This story was originally published in Forbes
Denise Lugo of Bloomberg says, “Public companies—including Amazon.com Inc. and Microsoft Corp.—are gearing up for the most historic accounting changes to hit U.S. capital markets in decades.”
Denis Pombriant of Beagle Research says, “We have before us a perfect accounting storm, the likes of which has not been seen since the late 1990s.”
Josh Paul, Head of Technical Accounting & SEC Reporting at Alphabet says, “Hopefully, fear is what you’re feeling now.”
What are these people talking about? The most profound new compliance changes to come to corporate finance since Sarbanes-Oxley. And they’re five months away.
But you knew that already. Or did you?
Deadlines for the new ASC 606 and IFRS 15 revenue recognition rules start in FY18 for public companies (or after December 15, 2017) and a year later for private firms.
This is a big deal. For many companies, this has the potential to impact sales, go-to-market strategies, compensation plans, product roadmaps, sales commissions, everything.
Verizon has been working on this for three years. Workday has hired a dedicated team of accountants to pore through 6,000 contracts. Uber’s reported revenues are being cut in half. GM expects impact to be upwards of $1 billion.
So what’s going on, exactly?
After twelve years of work, the Financial Accounting Standards Board (FASB) and their European counterpart the International Accounting Standards Board (IASB) issued new standards for recognizing revenue from contracts with customers in 2014. The goal was to simplify and harmonize revenue recognition practices.
The result is that companies have to completely re-evaluate when and how they account their revenue. Right now thousands of accountants are scouring through old contracts to determine whether their sales need to be booked differently.
“It impacts every aspect of how you go to market and run the business, requiring changes in systems, processes and reporting both internally and externally to investors both public and private,” says Hortonworks CFO Scott Davidson. “It’s a very heavy lift for us.”
The new standards are based on one overarching principle: companies must recognize revenue when goods and services are transferred to the customer, in an amount that is proportionate to what has been delivered at that point.
That’s pretty easy to do when you’re selling widgets, but poses problems in the digital economy, where service relationships can change drastically over time.
For starters, subscriptions change frequently. Whether a customer upgrades or downgrades a Zuora plan, or adds a few Salesforce seats, contract changes are the norm. In my company’s experience, every subscription contract undergoes an average of four mid-term changes.
These changes can make the most basic compliance obligation – identifying a contract – a matter of some debate. In some circumstances, contract changes are handled as a modification to the existing contract, while in other situations, a separate contract is created.
Additionally, subscriptions are complex and rolled out over time. The handling of common subscription characteristics—e.g. evergreen subscriptions, nonrefundable upfront fees—becomes tricky when companies have to decide whether to recognize revenue right away or defer it.
Verizon, for example, has decided it that it will credit more of its revenue to equipment sales, and recognize it earlier than its subscription fees, and has to make all sorts of painful changes to its accounting software as a result.
According to Deloitte, the new standards significantly increase the amount of information companies are required to disclose about their revenue activities: “It’s as if your teacher isn’t just demanding that you show your work, but also that you write an in-depth essay explaining the approach you chose, why you chose it, what assumptions you made, what tools you used, and what processes you followed to ensure nothing would go wrong.”
Given three years to do something about it, most finance departments promptly forgot about the new regulations. And with a few exceptions, today they’re either panicking to very little effect, or being willfully ignorant. Make no mistake — some corporate valuations are going to tank as a result.
The latest Price Waterhouse Coopers survey on the topic is not reassuring: 75 percent of public companies they surveyed are currently assessing the impact of the new standard but “have not yet started implementing.” Just over half of the companies they surveyed “have not even chosen a method of adoption.”
I’ve been banging the drum for years about how revenue recognition standards need to change to keep pace with the global explosion of digital services. Today’s accounting rules were written for the Spice Trade (literally — Luca Pacioli invented double bookkeeping in the 15th century), and they simply don’t apply to the modern world of recurring digital services.
Well, apparently someone listened — not just to me, but to everyone in the rapidly growing Subscription Economy. Today the requirements for reporting recurring revenue—a critical metric for evaluating a company’s financial performance—vary across all sorts of different industries and markets. These new regulations are intended to level the playing field.
So today I have some good news and some bad news for anyone running a business model that involves recurring revenue. The good news is that these new rules are a huge affirmation of the subscription model, and will provide a welcome framework for investors and analysts.
The bad news, as previously mentioned, is that they will take a lot of compliance effort, and there’s not much time. Smart, progressive companies like Zendesk, SurveyMonkey and Symantec are already automating their finances, educating investors and recasting revenues. Others, not so much. The clock is ticking.
Learn how Zuora RevPro can help you meet the new standards!