note: This step only applies when there are multiple performance obligations. However, when it does apply, it’s crucial to:

A common challenge here is determining SSP for bundled services, which can require historical data and significant judgment. For example, say a telecommunications provider sells a bundle including internet, cable, and phone services at a discounted price. Allocating the price to each service based on SSP demands market comparisons and precise calculations to ensure compliance with ASC 606.

Revenue is recognized when (or as) the performance obligation is satisfied. This could occur over time (e.g., as services are rendered) or at a point in time (e.g., upon delivery of goods). Accountants must use a decision tree to determine whether to recognize revenue over time or upon completion.

As a certified public accounting firm, here are some common challenges to applying the Revenue Recognition Standard.

When more than one party is involved in providing goods or services to a customer, a reporting entity must consider whether it has promised to provide goods or services to customers itself (as a principal) or to arrange for those goods or services to be provided by another party (as an agent). An entity is a principal and therefore records revenue on a gross basis if it controls a promised good or service before transferring that good or service to the customer. An entity is an agent and records as revenue the net amount it retains for its agency services if its role is to arrange for another entity to provide the goods or services.

Example

For example, a contract manufacturer (Company A) enters into an agreement with a distributor (Company B) to provide customized electronic components to an end customer. Depending on specific facts and circumstances, Company A may either be the principal or agent in this scenario:

If Company A receives the order from Company B and produces and delivers the components directly to the end customer, is responsible for fulfilling the contract and bears inventory risk, and sets the gross price charged to Company B, they are likely the principal in this scenario.

However, if Company A instead acts as a fulfillment partner for a large OEM (Company C) in which it earns a commission fee upon product delivery and does not take title to the components, Company C sets pricing and product specifications, and Company A only provides certain assembly services however raw materials and other direct costs are directly sourced from Company C, Company A is likely an agent in this scenario and would record the net revenues from its commission fee.

Principal versus agent consideration is one of the more common application issues we see amongst our clients and requires significant analysis as it has significant implications throughout the five-step model.

Contract modifications represent one of the most complex areas of revenue recognition under ASC 606. These modifications can occur when parties agree to change the scope or price of a contract, and their accounting treatment can significantly impact revenue recognition timing and amounts. The standard provides three potential approaches for handling modifications, each requiring careful analysis:

Bill-and-hold arrangements present unique challenges in revenue recognition, particularly in manufacturing and distribution industries. These arrangements occur when a company bills a customer for products but retains physical possession of them. While seemingly straightforward, these situations require careful evaluation to determine appropriate revenue recognition timing.

For revenue recognition to be appropriate in a bill-and-hold scenario, companies must satisfy several specific criteria:

Bill-and-Hold Revenue Recognition – Key Criteria

For a company to recognize revenue in a bill-and-hold arrangement, these conditions must all be met:

Companies must also evaluate whether they are providing custodial services that might constitute a separate performance obligation requiring additional accounting consideration.

The treatment of warranties under ASC 606 requires careful analysis to distinguish between assurance-type and service-type warranties, as their accounting implications differ significantly:

For example, if a technology company offers an extended warranty that includes preventative maintenance and software updates beyond fixing basic defects, this would likely constitute a service-type warranty.

Companies often struggle with warranties that contain elements of both types. In these cases, they must exercise significant judgment to determine whether certain warranty provisions extend beyond assuring basic functionality. This evaluation should consider factors like:

It’s important to maintain clear documentation supporting a company’s warranty classification decisions and ensure consistent application of policies across similar arrangements.

While ASC 606 implementation challenges persist, companies can successfully navigate these requirements by:

For companies transitioning to GAAP or experiencing growth, understanding these revenue recognition principles is especially important for accurate and consistent financial reporting. 

See the FASB’s full ASC 606 accounting standards here.

If your business needs support implementing ASC 606 or improving its revenue recognition processes, Haskell & White’s experienced team is here to help your team with the accounting standard. Contact us today to learn more.

The Financial Accounting Standards Board (FASB) has issued a significant update to its Accounting Standards Codification (ASC) under Subtopic 220-40, focusing on expense disaggregation disclosures. This update is designed to improve the utility of financial reporting by providing more detailed expense information for public companies.

As a public accounting firm, we take an advance look at all new standards before they are issued and adopted. In this article, we have outlined the key elements of the update, its implications, and strategies for implementation to help public companies better prepare for the new standard and eliminate surprises during their financial statement audit under PCAOB guidelines.

Investors, lenders, and other stakeholders have expressed concerns about the limited granularity of expense information in financial statements. Current income statements often consolidate diverse costs into broad categories such as “cost of sales” or “selling, general, and administrative expenses” (SG&A). This lack of transparency hinders stakeholders’ ability to:

This update from the FASB aims to address these gaps by requiring detailed expense breakdowns within relevant captions of the income statement.

