You have most likely heard at least something about the new financial revenue recognition standards known as ASC 606 in the US and IFRS 15 in Europe and other geographical regions, as we have just passed the start date for these measures. IFRS 15 went into effect on January 1, 2018, and ASC 606 went into effect for public companies on the same date. ASC 606 will also apply to private companies on January 1, 2019. It’s worth taking some time to acquaint yourself with the deeper implications of these regulations. In particular, if your company holds, writes, or uses contracts, these standards will have a significant effect on your organization. In other words, they will affect nearly all businesses across the board, and may even impact your individual role within your company.
Why revenue recognition matters
The best way to understand why these standards were established is to first consider what revenue means for a company. Revenue is a primary indicator of financial health and growth. It influences public opinion regarding how a company is doing overall, and it is a primary KPI for shareholders and/or investors. This is why regulations exist that govern how financial statements are prepared to ensure consistency and reliability.
Comparing apples to oranges
Consistency and reliability have hardly been the watchword when it comes to revenue recognition. Practices vary significantly, to say the least. There are differences by geographic region, and variation across industries.
The two principal regulatory bodies behind the new rules are the Financial Accounting Standards Board (FASB), which establishes what falls under the Generally Accepted Accounting Principles (GAAP), or the gold standard for accounting practices. This organization created Accounting Standards Codification (ASC) 606 for revenue recognition in the United States. The International Accounting Standards Board (IASB) establishes international standards of practice and is the authority behind the International Financial Reporting Standards, including the new IFRS 15. The latter affects most global regions beyond the US with a few notable exceptions (see this map for details of the international regulation’s jurisdiction).
Prior to the new measures, both international and domestic accounting standards lacked uniformity. In the FASB’s own press release, it stated that its General Accepted Accounting Principles included “complex revenue recognition requirements for specific transactions and industries.”[i] In other words, different industries were using different accounting methods for similar transactions. Comparing revenue recognition across companies, industries, jurisdictions and capital markets, has been like comparing apples to oranges. This made information inconsistent across the board, and company information difficult to compare. The need for change also came out of the fact that international standards didn’t offer enough guidance when it came to complex revenue scenarios.
IFRS 15 and ASC 606 were issued jointly to remedy this situation, creating a robust global framework that will serve to standardize and simplify revenue recognition practices from contracts with customers, so that there will be less variation in these figures and they have a more transparent, comparable, and quantifiable meaning across the board.
Understanding how the new revenue recognition standards work
According to the FASB, “the core principle of the new standard is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those goods and services.”[ii] In other words, revenue is how much a company expects to be paid in exchange for goods and services.
While this may sound simple, and the end result of implementation of the new standards may be simplification on a broad level, the process of creating standardization will cause virtually every company to make changes, or at least examine whether changes are required.
This is especially true since so many transactions are complex in structure. More often than not, companies are not selling a single, countable, stand-alone product. Instead, many of today’s business transactions include various product bundles that might also be associated with training, professional services, tiers of support, warranties, and the like.
IFRS 15 and ASC 606 apply to nearly all contracts (although there are a few exceptions). The entire sales contract process will be affected, from pricing, through quotes, orders, contracts, and finally revenue recognition. Key features of the new standards include the following:
- A five-step model determines when to recognize revenue, and at what amount.
- Revenue is recognized when (or as) a company transfers control of goods or services to a customer at the amount to which the company expects to be entitled.
- Depending on whether certain criteria are met, revenue is recognized either over time, in a manner that best reflects the company’s performance, or at a point in time, when control of the goods or services is transferred to the customer.[iii]
Being ready for the new revenue recognition standards
While there are more details to understand, particularly regarding the 5-step model, it is equally important to consider up front the best ways to be prepared for these changes. Automation is primary among these, particularly because it can streamline the ways that your organization creates and closes deals at the same time that it enforces compliance with the new revenue recognition standards.
The two most important platforms to include in the process of automation are:
- CPQ software: This software can help you control how sales structures deals from the beginning, so that the revenue recognition rules your organization has created are automatically and correctly enforced. The rules can be baked into the product catalogue, up-sell and cross-sell programs, contracts, and other areas of the sales process.
- Implement a contract lifecycle management (CLM) solution. As the new standards are based entirely on contracts with customers, this is perhaps the most important practical step that you can take. A contract lifecycle management solution, such as Conga Contracts, can operate in conjunction with your existing systems by integrating with your Salesforce CRM, providing a cohesive, centralized framework for automated IFRS 15 and ASC 606 compliance. Because the new standards will affect contracts throughout their lifecycle, contract management can address many points where the new standards will have an effect.
To learn more about how the revenue recognition standards work, and understand the specific ways that contract lifecycle management can ensure compliance, download this whitepaper, “Practical steps to prepare for IFRS 15 and ASC 606.”