Revenue Recognition & Financial Management

Revenue Recognition is defined in multiple ways by multiple standard setting and regulatory bodies with a seemingly endless list of considerations, rules, exceptions, and headaches. Put simply, revenue recognition principles exist to provide guidance to business entities on how to recognize their revenue to provide accurate, transparent, and consistent financial statements.

Revenue Recognition & Financial Management

At the core of revenue recognition law is the matching principle, an accrual based accounting principle mandating companies to associate expenses with related revenues consistent with the time periods each is incurred. Pairing revenues with expenses enables companies to more accurately understand their current financial health, whereas recording revenues without regard to expenses (or vice versa) does not paint a clear picture for business owners or investors.

United States Generally Accepted Accounting Principles US GAAP International Financial Reporting Standards IFRS Security & Exchange Commission SEC Staff Accounting Bulletings SAB Revenue Recognition

Revenue recognition guidance and standards vary based on the type of accounting principles your company is required to or elects to use in preparing its financial statements. The three primary types of accounting principles most companies use to prepare their financial statements are as shown at left.

Typically, companies in the United States prepare their financial statements based on US GAAP while companies domiciled outside of the United States prepare their financial statements under IFRS. Additionally, companies which are publicly traded in the US, have to also comply with SEC accounting regulations included in the SEC Staff Accounting Bulletins.

US GAAP

US GAAP offers principles based rules regarding the recognition of revenue. These rules can be found in the FASB Accounting Standards Codification (ASC) 605 – Revenue Recognition and Section 606 – Revenue Recognition from Customers with Contracts. Section 605 – Revenue Recognition, offers general guidance on when to recognize revenue in addition to specific industry based guidance for certain industries and types of transactions.

Generally, under US GAAP revenue is recognized when the following occurs:

  • Revenue is Realized or Realizable

    Company has exchanged goods or services for actual cash or receivables with a determinable value.

  • Revenue is Earned

    Company has substantially delivered the goods or services as obligated.

Section 605 also contains guidance on revenue recognition for specific industries and types of transactions under ASC 605. This includes the following:

  • Construction
  • Agriculture
  • Airlines
  • Contracts Construction / Federal Government
  • Entertainment
  • Oil & Gas
  • Financial Services
  • Franchisors
  • Health Care Entities
  • Not for Profits
  • Real Estate Entities
  • Regulated Operations
  • Software
  • Multi-Elemental Agreements

Effective at the end of year 2017, companies filing under US GAAP must comply with ASC 606 – Revenue from Contracts with Customers. This new guidance applies a principles based approach across industries which is a divergence from the previously rules-based and industry-specific guidance. Under ASC 606, revenue is recognized based on the following five criteria:

  • The parties to the contract have approved the contract and are committed to perform their prospective obligations.

  • The entity can identify the rights regarding the goods or services to be transferred.

  • The contract has commercial substance (i.e., risk, timing, and amount of future cash flows will change as a result of the contract).

  • The entity can identify the payment terms for the goods or services to be transferred.

  • It is probable that the entity will collect consideration in exchange for transferred goods and services.


SEC SAB

Per SEC SAB Topic 13, revenue is realized or realizable and earned when the following occurs:

  • Persuasive evidence of an arrangement exists (such as a contract)

  • Delivery has occurred or services have been rendered

  • The seller’s price to the buyer is fixed or determinable (generally, products have a standard price included in the product catalog)

  • Collectability is reasonably assured (for example, the customer is deemed creditworthy based on a credit check)

In addition, SEC SAB Topic 13 states that when multiple revenue generating activities are included in a contract, they should be broken into multiple units of accounting when calculating recognized revenue.

IFRS

Companies filing under International Financial Reporting Standards (IFRS), have a separate set of principle based revenue recognition standards issued by the International Accounting Standards Board (IASB) which are included in the International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS). Specifically, revenue recognition guidance is included in IAS 18 – Revenue, IAS – 11 Construction Contracts, and IFRS 15 – Revenue from Contracts with Customers.

Recognize revenue when (or as) the entity satisfies a performance obligation.

IAS – 18 stipulates that revenue is recognized when the following occurs:

  • It is probable that any future economic benefit associated with the item of revenue will flow to the entity.
  • The amount of revenue can be measured with reliability.

Specific guidance is also included in IAS-18 Revenue for the recognition of revenue relating to the sale of goods and rendering of services. For revenue relating to the sale of services to be recognized, the following must additionally occur:

  • The degree of delivery of the product or service can be measured
  • The costs incurred, or to be incurred, in respect of the transaction can be measured reliably

For revenue relating to the sale of goods to be recognized the following must additionally occur:

  • The seller has transferred to the buyer the significant risks and rewards of ownership
  • The seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold
  • The costs incurred or to be incurred in respect of the transaction can be measured reliably

Effective January 1, 2018, companies filing under IFRS will be required to comply with IFRS 15 – Revenue from Contracts with Customers. This standard is almost identical to ASC 606 and was created in conjunction with the FASB in an attempt to reduce differences in revenue recognition between IFRS and US GAAP. Under IFRS 15, revenue from contracts with customers is recognized based on the following criteria:

  • Identify the contract(s) with a customer

  • Identify the performance obligations in the contract

  • Recognize revenue when (or as) the entity satisfies a performance obligation

  • Determine the transaction price

  • Allocate the transaction price to the performance obligations in the contract

Recognize revenue when (or as) the entity satisfies a performance obligation.


