The complexity of businesses and their transactions requires an adaptable and detailed standard that can be consistently applied across industries to recognize revenue. ASC 606 is the new revenue recognition standard to be applied in US GAAP to improve the accuracy of revenue recognition. It concerns revenue related to contracts with customers and sales of some non-financial assets that are not an output of the entity’s ordinary activities, such as property, plant and equipment. Other types of revenue are not in scope. This guidance has been transitioned jointly by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB).
All project driven industries, such as Water Management, are impacted. We expect to see the most significant changes for unregulated services such as Design and Build or Operation and Maintenance, with Regulated services expected to be less exposed.
Non-listed companies are required to apply the revenue recognition standard for annual reporting periods beginning on or after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. Application would be permitted earlier only for an annual reporting period beginning after December 15, 2016. The implementation of the new standard will require the restatement of the financial statements if the company decides to apply the standard retrospectively.
To facilitate the analysis of potential impacts, a five step approach has been developed, as the process tends to become more complex for long term contracts with customers.
The steps are: the identification of the contract with the customer, the split of the contract into performance obligations, the definition and allocation of the contract/transaction price to each performance obligations, and timing of the revenue recognition.
Due to the complexity of the transaction, it will be important to identify the end customer of each contract and its deliverables. When a city, for example, negotiates and awards a contract to a water treatment company to manage the full cycle of wastewater for the municipality, by creating and operating a new waste water plant, it will be important to take into account what different performance obligations are included in such a contract. While designing, building, operating or maintaining a facility are different performance obligations, and should be accounted for separately in a single contract, it will be important to be able to assess the cost and profitability of each of these elements, as they will be the drivers to allocate price. As an example, it is very common that operation and maintenance are higher margin phases when compared to building. Such consideration may modify revenue recognition if previously the company did not split the contract into performance obligations and was recognizing revenue as a whole. After pricing each of them, the company will recognize revenue over time by measuring progress on each.
Some regulated services are in the scope of ASC 606 such as revenue with customer based on regulated tariffs. Despite the role the regulator plays in determining the rate, there is an actual contract with a specific price and identifiable customer. Nevertheless, the major industry players do not expect significant impacts. Revenue subject to refunds and alternative revenue programs will be covered by ASC 980-605 and will be out of the scope of ASC 606. U.S. GAAP specifies that revenue subject to refund arises in contracts between an entity and a regulator, which does not meet the criteria of ASC 606. This was confirmed by the AICPA’s Power and Utilities task force.
The implementation of the new standard is challenging not only in terms of valuation and timing of revenue recognition, but also in terms of changes to operational and financial reporting. The perception of the actual company’s performance will be altered as the increased need of disclosures and qualitative information will allow a better benchmark across the industry. Financial communication with stakeholders will then play an increased role in explaining the standard’s impact on the company’s performance and its place among its competitors.