Since the release of Accounting Standards Codification (ASC) 606 and the International Financial Reporting Standards (IFRS) 15, revenue recognition has been a hot topic. Essentially, revenue recognition identifies the specific conditions in which revenue can be recognized and how a company needs to account for it. On the surface, revenue recognition sounds easy enough. You provide a product or service, receive payment, and recognize the revenue, right? Not quite… According to the revenue recognition principle, revenue can only be recognized once it’s earned. This is where things get complicated and revenue recognition automation comes into play.
When can Revenue be Recognized?
The complexities surrounding revenue recognition are largely dependent on your business model, revenue recognition method, and the accounting method (cash or accrual basis) used – each containing pros and cons. Additionally, selection of revenue recognition methods varies based on many factors, including the industry, size of the company, certainty of payment, etc.
Although there are many revenue recognition methods, we’re going to cover the five most common ones.
Commonly used by retail businesses, revenue is recognized when the sale is made, regardless of whether the customer pays in cash or by credit.
Percentage of Completion:
Typically used when there’s long-term contract agreements such as with construction and engineering companies. A percentage of the total revenue is recognized upon reaching contractual milestones.
Used for large dollar purchases such as vehicles, real estate, home appliances, etc., revenue is recognized when each payment is received.
Completed Contract Method:
Frequently used by smaller construction companies, revenue can only be recognized (even when cash is received) once all performance obligations within the contract have been fulfilled and accepted by the customer.
Cost Recovery Method:
The most conservative of revenue recognition methods, it’s typically used when there is uncertainty regarding the collection of money from the customer. Revenue is only recognized once all costs associated with the sale of products or services have been recovered.
Manual Methods Bog Down Your Business
How do you know which revenue recognition method is right for your business? While each has advantages and disadvantages, some are better suited for certain industries, business models, performance obligations, and fulfillment methods than others.
Using the wrong method not only can have regulatory compliance repercussions, but can lead to inflated or deflated revenue, expenses, and profit numbers. When those numbers misrepresent reality they can affect management decisions, tax liability and investor confidence.
To illustrate, say that you have a subscription-based SaaS company charging $30/month/user for the basic plan, and customers pay annually. We’ll also assume that one of your customers purchased the basic plan for 100 users and is paying $3,000 at the start of each calendar year. Your subscription revenue recognition would be $250 per month. That is, however, unless during the calendar year the customer:
- Increases or decreases the number of users
- Cancels the subscription prior to the contract end date
- Upgrades or downgrades their plan
- Requests services that incur an additional fee
- Missed payments
Any of the above can result in accounting complications and errors that can significantly affect your records. When you’re manually handling revenue recognition, it is time-consuming and error-prone. Revenue recognition automation simplifies the process, eliminates errors, helps to ensure regulatory compliance, and frees your resources for other high-value activities.
Benefits of Revenue Recognition Automation
The key to simplifying revenue management, recording correct numbers, and ensuring regulation adherence is automation. Basically, revenue recognition automation removes the human factor of this labor-intensive task, eliminating the possibility of errors. But its benefits don’t end there! Here are some of the additional advantages of implementing revenue recognition automation.
- Consistent and aggregated data: Automation collects and groups disparate data from multiple sources, making the handling of revenue contracts much easier.
- Costs associated with contracts: Contracts need to account for all revenue-related costs such as cost of goods sold, commissions, accruals, rebates, etc., which when done manually is extremely difficult. Automation eliminates the financial risk associated with contract costs.
- Contract changes: Not a rare occurrence, contracts are frequently changed due to a number of circumstances. Automation ensures proper allocation of the changes, improving efficiency and accuracy.
- Event-based revenue recognition: The ability to accurately track revenue recognition event triggers such as delivery, acceptance, timing, consumption, etc., is critical. By automatically tracking the timing of events, you’re able to recognize revenue as soon as the trigger is met.
Want to know more? Watch this Guide to Automating Revenue Recognition to learn why automating revenue recognition matters, how it helps ensure your business is ASC 606 or IFRS 15 compliant, and the benefits of a combined billing and revenue recognition solution.
Revenue Recognition Automation in Action
Automated revenue recognition isn’t just for subscription-based companies. Are you a franchisor that’s expanding your market share or geographic reach by franchising your products, services, and brand? Revenue recognition automation enabled one franchisor to not only overcome their challenges but gain additional unforeseen benefits.
As their business grew on a worldwide basis, Self Esteem Brands needed a way to reduce errors, streamline billing and invoicing for their franchisees, and monetize the relationships with their growing base of franchise owners. To do this, they required a solution that could automate the invoicing of franchise royalty fees, technology fees, and advertising fees; trigger event-based revenue recognition by capturing data from disparate systems; and efficiently scale to manage numerous tax requirements and languages.
As they looked at their options, one company stood out – BillingPlatform. Today, Self Esteem Brands is reaping the benefits of automating data sync with their franchise management system. They now facilitate billing through revenue recognition; improved their auditability and compliance with end-to-end automation that is supporting complex revenue recognition audits; and enhance their franchisee relationships by providing exceptional experiences.
Say Goodbye to Manual Effort
We believe we’d be hard-pressed to find many companies that can honestly say revenue recognition automation wouldn’t benefit their company. When it comes to mitigating compliance risk, maintaining an accurate audit trail, and simplifying the complexities associated with revenue recognition, you can’t leave anything to chance. Are you ready to decrease risk, outperform your peers, and gain a competitive advantage? If so, the way forward is through revenue recognition automation and our team of experts is ready to help.