ASC 606 has made understanding revenue recognition patterns more complicated. Having an understanding of the model economics will help explain current period revenue and predict future revenue patterns. Below are the four drivers that impact how revenue is recognized over the life of a proportional performance model:
- Changes to the transaction price: additional milestones earned over the course of the performance obligation period will increase current period revenue. Changes will be amplified the closer the performance obligation is to completion. If you are 80% completed and receive an a $1M milestone, $800K of will be recognized as revenue and $200K will deferred. If you are 20% completed, $200K will be recognized as revenue and $800K will be deferred.
- Changes to the current period spend: revenue is recognized as the company moves closer to completing the performance obligation. Conceptually this makes sense. Explaining changes between what was predicted in the prior period and what is actually recognized in the current period can be explained through a budget vs. actual analysis.
- Changes to the total spend: changes to the total spend through completion of the performance obligation will have an impact on the current period revenue by either diluting or concentrating the actual spend through the current period. If a program delay adds additional spend, if all else is equal, the percentage complete on the project will decrease, decreasing the current period revenue. This happens because the increase in total spend dilutes the work already performed.
- Changes to the weighted average impact of each program: related to the change in total spend, if one program’s total spend increases, the impact of that program’s period spend will have a bigger effect on the total revenue recognized. A program that commands 50% of the total spending to complete the performance obligation will have more impact on the revenue earned than a program that only commands 20% of the total spending.
Having a thorough understanding of each driver’s impact to the period revenue will be critical to explain and predict future revenue timing. Understanding the future revenue timing is important for the short-term vs. long-term deferred revenue classification and could also have tax implications.
The organization’s FP&A function will be critical to help distinguish between timing and permanent spending changes. A timing change will have a smaller effect on current period revenue compared with a permanent change because a permanent change impacts the total spend, diluting or amplifying the impact of the spend already incurred. Organizational communication will be critical across accounting, finance and project management.
Preparing, maintaining and reviewing this level of financial data is difficult with only an Excel spreadsheet. With all the implications and additional work that ASC 606 is adding to accounting teams, remove the pressure of maintaining spreadsheets. Find out how intheBlk’s revenue recognition tool can provide this detail. Take the guesswork out of your collaboration revenue. Sign up for a demo today and start benefiting from our cloud-based revenue recognition solution.