ASC 606 Revenue Recognition Walkthrough

Why ASC 606 Still Demands Attention

ASC 606, Revenue from Contracts with Customers, replaced virtually every industry-specific revenue standard when it took full effect for public companies in 2018. Years later, it remains one of the most frequently cited sources of restatements, audit adjustments, and SEC comment letters. Whether you are implementing a new billing model, onboarding a company through an acquisition, or simply training a new team member, a solid command of the five-step model is non-negotiable.

This walkthrough breaks down each step with practical guidance, common traps, and a decision framework you can apply immediately.

The Five-Step Model at a Glance

Before diving into each step, here is the high-level framework:

1. Identify the contract with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations
5. Recognize revenue when (or as) performance obligations are satisfied

Every revenue transaction–no matter how simple or complex–flows through these five steps. Let’s examine each one.

Step 1: Identify the Contract

A contract exists when all five criteria in ASC 606-10-25-1 are met:

• Approval and commitment – Both parties have approved the contract and are committed to their obligations.
• Identifiable rights – Each party’s rights regarding goods or services can be identified.
• Payment terms – The payment terms for the goods or services are identifiable.
• Commercial substance – The arrangement has commercial substance (i.e., the risk, timing, or amount of future cash flows is expected to change).
• Collectibility – It is probable that the entity will collect the consideration to which it is entitled.

Practical Tips

• Collectibility is assessed at inception. If a customer has a poor credit history, you may need to defer contract recognition until cash is received or the credit risk is mitigated.
• Contract modifications (scope changes, pricing amendments) are evaluated under their own sub-framework. A modification can be treated as a separate contract, a termination-and-creation of a new contract, or a cumulative catch-up adjustment.
• Verbal and implied contracts count. ASC 606 does not require a written document. If your sales team routinely makes verbal commitments that create enforceable rights, those commitments may constitute a contract.

Step 2: Identify Performance Obligations

A performance obligation is a promise to transfer a distinct good or service (or a series of distinct goods or services that are substantially the same and have the same pattern of transfer). The two-part “distinct” test asks:

1. Capable of being distinct – Can the customer benefit from the good or service on its own or together with readily available resources?
2. Distinct within the context of the contract – Is the promise separately identifiable from other promises in the contract?

Common Scenarios

Framework for Judgment Calls

When the answer is not obvious, ask these questions:

• Does the entity regularly sell the item separately?
• Would another vendor be able to provide the service without significant rework?
• Does the good or service significantly modify or customize another good or service in the contract?

If the item is sold separately and does not require significant integration, it is likely a separate performance obligation.

Step 3: Determine the Transaction Price

The transaction price is the amount of consideration to which the entity expects to be entitled. Key components include:

• Variable consideration – Discounts, rebates, refunds, performance bonuses, penalties, and price concessions. Estimate using either the expected value method or the most likely amount method.
• Constraining variable consideration – Include variable consideration only to the extent it is probable that a significant reversal will not occur.
• Significant financing component – If the timing of payments differs significantly from the timing of transfer (typically more than 12 months), adjust for the time value of money.
• Non-cash consideration – Measure at fair value.
• Consideration payable to a customer – Treat as a reduction of the transaction price unless the payment is for a distinct good or service.

Best Practice

Build a transaction price memo template that your team populates for every non-standard arrangement. Include fields for each component above, the estimation method chosen, and the constraint analysis. This creates an audit trail and forces consistent application.

Step 4: Allocate the Transaction Price

Once you have identified the performance obligations and determined the total transaction price, allocate the price to each obligation based on relative standalone selling prices (SSP).

Establishing Standalone Selling Price

The best evidence of SSP is the observable price when the entity sells that good or service separately. When that is not available, use one of these estimation approaches:

• Adjusted market assessment – Estimate the price customers in that market would be willing to pay.
• Expected cost plus a margin – Forecast expected costs and add an appropriate margin.
• Residual approach – Used only when the SSP is highly variable or uncertain. The residual is the total transaction price minus the observable SSPs of the other obligations.

Allocation Pitfalls

• Do not default to the residual approach for convenience. Auditors will push back unless the criteria are clearly met.
• Discounts should be allocated proportionally across all obligations unless there is observable evidence that the discount relates entirely to one or more (but not all) obligations.

Step 5: Recognize Revenue

Revenue is recognized when (or as) a performance obligation is satisfied by transferring control of the promised good or service to the customer. Control can transfer either:

• Over time – If one of three criteria is met: (a) the customer simultaneously receives and consumes the benefits, (b) the entity’s performance creates or enhances an asset the customer controls, or (c) the entity’s performance does not create an asset with alternative use and the entity has an enforceable right to payment for performance completed to date.
• At a point in time – If none of the over-time criteria are met, recognize revenue at the point in time when control transfers, considering indicators such as transfer of legal title, physical possession, significant risks and rewards, and customer acceptance.

Measuring Progress for Over-Time Recognition

Choose between input methods (e.g., costs incurred relative to total expected costs) and output methods (e.g., units delivered, milestones achieved). The method chosen should faithfully depict the entity’s progress toward complete satisfaction of the obligation.

Putting It All Together: A Quick Decision Checklist

Use this checklist every time you evaluate a new arrangement:

• [ ] Have all five contract criteria been met?
• [ ] Have I identified every distinct performance obligation?
• [ ] Have I considered all forms of variable consideration and applied the constraint?
• [ ] Do I have supportable standalone selling prices for each obligation?
• [ ] Have I determined whether each obligation is satisfied over time or at a point in time?
• [ ] Is my method for measuring progress (if applicable) consistently applied and supportable?

Final Thoughts

ASC 606 is principles-based by design, which means professional judgment is baked into every step. The companies that get revenue recognition right are the ones that invest in clear policies, well-documented memos, and cross-functional communication between accounting, sales, and legal teams. If you build the discipline to walk through these five steps methodically for every material arrangement, you will avoid the vast majority of revenue recognition surprises.