Of all the metrics used by investors to evaluate the performance of a business, revenue is perhaps the most important. Yet the revenue recognition guidelines under IFRS were different from those under US GAAP, a problem which needed to be addressed. The new guidelines are based on cooperation between the IASB and the FASB. The result was ASC 606 and IFRS 15, issued in May 2014 and effective for fiscal years ending after December 2017.
Most of the fuss has been over the impact of the new guidelines in terms of transactional accounting practices. However, according to many experts an equal impact will be seen in the areas of budgeting and planning. Host Analytics recently sponsored an insightful webinar discussing the matter, featuring Robert Kugel, SVP and Research Director for Ventana Research.
What the Changes Are and Why They Are Being Made
Mr. Kugel opened the webinar explaining that the new regulations are designed to both streamline unwieldy processes and drive more consistency in reporting revenue around the world. The new guidelines are principles-based, as opposed to the old rules-based guidelines. Companies should do more than simply examine their accounting practices, but will need to examine the structure and wording of their contracts in order to limit delays in revenue recognition. The new rules eliminate most of the industry-specific guidance, allowing auditors to rely instead on their professional judgment.
All companies that enter into contracts are covered under these regulations, with very few exceptions, stressed Mr. Kugel. The main thing companies need to focus on immediately is getting sales teams, legal teams, and finance teams on the same page, redrafting contracts for faster and easier revenue recognition, and setting up better processes for reviewing terms and conditions of their contracts.
How to Determine Which Contracts are Impacted
Next, Host Analytics’ VP of Product Marketing John O’Rourke presented the Host Analytics point of view. Mr. O’Rourke has previously posted blog articles on the issue, helping finance professionals to understand how the new guidelines stand to affect the budgeting and planning aspects of their jobs. According to O’Rourke, US GAAP’s guidelines before the recent changes were made were quite complicated, very detailed, and somewhat disparate. Different industries, therefore use differing accounting practices for transactions that are actually quite similar. According to the FASB, the new guidelines:
- Eliminate inconsistencies and shortcomings of the existing revenue requirements
- Deliver a heartier framework to address issues relative to revenue
- Make revenue recognition practices more cohesive across various organizations, industries, jurisdictions, and markets
- Give users a more useful body of information with better disclosure requirements
- Make financial statement preparation easier and simpler by lowering the number of requirements to which each organization has to refer
The new revenue recognition guidelines impact every organization that either contracts with customers in order to transfer goods or services or those organizations that contract for the transfer of assets that are not financial. The only exception is for contracts that are covered under other accounting standards (such as contracts for insurance products or leases). Companies that are publicly held must apply the new guidelines to their annual reporting periods that start after December 15, 2017. Non-public companies must apply the new guidelines to annual reporting periods that start after December 15, 2018.
The FASB has released a five-step process for determining whether revenue from a customer contract must be recognized under the new guidelines.
- Step 1 — Identify a contract with the customer.
- Step 2 — Identify the obligations relative to performance in the contract.
- Step 3 — Determine the price of the transaction.
- Step 4 — Specify the price of the transaction to the specific obligations of performance detailed in the contract.
- Step 5 — Recognize revenue if the entity satisfies the obligation for performance.
Experts recommend that organizations affected by these new guidelines and currently using spreadsheets for budgeting and planning purposes consider switching to a budgeting and planning software system that is capable of effectively handling the additional complexity of the new guidelines.
The webinar wrapped up with comments from a Host Analytics’ customer’s perspective. Derek Hazelwood, financial analyst for Interactive Intelligence, explained how having Host Analytics‘ cloud-based EPM platform is helping them adapt to the new revenue recognition guidelines. Interactive Intelligence is a software company with global operations, yet they have been able to quickly and easily adopt the system across finance, sales, marketing, and among the LOB managers, without relying on the IT department.
According to Hazelwood, Host Analytics is helping the teams at Interactive Intelligence to analyze their contracts in order to make the necessary changes according to the new regulations. The system has made it much easier to examine the contracts one by one, and has also enabled a new level of collaboration among the various teams, including legal, sales and marketing, and finance. Since their software business is heavily contract-based, this has been a tremendous help to their teams, as well as a great time saver.
You can view the full webinar replay here: How the New Revenue Recognition Guidelines Impact Budgeting and Planning.