The ASC 606 five-step model and the core principle

• State the core principle of Topic 606 in your own words
• Walk a customer contract through all five steps in order
• Identify which ASUs amended the original ASU 2014-09 text
• Link each step to the judgment an auditor will test

The core principle

ASU 2014-09 replaced most industry revenue guidance with one model in Topic 606. The core principle: an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which it expects to be entitled in exchange for those goods or services. Two ideas sit inside that sentence. Revenue follows the transfer of control, not the invoice or the cash. And the amount is what the entity expects to be entitled to, which can differ from the contract price.

The five steps

The standard applies the principle through five steps:

1. Identify the contract with a customer. A contract exists for accounting purposes only when the criteria in 606-10-25-1 are met: approval and commitment, identifiable rights, identifiable payment terms, commercial substance, and probable collection of substantially all of the consideration the entity will be entitled to.
2. Identify the performance obligations. Each promise to transfer a distinct good or service (or a series of substantially the same distinct goods or services with the same pattern of transfer) is a performance obligation.
3. Determine the transaction price. Start with the stated price and adjust for variable consideration (subject to the constraint), a significant financing component, noncash consideration and consideration payable to the customer.
4. Allocate the transaction price. Allocate to each performance obligation on a relative standalone selling price basis, with limited exceptions for discounts and variable amounts.
5. Recognize revenue when (or as) each performance obligation is satisfied. Satisfaction happens when the customer obtains control, either over time (if one of the three criteria in 606-10-25-27 is met) or at a point in time.

Contract costs sit beside the model in Subtopic 340-40: incremental costs of obtaining a contract and certain costs to fulfill one are capitalized and amortized.

The amendments that finished the standard

The FASB issued several updates before the effective date. The three that matter most for day-to-day work:

• ASU 2016-08 rewrote the principal versus agent guidance around control of the specified good or service.
• ASU 2016-10 clarified when promises are distinct, added the immaterial-promises and shipping and handling options, and reworked the licensing guidance.
• ASU 2016-12 clarified collectibility, added the sales tax presentation election, fixed the measurement date for noncash consideration at contract inception, and added transition expedients.

When you read a paragraph in an old memo, check whether these updates changed it. A memo that quotes the 2014 principal versus agent indicators, for example, is quoting superseded text.

Where the judgment sits

Every step has a judgment that drives the number:

An auditor uses the same five steps as a test map. The five-step contract memo template follows this order, and the rest of this track takes one step at a time, finishing with auditing revenue.

Contract assets, receivables and contract liabilities

Topic 606 also changes presentation. When either party has performed, the entity presents a contract asset or contract liability. A receivable is an unconditional right to consideration: only the passage of time is required before payment is due. A contract asset is a right that is conditional on something other than time, such as delivering a second item. A contract liability is the obligation to transfer goods or services for which the customer has paid or for which payment is due.

Scope reminders

Topic 606 does not cover leases, insurance contracts, financial instruments, guarantees other than product warranties, and certain nonmonetary exchanges. A contract that is partly in scope of another Topic applies that Topic's separation and measurement guidance first.

Running one equipment contract through the five steps