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Jun 21, 2016

IFRS15 / ASC606: Revenue Recognition Standards: Challenges and Opportunities

What is IFRS15 / ASC606?
The converged standards for revenue recognition released jointly by FASB and IFRS brings about significant changes to the way Organizations recognize revenue from contracts. These changes aim to standardize the revenue recognition processes across industries and jurisdictions and will impact most of  the industries in about 85% of the countries worldwide which follow either US GAAP and IFRS reporting standards. 

The core principle of the new standard is that "an entity should recognize revenue in an amount that reflects the consideration that the entity expects to be entitled to in exchange for goods or services." There are five steps to revenue recognition under the standards

1.  Identify the contract(s) with the customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations
5. Recognize revenue when each performance obligation is satisfied.

The new standards are a departure from the existing standards in four ways.

1. Unit of accounting for contracts is Performance Obligation and not Deferred Revenue. Each PO creates a Liability in the books of accounts as soon as either party 'performs'. PO liability is expressed in monetary terms as against deferred revenue which is non-monetary liability
2. Revenue schedules have been replaced by performance obligations.
3. Revenue and billing follow separate accounting paths. A receivable is generated when nothing other than passage of time exists between satisfaction of PO and the consideration due to the entity.
4. The first four steps in the five step process above must be completed at inception of the contract and should be reviewed on a regular basis.

Challenges to business
The new standards pose significant challenges to the business in terms of adoption and maintenance. 

Some of the challenges are:

1. Restatement of the prior years financial statements: The new standards require the retrospective adjustments of the the financial statements. One of the adoption approaches is the Full Retrospective Method, where Organizations need to restate their revenue, based on the new standards, for the two fiscal years preceding the date of inception. This means that they should restate their financial reports for Fiscal Year 2016-17 and 2017-18 and go live on the new standards from FY 2018-19. Since this restatement will have revenue implications, the Organizations will need to disclose the changes in advance to the investors. 
2. All the existing open contracts will need to be revisited and modified to adopt to the new standards. This will be challenging for some companies that have long-term contracts spanning a number of previous years. 
3. The new standards expects the Organization to make a significant number of judgements while deciding on various aspects related to the contracts. It is expected that they make these judgement based on auditable and transparent processes and information.  Organizations will need to make significant investments in implementing appropriate analytic solutions that can provide supporting data for their decisions.
4. The revenue information for contracts could be lying in multiple applications. It will need  technical effort to bring them on to a single location for analysis purposes. 
5. Since about 25 key process of the business is impacted by the new changes, Organization will face challenges related to process change and stabilization
6. There will be challenges related to talent acquisition, training and retention of the talent (especially IT and Accounting Talent).
6. Even during post adoption steady state phase, the contracts will have to be reviewed and modified based on updated information. This will call for further IT and Finance Support.

For the customer these changes provide an opportunity to revisit their current business processes and put in place systems and processes that will improve the business effectiveness.

Product vendors could look for significant jump in demand for their solutions as customers look for COTS products that can handle the challenges.

For implementations consultants this is a big opportunity to review and re-engineer an Organization's current business processes to support the new standards.  

Business requirements
Any solution to support the new standards should have the following minimum features.

1. Rule based, Automatic generation of contracts from elements lying in disparate applications
2. Rule based, automatic identification of performance obligations
3. Ability to seamlessly integrate (360 degrees) with multiple applications
4. Audit trail, approval processes and processes for review and oversight of contracts
5. Role based access control
6. Ability to calculate standalone selling price from existing sales transactions
7. Ability to manually upload standalone selling price or estimated selling price when historical information is not available
8. Ability to modify the interfaced information to support additional analytical requirements
9. Rule based, automatic allocation of transaction prices
10. Automatic / manual recording of satisfactions of performance obligations
11. Rule based, automatic revenue recognition and its accounting reflection 
12. Ability to iterate the process above by modifying the rules till Organization is satisfied with the outcome. Ability to freeze the approved solution.
13. Ease of generating analytical and operational reports for process review, audit and decision support requirements.

The new converged revenue recognition standards (IFRS15 / ASC 606) while challenging to the Organization, also creates opportunity to revisit the existing processes and implement process changes to improve business effectiveness. While the adoption date is fiscal year starting 1 January 2018, Organizations will have to start planning and preparing for the changes from about now. This will give them time to put in place proper systems and processes to prepare for the transition to new standards. In addition, an early start will also help Organizations to execute the talent acquisition and retention strategies required to handle the new standards.

Organization will require IT support to adopt to the new standards. Many vendors are coming out with COTS products that will handle the requirements. I have noted down bare minimum feature list that any such product should contain. Customer can evaluate the products based on the feature list discussed here.


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Proteus Technologies Pvt Ltd said...

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Barbara Dennis said...

Awesome analysis! Thank you for sharing such useful and informative explanation :) I work in the field of microsoft erp, which is connected with supporting and implementing leading erp busness software.

V K Ramaswamy said...

Hello Barbara Dennis
Thanks for commenting in my Blog. Currently I am managing an AX 2012 R3 Implementation for a customer in India. So we have something in common.