Tips for Implementing New Revenue Recognition Rules
The new guidance will force many companies to change the way they recognize revenue. That may create problems with existing financial software being used to allocate revenue for bundled products and services. Some of the changes that FASB identified include the following:
- An element of a sale can be recognized after being 'delivered' to the customer only if the item has a stand-alone value and if the element is expected to be delivered.
- A new concept of 'estimated selling price' gives companies the option of relying on internal estimates of the selling price of one of the bundled elements in a sale when there is no third-party evidence of the selling price nor something called vendor-specific objective evidence (VSOE).
- Companies can no longer use the residual method of accounting to allocate value of the elements of a sale. They have to decide at the inception of the products and services to be bundled whether to use estimated selling price, VSOE, or third party evidence of selling price.
- Companies will have to provide disclosure in their financial statements for how they came about the estimated selling price of the sale elements.
Companies that need to alter the way they recognize revenue for multi-element sales may want to hire outside consultants to help analyze the best way to proceed, how to determine prices, and what impact these changes will have on the company's financial statements.
Apple was ready to go when the FASB changes were announced. The company formerly had to recognize revenue for each sale of an iPhone over a two-year term to account for the software upgrades that came bundled with the device. Under the new rules, Apple has set a value for the software upgrades and recognizes that amount over two years, but the bulk of the revenue from each iPhone sale is for hardware and is recognized immediately.
Some ERP systems may be unable to handle this differentiation when it comes to implementing the new rules. As a result, some companies, just like NetSuite, are developing products that help businesses recognize revenue for these different elements under the new rules. 'It's very complicated,' Gill says. 'What our software does is it allows you to take your price list and for every item on the price list append additional prices or objective values. You're going to put in your prices and then put in these values and as you process a sales order the system will calculate the proper amount of revenue to recognize for each item based on the allocated values.'
Fusion-io opted for the NetSuite software. But the company also set up a pricing committee made up of senior management to go through on a quarterly basis and look at what products the company sells and what price to assign elements of multi-element products. 'We break out each element individually and say the product sale will be a certain amount and the maintenance will be a certain amount and we sell that over and over at about the same price to our customers,' says Voutaz. Where the company previously broke out the elements in spreadsheets, its accounting system now automatically applies the new revenue recognition rules. 'It's much easier,' she says.
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Recommended Resources:
A Shifting Software Revenue Recognition Landscape
A PricewaterhouseCoopers report on the impact of the new rules.
New Revenue Recognition Rules Are Now a Reality
A rundown on the new rules and history of the problem by Boston-area CPA firm Moody, Famiglietti & Andronico.
RevenueRecognition.com
Website dedicated to educating finance professionals on revenue recognition and other issues.
