FASB ASC 606 Revenue from Contracts with Customers: Understanding the Basics
The Financial Accounting Standards Board (FASB) is a non-profit organization responsible for setting accounting and reporting standards in the United States. FASB ASC 606 is a new revenue recognition standard that is designed to improve clarity, consistency, and comparability in financial statements. This standard applies to all entities that enter into contracts with customers to transfer goods or services.
In simple terms, FASB ASC 606 outlines a five-step model for recognizing revenue from contracts with customers:
1. Identify the contract(s) with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations in the contract.
5. Recognize revenue when (or as) the performance obligations are satisfied.
The first step is to identify the contract(s) with a customer. A contract is a written or oral agreement between two parties that creates enforceable rights and obligations. To be recognized under FASB ASC 606, the contract must have commercial substance, be approved by the parties involved, and have identifiable payment terms.
The second step is to identify the performance obligations in the contract. Performance obligations are promises to transfer goods or services to a customer. For example, a software company may promise to provide ongoing support services to a customer who purchases its software. In this case, the software and the support services are considered separate performance obligations.
The third step is to determine the transaction price. The transaction price is the amount of consideration expected to be received in exchange for transferring goods or services to a customer. The transaction price may include variable consideration, such as discounts or incentives, which must be estimated and adjusted as necessary.
The fourth step is to allocate the transaction price to the performance obligations in the contract. This involves determining the relative standalone selling price of each performance obligation and allocating the transaction price accordingly. If the standalone selling price cannot be determined, it must be estimated using a method that is consistent with the overall objective of FASB ASC 606.
The final step is to recognize revenue when (or as) the performance obligations are satisfied. Revenue is recognized when the customer obtains control of the promised goods or services. Control is achieved when the customer has the ability to direct the use of, and obtain the benefits from, the promised goods or services.
FASB ASC 606 is a complex standard that requires significant judgment and estimation. However, following the five-step model can help entities properly recognize revenue from contracts with customers. It is essential for companies to understand these new guidelines to comply with the new standards and avoid any risk of violating accounting regulations.
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