ASC 606: Ready or Not, Here It Comes
The ASC 606 regulation from the Federal Accounting Standards Board (FASB) is coming hard and fast for companies, but many don’t know where to even begin to understand the implications. For those in sales compensation or sales ops roles, this change may have huge impacts on the structure of your sales compensation rule configuration to account for new components or assessment logic in certain scenarios.
Many comp admins have reached out to me on this topic, overwhelmed by the detailed accounting and financial compliance implications described in detail all over the internet. The focus of this 2-part series is to provide some insights into the background of the ruling and considerations specifically for those in the sales compensation field regarding direct impacts to how you assess and calculate incentive compensation.
Why the Need for this New Regulation?
In the past, revenue recognition standards differed between the generally accepted accounting principles (GAAP) in the United States and the global provisions set by the International Financial Reporting Standards (IFRS). It was universally acknowledged that these rules needed to evolve due to varying ways they were being applied and loopholes they created, so the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) launched a joint initiative to better align these standard practices globally, which resulted in the 2014 publication of the new “Topic ASC 606: Revenue from Contracts with Customers”.
The ultimate objective was to outline a common way to recognize revenue for all contracts with customers across international standards. As part of that objective, there are five basic steps that must be addressed as part of this ruling:
- Identify the contracts with the customer
- Identify the separate performance obligations with the contract
- Determine the transaction price
- Allocate the transaction price to separate performance obligations
- Recognize revenue when, or as, each performance obligation is satisfied
These new regulations go into effect the fiscal year starting after December 15, 2017 for publicly traded companies and into similar effect for private companies after December 15, 2018. However, I advise that you work with your internal audit teams to ensure all details for compliancy are fully understood and planned for. Find the full details here.
What Does This Mean to Me on the Sales Comp Side?
Outside of the direct accounting compliance changes for how revenue is recognized, the implications reach into how the associated costs (i.e. commission expenses) are amortized over the expected timeframe of satisfying the performance obligations of the contract. This might be different than the actual contract or product terms. Instead of simply recognizing the commission expense in the period executed to offset the revenue, the comp admins and sales operations resources will now be responsible for helping identify and track the sales commissions and bonuses at the required level of detail to comply with new revenue recognition regulations. Now, manually tracking this data through spreadsheets will not be enough.
Below is a sampling of key items to take note from Subtopic 340-40 of the FASB ASC 606 ruling, which focuses on the incremental costs of obtaining a contract:
- Commission expenses can continue to be recognized when incurred if the determined amortization period is one year or less.
- Commission expenses must be amortized for individual reps over the anticipated life of the customer if the contract is longer than one year, but any indirect or rolled commissions for supervisors/managers will continue to be recognized immediately regardless of the determined contract term length.
- Every time the existing rep or other rep sells to the customer again, you must evaluate if that extends the life of the customer or servicing existing life expectancy. For each additional commission calculated and paid, you must be able to quantify the impact their action did to further that customer for commission expense amortization considerations.
- Depending on the type of industry (i.e. High-Tech, Life Sciences, etc.) you work in or products sold to customers (i.e. Services, Hardware, etc.), you might need to calculate commissions down to their customer, contract, and product level to determine the correct commission expense values for amortization over the period determined through analysis as it could vary down to that level of details.
Stay tuned for my next blog in this ASC 606 2-part series, which will provide tips on how you can prepare for these new revenue recognition rules.