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Recognizing revenue in the ‘new’ accounting standard ASC 606, which comes into force this January, is already best practice and it sounds straightforward. If an obligation is incomplete, the revenue associated with it should not be recognized until it is complete. That principle is one with which few would disagree.
But, in the real world, managing revenue recognition can be a challenging process and, according to a study by KPMG, 37 percent of finance executives are unsure if their company has sufficient internal controls over the transition to the new standard.
In larger or growing firms, and particularly in the service industries, revenue recognition is complex. Services are sold in a number of different ways - and when each contract can be judged to have been fulfilled and the revenue should be recognized varies according to the model.
Additionally, where this process is being done manually and across different departments, how a service engagement is actually progressing on the ground may be hidden from the finance department. It is this lack of visibility which forces people to adjust or tamper with the numbers - not from any malevolent motive but simply in an effort to make the numbers add up.
Unless they have a shared source of live, accurate information, it may be difficult or impossible for the finance department to gauge if obligations have or have not been met. It will not be immediately obvious when the effort required to complete an individual engagement is either more or less than was initially calculated.
In the absence of a clear picture, a finance team has to do the best they can with the information available, however that is the situation where problems arise. Where the revenue recognition process becomes reliant on subjective assessment, it cannot be consistent or predictable. In this situation, the finance team can only struggle in a doomed effort to make the sums come out right.
This may seem to work in the short term. But it inevitably introduces errors into the system. For example, Jane in finance feels that John in sales underestimates how long projects take to deliver, so she starts pushing the revenue recognition dates out, leading to a tendency for the firm to under-recognize revenue. Multiplied across the company, this approach may undermine investor confidence in the ability of the company to deliver its numbers.
The best way to get to a consistent and repeatable recognition of revenue in service industries is to have a system where finance and delivery collaborate, sharing live and accurate information.
Where the inputs from both these areas are up to date and accurate, the calculation of revenue becomes relatively straightforward. It can be automated and produced in a systematic way which breaks down each type of contract and recognizes the revenue according to the rules which have been set down. If the inputs are accurate and up to date, this method will always calculate the right answer.
Business managers who are concerned about complying with the new standard should ensure that their organizations adopt a rules-based approach, establish collaboration between different departments, and create a source of shared information which is accurate and up to date. These are the stepping stones to systematic, transparent and auditable revenue recognition.
David Scott is the Chief Technology Officer at Kimble Applications.