The Modern Finance Leader

Are You Ready for the New Revenue Recognition Standards?

By Seamus Moran, Senior Director, Financials Development, Oracle

With the season of giving upon us, many of you might be out buying gift cards for family and friends. These days, whenever I see one of those gift cards, I wonder: “How are all of these companies going to recognize this revenue when the new Revenue from Contracts with Customers accounting standard goes into effect for most companies in 2018?” 

Considering that consumers are expected to spend $25.7 billion on gift cards this holiday season, it’s not a trivial question. In fact, it’s one that any company should be asking if they’re project-driven, have complex contracts, or rely on recurring contracts to generate revenue. 

The list of industries that PwC says will be affected by the new standard indicates how far reaching it is. Companies that follow industry-specific guidance under US GAAP will have to pay close attention, it says. The biggest impact will be felt by companies in high technology, media and entertainment, communications, aerospace and defense, automotive, engineering and construction, pharmaceuticals and life sciences, to name more than a few. 

The basic premise behind the creation of the standard is simple enough: to establish the principles for reporting useful information to users of financial statements about the nature, timing and uncertainty of revenue from customer contracts. 

Defining and Accounting for Customer Satisfaction

Complying with the standard, though, is significantly more challenging. Under the new principles, businesses will only be able to recognize revenue when customer satisfaction with delivered goods and services is fulfilled. To meet specific performance obligations, companies will need to define the measure and timing by which customers are considered to be satisfied—as in, can my fitness center recognize a fifth of the revenue associated with my gift card each time I take one of five classes it covers? And, one step further, when does the service company managing the fitness center’s gift card program recognize its share of the sale? And what about the points my cousin earned when she used her credit card to buy the gift card? 

In short, any enterprise that bundles products with services, packages “freebies” with purchases, sells warranties on goods, etc., will need to rethink how and when they recognize revenue. 

The new standard, says PwC, could have a significant impact on the amount and timing of recognition. As a result, companies may have to review key performance measures and factors as esoteric as debt covenant ratios. This will impact contract negotiations, other business activities and budgets.

 

If it sounds complicated just trying to figure out how companies ranging from fitness centers to deep-well maintenance experts will determine when they need to recognize revenue, consider this: 

To meet the basic revenue recognition reporting rules, organizations will have to determine more precisely what value to place on products and services, and the costs related to them. Companies will have to factor in the impact that the new regulations will have on incentives and compensation packages. And marketing teams will need to rethink how they describe their products and services, the value-adds routinely used to make them more attractive, and all other promotional or incentive messaging. 

Let’s face it, terms and conditions will never be the same. 

Equally important, companies will have to take a deep dive into their past financial data and re-run the numbers against the new guidelines. How they recognized revenue over the past few years may have a significant impact on how they communicate near-term and future reports. Financial teams will have to reconcile past revenue recognition numbers with the new guidelines to enable a more accurate year-over-year performance review. Not to mention, they have to replace deferred revenue with performance obligation liability on their cut-over date balance sheet, hitting equity rather than revenue with the difference. 

How to Prep for ASC 606 / IFRS 15

This past summer, my colleague Nigel Youell offered a number of recommendations on what companies should be doing to prepare for the new reporting standard. 

First, businesses should study the impact of the standard and determine a strategy to meet it. Among other things, companies should define a procedure for assigning value to a contract’s performance objectives. Then organizations should realistically analyze their accounts subsystems to determine how well they can accommodate the new guidelines. 

Second, Nigel recommended that companies identify the reporting information required by external and internal stakeholders. Companies should determine what impact the guidelines will have on existing contracts, consolidate the historic impact under the new guidance, and then prepare reports illustrating the revenue difference under new and prior revenue conciliation models. 

Next, businesses have to implement required accounting subsystem changes, configuring accounting rules and setting up ledgers. They will almost certainly have to capture and process data they are not capturing today. They will have to adjust processes to “review at inception” and to accrue a “debt of goods and services when either party acts.” They’ll need to subscribe to new accounting services. And then they have to prove and report using dual accounting formats. 

Revenue Recognition Efforts May Need Several Attempts

For most companies, implementation of the standard is likely to be an iterative process. Early application of the standard’s ideas to your business are likely to require refinement, as the meaning of new concepts like performance obligations, valuation at expected consideration, and transfer to customers become more clearly understood in the context of your sales cycle. Chances are, it will take a second, third, and maybe more iterations of reporting plans before companies are comfortable with the concepts and statements, and how they are achieved. 

When all that’s done, companies can start transforming their businesses to support the new standard. They must clearly communicate the impact of the changes on multiple departments, train organizations on how to apply the guidelines, and finally begin reporting them. 

While the ultimate goal of creating these new guidelines is to simplify reporting and—as much a possible—have all businesses around the world recognizing revenue in the same way, this is obviously not a job that companies should put off any longer. 

Training to Prepare for Rev Rec

With that in mind, we’re offering a free webinar to help you understand what to do in the time that’s left. So be sure to check out the recording. 

Join me and colleague Lara Deen, Oracle’s VP and strategic process owner for global revenue recognition, along with Irene Truong, senior manager, Deloitte Advisory, and Gourav Rathi, manager, Deloitte Consulting. 

During the session, our panel discusses what companies are doing to prepare for compliance with the standard so they can have confidence in their reported revenue. Also, to help you understand the complexity of the standard, we offer insight into how you can automatically manage your performance obligations lifecycle, and reduce the risk of non-compliance by using rules-based administration of the accounting standard.

After listening to the recording, you’ll be able to: 

  • Articulate a deeper understanding of the new ASC 606 / IFRS 15 accounting standard
  • Utilize best practices to assess the standard’s impact to your business
  • Accelerate your preparation for compliance with the standard
  • Understand how to manage the complexity of the standard and ensure compliance

This time next year—just a few weeks before public organizations are expected to apply the new standard—will you be planning a relaxing holiday getaway? Or scrambling to determine how to report the income for all of the gift cards shared at office parties? 

Get started on your new revenue recognition processes. Attend the webinar on demand.

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