Make sure your budget and all forecasted financial statements reflect required changes to revenue recognition principles.
December 15th, 2017 came and went. This was the date after which publicly held companies whose annual reporting started after this date had to conform to FASB ASC 606 – Revenue from Contracts with Customers, which are the revised revenue recognition rules that must be adhered to by most business enterprises. Privately held companies had an extra year to be compliant.
According to FASB the core principle of ASC 606 is:
“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.”
FASB also provides five steps that companies must apply in order to achieve this core principle. These are:
- Identify the contract(s) with a customer
- Identify the performance obligations (promises) in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the reporting organization satisfies a performance obligation
This implies that ASC 606 applies to all companies that provide goods or services. Note that a formal contract does not have to be in place, just an agreement between the customer and its supplier (e.g., a PO with terms and conditions). Although not all businesses will have to make changes to the way they recognize and report revenues, all companies will have to apply these five steps in order to be able to determine whether changes to revenue recognition are required.
Since recognizing revenue and reporting revenue, deferred revenue and other components of the financial statements are going to change, it makes perfect sense to make these core changes also in the budget model, affecting all forecasted financial statements. Doing so will align the plan and budget format and logic to the actual accounting results and the actual financial statements. Analysis of actual results to budget will become more intuitive and meaningful.
Those who are veterans at applying revenue recognition rules in the actual accounting system know how difficult this is unless the accounting system or ERP software is designed or modified to do that. Some companies rely on third party software vendors who specialize in revenue recognition transactions and provide adherence to FASB ASC 606 (and previously ASC 605). This option is not as hard as keeping track of all revenue and deferred revenue transactions in a spreadsheet but requires careful and reliable interfacing of the ERP software to the third-party software solution and good internal audit year-round.
What about using revenue recognition in the planning and budgeting software?
Here is where I see many companies, especially in the SMB space (Small and Medium size Business) struggle.
First, we must answer the inevitable questions: “Why bother budgeting or forecasting revenue recognition and deferred revenue? Isn’t the sales budget sufficient?”
The answer is no, if you want your budget to have any resemblance to the actual accounting, and by that, I mean not just the amounts. Here’s the main reason why:
How are you going to analyze variances of actual results from the budget if the budget does not treat revenue and deferred revenue the same way your accounting software does?
If you sell subscriptions to a web based software application (SaaS revenue model), you must recognize revenue in the period the service (or obligation to the customer per FASB) is performed, regardless of when the sale was made or customer payment was received. Your budget entry for that revenue line must use the same logic.
Those who still use spreadsheets for planning, budgeting and forecasting are going to discover that performing intricate revenue recognition and deferrals is going to be extremely challenging because each budgeted revenue line (product, service, etc.) can have its own recognition schedule, with its own spread method, each starting at a different period in the budget (implying ending at a different period in the future).
The end result is (for those brave souls who actually incorporate this into their spreadsheet models) a convoluted set of worksheets with countless formulas and functions, links to other spreadsheets and of course, errors and omissions which are inevitable when building and deploying such spreadsheets in a corporate environment. This is no different than employing spreadsheets for all other budgeting activities and has been discussed in great detail in this blog and in other forums.
What about use of purpose designed planning and budgeting software solutions?
These software applications offer distinct advantages over spreadsheets, but many still require the user to program formulas, functions and links, often at a great expense due to reliance on external consultants to do the job. Then, maintenance of these budget models also becomes a big issue because scaling the model or making even minor changes often requires reliance on the same consultants, long delays in implementation and unforeseen errors or other project obstacles. Incorporating revenue recognition rules into these models adds to the complexity and cost of such implementations and may result in additional material errors and omissions.
Fortunately, these issues have already been greatly mitigated through use of Intelligent Planning technology incorporated into the planning and budgeting modules of modern-day FP&A (Finance, Planning and Analysis) software.Using this new technology, users can model their revenue to comply with FASB ASC 606. Relying on built-in business logic and accounting rules, and not having to program formulas, functions and links to other worksheets in the model, revenue recognition is modeled accurately and results in getting reliable forecasted financial statements, always in sync with the plan and budget.
When it comes to revenue recognition, make use of a software solution that has the built-in tools to comply with whatever new accounting rules FASB throws at you. As an added bonus, the forecasted financial statements will have the same look and feel as their actual accounting system counterparts.
Alan Hart – Bio
Alan Hart, MBA, is Principal Consultant at Pacific Shine Group in Portland, Oregon, with responsibility for client business development and hands-on client project implementations. Prior to starting Pacific Shine Group, he worked in various executive accounting and finance positions with technology and growth companies. Notable is his 18 years in the hi-tech manufacturing industry where he served as Controller, Vice President of Finance and CFO of several privately as well as publicly held companies in the Hi-Tech industry, such as Hybrid Arts, Inc., Hamilton Bay Associates and Syncronys Software. In his role in management consulting, Alan has worked in diverse industries and with a variety of clients, including fortune 1000 companies such as Boeing, Delta Airlines, Intel, Wyndham Worldwide and others, as well as many mid-market organizations such as Guitar Center, Ducommun AeroStructures, Cypress Semiconductor, TriQuint Semiconductor and others.
Combining his skills and experience in engineering with deep understanding of technical accounting, he is able to assist small and medium-size manufacturing companies establish GAAP compliant accounting and reporting systems.