For many organizations, the new revenue recognition standards set to go into effect in January 2017 hold the promise of simplifying and standardizing the way companies book their revenue. However, they also present the specter of business upheaval, system overhauls and reconfigured business processes.
In fact, some large companies are already asking standards bodies to delay enacting the standards.
Whatever the timing of the enactment, it’s clear change is coming and businesses need to be prepared.
The prospect of these changes became a reality in May 2014, when the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) Number 2014-09 “Revenue from Contracts with Customers.” Those standards require companies that recognize revenue under GAAP, with rules that differ significantly by industry, instead to begin to follow a new, single principle-based approach to recognizing revenue. At the same time, the International Accounting Standards Board (IASB) released the International Finance Reporting Standard (IFRS) 15, “Revenue from Contracts with Customers.”
The core principle of the new standard is companies should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Public entities are required to adopt the new standard for reporting periods after December 15, 2016. Private companies must adopt in 2018 but can choose to adopt early in 2017.
While that may seem a long way off, this is a historic change to revenue recognition and companies need to take steps now to evaluate the potential impacts on financial statements, information systems, processes and controls.
The new standards present some distinct challenges for software companies in particular. Just how disruptive will the new standards be? Well, for example, many software companies still rely on spreadsheets and manual reconciliation processes to recognize revenue. While it’s always surprising to hear that companies are willing to live with these painful and error-prone exercises, that approach isn’t going to be an option under the new standard.
A look back at some of the changes to revenue recognition standards over time offers some lessons as well. The last major changes to revenue recognition that significantly impacted software companies happened in 2010, when FASB released ASU 2009-13 and ASU 2009-14. Those changes left technology companies grappling with reporting revenue from multi-element arrangements, and revenue from arrangements that include hardware and software components respectively. ASU 2009-13 (EITF 08-1) also introduced a third tier of evidence required to separate different components of a contract. If vendor-specific evidence (VSOE) was not available, and third-party evidence (TPE) was not available, then a new (at the time) concept called estimated selling prices (ESP) was required.
How did software companies adjust? Many companies turned to their financial software vendor for help, and those that turned to NetSuite saw some distinct advantages. NetSuite provided a centralized data source to calculate ESPs, tight integration between financial systems and professional services automation systems, and dashboards and reports that provided real-time visibility for monitoring revenue and breakouts.
Revenue recognition has only become more complicated in the intervening years as software companies have expanded deeper into the sale of solutions including subscription services, usage-based billing, professional and other services-based offerings and more.
NetSuite will prepare its customers for the latest standards as well. As a large publicly traded software company we understand the challenges our industry faces during these types of changes, so naturally we provide the type of purpose-built functionality that will let software companies successfully transition to ASU 2014-09. Specifically, our integrated order management, billing, revenue recognition and multi-book accounting capabilities. Once again, customers will benefit from the increased business visibility and the granular reporting necessary to support a greater use of management judgment that will come into play under the new standard. What’s more, since NetSuite is a cloud-based system, these changes and any customizations that are made to comply with the new standards automatically carry forward with every upgrade.
Finally, we’re actively engaging with our existing customers and working closely with our key partners in the accounting and audit consultancy industries as the guidance continues to be updated.
This is a fundamental change to the way businesses recognize revenue; and while enactment is still a way off, anyone that has been through this sort of change can attest it’s better to be prepared early than late. Not surprisingly, preparations are going to fall to the finance team.
In particular, companies should begin focusing on five distinct areas that will require much closer examination:
- Selling products vs. selling solutions. With so many software companies bundling products and services in different models, revenue recognition is more complex. Flexible, easily integrated finance systems are paramount.
- Financial statement presentation. The new standards require companies to report on their transition to the new standard. Spreadsheets aren’t going to do the trick. Multi-book (or parallel books) accounting will be a vital tool.
- Sales compensation. Think this is confusing to the finance team? Pity the company that built its sales compensation around revenue recognition that now needs to explain the changes to its sales force. A clear understanding of the link between sales compensation and financials will make a huge difference.
- Expense matching. Companies are going to need to match their expenses to the changes in the way revenue is recognized. That’s going to require new processes to track and allocate costs in complex, multi-element arrangements.
- Investor, board and tax communications. If the new standard has a material impact on the business, the CFO will need to communicate those changes. Done improperly, that can affect company valuations, impact resource allocation, cash flow and investment decisions and reduce visibility.
For more information on how to prepare your company and finance team for the new revenue recognition standards and greater detail on these five areas, check Five Key Considerations for Adopting ASU 2014-9.
Daniel Miller is general manager of NetSuite’s software vertical and vice president of finance. He brings over 25 years of professional experience to NetSuite, most recently as SVP and CFO of Nexant where he managed accounting and IT corporate service groups, and led financing initiatives to support strategic growth plans. He began his career as a senior accountant with Deloitte & Touche, subsequently serving as senior treasury manager for Genentech and corporate controller for Extreme Networks before moving to executive roles.