The update applies solely to public companies and excludes private entities, nonprofits, and employee benefit plans. However, the FASB has indicated that it may revisit the applicability of these requirements to private companies based on public entities’ experiences.

While early adoption is permitted, these changes will officially take effect for public companies with fiscal years beginning after December 15, 2026, with interim period disclosures required starting in 2027. The transition will be prospective, though entities may opt for retrospective application for comparative periods​.

The FASB’s update includes five main provisions designed to enhance disclosure requirements for a public company. These include:

Public entities must break down expenses within the following categories if they are included in relevant captions (e.g., cost of sales or SG&A):

A “relevant expense caption” refers to expense line items from continuing operations that include at least one of the specified categories. Some examples include “cost of goods sold,” “cost of services,” “selling, general, and administrative expenses,” and “research and development.”

This added level of transparency allows users of public company filings to assess cost structures more clearly.

This provision takes disaggregation further by requiring public companies to provide additional detail about inventory and manufacturing expenses, including:

An entity will be required to disclose how it defines other manufacturing expenses.

Changes in inventories in the current period will equal the difference between the amount of inventory included on the balance sheet presented at the end of the prior period and the amount of inventory included on the balance sheet presented at the end of the current period.

Other reconciling items should include other amounts that are necessary to reconcile costs incurred to expenses recognized. Examples include:

Additionally, entities must qualitatively describe any other manufacturing expenses and any other reconciling items.

This update requires entities to incorporate certain GAAP-mandated disclosures into the same tabular format as other disaggregated expense information.

The update has two ways in which to incorporate already required expense disclosures, depending on the expense item and whether it is included in more than one relevant expense caption.  For example, impairment losses will always require separate disclosure for each relevant expense caption regardless of whether the total is broken out in more than one relevant expense caption, whereas the provision for expected credit losses and warranty expense will require separate disclosures only if those amounts are included entirely in one relevant expense caption.

Materiality thresholds still apply, meaning that disclosures are only necessary when deemed significant.

Within the required tabular format disclosure, an entity must disclose for each relevant expense caption an amount for other items. The amount for other items is the difference between:

The total in the tabular disclosure must agree back to the income statement.

An entity is also required to disclose qualitative descriptions (based on their natural expense classification) of these other items. These descriptions must be detailed enough to provide meaningful insight into the composition of residual expenses.

Finally, an entity must disclose their total selling expenses, and, on an annual basis, an entity must provide a clear definition of what constitutes selling expenses. For example, a company may define selling expenses as:

While these definitions can vary from company to company, they must be consistently applied and clearly explained​.

The FASB’s expense disaggregation update represents a significant shift towards greater transparency in financial reporting. By breaking down complex expense categories, the update aims to provide stakeholders with clearer insights into a public company’s financial health and performance. While the update will not alter the face of financial statements, it will significantly expand the volume and detail of disclosures in the footnotes. 

Ahead of these changes, our recommendations as a public accounting firm are that public companies prepare to:

Public companies would be well served to align their reporting processes with the new requirements, turning this regulatory challenge into an opportunity for improved communication and trust. If you’re looking for assistance in making these changes, contact the Haskell & White team to learn how we can help.

For more information on the accounting standard update and for examples, visit the FASB website.

On October 25, the Financial Accounting Standards Board (FASB) issued a simpler accounting option that will enable private companies to more easily measure certain types of shares they provide to both employees and nonemployees as part of compensation awards. Here are the details.

Complex rules

Many companies award stock options and other forms of share-based payments to workers to promote exceptional performance and reduce cash outflows from employee compensation. But accounting for these payments can be confusing and time-consuming, especially for private companies.

To measure the fair value of stock options under existing U.S. Generally Accepted Accounting Principles (GAAP), companies generally use an option-pricing model that factors in the following six variables:
1. The option’s exercise price,
2. The expected term (the time until the option expires),
3. The risk-free rate (usually based on Treasury bonds),
4. Expected dividends,
5. Expected stock price volatility, and
6. The value of the Company’s stock on the grant date.

The first four inputs are fairly straightforward. Private companies may estimate expected stock price volatility using a comparable market-pricing index. But the value of a private company’s stock typically requires an outside appraisal. Whereas public stock prices are usually readily available, private company equity shares typically aren’t actively traded, so observable market prices for those shares or similar shares don’t exist.

To complicate matters further, employee stock options are also subject to Internal Revenue Code Section 409A, which deals with nonqualified deferred compensation. The use of two different pricing methods usually gives rise to deferred tax items on the balance sheet.

Simplification measures

Accounting Standards Update (ASU) No. 2021-07, Compensation-Stock Compensation (Topic 718): Determining the Current Price of An Underlying Share for Equity-Classified Share-Based Awards, applies to all equity classified awards under Accounting Standards Codification Topic 718, Stock Compensation.

