This Q&A with Zuora’s SVP of RevPro Jagan Reddy was first published by FEI Daily and published at financialexecutives.org.
Private Companies: Prepare Before the 2019 Revenue Recognition Wreckage
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 for public and private companies globally.
Private companies were given five years to completely reevaluate 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 before the 2019 deadline hits.
Why do private companies need to be concerned about ASC 606?
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 (FY19). 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.
The new standards require the same compliance as public companies (except SEC disclosures). Many concepts are new or require more discrete calculation (standalone selling price, variable consideration, contract modifications). Private companies can learn from the examples of public companies over the next year as we watch the first Q1 earnings reports and 10Q’s filed in January.
What must private companies do to automate?
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.
My first recommendation for ASC 606 automation: don’t underestimate the time it will take. There are two options when it comes to 606 adoption. One requires a company to restate two years of financial history while reporting under the new standards moving forward. Restatement is a time consuming process and enough time should be allowed to process historical transactions.
Second: Focus on the data. Every business is unique and will have very specific requirements under 606 guidance. Some have multiple deliverables within a contract, license revenue, or special concerns with long-term contracts, and others could see significant financing components and additional cost recognition. It’s important to establish 606 policies and have memos drafted and approved by auditors prior to kicking off an automaton timeline which can take more than a year to complete. It’s best practice is to work the assessment project and automation project in tandem.
How can private companies implement a scalable and sustainable compliance practice?
Automate with the right solution, including the right experience held within that solution’s company. Ensure the right resources are on hand internally and fill in with external experts. It isn’t rare to see a conference room filled with new faces when it’s time to pore through customer contracts. Revenue accountants are in higher demand than ever. Together with auditors, financial teams must focus on a timeline with enough buffer room (more than you think you’ll need) to complete the process. Here’s an overview of a four step process that works for private companies:
- Get started: Build your team, perform an initial assessment and outline your strategy.
- Operational planning: Identify gaps in processes and data, make key decisions and begin making your detailed plans.
- Preparation: Review business and policy requirements, ensure data is complete and ready, design and test system.
- Implementation: Launch software to automate 606, conduct user training and testing, prepare everything to go live and learn about preparing for better financial audits.
What are the risks of not being prepared to meet ASC 606 requirements?
Non-compliance is the biggest risk. ASC 606 and IFRS 15 require significant professional judgment, and subjectivity is prone to errors and biases. Revenue recognition errors – the #1 reason for restatements – have lead to delayed street reportings, firings, jail time, and tarnished reputation. For pre-IPO companies, non-compliance could be a huge risk to potential investors and an S-1. Deloitte released a survey of 3,000 companies indicating slow progress among private companies on implementation of the new revenue standard may delay IPOs.
To get it right, companies must undergo immense manual work and rework. 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.”
Companies who miss the required adoption and disclosure dates may receive “comment letters” from the SEC, although the SEC has stated they will be delaying sending letters to give people a little more time to adjust. That goes to show just how challenging the standards have become without automation.
What does the Jan. 1 deadline mean for companies required to comply with ASC606?
It’s the difference between public (now) and private (1 year from now) company requirements. Restatement method and execution must be in place by the first of the year and 606 guidance must be followed and reported on from there on out to auditors and investors.
If you’re a private company, follow the lead of others in your industry.
And keep watching. As of Q3 only 38% of the S&P had publicly disclosed to investors how they think they’ll be impacted by 606. Only 30 companies “early adopted” ASC 606 and those that expect a material impact include Take-Two, Amazon, GM, EA, GE, Microsoft, and Boeing. Across all industries, companies are seeing very different outcomes as a result of ASC606 and IFRS15 and we’ll have to wait and see the market’s reaction in 2018.
Jagan Reddy is the SVP of Zuora RevPro