In most businesses, the hard work of contracting is left up to legal counsel. An attorney is tasked with reviewing and drafting sales contracts, often with no consideration as to how the accounting department is going to recognize this revenue from these contracts. This approach traditionally has not presented a headache for anyone outside the accounting department; however, a new revenue recognition standard known as ASC 606 is going to change this dynamic. ASC 606 will force organizations to think much more carefully about how to draft contracts that are compatible with their revenue recognition processes. That’s because ASC 606 will fundamentally change how businesses recognize revenue from complex contracts, including subscriptions, multi-year contracts, and recurring-revenue relationships. To facilitate this transition, businesses should be ordering a top-to-bottom review of their contracting processes, with an eye toward restructuring contracts to streamline and enhance their compliance obligations under ASC 606.
Simplus Salesforce Quote-to-Cash implementation specialists are asked all the time about what’s changing under ASC 606 and how businesses can best prepare for the transition. That’s why we’ve put together a multi-part blog series to educate businesses about various facets of ASC 606. In the first post, we explored essential things to understand when dealing with complex revenue recognition. In the second post, we looked at what you’ll need to know to achieve ASC 606 compliance. In the third post, we explained how ASC 606 will connect your sales and accounting teams. In the fourth post, we chronicled how ASC 606 compliance will lower costs and enhance customer relationships. In this post—the fifth and final installment—we present best-practices tips for how you can restructure your contracts to optimally align with ASC 606 accounting standards:
1. Finance, sales, and legal departments should structure contracts together: The most direct way to change how contracts are drafted is to change who is drafting them. Instead of letting your legal counsel take the reins, you want to put legal counsel on equal footing with your sales team and finance departments. All three teams should feel equally empowered to develop contract language that aligns with each team’s needs and requirements. By working together, these teams will produce contracts that are not only legally sound, but that also improve the sales cycle and streamline ASC 606 revenue recognition processes.
2. Contracts should spell out accounting treatment: ASC 606 will require revenue from sales contracts to be recognized at the time that goods and services are delivered to your customers. What this means is that when your accounting department reviews contracts, they need to be able to readily discern from each contract when your customers are receiving goods and services. That’s why it makes perfect sense to explicitly spell out accounting treatment for your contracts. For example, you want to state whether a performance obligation is symbolic or functional, as this distinction determines whether revenue is recognized over the term of the contract or at a specific point in time.
3. Contract elements should be classified and standardized: Although contracting traditionally has not focused on standardization, your accounting folks will have a much easier time with their revenue recognition processes if your contract language is standardized. That means you want to focus on classifying all of the language in a contract into discrete, standardized contract elements. These plug-and-play contract elements will not only streamline work for your accounting department, but the increased standardization also will ease the burden of contract writing itself.
4. “Buyer’s side” contracts should be treated as exceptions: Oftentimes, businesses come under pressure from customers to let the customer draft contracts on the customer’s letterhead. Because businesses tend to oblige the customer’s request, they feel that it’s infeasible to create standardized, plug-and-play contract elements. But that’s not the best way to look at this issue. “Buyer’s side” contracts should be treated as one-time exceptions; moreover, when you receive these requests from customers, you want to offer up your standardized, plug-and-play language—and respectfully encourage your customers to use it as the starting point.
When you prioritize ASC 606 considerations as you restructure your sales contracts, you’re facilitating the automation of revenue recognition processes and, indeed, the entire sales cycle. The most important tips to keep in mind as you restructure your contracts are to bring legal, sales, and accounting teams together, to spell out accounting treatment in contracts, to classify and standardize contract elements, and to treat “buyer’s side” contracts as one-time exceptions.