From the desk of Mike Morini
We are getting a lot of positive feedback and interest in our revenue recognition offering. Our customers and prospects have been reading our white papers and our blog posts, and are letting us know they appreciate the insights we’re providing and are looking forward to more. So we decided to continue this focus with a series of seven posts on revenue recognition, starting with our earlier November 2 post “What’s so important about properly recognizing recurring revenue?” This is the second in this series, and we hope you find it and the entire series beneficial to you and your company. We also encourage you to continue the conversation by commenting on this or any of our blog posts.
Revenue Recognition Regulations. Are all these regulations a good thing?
A lot of people just don’t like regulation at all, but the regulation of financial accounting and reporting does have its merits. Take revenue recognition for example. Revenue is reported on the top line of the business Profit and Loss statement. If the number at the top of the statement is inaccurate or misrepresented, it’s a pretty safe bet that other key values on the statement might be wrong as well. And it’s not just sales and profit data on the P&L that can be wrong. When revenue is not properly recognized, the Balance Sheet’s assets, liabilities, and owner’s equity values are usually wrong too.
This seems like pretty dry stuff, so maybe we shouldn’t care.
Well, consider some high-profile situations regarding financial accounting and reporting results where regulations were not enforced or gaps were exposed through intentional misrepresentation. The Savings and Loan crisis of the 1980’s cost taxpayers around $90B. A succession of compliance-related failures at Enron in 2001 and at WorldCom in 2002 set records for the largest bankruptcies in history. And we are aware of various recent banking-related failures where as many as 9 out of 10 Americans may have been financially affected. We don’t know yet all that this will cost us as taxpayers, but it’s going to be huge.
OK, then some folks might feel that accounting and reporting regulation could actually be a good thing.
Are there some basic revenue recognition rules?
Now, from an earlier post we know about the matching of revenue and costs, but revenue recognition is more than just timing and matching. Are there some other key rules in terms that we can understand and relate to?
There are a lot of rules, but some basics might provide a good revenue recognition foundation:
• You need a contract, an agreement, a purchase order, something indicating that you and the customer agreed on them buying something from you. Without this, you likely have no claim.
• You must do what is expected, or no revenue. You need to have met the expected obligations, and the customer is expected to accept that you have delivered the product or rendered the service.
• No logical valuation, no revenue value. The price or value of the revenue is in an agreement, or is based on your or a competitor’s comparable offerings, or your reasonable, justifiable estimate.
• Just hoping a customer likes you and will pay you won’t be enough. Your reasons for expecting a payment is in an agreement, or some history of prior dealings, or in your normal business practices.
• Bundling mixed products, services, and subscriptions can provide great pricing opportunities, but you need to separate the elements to see if there are any revenue recognition interdependencies.
And who defines all these rules anyway?
As you might suspect, there is an alphabet soup of acronyms for the several entities that author, influence, or convey the regulations, standards, principles, and positions defining revenue recognition compliance. They include FASB and IASB, GAAP and IFRS, the EITF, the SEC, the SOX Act of 2002, and the AICPA. Some good news is that they are all working toward greater convergence, which should make life easier and improve compliance. Rather than go through all of this here, I suggest you check out our comprehensive white paper at http://info.ariasystems.com/recurring_revenue_recognition.html.
So these governing entities basically say that when you have met your obligation as defined in an agreement with your customer, and you have broken down your bundles’ independent revenue elements, you are able to properly earn revenue at your agreed-upon value. And this is a good thing.
Let us know how your revenue recognition efforts are working for you!