The updated guidance allows private companies to determine the current price input in accordance with the federal tax rules, thereby aligning the methodology used for book and federal income tax purposes. Sec. 409A is referenced as an example, but the rules also include facts and circumstances identified in Sec. 409A to consider for reasonable valuations. The practical expedient will allow private companies to save on costs, because they’ll no longer have to obtain two independent valuations separately for GAAP and for tax purposes.

Right for your Company?

Private companies that take advantage of the practical expedient will need to apply it prospectively for all qualifying awards granted or modified during fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early application, including application in an interim period, is permitted for financial statements that haven’t yet been issued or made available for issuance as of October 25, 2021. Contact your CPA for more information.

© 2021

Updated accounting rules for long-term leases took effect in 2019 for public companies. Now, after several deferrals by the Financial Accounting Standards Board (FASB), private companies and private not-for-profit entities must follow suit, starting in fiscal year 2022. The updated guidance requires these organizations to report — for the first time — the full magnitude of their long-term lease obligations on the balance sheet. Here are the details.

In 2019, the FASB deferred Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), to 2021 for private entities. Then, in 2020, the FASB granted another extension to the effective date of the updated leases standard for private firms, because of disruptions to normal business operations during the COVID-19 pandemic.

Currently, the changes for private entities will apply to annual reporting periods beginning after December 15, 2021, and to interim periods within fiscal years beginning after December 15, 2022. Early adoption is also permitted.

Most private organizations have welcomed these deferrals. Implementing the requisite changes to an organization’s accounting practices and systems can be time-consuming and costly, depending on its size, as well as the nature and volume of its leasing arrangements.

The accounting rules that currently apply to private entities require them to record lease obligations on their balance sheets only if the arrangements are considered financing transactions. Few arrangements are recorded, because current accounting rules give lessees leeway to arrange the agreements in a way that they can be treated as simple rentals, or operating leases, for financial reporting purposes. If an obligation isn’t recorded on a balance sheet, it makes a business look like it is less leveraged than it really is.

The updated guidance calls for major changes to current accounting practices for leases with terms of one year or longer. In a nutshell, ASU 2016-02 requires lessees to recognize on their balance sheets the assets and liabilities associated with all long-term rentals of machines, equipment, vehicles, and real estate. The updated guidance also requires additional disclosures about the amount, timing, and uncertainty of cash flows related to leases.

The new definition of a lease is expected to encompass many more types of arrangements that aren’t reported as leases under current practice. Some of these arrangements may not be readily apparent, for example, if they’re embedded in service contracts or contracts with third-party manufacturers.

You can’t afford to wait until year-end to adopt the updated guidance for long-term leases. Many public companies found that the implementation process took significantly more time and effort than they initially expected. Contact us to help evaluate which of your contracts must be reported as lease obligations under the new rules.

© 2021

Accounting departments across the country are facing multiple challenges, from daily cash management to complex accounting matters. In addition, most entities are navigating the available governmental relief programs related to the COVID-19 pandemic and are negotiating rent deferrals and concessions with their lessors. Accounting for rent deferrals and concessions raised a number of questions by the lessor and the lessee. Can you imagine the number of leases Walmart or Starbucks have?

The Financial Accounting Standards Board (“FASB”) staff has developed a question-and-answer document to address frequently asked questions in regards to rent concessions resulting from the COVID-19 pandemic. The FASB staff has provided interpretive guidance, in the form of an accounting policy election, to simplifying the accounting for lease concessions resulting from the COVID-19 pandemic. If such election is made, entities will not have to analyze each lease agreement to determine if enforceable rights and obligations for rent concessions exist in the agreement. In other words, they can elect to not apply the lease modification guidance as outlined in the new lease accounting standard (Topic 842) or the accounting for a change in lease provisions guidance as outlined in the legacy lease accounting standard (Topic 840) to those agreements.

This election is available for rent concessions that are related to the COVID-19 pandemic and do not result in a substantial increase in the lessor’s rights or the lessee’s obligations under the agreement. For example, total cash flows resulting from the modified agreement are substantially the same as or less than the total cash flows required by the original agreement. However, the term “substantially the same or less” was not defined by the FASB staff and entities will need to use reasonable judgement.

The FASB staff noted that there are multiple ways to account for rent deferrals when electing to not apply the lease modification method; however, the FASB staff has not indicated a preference for one method over the other. The FASB staff listed the following two methods:

1. Account for the concessions as if no changes to the lease contract were made. Under this method, a lessor would increase its lease receivable, and a lessee would increase its lease payable. In the income statement, a lessor would continue to recognize income, and a lessee would continue to recognize expense during the deferral period.

