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The revenue recognition challenge

The revenue recognition challenge 1

By Andy Campbell, global solution evangelist at FinancialForce

Despite the fact that the two main revenue recognition standards – ASC 606 and IFRS 15 – were implemented over 3 years ago to drive consistency in financial reporting and resolve issues, many public and privately held companies are still having issues ensuring compliance. This is not due to lack of trying though, but it is proving to be more challenging than expected for some businesses to complete the necessary steps to ensure that they are reporting accurately.

Recognising revenue correctly is imperative for business success yet the complication of this process and the potential for error carries significant risks of reputational damage. Indeed, in the past there have been issues relating to misrepresentation of accounts, largely as a consequence of the expansion of services that businesses offered. As a result, some organisations have had to resort to the drastic measure of restating their accounts.

So, how do organisations rectify this and achieve compliance?

The background

The root of the problem is the fact that many businesses no longer just sell products but also sell services, which have far more complex revenue recognition rules. Over time as companies have expanded the range of services that they offer, they have had difficulty changing their revenue recognition processes to reflect this new situation. Many organisations still operate a model based on a simple three step process of manufacture, deliver, and pay. In such a situation recognising revenue was relatively straightforward. Now, the processes are less linear and far more complex.

Modern digital businesses, such as cloud-based ‘software as a service’ (SaaS) providers, offer a wider range of products and services that each have different delivery, billing, and payment options. For example, usage or consumption-based subscription offerings are significantly different to the traditional model of a one-time purchase of a physical product. Indeed, there are many different purchasing options from a one-off purchase of software to a multi-year contract with its own defined terms. Within each purchase there are usually several additional options available, such as maintenance costs which are either included or able to be added on as an extra cost depending on the desired level of service. This can cover initial installation, telephone support, in-person visits, manual updates, and call out contracts.

Each additional item may incur an extra cost with corresponding rules for billing, delivery, payment, and revenue recognition. On top of that, the selected processes will all need to be immediately accessible and visible to auditors. Once all of this is taken into consideration, it is easy to see why some businesses have found it difficult to achieve compliance.

The route to compliance

The good news is that there are some simple steps that businesses can take to rectify this situation. The first step is to review the organisation as a whole and get a clear picture of the overall revenue recognition requirements. Once this has been understood, the next step is to evaluate the existing contracts to establish the scope of the work being delivered.

Businesses need a new rules-based framework against which they can assess contracts, and if the contracts are liable to change, to ensure that processes are in place to reflect the implication of these changes. From this, businesses can start to prepare the right reports for internal and external stakeholders in order to pass an audit – the decisive component of the entire process.

Lastly, companies need to ensure that they have the right technology in place to capture and report revenue correctly. And that is typically when the fun begins.

The technology conundrum 

Many organisations still rely on legacy ERP systems to manage all of their financial transactions. These were originally designed for product centric organisations that delivered simple one-off transactions, so revenue recognition was never really a major issue. However, they are not equipped to deal with the modern services economy with its variety of different service offerings, business models and revenue streams. Therefore, companies have often resorted to relying on spreadsheets and developing cumbersome workarounds to address their complex revenue recognition needs.

This results in many issues. Spreadsheets are notoriously difficult to audit because they tend to be inefficient and error prone. In addition, because they are often accessed by multiple users there tends to be version-control issues as different users save their changes across each other. This impacts data quality which has a knock-on effect on the quality of the reports that are built using this data. Another major concern is that many ‘bolt on’ revenue recognition solutions rely upon historic transactional data, such as billed invoices, as the prime source of information. This requires data to be processed retrospectively ‘after the event’ which can lead to significant complications especially if there are frequent adjustments and recalculations to be made.

The right solution

There is no one size fits all solution to the revenue recognition problem. There are multiple technology providers out there so businesses must ensure that their selected solution has a number of different features, for example data models that are both powerful and flexible. Such software would be able to control complex use cases, such as multi-element arrangements, as well as recognise revenue from various different sources, including straight from contracts, invoices, and orders.

Due to the number of different services that many businesses offer, it is important that the selected technology solution can seamlessly integrate with other applications. The best cloud platforms are able to harness the power of existing applications and integrate them directly with other software, such as professional services automation (PSA) and customer relationship management (CRM) platforms.

Configurable templates and rules are another vital feature as they allow companies to be adaptable. Different rules can be created based on an organisation’s needs and how it wishes to recognise revenue. Applications ought to have forecasting capabilities to give companies a complete overview of their business, going beyond retrospective reporting. Cloud platforms should enable organisations to obtain revenue forecasting with forecasted and recognised values on numerous revenue data sources.

Ultimately, the priority should be to select an application that can automate the revenue recognition process from start to finish. The aim should be to deliver ‘one click revenue recognition’ with every aspect of the process delivered seamlessly. The platform must provide complete traceability and audibility, while also separating billing from revenue recognition processes to ensure that the two are distinct. These considerations will simplify the auditing process, improve internal functionality, and ultimately ensure that revenue is correctly recognised, and compliance is achieved for the required standards.

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