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5 Ways Credit Teams Can Improve Compliance with ASC 606 and IFRS 15

ASC 606 and IFRS 15 Explained

The Accounting Standards Codification Section 606 (ASC 606) ruling was issued a few years ago, but many finance and credit professionals are just now asking, “What is 606 and how will it affect my business?”

ASC 606 and its international counterpart, IFRS 15, set a new global standard for the revenue recognition process. The move to a global standard for accounting and reporting is important, especially as new business models such as subscription-based services have become more prevalent. The new standard appreciates that taking a calendar-based approach to recognizing revenue no longer fits today’s world of on-demand cancellation arrangements and no-questions-asked return policies. The goal is to level the playing field so that all stakeholders can accurately evaluate risk, opportunity, and reward in their business relationships.

Overall, the goals of ASC 606/IFRS 15 are:

  • Transparency – Ability to easily compare financials across the globe
  • Accountability – Make financial information more freely available and accessible
  • Efficiency – Help investors identify risk and opportunity across the world

For credit risk professionals, ASC 606 reevaluates the definition of collectability, which must now have a future-looking component (not based on historic losses).
 

This accounting rule change may be the most impactful change to the credit risk profession in recent history, outpacing even US-based Sarbanes-Oxley in its importance. For credit risk professionals, ASC 606 reevaluates the definition of collectability (credit loss), which must now have a future-looking component (that isn’t based on historic losses). It ties revenue to accurate identification of the customer and proper evaluation of collectability. It also settles the age-old conflict between sales and credit: When is a sale really a sale – at the time the product is sold or at the time the revenue can be collected?”

 

The Impact to Credit Processes

So how does the credit professional address and incorporate these rule changes? Credit plays a pivotal role in the successful and accurate reporting of revenue. Your customers’ creditworthiness is central and required in the accounting process, and compliance requires a credit check at initial sale, ongoing monitoring of creditworthiness or contract terms, and accurate tracking of your customers’ corporate linkage.

The timing of reporting revenue events can now be stretched to match the customer’s longevity – and understanding the commercial relationship is now paramount. It’s up to the credit professional to empower those onboarding new customers to truly understand the counterparty in the exchange.

5 Ways for Credit Teams to Simplify Revenue Recognition:

  • Identify Customers & Contracts – Establish a customer master file to understand all contracts and pricing for each customer. A credit process is required to identify the customer and the contract and then determine the collectability risk of each new sale to a new or existing customer.
  • Link Customers – Evaluate how you establish and maintain the relationships between your accounts for consistent treatment. Finance teams must map the delivery and billing points in the agreement to drive consistent revenue treatment to the same customer.
  • Evaluate Collectability – Review options for upfront credit decisioning and automated credit decisioning workflows, leveraging both internal and third-party data. Also consider options for professional services engagements to review your credit policy. It’s important to create a forward-looking model that helps predict credit losses.
  • Align Collections – Accurate identification of collectability determines the revenue that must be deferred. Allocate or assign line-item pricing to ensure alignment with delivery and collections. Create a repeatable, reliable collections strategy and procedures to maximize revenue recognition that will withstand an audit.
  • Monitor Changes – Ensure you have a best-in-class framework to monitor your embedded base of accounts over time. The accounting standards require that you maintain awareness of changes to customer identity and collectability over time. This way you can claim the revenue with confidence.

Does Your Company Need to Comply with ASC 606/IFRS 15?

Even if your company isn’t looking for investors, is privately owned, and you don’t publish financials, the reality is that ASC 606/IFRS 15 likely affects you anyway. If you’re working for a firm that has operated under GAAP standards, for example, then you are likely required to comply, because these are the new GAAP standards.

Remember, while there are no direct fines, there are indirect fines. Operating outside of GAAP is a violation of the business norm and could lead to lower investment, more fear from business partners, or the decision not to engage. All businesses that plan to share financials for business or investment purposes are required to adjust their processes by year’s end. (Public companies began reporting with their first quarterly earnings in 2018.)

As we look ahead, we’ll see how the rules impact the financial reporting of revenue directly. The reporting of revenue is a key factor in many decisions of volume, dependence, and capacity for future partnerships. This will impact the ability to get loans and continue commercial relationships as the market changes around you.

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