2. Account for the deferred payments as variable lease payments.

Regardless of the election made, entities should disclose material concessions and its accounting impacts. This FASB staff interpretive guidance is a welcomed simplification for many businesses that are already working through several new accounting changes, such as revenue recognition, leases, and credit losses.
Visit Haskell & White’s COVID-19 Resource Center for ongoing updates and resources available to further assist you, or contact our local accounting firm so we can discuss your particular situation.

Private companies and most nonprofits were supposed to implement updated revenue recognition guidance in fiscal year 2019 and updated lease guidance in fiscal year 2021. Amid the novel coronavirus (COVID-19) crisis, the Financial Accounting Standards Board (FASB) has decided to give certain entities an extra year to make the changes, if they need it.

On April 8, the FASB agreed to issue a proposal that would have postponed the effective dates for the revenue recognition guidance for franchisors only and the lease guidance for private companies and nonprofit organizations that haven’t already adopted them. In a surprise move, on May 20, the FASB voted to extend the delay for the revenue rules beyond franchisors to all privately owned companies and nonprofits that haven’t adopted the changes. FASB members affirmed a similar delay on the lease rules.
The optional “timeout” is designed to help resource-strapped private companies, the nation’s largest business demographic, better navigate reporting hurdles amid the COVID-19 crisis. A final standard will be issued in early June.

Under the changes, all private companies and nonprofits that haven’t yet filed financial statements applying the updated revenue recognition rules can opt to wait to apply them until annual reporting periods beginning after December 15, 2019, and interim reporting periods within annual reporting periods beginning after December 15, 2020. Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), replaces hundreds of pieces of industry-specific rules with a principles-based five-step model for reporting revenue.
FASB members extended the revenue deferral to more private companies and nonprofits to help those that were in the process of closing their books when the COVID-19 crisis hit. Private entities told the board that having to adopt the standards amid the work upheaval created by the pandemic layered on unforeseen challenges. In today’s conditions, compliance may need to take a backseat to operational issues.

Last year, the FASB deferred ASU No. 2016-02, Leases (Topic 842), for private companies from 2020 to 2021. This standard requires companies to report — for the first time — the full magnitude of their long-term lease obligations on the balance sheet.
The FASB’s recent deferral will allow private companies and private nonprofits that haven’t already adopted the updated lease rules to wait to apply them until fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Public nonprofits that haven’t yet filed financial statements applying the updated lease rules can opt to wait to apply the changes until fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.

The new revenue recognition and lease accounting rules will require major changes to your organization’s systems and procedures. If you haven’t yet adopted these rules, Haskell & White can help you develop a plan that fits your schedule while you work through the many operational changes of operating safely in a global pandemic.

© 2020

There’s been lots of back and forth about the merits and drawbacks of off-balance sheet accounting, but no matter which side of the argument you’re on, a new standard for lease accounting has been established and it will affect your business. As demands for transparency in financial reporting rise, all leases—from office equipment to warehouses to manufacturing equipment—will need to be presented on your company balance sheet. Organizations that were previously expensing all lease payments through operations under the historical lease accounting treatment will see a significant change in their financial statements.

Here’s what you need to know about how these new lease accounting practices will apply to your business.

The new standard essentially requires all leases to receive similar treatment to what were formerly called “capital leases,” specifying that property under lease now must be recorded as an asset. The related leasing obligation is then recorded and accounted for in a manner that closely mirrors a mortgage. Capital leases are now known as “financing leases,” with similar accounting to that from days of old. Leases that were formerly expensed as operating leases will now result in a capitalized asset—along with a corresponding liability.

The new standard presents changes to wording and underlying definitions as well as practical changes that can complicate accounting and disclosures.

First, you’ll have to identify all leases. Some will be easy to spot, since the title on the top of the document will be clearly marked. However, the new standard also applies to certain leases that may be embedded within other contracts for services. Depending on the size and scope of your business, combing through all service agreements can take time, so it’s best to get on top of this task right away. Even though you may consider this an easy step, ask for help from your CPA firm. They will be able to provide guidance that addresses any specific issues with the leases.

Next, you’ll need to identify a number of variables related to each lease/classes of leases, some of which can be difficult to ascertain. These variables include: the lease term, what is included in payments, and the underlying interest rate. Additionally, whether a lease is classified as a financing lease or operating lease can actually shift over time, based on changes in circumstance. This classification adjustment also applies to overall accounting and disclosure when significant events occur, such as renewal or early termination.

If you haven’t begun to review your lease holdings, you’re not alone. Early indicators suggest that many companies have not yet started preparation to implement this new standard, even though it is effective if your year-end is after December 15, 2018 (for public companies). For private companies, implementation of the new standard can begin for your 2020 calendar year if your fiscal is on the calendar year. In either case, the transition to this new standard will require you to calculate the effects on a retrospective basis for at least one year prior to implementation.

Reach out to your CPA firm to start digging into this ASAP. With such a large volume of data to collect and analyze, the sooner you begin, the better.