As we march toward its adoption, ASC 606, Revenue from Contracts with Customers, is on the mind of every CFO and controller. The new revenue recognition standard is a sweeping set of new regulations that all of the major accounting firms agree may constitute the biggest accounting change the world has seen in over a decade.
According to the Financial Accounting Standards Board (FASB), the new standard: removes inconsistencies and weaknesses in existing revenue reporting requirements; provides a more robust framework for addressing revenue issues; improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; and provides more useful information to users of financial statements through improved disclosure requirements.
However, the implications of the new guidelines goes well beyond a few adjustments to accounting practices and processes—it demands a comprehensive overhaul across all aspects of the business—finance, sales, operations, services and IT—that requires a tremendous amount of planning. The transition deadline is looming. Organizations must take immediate action to establish a program management office, develop a transition plan, conduct financial systems impact assessments, review existing contract and revenue processes, and much, much more.
Your team will have to run fast and hard with technology partners the company can trust. Don’t worry; NetSuite has assembled the following guide based on a long history of leadership in providing revenue management and accounting solutions that help organizations comply with evolving standards.
By now, most corporate executives have heard of the new revenue recognition standard. Widespread changes to the method by which companies account for and report revenue are rapidly approaching and failure to adequately prepare for compliance exposes any business to significant risks.
If you aren’t already familiar with these changes, The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB)—the two main accounting standards organizations—jointly announced a new, converged set of revenue recognition guidelines in May of 2014. Their goal is to replace a slew of industry-specific standards in the U.S. and Europe with a single, principal-based approach.
FASB refers to the converged guideline as ASC 606, or Accounting Standards Codification, Topic 606. Before it was formally entered into the FASB codification, it was widely referred to as Accounting Standards Update (ASU) 2014-09. The IASB refers to the new guideline as IFRS 15. Regardless, the guideline is titled Revenue from Contracts with Customers.
As with any change to revenue accounting standards, the initial set of questions that come to mind for a CFO are: What does this mean for my organization? What will be the impact on our financial results?
The new revenue model’s core principle and application can be depicted as follows: Recognize revenue to depict the transfer of 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.
At first glance, these steps seem straightforward and even simple, but as with any regulatory change of this magnitude the devil is in the details.
For example, the new standard calls for more management judgment in estimating fair market value, segregating performance obligations and determining collectability. On top of that, there are new variable considerations—for items such as bonuses, penalties and refunds—that will need to be considered when determining probable obligations.
Adding another layer of complexity is the need to comply with disclosures requirements related to transitioning to the new standard. Companies have two choices in how to make the transition and report the impact as part of its financial statements: the full retrospective approach, or the modified approach. Entities should work with their auditors to carefully evaluate the advantages and disadvantages of both approaches before selecting the method by which they will adopt the new ASU.
No industry is immune to the impacts of ASC 606. That said, the new standard will impact some industries more than others. These examples just begin to scratch the surface and should not be considered comprehensive.
Even industries in which revenue recognition has been historically simple and straightforward will see increased complexity. Major accounting firms like Deloitte have created in-depth reviews of industry-specific requirements complete with examples and insights into ways the revenue standard is likely to impact specific industries.
On August 12, 2015, the FASB formally deferred the effective date by one year, this action speaks to how significant an undertaking it will be to transition to the new standard for both public and private companies. The new deadline for ASC 606 adoption by public companies is for reporting periods beginning after December 15, 2017. Privately-held companies have the option of adopting at the same time as public companies, or waiting until annual periods beginning after December 15, 2018.
The best approach is to start now with assessing impacts across the organization. Corporate finance teams need time to become familiar with the changes, adjust to auditor interpretations, plan for reporting during the transition period, and prepare for the new level of rigor required to support the increased use of management judgment and the resulting disclosures. The sooner a business can reach compliance, the sooner it can put valuable resources and attention back on what matters most: innovating and driving the business forward.
Although ASC 606 will have varying degrees of impact across industries, one thing is certain—finance and IT departments will take the brunt of the impact. Existing financial systems will need to be evaluated for their ability to accurately cover all the permutations of an organization’s various revenue arrangements.
Finance teams must shore up existing processes and systems to ensure compliance. For large organizations this will be a challenging task given most legacy financial systems are rigid and difficult to modify, and were likely deployed decades ago. Updating a traditional, on-premise financials/ERP system also places a tremendous burden on IT administrators who are tasked with what will certainly be a time-consuming exercise, tapping out staff and budgets.
Any privately-held company who is working toward an IPO or other significant funding event, or who has hopes to be acquired by a public company, will require a robust financial management system that meets the challenges of adopting the new standard. Companies who have long relied on a combination of QuickBooks and Excel, a manual solution that is tenuous at best under existing GAAP, will find this combination even more risky.
For both large and small companies, any manual effort required to reconcile revenue and report results to auditors, board members and investors will result in a substantial drag on the business.
With so many processes changing, companies in every industry must adopt flexible systems that can adapt to the new requirements. Ultimately, the finance and IT organizations need a modern and agile financial management/ERP system that can provide three critical capabilities.
In short, organizations will benefit from a modern approach to the challenge of complying with evolving regulatory standards. They need a next-generation revenue engine that features a fully automated workflow that covers revenue arrangement: construction, allocation, adjustment, exceptions, charge, billing detail and reporting. Additionally, the solution must be highly configurable, fully integrated with core financial applications such as order management and billing, and support parallel/multiple books.
Now is the time for businesses to begin planning for this significant change. One thing all of the major accounting firms agree on is that preparation will cut across the organization. It’s important to discover your current state, identify the gaps and then get alignment internally with finance, sales operations, legal and IT.
Here is a breakdown of the major work efforts required over the next two years, assuming an adoption date of January 1, 2018.
Remember, ASC 606 is the most sweeping change to revenue accounting in decades. Nothing less than a comprehensive review of an organization’s complete revenue function will suffice. You might compare it to a home remodeling project. You never know what you are going to find behind those walls or how long it will take to repair.
The transition to ASC 606 will impact your entire finance organization, from people to processes to systems. Start an end-to-end review of your financial systems now and make sure those systems can support compliance or take steps to implement new systems that can.
Beyond your finance organization, your sales operations, provisioning, billing and services groups—and even external stakeholders like auditors and your board of directors—also need to get hands-on with transitioning to ASC 606.
The deadline was extended once and is not likely to be extended again. The 2018 timeline for ASC 606 adoption is deceptive. Organizations must begin preparing now for the long journey ahead and expect bumps in the road.
Although the transition is arduous at best, the good news is moving to ASC 606 ultimately presents a strategic opportunity for companies to move away from rigid, outdated or broken systems and build a back office that is both adaptable and efficient. Indeed, ASC 606 serves as the foundation for future regulatory changes in the business landscape that are sure to follow.
The information contained herein is not necessarily all-inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriately qualified professionals for your individual facts and circumstances.