The ASC 606 switch isn’t simple, and now that the deadline to adopt the new standard for most public companies has arrived, the reality is that many are woefully unprepared for the significant changes it brings. I fear that some public companies will be forced to restate their revenues, and their stocks will fall sharply in that aftermath.
Even private companies, which have an additional year to adopt the standard, will run into trouble if they aren’t in compliance with ASC 606. Raising venture funding or getting traditional bank loans may be out of the question if firms don’t have financial management systems that conform to the new standard.
I believe the impact of ASC 606 will rival that of the Sarbanes-Oxley Act of 2002, which sought to protect shareholders and the general public from accounting errors and fraudulent corporate practices. We all remember how painful that transition was for many U.S. businesses, as they paid astronomical costs to meet the requirements and leaned hard on their finance and internal audit teams to do so.
The changes to the revenue recognition guidelines require many companies to rethink the way they do business, and find technology that brings them into compliance.
Take sales commissions, for instance. These commissions are typically paid in full when a contract is signed. But under ASC 606, payments must be spread over the life of the sales contract. Let’s say a sales rep signs up a new customer that agrees to pay $100 a month for the next three years. Prior to ASC 606, the sales rep would be paid a one-time commission of, say, $1,000 upon the booking of that long-term contract and the rep’s company would incur the full $1,000 expense at that time.
Under the new guidelines, this is no longer allowed. Instead, from an accounting perspective, the $1,000 commission expense must be spread over the lifetime of the contract. As a result, the new guidelines have a material impact not just on revenue recognition, but on the actual profitability of your company.
What’s more, ASC 606 requires all interactions with a customer to be captured in a single contract. If a customer buys service A, and in six months, buys service B, both must be reflected on the original contract. This means more work for the accounting department and strict governance over how relationships are captured and tracked.
Even companies with moderately complex customer contracts will see an extensive impact under the new standard as they audit every single contract. Suddenly ASC 606 looks to be as much of a CRM function as it is financial.
This is where it's clear that the solution rests in technology. The good news is that many of the top cloud financial management software vendors have already rolled out solutions to address the upcoming rules for revenue reallocation and expense amortization. The new challenge becomes how to evaluate solutions for ASC 606 standards.
One of the key things to look for when evaluating these solutions is to ensure they use automation, not spreadsheets and other manual workarounds that can drain accountants’ time. Look to solutions that provide out-of-the-box functionality, reduce dependence on IT resources and don’t require complicated scripting.
For instance, when a contract changes, the system should automatically trigger revenue reallocation across a variety of recognition schedules. It should also include automated dual-reporting with side-by-side results based on both old and new guidelines, so it’s easy to spot how the rule changes impact the bottom line.
This matters more than you may think. Companies that were considered $100 million businesses under previous reporting standards could now be $95 million businesses, or even $105 million businesses – even though their results haven’t changed at all.
With ACS 606-compliant technology in place, businesses can begin educating investors about changes in financial performance brought on by the new standard, rather than facing difficult questions, miscalculations, and financial risk.
Although the switch to ACS 606 isn’t simple, it doesn’t have to cost businesses a domino effect of potential financial exposure or liability. The first financial quarter of 2018 will be a strong indicator for which public companies have their houses in order, and those that need help, quickly.