Is your retail business ready for the new revenue recognition rules (ASC 606)? How will the new revenue recognition rules impact retailers? Here’s what you need to know about the key changes impacting revenue recognition.
Retailers are facing significant changes with the implementation of ASC 606: Revenue from Contracts with Customers, which replaced ASC 605. Issued by the Financial Accounting Standards Board (FASB), ASC 606 aims to provide a more consistent and transparent approach to recognizing revenue across industries. While many retailers initially thought the impact would be minimal, it has become clear that ASC 606 affects several key areas of revenue recognition, including gift cards, loyalty programs, customer incentives, and return policies.
In this article, we’ll focus on the five most significant differences between ASC 606 and ASC 605 that will affect retailers. Understanding these changes is crucial for retailers to ensure compliance and adapt their accounting systems effectively.
Transfer of Control vs. Transfer of Risks and Rewards
Under ASC 605, revenue recognition was primarily based on the transfer of risks and rewards of ownership. This typically occurred when the goods were delivered to the customer, meaning revenue was recognized at the point of sale, assuming no significant returns or uncertainties.
ASC 606 shifts the focus from risks and rewards to control. Revenue is recognized when control of the goods or services is transferred to the customer, which may or may not align with the delivery of the product. This means that in some cases, revenue may be recognized earlier or later than it was under ASC 605, depending on the specific terms of the contract.
For example, if a retailer sells a product with an extended warranty, under ASC 606, revenue must be recognized when control of the product is transferred and the warranty service is fulfilled, potentially over time. This change also applies to service contracts, digital goods, and long-term agreements where delivery is spread over time.
ASC 606 focuses on when control of the goods is transferred, not just when risks and rewards pass to the customer.
More Detailed Identification and Allocation on Performance Obligations
ASC 605 didn’t require retailers to explicitly identify performance obligations—distinct goods or services promised in a contract. Revenue could often be recognized based on the overall sale price when goods were delivered, or services were rendered.
In contrast, ASC 606 introduces a more detailed approach to performance obligations. Retailers must now identify distinct goods or services that make up a contract and allocate a portion of the transaction price to each performance obligation. This means that for complex contracts (e.g., bundled goods and services, extended warranties, or loyalty programs), the retailer needs to recognize revenue for each performance obligation separately as it is satisfied.
For example, if a retailer bundles a product with an extended warranty or loyalty points, ASC 606 requires the revenue from the product to be recognized at the point of sale, but the revenue from the warranty or loyalty program will be recognized over time, as the services are provided or points are redeemed.
Retailers must now identify distinct goods or services that make up a contract and allocate a portion of the transaction price to each performance obligation.
Variable Consideration and Customer Incentives
ASC 605 allowed for revenue to be recognized at the transaction price agreed upon in the contract, with adjustments made for returns, discounts, and rebates after the sale, if necessary. There was less emphasis on accounting for variable considerations upfront, meaning retailers had more flexibility in recognizing revenue based on what was paid or expected to be paid.
Under ASC 606, however, variable consideration (such as discounts, rebates, promotional offers, or contingent pricing) must be estimated and included in the transaction price at the time of sale. Retailers need to estimate the likelihood of discounts, rebates, or performance-based incentives being triggered, and they must include these estimates when determining the transaction price.
This change can lead to earlier recognition of revenue compared to ASC 605, especially for retailers with frequent promotions or discounts. For example, if a retailer offers a conditional discount (e.g., “buy one, get one free”), ASC 606 requires the retailer to estimate the expected total value of the transaction at the time of sale, adjusting for the discount.
Variable considerations, like discounts or rebates, must be estimated and included in the transaction price upfront.
ASC 606 requires recognizing a liability for gift card sales, with revenue only recognized when redeemed.
Loyalty Programs and Customer Rewards
Loyalty programs, such as reward points or credits for future purchases, are commonly used by retailers to encourage repeat business. Under ASC 605, retailers could recognize the full revenue from a sale immediately, even if loyalty points were issued, treating them as incidental and not requiring separate tracking.
Under ASC 606, however, loyalty points are treated as a separate performance obligation. Retailers must allocate part of the transaction price to the points based on their standalone value, recognizing revenue when the points are redeemed or expired. This could delay revenue recognition compared to ASC 605, especially for retailers with large loyalty programs.
For example, when a customer earns points for a purchase, the retailer must allocate a portion of the sale price to those points and recognize the revenue when the points are redeemed or expired, considering the likelihood of breakage (unredeemed points).
To comply with ASC 606, retailers must update their accounting systems to track and allocate revenue accurately, ensuring they handle the complexities of loyalty programs and monitor any further guidance from the FASB. By proactively adapting, retailers can ensure compliance and benefit from greater transparency in their revenue recognition practices.
Loyalty points are now considered a separate performance obligation, with revenue recognized when points are redeemed.
Conclusion
Implementing ASC 606 is a pivotal moment for retailers, offering more than just compliance—it’s a chance to revolutionize financial transparency and operational efficiency. With clearer revenue recognition for loyalty programs, gift cards, and promotions, retailers can unlock deeper insights into their business performance. This shift empowers companies to make smarter decisions, boost investor confidence, and strengthen customer trust. The future of retail finance starts now!
Applied Expertise: accounting, ASC 606, revenue recognition, FASB, retail accounting, performance obligations, transfer of control, variable consideration, customer incentives, gift cards, breakage revenue, loyalty programs, transaction price allocation, financial transparency, operational efficiency, compliance, accounting systems, financial reporting, promotional offers, conditional discounts, extended warranties, contract terms, unredeemed points, escheat laws, revenue recognition practices, retail finance
