April 10, 2018
Article written by Neema Jyothiprakash, Product Marketing Manager, Bluewolf, an IBM Company
Last year, Uber reported revenue numbers that dropped to half of their usual profits. Retailers like Amazon, Starbucks, and Wal-Mart expect a rise in revenue numbers by hundreds of millions of dollars. While many different factors affect revenue numbers, the single reason for these swings are new accounting rules. If you’re in charge of sales operations, commissions, product offerings, IT, legal, and of course, finance or accounting, you are experiencing the biggest change in accounting in the last 15 years.
The new accounting rules ASC 606 in the U.S., and its international counterpart IFRS 15, standardize and simplify revenue recognition across all industries. Revenue recognition is an accounting principle that determines what a company claims as revenue from the cash received in bookings, which of course, signifies a company’s profitability to shareholders, investors, and customers.
Prior to the new rules, companies recognized revenue once earned. For example, if I pay for a magazine at the airport, the shop recognizes revenue immediately after exchanging cash for the magazine. Or, when I sign up for my Spotify subscription, Spotify recognizes revenue each month, when I pay the subscription, and when they deliver my service.
Now, companies must recognize revenue when they fulfill their promise to deliver goods and services, as outlined in contracts with customers.
My first thought was, “doesn’t getting the magazine mean the shop fulfilled its promise? What do the new rules change exactly?”
In order to remain compliant, companies must now institute a new model that dictates how you recognize revenue with your customers. At Bluewolf, an IBM Company, we believe that model should be implemented on Salesforce, since it houses all your customer data. Salesforce is powerful enough to ensure ASC 606 compliance, and at the same time, helps improve your customer lifecycle.
- Identify the contracts with the customer
- Identify the distinct performance obligations in the contract
- Determine the expected transaction price
- Allocate the transaction price to the performance obligations
- Recognize revenue
Imagine I purchase a 12-month subscription for ad-space inside an online magazine. I pay for the subscription up-front, so at $100 a month, the company receives $1200 total. Service fees are included for free, since I purchased the ad-space from a promotional marketing email.
According to the rules, the magazine must first identify their contract with me, with the contract understood as the legal representation of all obligations involved in a deal between two parties i.e., the terms and conditions I agree to when purchasing ad-space online.
Then, the magazine must identify distinct performance obligations in the contract. A performance obligation is the promise to transfer a good or service. In this case, the magazine providing ad-space for me to use, and related services, like access to a customer service rep who can help me troubleshoot technical issues.
Next, the magazine must determine the transaction price, which is the amount a business expects to be entitled to in exchange for fulfilling the performance obligations. Since the contract includes a “variable consideration,” (discounts, rebates, refunds, bonuses, etc.), the magazine must estimate how much they will receive based on how much of the goods and services they deliver. There are two methods to estimate, and each company will pick a method most effective for their business. Here, $1200 will be part of the transaction price since its the subscription rate, and the normally $30 per month service fee which is discounted, may also be included. ASC 606 states that “variable considerations” can now be recognized.
Step 4 is to allocate the transaction price to performance obligations in the contract, relative to the Standalone Selling Price (SSP).
Finally, in Step 5, the magazine recognizes revenue upon transfer of control over goods and/or services. The magazine recognizes the $100 subscription fee as it is completed per month, regardless of the fact that I paid for it up-front. They also recognize the $30 per month for services as it is completed, even though I, the customer, don’t pay for it. Prior to 606, this discount may have been accounted for as a selling cost. So, the magazine recognizes still recognizes $1200 for the year, but monthly, the amount might be less than $100, depending on how the magazine pro rates charges or weights the probability of contract outcomes.
My example is simple, but you can imagine how these details in a sales deal can quickly become complex if you add in fees, warranties, ramp pricing, rebates, services and support, and customer expectations.
There are two consequences of the 5-step model. 1) Companies must re-evaluate business processes relevant to the 5 steps, and 2) To report on these data points, companies must capture them first.
Every business will have distinct business processes which map to the 5 steps, but here’s where you can start:
- Package and price your offerings so they align to performance obligations
- Require sales to fill in all data points during deal structure - product selection, pricing, and quote/proposal generation, contract length, fees, and discounts or promotions
- Integrate performance obligations and transaction prices from sales process into contracts
- Mitigate increased contract risk with streamlined approvals
- Clarify language in contracts to ensure compliance
By now, most companies have a plan to address ASC 606 and IFRS 15, however, not all of them are taking an integrated approach between sales, operations, and finance to implement the new rules. Outside a lack of technology, part of the challenge is also interpreting the rules. 606 is primarily principal-based, so how the rules apply to each business is not absolutely clear. In fact, that makes it even more untenable to address these changes without a digital, cloud-first, agile strategy.
At Bluewolf, we see Quote-to-Cash as the set of technologies that drive ASC 606 and IFRS 15 compliance on Salesforce while ensuring the front office of sales and marketing do their part to make it less painful.
Curious to assess your business and technology requirements for ASC 606 compliance?
Check out how CPQ (Configure-Price-Quote) and CLM (Contract Lifecycle Management) align the front and back office to implement the new rules, or talk to an expert today.
*Disclaimer: Bluewolf is not sharing accounting, legal, or tax advice regarding ASC 606. If you require such advice, please contact a qualified financial advisor.