You have probably heard by now about the new revenue recognition standard that goes by the acronym ASC 606. If you have, you know its importance.
The importance stems from two things:
- It is a crucial accounting regulation
- It mostly affects public companies
2018 was the first year the ASC 606 was in effect, and its results are still not entirely clear to many, especially private equities who haven’t paid enough attention to it.
The primary goal of the regulation is to standardize revenue recognition for all industries. In essence, it aims to eliminate industry-specific accounting for revenues and introduce a specific five-step principle approach.
The core principle here is that companies need to identify revenue after the customer gains the goods or services, and do it in the amount the company expects to get in exchange for the products it provides. To make it more clear, this significantly changes when and to what extent companies identify revenue.
When it comes to private equity though, the implications of the regulation are much different and way more serious. We at Consero wanted to make sure that the private equity firms working with us, as well as those still not familiar with our services, to understand the vast implications the new standard has on their business.
Implementation of ASC 606 among private companies
Private companies are still showing slow progress with the implementation of the new regulation.
The problem with this lies in two things:
- Even though private companies had an extra year for the implementation, they had a more difficult task ahead. They are left out of many of the disclosure requirements the new standard poses, but they still have other disclosures, and then other compliance challenges afterward.
- Private companies are usually less prepared to deal with these types of compliance regulations than public companies.
It’s worth mentioning that the private companies that are nearing their initial public offerings can also cause problems for themselves without proper compliance with the new standard.
The software as a service model
When it comes to SaaS model, there are other problems as well. The pure-play cloud-subscription services can’t feel the full impact of the ASC 606, but term and perpetual licenses can. And as for hybrid subscriptions, they have the worst of it.
With 606, revenue in hybrid subscription models that base on term licenses needs to identify at once. That doesn’t mean that the whole business model needs to change, but it makes it a lot more complicated and filled with nuances which must share with investors. One of the solutions here is to fine-tune customer agreements.
In the end, the PE firms that have portfolios filled with such models, the lack of ASC 606 compliance can affect their exit strategies as there’s no way to point to reported recurring revenues clearly.
The impacts on the industry
Even the PE firms not dealing with technology firms need to care for the new standard as they too are affected. The tech sector is the most affected one, but the following areas are also affected:
- Aerospace and defense
- Media and entertainment
- Life sciences and pharmaceuticals
- And many more
All in all, industries that rely on customer contracts are vastly affected. However, other impacts are still not evident and cannot, as of yet, be anticipated.
When you take a look at the more broader effects, any organization that uses contracts with customers to transfer services or goods is affected.
The impact comes in the form of:
- Revenue-recognition timing
- Processes and internal controls that capture data in financial reporting
- Required disclosures and necessary modifications to IT systems
Technology needs to enable implementation
It’s worth mentioning that the best way to approach the application of the new standard is through technology. However, the technology solution needs to be chosen after you have identified the right path for the strategic implementation of the new revenue recognition model.
Consero can help you here as we aim to step in and take the lead when the existing accounting leadership is not prepared or is not present in the company.
Our technology support and enable proper revenue recognition with three different options:
- Order entry
- Deferred revenue model
- Contracts module
This option is used when there is a low volume of contracts, and it includes:
- Amortization of revenue over the life of a contract
- Separation of invoicing and revenue (quarterly invoicing with monthly revenue recognition for example)
- Different delivery options for items with default settings within item setup
- Links with projects
Deferred revenue model
This model is used when you have a relatively high number of contracts (that number should be below 150) and when you need to reallocate revenue across different products which can also have discounts.
- Has a fully automated revenue allocation process
- Can create a systematic approach to revenue reallocation
- Provides a complete audit trail
The last option is the most complex one as it’s made for a much higher contract volume.
It can automate the most critical process you have – turning orders into cash. The module does that by:
- Maximizing billing and collections
- Automating revenue deferral and revenue recognition
- Optimizing contract renewals
Its key features are:
- The ability to automate revenue recognition and deferral. You can set up revenue recognition rules for different types of products and services to post revenue automatically.
- It can automatically generate billing schedules from contractual billing rules and can consolidate multiple billing types into single bills.
- It connects project accounting with revenue recognition, by using timesheets and completed milestones to automatically recognize revenue, while maintaining a separate billing schedule.
- It has a pre-configured cloud connector that manages orders and transactions while automating revenue recognition based on bookings data.
It’s up to you to choose the technology option that suits your needs. Consero can make sure that you make the right choice, but the key for you is first to understand the impacts of the ASC 606 which we have previously discussed and then adopt the right technology.