Revenue Recognition: Challenges and Implementation
Strategies
Introduction
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
Revenue recognition has always been challenging for companies due to
various intrinsic complexities involved in the process. However, recent
changes introduced by Financial Accounting Standards Board (FASB) and
International Accounting Standards Board (IASB) have exacerbated these
challenges manifold. The new revenue recognition standard – ASC 606 or
IFRS 15 aims to provide a single, comprehensive model for all contracts with
customers to improve comparability across industries and capital markets.
While the intention is noble, complying with the new guidelines comes with
its fair share of difficulties.
This paper aims to discuss some of the major challenges companies face in
implementing the new revenue recognition standards and suggests
strategies to overcome them. The first section focuses on understanding the
core principles of ASC 606/IFRS 15 and the changes it has brought. The next
part elaborates on practical challenges arising due to complexities related to
contract types, performance obligations, variable considerations etc. Finally,
the last section presents key strategies that management can adopt to
streamline revenue recognition process as per the new standards.
Core Principles of ASC 606/IFRS 15
The new revenue recognition standards are based on the core principle that
an entity should recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or
services.
Some of the key elements introduced by ASC 606/IFRS 15 include:
- Identification of Contract: A contract with enforceable rights and
obligations between two or more parties needs to be identified before
revenue can be recognized.
- Identification of Performance Obligations: Distinct goods or services
promised in a contract constituting performance obligations that need
to be assessed and accounted for separately if they are distinct.
- Determination of Transaction Price: The transaction price is the amount
of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. Variable
considerations like discounts, rebates, refunds etc. need careful
estimation.
- Allocation of Transaction Price: The transaction price is allocated to
each performance obligation based on their relative standalone selling
prices at contract inception.
- Recognition of Revenue: Revenue is recognized when (or as) the entity
satisfies a performance obligation by transferring a promised good or
service to a customer. Control transfer criteria needs to be assessed for
each obligation.
- Costs to Obtain/Fulfill a Contract: Incremental costs to obtain a contract
are capitalized if expected to be recovered. Costs to fulfill a contract
are also capitalized if within the scope.
The new framework requires robust processes and accumulation of more
contract-related data to implement these principles correctly. Let us now look
at some practical challenges that arise in the implementation process.
Challenges in Implementation
Complex Contract Types
Companies dealing with complex contract types find it difficult to comply
with the new standards. For instance, in construction contracts identifying
distinct performance obligations can be challenging. Similarly, in contracts
having significant customization or modification clauses, delineating
performance obligations becomes complex.
Ascertaining whether a good or service is ‘distinct’ as promised in the
contract based on control transfer criteria is a major area of ambiguity. For
long term service contracts extending over years, it may not be
straightforward to assess satisfaction of performance obligations periodically.
All these intricacies push up the compliance cost and implementation time
significantly.
Variable Considerations
Estimating variable considerations like discounts, rebates, penalties, refunds
etc. pose compliance difficulties. Frequently such estimates involve
management judgments introducing uncertainties.
Evolving market conditions or customer behaviors can often upset initial
projections. Keeping pace with contract modifications adding/altering
variable components on an ongoing basis is another hurdle.
With significant amount of revenues tied to such variable clauses, even small
errors in estimation can materially impact financial statements. Therefore,
variable considerations require robust estimation methodologies and
constant validation.
Contract Combinations
Deciding correct combination of contracts as a single arrangement or
separate ones as per control and dependency criteria defined in ASC 606 is
not straightforward.
In bundled sales involving distinct goods/services delivered over time,
allocation of transaction price to individual performance obligations also
becomes intricate. Similarly, identifying separate performance obligations
within a contract having significant service elements poses its own share of
complexities.
Judgment Calls
Exercising correct judgement calls remains crucial. For instance, whether a
good or service is promised as distinct, estimating discount rates for contract
modifications, deciding timing of satisfaction of performance obligations etc.
involve judgment that can alter revenue recognition significantly if assessed
incorrectly.
Such judgment calls if not applied consistently pose compliance difficulties
and increase audit risks as well. Therefore, documented policies and
periodical reviews assume greater importance.
Technology Integrations
Interface of existing accounting/ERP systems with requirements of new
standards represents a huge implementation challenge. Configuring systems
to capture right kind of contract data, tracking performance obligations
through delivery lifecycles and automating appropriate recognition entries
requires substantial upgrades.
Resources with technical expertise are also needed to develop custom
tools/workflows for revenue recognition as per new guidelines within
available systems. Integration projects entail significant costs, disruption
risks and implementation timelines.
Cost Implications
Compliance with ASC 606/IFRS 15 comes at a steep cost. Apart from system
integration expenses, companies incur substantial accounting advisory,
internal control evaluation and audit costs.
Ongoing expenses also increase due to requirements of robust data archival,
separate analyses for contract modifications, review mechanisms for variable
considerations and impairment assessments. This puts pressure on profit
margins, at least in the short term.
People and Process Changes
Incorporating revised revenue recognition processes demands changes
across departments like business development, project management,
finance etc. Extensive training is required to build requisite skills and change
mindsets as per new guidelines.
