Recognising the problems with your revenue recognition
Revenue recognition has been a growing headache for many accounting teams in recent years. While there has long been some complexity involved for companies that deliver contract-based projects over extended periods of time, there is also an increasing number of organisations adopting flexible consumption models (FCM) — such as the “X as a service” offered by many technology companies — that confuse things further. This shows no signs of slowing: in 2021, the UK’s public cloud SaaS market was estimated to be valued at £7.2 billion, and is set to grow to £10.9 billion by 2025.
As many accounting teams will know, the challenge presented by business models such as FCM is that it becomes complicated to identify when revenue can be recognised as such. Some FCMs will be based around a set subscription, in which case the full amount of money from an annual subscription cannot be recognised at the point of sale but split across a 12-month period. For other FCMs, revenue recognition is tied to when baseline performance obligations are met and provided to a customer. For example, a printer or photocopier business may offer a service where customers pay for ink or sheets of paper used per month.
With revenue recognition now being subject to increased regulation and greater scrutiny, most companies have some sort of system or method in place to make the process easier — easier, that is, in the loosest definition of the word. Experience has shown us that many companies still struggle with the process, and in fact currently use systems that were never designed to provide a lasting solution.
A quick fix
When IFRS 15 came into effect in 2018, many businesses rushed to introduce a tactical solution that could tick the box of revenue recognition compliance. Almost five years later, these solutions — often small bespoke systems, bolt-on functions or even spreadsheets — are still in place, having remained largely unmodified and unreviewed during the intervening years. These stopgap solutions have become permanent fixtures that do not integrate well with other core systems. This has resulted in processes that are often manual, error prone, time consuming and consequently present significantly greater business risk.
However, businesses are becoming increasingly aware of the issues of inefficient solutions. In the wake of COVID-19, resilience has become a key focus for many companies as they seek to ensure their systems are as robust and efficient as possible. Bolt-on revenue recognition systems are a prime target for improvement.
One of the main reasons that bolt-on revenue recognition systems are not suitable for ongoing compliance or operational efficacy is that the process of effective revenue recognition involves handling a lot of data. Data needs to be gathered from multiple sources in a way that is reliably accurate and produces a clear trail for auditors. Using disparate, siloed systems makes this clear audit trail difficult to ensure, especially in cases where different data formats and system architectures are involved. In the best case scenario it’s simply difficult to make a direct link between data sources and revenue recognition; in the worst case it can seriously compromise data integrity, causing inconsistency and errors.
For those companies forced to rely on using spreadsheets, this audit trail is even more difficult to provide and introduces a significant risk of error. If an accounting team is using a spreadsheet to reconcile revenue recognition with sales, it involves a lot of time spent manually pulling out data. A company might have a revenue spreadsheet with more than 1000 rows of sales data, which would need to be reviewed row-by-row every month to see what new revenue could now be recognised in the system. This will almost certainly lead to mistakes of which the infamous instance of human error on a financial spreadsheet leading to a $6.2 billion loss for JP Morgan in 2012 is a cautionary tale.
Recognising the solution
Effective revenue recognition is only going to become more important as market conditions continue to prompt more businesses to expand their offerings and introduce new business models. Putting that effective recognition process in place ultimately relies on having a single source of truth: one fully integrated platform that can automatically pull all necessary data from connected systems in a unified format.
Unlike prior to IFRS 15, planning the implementation of an effective revenue recognition system should not be rushed. There are guides available on how best to implement an effective revenue recognition system. In general, financial managers should carefully consider how they will gather and monitor necessary performance obligations such as resources consumed and costs incurred, how to record revenue recognition rules and how to apply revenue calculations. This should include all revenue streams from multiple sources such as opportunities, orders, contracts, projects, subscriptions and invoices, all in one place.
Crucially, the system should be able to give accounting teams flexibility to cater to unique contract requirements, and should be suitable for automating to reduce errors and manual time. As such, systems need to be fully compatible with key operational platforms such as customer relationship management (CRM) and professional services automation (PSA). This integration should allow the automatic collection of data to produce clear audit trails for even complex sales with multiple data sources, while also making it easy to view performance obligations per contract.
No matter the specific set-up, it’s clear that the stopgap solutions are not practical or sustainable. After almost five years, it’s about time for organisations to finally treat the headache of revenue recognition.