The new revenue recognition standard, ASC 606, has been causing a stir in the business world. Companies have been scrambling to make changes to their accounting practices in order to comply with the new regulations, which dictate how revenue must be recognized and reported. One of the biggest challenges companies face is determining the cost to obtain a contract under ASC 606. In this article, we will explore what this cost entails, how it is calculated, and what impact it has on a company`s financial statements.
The cost to obtain a contract under ASC 606 refers to the expenses a company incurs in order to secure a new customer or contract. These expenses can include sales commissions, marketing costs, legal fees, and other costs associated with the sales process. Under ASC 606, these costs must be capitalized and recognized as an asset when incurred, as opposed to being expensed immediately.
The calculation of the cost to obtain a contract can be complex, as it involves determining the incremental costs incurred to obtain a contract that would not have been incurred if the contract had not been secured. For example, if a salesperson receives a commission for closing a deal, the incremental cost of that commission would be included in the cost to obtain the contract. However, if that salesperson would have received the commission anyway for other sales, then it would not be included in the calculation.
Once the cost to obtain a contract has been determined, it is then amortized over the life of the contract. This means that a portion of the cost is recognized each year as the company earns revenue from the contract. The amortization of the cost to obtain a contract is recorded as an expense on the income statement, and the remaining balance of the asset is reported on the balance sheet.
The impact of the cost to obtain a contract under ASC 606 can be significant for companies, particularly those in industries with long-term contracts or high sales commissions. The capitalization of these costs can result in lower expenses in the short-term, but higher expenses over the life of the contract. This can impact key financial metrics such as gross margin and operating income.
It is important for companies to understand the requirements under ASC 606 and properly calculate the cost to obtain a contract in order to avoid potential financial misstatements or non-compliance. This may require significant changes to accounting policies, systems, and processes, as well as additional resources for data gathering and analysis.
In conclusion, the cost to obtain a contract under ASC 606 is a key component of the new revenue recognition standard. Companies must properly calculate and amortize these costs in order to comply with the regulations and accurately report their financial statements. While this may require significant effort and resources, it is essential for companies to ensure they are in compliance and avoid potential penalties or reputational damage.