What is revenue recognition and where do I start?
Getting a complete picture of your organization's revenue is never easy. Changing regulatory requirements to the new revenue recognition standards (e.g. ASC 606 & IFRS 15), evolving business models, and over reliance on manual processes, can make the management of revenue recognition cumbersome. But what are the revenue recognition parameters?
The definition of revenue recognition is “the principle is a cornerstone of accrual accounting together with matching principle. They both determine the accounting period, in which revenues and expenses are recognized.”
According to the principle, revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or services rendered), no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.
Cash can be received in an earlier or later period than obligations are met (when goods or services are delivered) and related revenues are recognized that results in the following two types of accounts:
- Accrued revenue: Revenue is recognized before cash is received.
- Deferred revenue: Revenue is recognized after cash is received.
Revenue realized during an accounting period is included in the income.
Revenue Recognition Datasheet
Get a complete picture of your organizations's revenue. Both recognized and unrecognized.
Revenue versus cash timing
Accrued revenue (or accrued assets) is an asset such as proceeds from a delivery of goods or services, at which such income item is earned and the related revenue item is recognized, while cash for them is to be received in a later accounting period, when its amount is deducted from accrued revenues. It shares characteristics with deferred expense (or prepaid expense, or prepayment) with the difference that an asset to be covered later is cash paid out to a counterpart for goods or services to be received in a later period when the obligation to pay is actually incurred, the related expense item is recognized, and the same amount is deducted from prepayments.
Deferred revenue (or deferred income) is a liability, such as cash received from a counterpart for goods or services which are to be delivered in a later accounting period, when such income item is earned, the related revenue item is recognized, and the deferred revenue is reduced. It shares characteristics with accrued expense with the difference that a liability to be covered later is an obligation to pay for goods or services received solo from a counterpart, while cash for them is to be paid out in a later period when its amount is deducted from accrued expenses.
For example, a company receives an annual software license fee paid out by a customer upfront on the January 1. However the company's fiscal year ends on May 31. So, the company using accrual accounting adds only five months worth (5/12) of the fee to its revenues in profit and loss for the fiscal year the fee was received. The rest is added to deferred income (liability) on the balance sheet for that year.
New revenue recognition standards: ASC 606 and IFRS 15
ASC 606 and IFRS 15 are the new revenue recognition standards that affect all businesses that enter into contracts with customers to transfer goods or services – public, private and non- profit entities. Publicly held businesses must abide with the requirements in ASC 606 by December 15, 2017. Non-publicly held businesses have until December 15, 2018.
Developed jointly by the Financial Accounting Standard’s Board (FASB) and International Accounting Standards Board (IASB), ASC 606 and IFRS 15 provide a framework for businesses to recognize revenue more consistently. The standard’s purpose is to eliminate variations in the way businesses across industries handle accounting for similar transactions. This lack of standardization in financial reporting has made it difficult for investors and other consumers of financial statements to compare results across industries, and even companies within the same industry.
Meeting the new compliance standards will take time and careful planning but it shouldn’t be a dreaded process. In fact, organizations large and small will find the transition provides an opportunity to transform their businesses for the better.
Finding the right technology to help
A robust technology solution, e.g. a revenue recognition cloud application, can offer two key ways of reducing the amount of required manual effort: automation and flexibility across your revenue recognition processes. First and foremost, the right solution helps you track various revenue streams, automate allocations and calculations, and configure different rules and templates for different calculations—all while eliminating your reliance on overly complex spreadsheets.
Additionally, a strong technology solution also eases the pain of implementing a transition method. Your choice of method should be driven by what’s best for investors, auditors, and financial statement readers, not by the capabilities of your IT systems (or lack thereof). With a strong technology solution, you can recognize revenue under the current standards up to the transition date, then seamlessly deploy retrospective or parallel recognition processes. Let your systems empower you to make the best choice for your stakeholders.
With the right system in place, you can produce clear audit trails and attach supporting documents and evidence directly to transactions. A robust tool also provides user-friendly reporting options, allowing you to slice, dice, and customize your data on a summary level or on an item-by-item basis. With better reports, your business teams will make better decisions.
What should you look for in a revenue recognition cloud application?
- Powerful, flexible data models: Revenue models continue to multiply, from product-based to SaaS to bundled and usage-based contracts. The right tool recognizes revenue from multiple sources, including directly from opportunities, orders, contracts, projects, and invoices. The data model should also handle complex use cases, including multi-element arrangements.
- Seamless integration with other applications: The best cloud applications harness the power of your existing platforms (e.g. Salesforce) and integrate directly with your other applications, including customer relationship management (CRM) and professional services automation (PSA).
- Configurable templates and rules: The right tool enables you to adapt to whatever comes next. Create different rules based on your needs and how you want to recognize revenue. Find a tool that adapts to what’s best for your business—not the other way around.
- Forecasting capabilities: Go beyond retrospective reporting to gain a complete picture of your business. A cloud application should empower you to derive revenue forecasting with both recognized and forecasted values on multiple revenue source data.
FinancialForce Revenue Recognition
FinancialForce eliminates error-prone and time-intensive spreadsheets, automates recognition calculations, and adheres to all key revenue recognition standards while helping you achieve compliance with the new revenue recognition standards of ASC 606 and IFRS 15. Supporting AICPA, FASB and SEC regulations, including the requirements for Vendor Specific Objective Evidence and Sarbanes-Oxley compliance with Section 404, FinancialForce offers a complete and graphical view of your revenue situation either in summary form, or on an item by item basis.
Get the FinancialForce advantage:
- Eliminate manual processes and calculations (saving time and money, while eliminating costly errors)
- Clear visibility and auditability into all aspects of the revenue recognition process
- Eliminate the dependency on spreadsheets and associated data integrity issues - get one source of the truth
- Obtain revenue recognition information in a secure, central place online
- View revenue recognized to date, deferred and forecasted
- View revenue by account, customer, project, group, region, practice or cost center
- Use ‘Chatter’ to discuss revenue transactions and line items