Rev Rec Software & As-A-Service

Product and Service providers need quality financial management systems able to accurately amortize and recognize revenue and related expenses in accordance with the appropriate accounting rules and regulations. As such, many companies are starting use revenue recognition software to automate the process of calculating earned revenue. The potential benefits of using revenue recognition software include the following:

Automation of Manual Processes

Reduction of Errors in Calculation of Recognized Revenue

Real-Time Reporting of Recognized Revenue

Improved Revenue Forecasting

Standardization of Revenue Recognition Policies Across Subsidiaries

Greater Transparency and Auditability

Improved Controls Over Revenue Accounting Policies and User Access

Faster Time to Close

Audit Fees and Time Savings

Financial Management Systems (FMS)

Changes in regulations are also driving companies to consider revenue recognition software to help ensure compliance and ease the transition to the application of the new guidance to their accounting processes. For example, new revenue recognition principles for contracts with customers were issued for both US GAAP and IFRS. Specifically, ASC 606 – Revenue from Contracts with Customers under US GAAP and IFRS 15 – Revenue from Contracts with Customers under IFRS. Many revenue recognition software providers offer switch-like functionality to change to reporting under the new accounting standards.

Financial Management Systems (FMS) typically store financial information to support the issuance of financial statements, invoice generation, payment issuance, payable and receivable management, and generate analytic and performance reports. Each company has different requirements that their selected FMS needs to satisfy, and each FMS product offers a varying degree of functionality, integration, and cost. It is important to understand all business needs the FMS aims to serve, and how its role integrates into the company’s overall system architecture and strategy.

Rev Rec & FMS Components

Revenue Recognition and Financial Management System

Revenue Management

Revenue Management is the process of strategically managing pricing, production, availability, and offerings of products or services based on revenue analytics to maximize total revenue and revenue growth. At the heart of this processes, is the ability to access and analyze consumer and customer data such that the company can properly identify how to align the availability and offering of a product or service with the perception of value received by the customer.

Revenue Allocation

Revenue Allocation is the act of allocating portions of the total revenue charged for a product or service to its various sub components. This may be, for example, in the instance of a product sold the various multiple products included in the bundle of products. Additionally, revenue may be allocated differently for services including warranty or support services. Specific accounting guidance exists for allocating revenue to the various sub components of the product or service sold.

Under US GAAP and SEC regulations contracts for services or products sold with multiple sub components are required to be broken up into individual units of accounting to which revenue is allocated based on their standalone value, or managements best guess as to value if the stand alone value does not exist. These types of agreements are referred to as multi-elemental arrangements, where the multiple elements represent individual units of accounting. The process of allocating revenue and recognizing when the revenue is earned under US GAAP can be complex and, ensuring an organization is in compliance can require somewhat substantial analysis.

Under IFRS, revenue is allocated to individually identified performance obligations and then recognized when the performance obligation is satisfied.

Trigger Processing

Service providers leverage different trigger points in the service delivery lifecycle to appropriately recognize revenue. Trigger Processing isused to start the amortization of earned and deferred revenue. Generally, the amortization schedule will mirror the service delivery schedule, assuming all other GAAP/IFRS revenue recognition criteria are met. Once an earned trigger event occurs, revenue will begin to be recognized as appropriate based on the type of service and applicable facts and circumstances related to delivery.

Revenue Forecasting

Accurately forecasting revenue is vital for success and sustainability. Revenue Forecasting aids in providing profitability estimates to Wall Street, understanding future cash flows, setting future benchmarks, and budgeting for investments and future expenses. Financial management systems can provide more accurate revenue forecasting reports by utilizing historical earned and deferred revenue, as well as other custom assumptions defined by the company. FMS specific data may also be used in conjunction with other Business Intelligence (such as customer churn, growth rates, market share insight) to provide useful forecasted revenue reports.

Financial Reporting

A key component of any Financial Management System is the ability to generate Financial Reports. These reports include the balance sheet, income statement, balance sheet detail, income statement detail, trial balance, cash flow statement, and change in stockholder equity. In addition, many other custom-built reports are typically standard for most business needs. Financial statements are not only used to provide information to investors and key stakeholders, but also needed to meet the demands of the businesses’ regulatory and tax reporting requirements.

Invoicing

Invoicing is an integral part of any business process. Some companies utilize their Financial Management System to deliver invoices, such as sending invoices from NetSuite. Other companies may send invoice data from the Financial Management System to other systems which subsequently generate the statement or alternatively, some companies may process invoices through a billing system which feeds transactional information into the Financial Management System.

Regardless of the delivery method of the invoice, it is key that the Financial Management System accurately generates the invoice data including purchases and payments received. Additionally, it is vital that the Financial Management System can track the issuance of the invoices to ensure invoice accuracy and delivery for revenue and financial reporting purposes.

