Wait. Who invited ASC 606 to the party?
ASC (Accounting Standards Codification) 606 is the not-so-new revenue recognition standard that affects all businesses that enter into contracts with customers to transfer goods or services – public, private and non-profit entities. Both public and privately held companies should be ASC 606 compliant now based on the 2017 and 2018 deadlines.
How does ASC 606 impact you?
The U.S. Generally Accepted Accounting Principles (GAAP) guideline—known as ASC 606—requires businesses to track and identify their earned and deferred revenue.
As usual, it’s not as easy as it sounds (as you might already know).
We won’t get into the details. Our competitors have some helpful guides on how to understand the rules.
Accounting rules like ASC 606 and IFRS 15 as we all might know, are all but direct. You’re better off asking an expert or buying software that helps make this process easy.
However, what you should never outsource is the understanding of what happens when you don’t follow the rules.
ASC 606 adds new fears and challenges
Subscription-based businesses often find themselves collecting payment before rendering all services or products, complicating their approach to complying with these newer rev rec rules. And getting revenue recognition for SaaS right as a business scales becomes increasingly tedious and unmanageable if done manually or within legacy systems. So much so, at certain stages, using Excel for revenue becomes more common than using cloud software. Even in 2022.
All because ASC 606 requires these businesses to recognize recurring revenue differently. A customer may pay for a year’s worth of software access. Still, the seller can only recognize revenue after the first month of a $1,200 annual subscription ($100 as recognized and the remaining $1,100 as deferred revenue). And keeping track of all this is where the headache really sets in.
Consequences for ASC 606 noncompliance
So what happens if I find my business in a state of noncompliance? Noncompliance with financial reporting can result in deficiencies in material weaknesses, often identified by a company’s auditor (yes, you will get audited).
What’s a “material weakness”?
A material weakness arises when a company’s internal controls—activities, rules, and processes preventing significant financial statement irregularities—prove ineffective.
Uh oh.
What happens when auditors uncover material weaknesses?
The short answer: It’s not good.
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- Investors or potential investors lose confidence (public and private).
- External audit fees increase to identify and address material weaknesses.
- Legal fees sky-rocket.
- Companies struggle to obtain loans and competitive rates due to their high-risk reputation.
- Folks lose jobs due to a lack of oversight and governance.
Still don’t believe me?
The behemoth cloud application and platform service provider Oracle announced its quarterly earnings toward the end of 2018, only to restate it the next day with close to half a billion dollars wiped out from its top-line revenue. While they were compliant the following year, Oracle took a hit to its earnings forecasts, and its stocks decreased by 7.5%.
Additional collateral damage included Uber and Tesla. While Uber would see its reported revenue drop by more than half, Tesla added $299 million to its sales revenue after adopting the new standards. Tesla's increase was merely an accounting change and didn't actually say anything about its growth.
But hey. There’s some silver lining, I think? Not all companies with deficiencies end up with a 16% drop in stock price like Revlon did in 2018, or massive legal fees and class action lawsuits like Marriott faced in 2019
The moral here? To avoid the significant impacts of ASC 606 noncompliance, maintaining proper controls and compliance with your people, process, and technology are critical for both public and private companies.
If not today, someday
The other lesson here:
Even if you’re not Marriott, this applies to you. Maybe not today, but someday.
We know from personal experience and from many of our customers that it can be easy to let today’s fires make tomorrow’s priorities get away from you. It’s why we build our products the way we do.
Business is crazy. All day. Every day.
Unfortunately, compliance doesn’t care.
ASC 606 compliance applies to every organization, both public and private, both big and small. And the regulations heavily impact software companies in particular. Whether you have to hire a consulting firm or a CPA team to ensure your financial systems comply or manage them internally, not complying is not an option.
Well, I guess noncompliance is an option.
If you’re into hefty consequences, that is.
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