Changes in organizational design and redefined KPIs may be required to
establish accountability as contracts/obligations now span multiple
individuals and functions. Any weaknesses in execution of such
organizational changes compromise smooth implementation.
Given the scale of transformations involved in complying with new
standards, companies face immense challenges in driving holistic changes
across people, processes and technology within envisioned timelines.
Overcoming these challenges calls for well-thought implementation
strategies.
Implementation Strategies
Develop Robust Accounting Policies
Crafting clear, unambiguous accounting policies is perhaps the single most
important first step towards ASC 606 compliance. Key elements like contract
identification procedure, performance obligation assessment methodology,
technique for variable consideration estimation all need documented
policies.
Companies should involve cross-functional experts in policy formulation and
get approvals from highest governance bodies like audit committee. Policies
require periodic reviews and updates to address emerging implementation
issues. This lays a strong foundation.
Leverage Technology
Investments need to be made to upgrade accounting/ERP systems with right
capabilities for revenue recognition as mandated by new standards. Apart
from ensuring system configuration as per requirements, tools like data
visualization dashboards, automated work flows and analytic capabilities
should be developed to improve efficiency.
Cloud-based offerings from leading vendors can be leveraged to minimize
upfront investments. Regular system trainings, debugging of issues and
change management assume importance in optimum technology leveraging.
Perform Risk Assessments
Undertake comprehensive risk assessments to identify pain areas in contract
portfolio. Obtain insights on types of contracts requiring additional scrutiny,
departments needing capacity building, potential restatement risks due to
past transactions etc.
Risk areas warrant special focus like development of robust estimation tools,
separate review mechanisms by finance, internal audits etc. for continual
improvement. Comply with additional disclosure requirements pertaining to
uncertainties around at-risk revenues.
Focus on Data Management
Leverage technologies like customer data platforms (CDP), data modeling
tools etc. to effectively manage multi-dimensional contract data mandated
by ASC 606. Build capabilities for data extraction, cleaning, analytics and
secure archival.
Streamline master data, integration of financial and operational systems and
establish protocols for data sharing across stakeholders like sales, projects,
billing etc. Outsource non-core data management functions to experts if
required.
Train and Communicate
Conduct periodical, top-down training/communication programs for all layers.
Focus on technical know-how required by accountants, hands-on process
understanding for business and financial sensitized trainings for senior
executives.
Develop interactive e-learning modules, story-based case studies, refresher
workshops and structured knowledge retention exercises to build sustainable
competencies. Two-way communications reinforce commitment and address
concerns at grassroots.
Strengthen Internal Controls
Along with accounting policy reviews, augment existing internal controls with
additional layers for new elements brought in by ASC 606 like contract
changes oversight, periodic project status tracking, sample-based audits of
variable consideration estimates etc.
Key controls like segregation of duties, authorization protocols and reporting
mechanisms require rigorous testing and strengthening to prevent
procedural lapses during transition. Appoint process owners to drive
adherence.
Evaluate Business Impacts
Assess implications of new standards on key business matrices like margins,
working capital, cash flows and disclosures. Identify actions needed for
realignment of long term contracts, sales incentive plans, billing, credit terms
with customer etc. Decide contract asset creation strategies.
Provide revised financial targets with qualitative/quantitative assessment of
compliance impacts to board and investors. Address queries to build
confidence during transition phase.
Leverage Expert Advisory
Depend on external advisory expertise during initial years of implementation.
Outsource customized solution design, critical system validations, specialized
training needs and first time accounting guidance.
Rely on consulting firms for periodic health checks of compliance maturity,
sharing of evolving global practices and industry benchmarks. Leverage their
project management capabilities to navigate transition smoothly within
envisioned deadlines.
Implement in Phases
For large organisations, divide implementation into multiple phases based on
contract type/duration, geographies, associated risks or departmental
complexities. Have staggered timelines with initial focus on high revenue
streams and complex scenarios.
Pilot implementation for select groups helps identify gaps before large scale
rollout and build case for incremental investments. Phased approach with
periodic reviews facilitates learning while implementing.
Monitor Progress Closely
Assign clear ownership at senior management level for driving ASC 606
compliance. Define metrics for continual monitoring of progress against
targets across workstreams like system upgrades, risk assessment closure
rates, financial impacts, training coverage etc.
Highlight red flags instantly based on monitoring for corrective actions. Seek
periodic updates from process owners and internal/external auditors. Close
gaps detected during transition period on priority for establishing compliant
state.
In Conclusion
While bringing in transparency and comparability in financial reporting,
implementation of new revenue recognition standards also imposes
challenges for companies. Adopting a well thought strategy around people,
processes and technology is imperative to drive the transition smoothly.
Key lies in developing a holistic compliance roadmap involving all
stakeholders, continuously tracking progress, embracing changes proactively
and addressing issues timely. Reliance on expert advisory during initial years
also helps. With right strategies and commitment, organizations can
overcome obstacles to establish sustainable compliance with ASC 606 and
IFRS 15.
