Revenue is a key metric subject to considerable scrutiny by investors, analysts and other stakeholders. The timing and recognition of that revenue – often a highly complex endeavor – is one of the top accounting and auditing areas of risk.
Many companies offer multiple solutions to their customers’ needs. Those solutions may include multiple products, services or rights to use assets with performance occurring at different points, or over different periods of time. Revenue recognition is also often subject to specialized industry guidance or practices, for example, software, construction and entertainment and media. Additionally, many companies are transforming their business and delivery models as technology becomes increasingly pervasive and disruptive.
Now, comprehensive new accounting rules from FASB and IASB – designed to help converge global accounting standards – are set to change the way many U.S. companies recognize revenue on their financial statements. And that could reverberate through their processes and systems in significant ways.
The new standard will impact some industries more than others, but will have some level of impact on all companies. Those impacts may include changes to the number of deliverables in an arrangement that revenue must be allocated to, the way in which revenue is allocated to those deliverables, the timing of recognition of revenue and other areas such as the accounting for collectibility, contingent revenue and accounting for contract costs, such as sales commissions, just to name a few. Such changes are likely to fundamentally impact key financial measures and ratios for U.S. companies.
For example, when accounting for arrangements today where some portion of the revenue is contingent (for example, royalties), companies may wait until contingent amounts are known, and book the actual amount when the contingency is resolved. Under the new approach, companies that have predictive experience with such arrangements may be required to make an estimate of the revenue the company is expected to be entitled to and allocate some of that contingent revenue to up-front deliverables. The increase in the use of such estimates means that companies will need to track those estimates over the life of a revenue arrangement and periodically revisit those estimates to determine whether facts and circumstances indicate that an adjustment to revenue is appropriate. There are a number of benefits to the new standard. Particularly in industries with industry specific guidance like the software industry, companies have gotten used to constraining certain business practices to avoid the resulting unfavorable impacts to the way revenue is recognized. The new rules may provide companies in these situations with opportunities to structure their business and go to market in a way that makes sense for the business and still get an accounting answer that reflects the economics of the transaction, which doesn’t always happen under today’s rules. It is important that businesses balance this incremental flexibility with the associated back office burden that may be required to ensure such arrangements are properly accounted for.
Companies will need to reevaluate their business processes and systems underlying the quote-to-cash cycle to determine what changes need to be made to enable the judgments and estimates required under the new standard as well as capture the appropriate data needed for the new disclosures. Navigating the complex and changing revenue guidance – and applying it to the specific facts and circumstances around your business – requires a deep understanding of the applicable standards, technical fluency and a rigorous business focus.
While the new rules won’t take effect until after December 15, 2016 in the US, many companies are starting their preparations now in order to allow for the necessary business process and system changes to be implemented and tested prior to the implementation date. Additionally, companies will need to understand what their model and financial statements are going to look like under the standard in order to forecast and develop guidance for the year of adoption.
PwC’s team of professionals can help you begin the impact assessments, evaluate the changes under the new regulations, and determine how significant they will be going forward.
Contact us to learn more about how we can help you manage through this complex transition effectively.