Service level agreements (SLAs) are formal agreements between service providers and their clients that outline the level of service that will be provided. The new accounting standard ASC 606 has implications for companies that have SLAs with their clients. This article will discuss the impact of ASC 606 on service level agreements.
What is ASC 606?
ASC 606 is the new revenue recognition standard issued by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in 2014. It provides a comprehensive framework for recognizing revenue from contracts with customers and replaces the previous revenue recognition standard, ASC 605.
What are service level agreements?
Service level agreements (SLAs) are contracts between service providers and their clients that specify the level of service that will be provided. SLAs outline the metrics that will be used to measure service quality, such as uptime, response time, and availability. SLAs are common in the technology industry, where service providers offer software as a service (SaaS), cloud computing, and other IT services.
How does ASC 606 impact service level agreements?
Under ASC 606, revenue is recognized when the performance obligation is satisfied. A performance obligation is a promise to transfer a good or service to a customer. SLAs can be considered performance obligations because they promise a certain level of service. Therefore, revenue from SLAs must be recognized over the term of the agreement, as opposed to upfront.
ASC 606 introduces a five-step process for recognizing revenue from contracts with customers. The five steps are as follows:
1. Identify the contract with the 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 the performance obligation is satisfied
SLAs can complicate this five-step process because they are not always straightforward to identify. For example, if a SaaS provider offers a SLA that promises 99.9% uptime, is the SLA a separate performance obligation, or is it part of the overall service that is being provided? ASC 606 requires companies to carefully consider the terms of their SLAs to determine how revenue should be recognized.
ASC 606 has implications for companies that have service level agreements with their clients. The new revenue recognition standard requires careful consideration of the terms of SLAs to determine how revenue should be recognized. Companies should work closely with their accounting and legal teams to ensure that they are complying with ASC 606 and accurately recognizing revenue from SLAs.