RevStream's Point of View on ASC 606 Transition Methods

Chris Millikan, Product Manager & Technical Accounting SME About The Author

Jun 29, 2017 9:48:56 AM

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Factors to Consider in Transition Method Selection – ASC 606

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date


Below we explore factors that entities might want to consider in selecting a transition method when adopting the new revenue recognition guidance. First, we will provide a background on the two transition methods that the FASB has prescribed in adopting the standard and then we will provide factors that a company may want to analyze in making this important decision on how to the adopt revenue recognition standard. 

Effective Dates

The guidance is effective for public entities for annual reporting periods beginning after December 15, 2017 and interim periods within that reporting period. Nonpublic entities are required to adopt the guidance for annual reporting periods beginning after December 15, 2018 and interim reporting periods beginning after December 15, 2019. As such, nonpublic entities are not required to adopt the guidance in interim periods in the year of adoption. 


All entities may elect to early adopt the standard, however, not earlier than annual reporting periods beginning after December 15, 2016 including interim reporting periods within that reporting period, which was the standard’s original effective date before the 1 year delayed effective date. 

ASC 606 Transition Method Overview:

There are two transition approaches that are acceptable to implement the new revenue standard: (1) full retrospective and (2) modified retrospective. For purposes of applying the transition requirements, the date of initial application is the start of the reporting period in which the entity first applies the guidance.  For example, a public calendar year-end company would have a date of initial application on January 1, 2018.  The FASB also clarified that for contracts that are completed[1] before the date of initial application that entities will not have to apply the revenue standard to these contracts as prescribed by each transition method. Please note that the population of completed contracts is different under the two transition methods. Under the full retrospective method an entity can only exclude contracts that begin and are completed within the same annual (fiscal) year while under the modified retrospective method an entity can exclude all completed contracts as of the date of initial application. 

  • Full Retrospective[2]: Retrospectively to each prior reporting period presented, subject to the election of certain practical expedients (see below). This means entities will have to apply the new guidance as if it had been in effect since the inception of all its contracts (both completed and not completed subject to practical expedients) with customers presented in the financial statements (2016, 2017, and 2018). A public calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. In its 2018 annual report, the company would revise its 2016 and 2017 financial statements and record the cumulative effect of the change recognized in opening retained earnings as of January 1, 2016. The entity may elect any of the following practical expedients[3]:

    • For completed contracts, an entity need not restate contracts that begin and end within the same annual reporting period.

    • For completed contracts that have variable consideration, an entity may use the transaction price at the date the contract was completed rather than estimating variable consideration amounts in the comparative reporting periods.

    • For all reporting periods presented before the date of initial application, an entity need not disclose the amount of the transaction price allocated to remaining performance obligations and an explanation of when the entity expects to recognize that amount as revenue.

    • For contracts that were modified before the beginning of the earliest period presented, an entity need not retrospectively restate the contract for each contract modification occurring before this period. Instead, an entity shall reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented when:

      • Identifying the satisfied and unsatisfied performance obligations

      • Determining the transaction price

      • Allocating the transaction price to the satisfied and unsatisfied performance obligations.

However, an entity is still required to account for each modification made after the beginning of the period presented under the standard. 


An entity that elects to adopt the new revenue recognition standard using the full retrospective transition approach is required to provide the disclosures in ASC 250-10-50-1 to 50-2, Change in Accounting Principles. However, there are a couple of reliefs from this guidance that has been afforded by the FASB. An entity need not disclose the effect of the changes on the current period (2018), which otherwise is required by paragraph 250-10-50-1(b)(2).  However, an entity shall disclose the effect of the changes on any prior periods that have been retrospectively adjusted (2016 and 2017). 

  • Modified Retrospective: Retrospectively with the cumulative effect of initially applying ASC 606 recognized at the date of initial application (January 1, 2018 for public company with a December 31 year-end). That is, an entity applies the guidance only to the current period presented in its financial statements (2018). Under this transition method, an entity may elect to apply the guidance retrospectively either to all contracts at the date of initial application or only to contracts that are not completed at the date of initial application. 

A public calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. At that time, the company must record the cumulative effect of the change recognized in opening retained earnings and financial statements for 2016 and 2017 would remain unchanged. An entity would do so by comparing the revenue recognized from contract inception up to the date of initial application (December 31, 2017) to the amount that would have been recognized if it had applied ASC 606 since contract inception.   The difference between those two amounts would be accounted for as a cumulative effect adjustment and recognized on the date of initial application (January 1, 2018). In addition, if an entity elects this transition method it is also required provide additional disclosures in the reporting period that includes the date of initial application (that is, the year of adoption). Please note that the following disclosure information is not required for the year of adoption for the full retrospective method, but is required for the comparative years presented under this method.

