2018 is upon us, and public companies will be adopting Accounting Standards Codification, Topic 606 (aka ASC 606). While seemingly a surprise for many companies, the new revenue recognition rules have been a long time coming. The FASB and IASB issued their final standard on ‘revenue from contracts with customers’ on May 28, 2014, after some 12 years in the making; the revenue recognition topic was first added to the FASB agenda back in May 2002. Since then, discussion papers were issued in 2008, and exposure drafts shortly thereafter, eventually resulting in the issuance of the final standard in the form of ASU 2014-09 and IFRS 15. With much dialog, adjustments, and modifications along the way, here we are at the effective date for most public entities.
So ready or not, the time has come for businesses to shift to the new revenue recognition guidance for revenue from contracts with customers, a replacement of almost all prior GAAP revenue guidance. This framework was developed to provide a consistent approach across industries for recognizing revenue from contracts with customers (vs other revenue types). Businesses will recognize revenue when control of the promised goods or services is transferred to customers, at an amount that reflects the consideration to which the business expects to be entitled in exchange for those goods or services. The impact is expected to vary widely, as some businesses will experience significant change across revenue management and financial statement disclosures, while others may see less of an impact on revenue recognition while focusing more on the new disclosure requirements.
Early ASC 606 Adopters Provide Guidance on Disclosures
We saw some businesses adopt early during 2017, providing an advanced perspective of the impact of the new guidance on their business and financial statement disclosures. Alphabet, the successor holding company to Google established in 2015, is one such company that adopted ASC 606 early, effective as of January 1, 2017. In their 10-Q for the quarter that ended March 31, 2017, Alphabet noted their adoption using the modified retrospective method applied to contacts that were not yet completed as of January 1, 2017. They explained “We recorded a net reduction to opening retained earnings of $15 million as of January 1, 2017, due to the cumulative impact of adopting Topic 606, with the impact primarily related to our non-advertising revenues” They further noted the impact for their Q1, stating “The impact to revenues for the quarter ended March 31, 2017, was an increase of $14 million as a result of applying Topic 606”
You would be correct in thinking that $15 million is somewhat of a rounding adjustment for the Alphabet reporting entity, they reported close to $25 billion in total revenue for the quarter that ended on March 31, 2017. Of that total amount, over 86% was disclosed as advertising revenue generated either on their own properties or on ‘network member’ properties. Alphabet recognizes advertising revenue as ads are either clicked on (cost per click, CPC) or displayed (cost per impression, CPM), and these methods were consistent between ASC 605 and ASC 606, resulting in minor change for most of the advertising revenue recognition.
But the analysis had to be done to properly adjust all impacted customer revenue in play for the retained earnings adjustment as of January 1, the start of their adoption period. Alphabet did also note other areas impacted by the new guidance, noting the new framework language of Performance Obligations and the allocation of contract value based on relative Standalone Selling Prices (SSP): “Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin.”
They further noted the inclusion of estimates for variable consideration caused by cash-based incentives or credits, stating that these estimates required a reduction in revenue recognized during the period reported. They also discussed analysis related to the principal vs agent element of the new guidance, stating the reasoning behind the reporting of revenue on ‘network member’ sites on a gross basis: “We are the principal because we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory, being primarily responsible to our customers, having discretion in establishing pricing, or a combination of these.”
They also discuss the cause of deferred revenue, and note that “The increase in the deferred revenue balance for the three months ended March 31, 2017, is primarily driven by cash payments received or due in advance of satisfying our performance obligations…”, and additionally discuss the practical expedients relied up on excluding commissions and disclosure of the unsatisfied performance obligations for contacts under one year in length.
So while Alphabet may not have had a large % revenue adjustment as a result of ASC 606 during their first reporting period of Q1 2017, they certainly have worked through all aspects of the new guidance as it relates to their revenue recognition policies and disclosures. It will be very interesting to see the impact on other businesses as we proceed into the first reporting period in 2018.
Over To You
What will you be incorporating into your 2018 revenue recognition adoption plan? What updates can you make to your current systems to stay relevant and compliant with the new regulations? Keep in mind that when it comes to revenue recognition, system improvements like having a revenue sub-ledger can make a big difference come fiscal year-end.
We hope that you will come back and continue with us here, and also read additional blog posts here. We will strive to track and discuss some of the more notable disclosures as they are released, adding to the conversation. We look forward to hearing from you, so feel free to join the conversation on LinkedIn