26 Aug Asc 606 Incremental Costs of Obtaining a Contract
ASC 606, or Accounting Standards Codification 606, is a comprehensive overhaul of revenue recognition guidelines that was implemented in 2018. The new standards aim to provide clarity and consistency in financial reporting by establishing a single set of principles for recognizing revenue from contracts with customers.
One of the key components of ASC 606 is the assessment of incremental costs of obtaining a contract. An incremental cost is defined as a cost that is incurred specifically to obtain a contract and that would not have been incurred if the contract had not been obtained. Examples of incremental costs include sales commissions, legal fees, and advertising costs.
Under ASC 606, these incremental costs must be recognized as an asset and amortized over the expected contract period if the following conditions are met:
1. The costs are directly attributable to a specific contract
2. The costs generate future economic benefits that will be realized over the contract period
3. The costs are expected to be recovered
If these conditions are not met, the incremental costs must be expensed as incurred.
The recognition of these costs as an asset is a significant departure from previous accounting standards, which required these costs to be expensed as incurred. By allowing contractors to recognize these costs as an asset, they can defer recognition until they generate revenue from the contract.
To determine the appropriate amount of incremental costs to recognize as an asset, contractors must estimate the expected recoverable amount of these costs. This estimate should take into account the expected duration of the contract, the expected profitability of the contract, and any potential risks or uncertainties.
It is important to note that the recognition of these incremental costs as an asset is only applicable for contracts that meet certain criteria. For example, contracts must have a defined term, and the contractor must have the ability to enforce the contract.
In summary, ASC 606 requires contractors to recognize incremental costs of obtaining a contract as an asset and amortize them over the contract period. This change in accounting standards provides contractors with more flexibility and consistency in recognizing revenue from contracts with customers. By carefully assessing and estimating these incremental costs, contractors can ensure compliance with ASC 606 and accurately reflect their financial performance.