  • The amount by which each financial statement line item is affected in the current reporting period by the application of this Update as compared to the guidance that was in effect before the change.

  • An explanation of the reasons for significant changes.

Items to Consider in Selecting a Transition Method

In our view, the following factors should be considered by entities when selecting a transition method under the new revenue recognition standard. This should not be viewed as a comprehensive checklist, but factors to be analyzed among others that are entity specific that will aid companies in their transition method selection analysis. We view that the selection of the transition method is very entity specific and will vary from entity to entity and even entities within an industry. As such, we do not view that there is a single method that is appropriate for all companies. That is, this is not a one size fits all proposition. 

Comparability

The full retrospective transition method will result in more comparable financial statements due to the fact that both comparative years (2016 and 2017) will be under the new revenue recognition standard.  Whereas, under the modified retrospective transition method, 2016 and 2017 will be under the existing revenue recognition guidance and the year of adoption (2018) will be under the new guidance.

Investor Information

The full retrospective method will allow investors to be able to compare prior period trend information more easily from the SEC filings. The use of the modified retrospective transition method will not allow this as easily and will likely result in the company providing this information outside of the filings to assist the investor community in their analysis of the company’s results. One other factor to highlight would be how comfortable is the CFO in explaining the differences introduced by applying the modified retrospective method in earnings conference calls and investor presentations.
 

SEC Registrants

Under the modified retrospective transition method, companies will not restate prior periods. As such, it may be more challenging for SEC registrants to compare results from operations for periods immediately before and after adoption of the new revenue recognition standard in Management’s Discussion and Analysis (MD&A) in their SEC filings.

 

Work/Risk in Year of Adoption

The modified retrospective method will require more work and, therefore, poses more risk in the period of adoption. This is because under the modified retrospective method there is a requirement to perform dual reporting in the fiscal year of adoption. That is, the company choosing this transition method must report under the new method in 2018 and must also provide disclosures detailing what the amount of revenue recognized in the year of adoption would have been under the previous revenue recognition standards. The full retrospective transition method pushes the dual reporting to the two comparative years (2016 and 2017) and, therefore, requires less work in the year of adoption and less risk of not completing the dual reporting. The reason for this is because there is no disclosure requirement under the full retrospective method to provide information on what revenue would have been under the previous revenue recognition standard in the year of adoption.

Volume of Data

There will be much more data to look at under the full retrospective transition method due to restating the two comparative years (2016 and 2017). Whereas, under the modified retrospective method the entity is only applying the new revenue guidance to the year of adoption. Although, it could be argued that there is more data being processed in the year of adoption under the modified retrospective method due to the dual reporting requirement in the year of adoption. 

Availability of Historical Data

Historical data may not be available to perform the full retrospective transition method due to being required to restate the two comparative years including recording a cumulative effect of adoption as of January 1, 2016. Historical data availability is less likely to impact the modified retrospective due to only applying the new guidance to the year of adoption and recording the cumulative effect of applying the new guidance as of January 1, 2018. The longer the contract term the more difficult for historical data to be available to apply the transition methods. Also, companies with significant contract modifications may find it difficult or not have the historical information on these changes to restate the two comparative periods. 

Time to Complete Analysis

As the required date of adoption of the new revenue standard approaches, there may not be enough time to complete the work required to use the full retrospective approach. If this is the case, companies may have no other choice than to use the modified retrospective approach. 

Material Adoption Impacts

If the impact of applying the new revenue recognition standard is not material to the company’s financial statements, this fact may mitigate the risk of prior periods (2016 and 2017) not being comparable to the adoption year (2018) under the modified retrospective transition method. If this is the case, then using the modified retrospective method may make more sense than using the full retrospective method related to the concern of the prior periods not being comparable. 

 

Peer Companies

Companies should reach out to their peers in which they benchmark themselves against to get feedback on the transition method that they are going to use. Companies will want to use the same transition methods as their peers so that the company’s results are comparable to its peers. 

Data Needed for Other Processes (e.g. Internal Analysis, Tax)

Applying the new revenue standard to the two comparative years (2016 and 2017) may be required for internal reporting purposes including for executive management, FP&A, tax, etc. as well as impacts to stock compensation, bonuses, and debt covenant calculations. If so, this may be an indicator that the full retrospective approach is the preferred transition method if historical periods will nonetheless need to be restated.
 

