Revenue Recognition - much more than a technology issue and a conversation with SAP

New revenue recognition accounting rules come into effect on January 1, 2018 for most entities. While this may not sound exciting to many readers, the implication of these changes on information systems, compensation and commission structures, sales methods and practices, and much more will keep some internal IT groups, systems integrators and accounting firms busy for the next year or two.

Interestingly, a subsequent wave of rules changes regarding lease accounting will immediately follow this but for now, I'm concentrating on the 'revrec' topic.

The new revrec rules have been long in the making with discussions among accounting profession going back to 2008. That means it should be no surprise to those among the readers who care about financial topics.

The rules are complex in that they may require data from contracts, sales order systems, billing systems, CRM, sales performance management and many other subsystems to facilitate the needed allocations and create the appropriate journal entries.

Will these changes affect all organizations? Certain industries, especially those with lots of contracts (think cable television providers) or those that bundle services, products and warranties together, like IT companies, will be especially challenged. Public firms must adopt the new standards first with private firms following a year later.

Recently, I had a discussion with Pete Graham of SAP on this topic.  Our conversation mostly focused on the business implications of the new revrec rules rather than a detailed product review of SAP’s RAR (Revenue Accounting and Recognition) module.

Pete indicated that many of their initial RAR customers are undertaking/have undertaken an Assessment Project. This type of project often starts in one part or division of a firm. The new rules are then applied to one or more groups of transactions within that division. That’s when the fun begins. It is at this time that companies realize:

• They will require additional data to create the correct journal entries going forward.
• Their understanding of the new rules may require several iterations with their external auditor to validate the new methods, processes and controls that this division will require.
• New or modified interfaces and integrations will be required.
• The existing ERP, revenue management or financial accounting software will need upgrading or replacement.
• There may be big surprises in store for their other divisions, business units, etc.

That last point is a key one as the accounting team will need to move even more quickly through all the remaining divisions or subsidiaries to ensure that the new rules are going to be consistently and correctly applied. But along the way, they may find that the approach they’ve chosen may become an expensive one to implement technically or expensive to operate longer term. As a result, operational trade-off issues will surface and will need to be examined by executives beyond those within the accounting organization. For example, the company may decide that:

• a policy change could be needed as it could materially reduce the number of journal entries required in meeting the new revenue recognition rules
• a change to the way commissions are calculated and paid to sales professionals could streamline future accounting requirements
• the company will disallow customer contracts to be appended or amended during the middle of the contract term as these events may trigger significant numbers of current and/or prior period accounting adjustments

Pete and I also discussed how companies need to model the effect of these new rule changes so that the company can have meaningful discussions with shareholders, board members and others regarding the potential impact of these changes on future period revenues and profits. These stakeholders will want to understand the impact of the rules change well before the changes go into effect.

We both agreed that these rule changes will be particularly tough on certain firms. Certain telecommunication, cable television, healthcare, utilities, high-tech and systems integrator firms may be impacted significantly. Software vendors who sell subscription-based solutions (software as a service) may be quite accustomed to revenue accounting rules from the past; however, new rules will need to be evaluated and implemented in these firms. Systems integrators or resellers of software and hardware may also be materially impacted as these rules require a partitioning of software, services, hardware, maintenance and warranties within a given arrangement.

We also had a robust discussion about the preparedness of the accounting and technology ecosystems to support these new accounting rules. I argued that some accounting firms may be looking narrowly at this as an accounting issue and ignoring many of the operational, integration, change management, training and other impacted areas of the business because of these new requirements. As one might expect, sales professionals who live off of commissions would be rightfully upset if their commissions or payout schedules are altered because of an accounting rule change. How these conversations take place, when they take place and other related discussions will have a pronounced impact on operations and on sales & marketing. Ignoring these people and operational aspects could be shortsighted. Pete tells me that SAP is already working with several of the major accounting firms but has extended their reach into regional and other firms as they expect the demand for expertise in this area will rapidly accelerate.

But are systems integrators any better prepared to handle the upcoming changes in revenue recognition and lease accounting? I have my reservations on this point as well mostly because the types of projects that will be undertaken will require more than just technical skills. Yes, there will be system upgrades to ERP or financial software that must be performed and there will be numerous integration activities, too. However, none of these can take place unless the integrators have individuals on staff with significant understanding of the new accounting rules and have a fundamental level of understanding of accounting. Implementing new revenue recognition software is not a matter of simply sitting down and converting old data to a new system. Nor is this effort as simple as setting up some configuration tables and watching the magic happen. These projects will require configurations, testing, what-if accounting scenarios, creation of allocation rules, maintenance of dual sets of books and many more activities which may not be within the accounting background or skill set of many technology personnel or firms.

One area regarding readiness the Pete I both agreed on is that with many companies doing some pilot or assessment projects in 2016, there may be a severe crush or need for third-party assistance during 2017. Third parties will be needed to help with the technology upgrades, new financial module implementations, change management, process changes, compensation/commission changes, interface/integration work, etc. To meet this demand in 2017, integrators and accounting firms need to be staffing up and training today.

One other area that Pete I discussed was how these new revenue recognition solutions will require access to a number of different data sources. But these different data sources, not unsurprisingly, may not come from an ERP vendor. Strategic applications are generally applications that uniquely define the relationship between a company and its customer. As a result, strategic applications may be custom-built, one-off solutions that handle functions like order entry. Financial applications are generally viewed as tactical applications and can be purchased off-the-shelf. New revenue recognition solutions may need to take data from custom (or highly customized) order management, contract management and other solutions. The numbers of subsystems that must provide data to the new revenue recognition software could be as high as six applications. Pete indicated that some companies will be content to use generalized, low-volume integration or interface technologies while some customers will undoubtedly need a high volume integration solution. I would concur with his assessment.

One of the trickiest integrations though will be how companies incorporate certain deal specific data that resides on spreadsheets. While this is far from being an optimal data source, I am aware that a number of companies currently use spreadsheets to do some of their revenue recognition allocations today. The correct longer-term solution must be one that includes few or no spreadsheets.

SAP has a solution called RAR. This stands for revenue accounting and reporting. (see image above.)

SAP personnel have been tracking potential revenue recognition changes since 2008 and started their first forays into building a new platform for these calculations in 2010. Their first version of RAR was produced in 2014. One of SAP’s development team members was on the IFRS feedback group regarding proposed revenue recognition changes. SAP is now on the third version of their RAR solution.

A number of early adopter customers have been working with SAP to test out and validate the solution. SAP is currently working on the expense side of these new requirements.

RAR may come at no cost to some SAP customers. Customers interested though in the lease accounting functionality may want to license a separate lease administration module that is jointly marketed between SAP and Nakisa. Net-new customers may also want to evaluate S/4 Hana Finance with the new revenue recognition capabilities.