In an effort to streamline and update the revenue recognition process for businesses, the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are in the final stages of converging their separate standards for revenue recognition cycles into a single standardized and improved model.
With the last updates to this model almost complete, companies everywhere are now looking at their revenue recognition processes and making preparations to reconcile them with the new standard.
What’s Going to Change?
As they stand now, the generally accepted accounting principles (GAAP) used in the United States lay out different revenue recognition processes for different industries. As the FASB noted in a December 2011 newsletter, this can result in “different accounting for transactions that are economically similar.” Meanwhile, existing international standards, while not industry-specific, “have limited implementation guidance and can be difficult to understand and apply,” according to the FASB.
While the new joint standards have yet to be officially enacted, both boards have offered a taste of what’s to come in a series of drafts. They propose a five-step model for the revenue recognition cycle that would apply to all industries:
- Identify the contract with the customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price.
- Recognize revenue when a performance obligation is satisfied.
This streamlines things in the larger scheme of things but creates new challenges for companies that have not traditionally had to worry much about revenue recognition compliance. Among them are businesses that sell multiple elements in a single bundle, packages that are also referred to as multiple-element arrangements (MEA). For companies like these, the new guidance raises several critical questions: How are performance obligations defined when dealing with MEAs? When are those performance obligations satisfied? How should revenue be reallocated according to Fair Value, and how is Fair Value correctly determined? And most importantly, what happens if your current ERP system is incapable of automating these new accounting tasks?
ERP is Not the (Whole) Answer
Enterprise resource planning (ERP) systems such as Oracle, SAP, and Microsoft Dynamics are immensely powerful and useful for a wide range of business activities. Unfortunately, by their very nature, these systems are usually “a mile wide and an inch deep” – they offer a broad set of capabilities to serve the widest possible range of company needs, but lack the depth to handle genuine complexity in any particular area. This includes revenue recognition – an area that will affect many if not most US corporations once the new revenue recognition guidance takes effect. Companies whose ERP infrastructure is not set up to accommodate these changes must now decide whether to replace their systems with something more suitable or find ways to improve their existing capabilities.
Of the two options, the “rip and replace” route is fraught with the greater risk. Because many companies use their ERP systems for a broad range of non-accounting tasks like customer relationship management, supply chain management, and project management, completely replacing a system can cause a major disruption of business. As several recent high-profile ERP disasters have illustrated, this kind of disruption can lead to significant costs in time, money, stock price, and investor confidence.
For most companies, enhancing existing ERP infrastructure is the better option. But it comes with its own caveats. Custom-coding an ERP solution, whether in-house or through a third-party contractor, may seem like an obvious fix. However, it also invites a whole different set of problems, not the least of which is the challenge of keeping that custom code up-to-date with ever-changing regulations and business practices.
A better alternative is to augment your current ERP system with a dedicated module – in this case, one that focuses specifically on handling additional complexity in revenue recognition from new regulations and or other factors. Such modules are supplied and implemented by vendors with expertise and experience in all aspects of revenue management. In this approach, the vendor, not your company, is responsible for keeping pace with changes in regulations and business practices. In addition, good plug-in modules will not only have been tried and tested with a number of different ERP systems but have already been proven out by a number of companies in verticals similar to your own, so you can be sure of their reliability.
If you’re preparing to respond to the new revenue recognition guidelines from the FASB and IASB, a good place to start is our newly-released “Guide to ERP Augmentation for Improved Billing and Revenue Recognition.”