Impact to Planned Revenue

There may be circumstances where deferred revenue under the previous revenue recognition standard will not be recognized as revenue in the financial statements when using either transition method. This circumstance could arise when revenue is recognized earlier under the new revenue recognition standard as compared to under the previous guidance. When the entity records the cumulative effect of adopting the standard under this circumstance, a portion of deferred revenue could be recognized in retained earnings rather than as revenue due to recognizing revenue earlier. 


An example will help illustrate this point. On December 31, 2017 Software Co. sells a software license to a customer that also includes 3 years of Post-Contract Support (“PCS”) for a total of $1.5 million.  Under existing standards these are considered separate elements and the transaction price is allocated as follows: (1) $1 million to software license and (2) $500,000 to PCS. Normally, the software license would be recognized upon delivery and the PCS over the 3-year maintenance period. However, the company does not have VSOE for PCS. As such, the entire $1.5 million price will be recognized over the 3-year PCS term (that is, $500,000 per year). Under the new revenue recognition standard, the license would be recognized upon delivery of $1,000,000 in 2017 and the amount allocated to the PCS of $500,000 would continue to be recognized over the 3-year PCS period. If Software Co. used the modified retrospective transition approach, the amount allocated to the software license of $1 million is not recognized as revenue in its financial statements because prior periods (2017) are not restated under the modified retrospective method. Instead, the $1 million for the software license would have been recognized as part of Software Co.’s cumulative effect adjustment of adopting the new revenue standard recorded in opening retained earnings on January 1, 2018. This is because the software license revenue would not be reported in 2018 as they were recognized in 2017 under the new guidance and as stated above prior periods are not restated under the modified retrospective transition method. 


Using the full retrospective transition method would likely result in deferred revenue being recognized in the income statement for the comparative years presented. However, it should be noted that a similar circumstance could arise under the full retrospective method, but only for the earliest comparative year presented. 

Current Guidance

2017

2018

2019

2020

Total

Revenue

-------

$ 500,000

$ 500,000

$ 500,000

$ 1,500,000

Deferred Revenue

$ 1,500,000

$ 1,000,000

$ 500,000

-------

-------

           

New Guidance

2017

2018

2019

2020

Total

Revenue

$ 1,000,000

$ 166,667

$ 166,667

$ 166,667

$ 1,500,000

Deferred Revenue

(Contract Liability)

$ 500,000

$ (333,333)

$ 166,667

$ 0

-------

Revenue Difference

$ 1,000,000

$ (333,333)

$ (333,333)

$ (333,333)

$ 0

           

Modified Retrospective

Transition Entry - 1/1/18

Debit

Credit

     

Deferred Revenue

$ 1,000,000

       

Retained Earnings

 

$ 1,000,000

     
           

Post ASC 606 Adoption 

Financial Statements

2017

2018

2019

2020

Total

Revenue

-------

$ 166,667

$ 166,667

$ 166,667

$ 500,000

Deferred Revenue

$ 500,000

$ 333,333

$ 166,667

$ 0

------- 

Retained Earnings Impact

$ 1,000,000

-------

-------

-------

$ 1,000,000

 

Product Support

RevStream 5X can help in your transition efforts in adopting the new revenue recognition standard in ASC 606. We can process transactions under multiple reporting methods using a single set of data including but not limited to under legacy revenue standards and under ASC 606. Whether you adopt the standard using either the full retrospective approach or the modified retrospective approach, RevStream 5X can support either method as it can process transactions for an inventory of contracts subject to the practical expedients noted above under both legacy and ASC 606 revenue standards back to the inception of the arrangements at the relevant transition dates, depending on which transition method is selected. We also have functionality that will compare the results under legacy and ASC 606 revenue standards for the purpose of arriving at the transition adjusting entries to beginning equity (retained earnings) for both revenue and expense at the relevant transition dates for either transition method selected.

 
Footnotes:

[1] The FASB clarified in ASU 2016-12, Revenue from Contracts with Customers (Topic 606):  Narrow-Scope Improvements and Practical Expedients, that a completed contract is one for which all (or substantially all) of the revenue has been recognized under previous US GAAP. 
[2] The FASB clarified in ASU 2016-12 that an entity that uses the full retrospective approach does not need to disclose the effect of the accounting change on affected financial statement line items in the period of adoption as required by ASC 250, Accounting Changes and Error Corrections. However, an entity is still required to disclose the effect of the changes on any prior periods retrospectively adjusted.
[3] The FASB decided in ASU 2016-12 to provide a practical expedient to reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented in accordance with Topic 606 when identifying the satisfied and unsatisfied performance obligations, determining the transaction price, and allocating the transaction price to the satisfied and unsatisfied performance obligations using either transition approach.