Identifying the contract (s) with the customers is the first condition for ensuring compliance with FASB ASC 606 and IFRS 15 internationally. Jointly developed by the International Accounting Standards Board (IASB) and the Financial Accounting Standards (FASB), ASC 606 is the new standard for recognition of revenue from contracts with customers.
In the unlikely case that you didn’t know about it, the IASB is responsible for International Financial Reporting Standards (IFRS) while FASB is responsible for U.S Generally Accepted Accounting Principles (U.S GAAP). So, the coming together of the two governing bodies to create a new accounting/revenue recognition standard was a bit unexpected.
It is true that some companies will be impacted more by the new revenue recognition than others. This is especially true for organizations that must follow specific industry guidance. These are the companies most likely to see an impact of ASC 606 on their revenue. Since revenue is as important as contracts and agreements, finding out the conditions for contract under ASC 606 is crucial. And, these conditions are exactly what we’ll be discussing here.
Conditions for Contract Under the New Revenue Recognition Standard
The Financial Accounting Standards Board (FASB) has established a five-step process to perform revenue recognition under ASC 606—the new revenue recognition standard. Identifying the contract with the customer is how you are required to start to process. Looks simple? It is anything but. Why do we say that? Because there are several conditions to meet and even more things to consider.
As defined by FASB, a contract is ‘an agreement between two or more parties which creates rights and obligations that can be enforced’. Here, the rights and obligations refer to entitlements and duties that have legal status and can be enforced as per the law. However, the meaning of the term can vary based on legal jurisdictions.
Now, there are several different ways of establishing contracts including oral, written and implied agreements. Under ASC 606, implied contracts are acceptable as long as the customer has reasonable expectation based on the past practices of the business that are part of the negotiated terms. The assumption that a business will provide ongoing support for the service/product being offered is an example of an acceptable implied promise under the new revenue recognition standard.
Even if there is no mention of it in the contact, but the customer knows that party providing the service/product offers support, then the negotiated contract including support is a reasonable expectation of the customer according to ASC 606. You may be itching to know the conditions for contract under FASB ASC 606. Well, here it is. Following are the five qualities of an agreement that makes it a contract under the new revenue recognition standard:
Approval of the contract by all parties involved including commitment to perform respective obligations
The rights of each party in the contract must be clear and identifiable
Payment terms must be identified in the contract
Ensure that the contact has commercial substance i.e. the contact impacts the amount, timing and risk of the company’s future cash flows
The company must evaluate its probability of collecting substantially all of the consideration that it is entitled to as per the contract
An agreement that fulfills that above requirement is considered as a contract under FASB ASC 606. If you want to know more about the new revenue standard or its compliance, then contact CallidusCloud today!