Though the deadline for implementing the new revenue standards, ASC 606 and IFRS 15, is right around the corner for public companies, only a handful are ready for the change. Even businesses (mostly subscription-based) that have been capitalizing and amortizing their commissions for years will need to adjust their current processes to align with the requirements of ASC 606. Within these companies, only a small percentage have a defined strategy in place as to how they’ll adjust their compensation process.
Preparing for the Impact of ASC 606
A lot of time and energy has been focused on how to manage the change from a revenue perspective, but not nearly as much effort has been spent addressing the expense implications, such as how to account for the incremental costs of acquiring customer contracts; such as commissions. Commissions will be directly affected by the new standards. Under ASC 606, commissions need to be capitalized as an asset and then amortized over the period the associated service is provided to the customer; if the service period extends beyond one year.
Adopting ASC 606
When preparing for the adoption of ASC 606, organizations must first decide whether they are going to take the full or modified retrospective approach. Once they’ve determined their approach, they have to decide whether to amortize at the portfolio or contract level.
Under the full retrospective approach, two years of historical financial statements need to be restated. This is only practical if a company has access to their contract and commission details at a granular enough level to support the restatement process. If they choose the modified retrospective approach then their financial statements have to be reported under the old and new standards during the adoption year; with an adjustment being made to the retained earnings balance under the new standard. This approach limits the amount of year over year trend analysis that can be conducted.
Next up, amortization.
The portfolio approach bundles like-contracts together, aggregates the associated commissions and then amortizes the earnings. Naturally, there is less data in this approach. This is good for businesses that have very little change within the company and whose customer contracts are all very similar. We find that this approach is most common for traditional-based business models.
On the flip side, subscription-based businesses are moving towards the contract-level approach. Things move so quickly in these organizations that they need an audit trail to help track all of the changes. Amounts paid out for commissions have to reconcile fully with what’s been capitalized and amortized over time. It’s an ongoing process for these ever-changing businesses. This method is complex, but gives greater visibility in the overall compensation accounting process.
A Sales Performance Management which integrates the compensation payout, accounting and modeling processes is critical to a successful adoption of ASC 606. Obero SPM is the only ASC 606-compliant compensation accounting solution designed for subscription-based businesses. Access Obero’s rich library of resources on preparing for compensation accounting under ASC 606.
Obero and the CFO Alliance recently held a webinar covering the new revenue standard and its impact on compensation accounting. To learn more about compensation accounting under ASC 606, watch the webinar recording.
About the Author:
Christopher Li is Chief Product Officer at Obero, a cloud-based Sales Performance Management Solution which supports the end-to-end sales life cycle and is the only solution designed to support compensation accounting under ASC 606.