Payment Issuance

Payment Issuance needs to be accurately controlled, recorded, allocated, and recognized by the Financial Management System. Additionally, the Financial Management System requires internal control functionality to limit the ability to view, issue, and modify issued payments. Also, the FMS needs to segregate, track, and recognize issuance and clearing of the various types of payments which may include checks, cash, credit card, ACH, gift cards, and wires.

AR & AP Management

Accounts Receivable (AR) represent cash owed to a company for delivered goods or services. Customer accounts receivable are maintained within the sub ledger of the Financial Management System and segregated by customer. The ability to report on receivable aging, track payments received, sales made, and outstanding customer balances is a key functionality of any financial management system.

Accounts Payable (AP) represents cash to other companies for purchased goods or services. Accounts payable are also maintained within the sub ledger of the Financial Management System and segregated by vendor or payee. The ability to report on payables outstanding and due dates, track payments issues, purchases made, and outstanding vendor liabilities is also a key functionality of any financial management system.

Performance Reporting

Key Performance Indicators (KPIs) are metrics selected by a company to quickly assess an organization’s performance. Enterprise grade financial management systems allow for advanced KPI reporting and analytics to aid decision makers and key stakeholders in analyzing trends and overall performance of an entity. Additionally, performance reports are utilized to identify potential risks and adverse trends. Performance Reporting is a key functionality of any financial management system.

Asset Tracking

The ability to track, depreciate, and record assets is a key component of any Financial Management System. Asset depreciation calculation logic may range from simple to complex depending on the type of asset being depreciated and the applicable accounting regulations the company is required to comply with. Some Financial Management Systems have built in depreciation functionality while others require third party Asset Tracking software to calculate the applicable amount of depreciation and entry generation.

Cash Flow

Cash Flow forecasting is vital to the success and sustainability of any business. Being able to accurately forecast cash flow to meet current and short term liabilities and fund future investment in assets and research and development is critical. Financial Management Systems often include cash flow forecasting reports and tools to help more accurately forecast future cash flow.

General Ledger (GL) & Accounting

The General Ledger is a record of all accounting journal entries for a given company. Put alternatively, the general ledger is the summation of all the line item debit and credits of the company. The GL is an integral part of any Financial Management System and is source for all financial reports.

As a result of the current postmodern ERP ecosystem, the automated generation of accounting entries may be initiated from data sources outside of the Financial Management System, such as from billing, quoting, or banking applications. It is vital that the integration between these systems is set up correctly and that owners of the systems have a thorough understanding of the integration and data flow between systems to ensure accurate financials reports.


Detailed: People | Process | Technology

The Revenue Recognition / Financial Management category is, in large part, the domain of the Finance and Finance-Billing organizations within an enterprise. These groups are charged with producing the month-end and year-end financials, processing payments and taxes, and nearly all tasks related to revenue recognition.

It is the Product organization’s responsibility to ensure that new products, services, and bundles make it into the billing product catalog and have the proper attributes for downstream monetization.

 

Finance-People-IconFinance-Billing-People-IconProduct-People-IconIT-People-Icon

KEY VENDOR ALERT
The Revenue Recognition / FMS domain is broken into two technology groups. First, software with a heavy focus on Revenue Recognition is listed. Then, ERP/FMS software vendors are shown.

Rev Rec Focused Key Vendors

Founded: 2009
HQ: San Jose, CA
Company Type: Privately held
Website: www.leeyo.com
Cloud/On-Premise: Cloud

Founded: 2006
HQ: Redwood Shores, CA
Company Type: Privately held
Website: www.revstreamone.com
Cloud/On-Premise: Cloud

Founded: 1999
HQ: Canton, MA
Company Type: Privately held
Website: www.softrax.com
Cloud/On-Premise: On-Premise

Founded: 1999
HQ: San Francisco, CA
Company Type: Public
Website: www.servicesource.com
Cloud/On-Premise: Cloud

ERP/FMS Key Vendors

Founded: 1998
HQ: San Mateo, CA
Company Type: Public
Website: www.netsuite.com
Cloud/On-Premise: Cloud

Founded: 1977
HQ: Redwood Shores, CA
Company Type: Public
Website: www.oracle.com
Cloud/On-Premise: Cloud

Founded: 2009
HQ: San Francisco, CA
Company Type: Privately held
Website: www.financialforce.com
Cloud/On-Premise: Cloud

Founded: 1999
HQ: San Jose, CA
Company Type: Privately held
Website: www.intacct.com
Cloud/On-Premise: Cloud

Founded: 2005
HQ: Pleasanton, CA
Company Type: Public
Website: www.workday.com
Cloud/On-Premise: Cloud

Founded: 2002
HQ: New York, NY
Company Type: Privately held
Website: www.infor.com
Cloud/On-Premise: Cloud

Founded: 1972
HQ: Walldorf, Germany
Company Type: Public
Website: www.sap.com
Cloud/On-Premise: Cloud

Founded: 1975
HQ: Redmond, WA
Company Type: Public
Website: www.microsoft.com/dynamics/
Cloud/On-Premise: Cloud

 

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