This article is based on a session led by Krystal Smith, Director of Finance at VFP, held in our latest team meetup.
Summary of the article:
The session covered key accounting concepts, including revenue recognition, ASC 606, and the differences between cash and accrual accounting methods. Revenue recognition involves recording revenue when it’s earned, while invoicing relates to issuing bills, which can occur at different times. ASC 606 standardizes revenue recognition for consistency across companies.
In today’s accounting landscape, few standards are as critical as ASC 606, which brought global consistency to revenue recognition practices across industries. Whether you’re new to finance or brushing up on recent standards, understanding how ASC 606 and core accounting principles shape revenue recognition is essential for accurate financial reporting and strategic decision-making.
There are two main accounting methods: cash basis and accrual basis. Cash-based accounting records revenue and expenses only when cash changes hands, making it simple but less comprehensive. In contrast, accrual accounting, typically used by larger firms, records revenue when earned and expenses when incurred, providing a clearer financial picture in line with the matching principle.
The accounting equation—assets equal liabilities plus equity—forms the foundation of financial reporting. Assets represent company resources, liabilities are obligations, and equity denotes the owner’s residual interest. This equation ensures balanced books and informs key financial reports like the balance sheet and income statement. The balance sheet offers a snapshot of assets and liabilities, while the income statement tracks performance over time.
The general ledger (GL) is the central repository for tracking transactions and supporting accurate reporting.
Implemented in 2017, ASC 606 aligns U.S. GAAP with international financial reporting standards (IFRS), promoting industry consistency. Under ASC 606, revenue is recognized either at a point in time or over time, depending on customer control over goods or services:
- Point in Time: Revenue, such as retail sales, is recorded when controlling transfers.
- Over Time: Revenue is recognized progressively, often in long-term contracts, using input or output methods.
ASC 606 also addresses unique scenarios like licensing and variable consideration. Licensing revenue may be recognized upfront or over time, and variable consideration involves ensuring additional revenue is “highly probable” to avoid later adjustments.
The five-step model of ASC 606 provides a structured approach to revenue recognition:
1. Identify the contract with a customer.
2. Define performance obligations in the contract.
3. Set and allocate the transaction price.
4. Allocate the transaction price to performance obligations.
5. Recognize revenue upon transfer of control.
This model impacts contract design, pricing, and compliance, aligning financial reporting with actual economic activity and supporting transparent financial disclosures.
ASC 606 is essential for consistent, transparent revenue reporting, whether applied to tech, manufacturing, or service industries. Mastering this standard helps companies provide accurate financial data, guide strategic decisions, and foster trust with investors and stakeholders.
