Remove inconsistencies and weaknesses in revenue requirements Provide a more robust framework for addressing revenue issues Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets Provide more useful information to users of financial statements through improved disclosure requirements Simplify and standardize the preparation of financial statements by reducing the number of requirements to which an entity must refer Overview Revenue is an important number to users of financial statements in assessing an entity’s financial performance and position. However, current revenue recognition requirements in the U.S. Generally Accepted Accounting Principles (GAAP) differ from those in International Financial Reporting Standards (IFRS), and both sets of requirements are in need of improvement. Financial Accounting Standards Board (FASB), which is responsible for governing U.S. GAAP in collaboration with International Accounting Standards Board (IASB) initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS that would: New Revenue Accounting Standards on Customer Contracts and its impact on ERP systems • Cognizant Solution Overview solution overview july 2016 | Convergence of US GAAP and IFRS New Revenue Standard US GAAP/IFRS Convergence Project Industry Specific Guidance Removed US GAAP (US Standards) IFRS (International Standards) New 5 Step Process Final Standard Issued May 2014 Effective 2017 public 2018 private Figure 1
Transcript
Remove inconsistencies and weaknesses in revenue requirements
Provide a more robust framework for addressing revenue issues
Improve comparability of revenue recognition pract ices across ent i t ies , industr ies , jurisdictions, and capital markets
Provide more useful information to users of financial statements through improved disclosure requirements
Simplify and standardize the preparation of financial statements by reducing the number of requirements to which an entity must refer
Overview
Revenue is an important number to users of financial statements in assessing an entity’s financial performance and position. However, current revenue recognition requirements in the U.S. Generally Accepted Accounting Principles (GAAP) differ from those in International Financial Reporting Standards (IFRS), and both sets of requirements are in need of improvement.
Financial Accounting Standards Board (FASB), which is responsible for governing U.S. GAAP in collaboration with International Accounting Standards Board (IASB) initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS that would:
New Revenue Accounting Standards onCustomer Contracts and its impact on ERPsystems
• Cognizant Solution Overview
solution overview july 2016 |
Convergence of US GAAP and IFRS
NewRevenueStandard
US GAAP/IFRSConvergence
Project
IndustrySpecific
GuidanceRemoved
US GAAP(US
Standards)
IFRS(International
Standards)
New 5Step
Process
FinalStandard
IssuedMay 2014
Effective2017 public
2018 privateFigure 1
To meet those objectives, the FASB is amending the FASB Accounting Standards Codification® and creating a new Topic 606, Revenue from Contracts with Customers, and the IASB is issuing IFRS 15, Revenue from Contracts with Customers. The issuance of these documents completes the joint effort by the FASB and the IASB to meet those objectives and improve financial reporting by creating common revenue recognition guidance for U.S. GAAP and IFRS.
Who is impacted?
The changes in accounting standards bears an impact on ALL public traded companies reporting to the Securities and Exchange Commission (SEC) in USA (will be effective for annual reporting periods beginning after 1st January 2018) as well as other private entities that report financial results to others in USA.
The changes also impact 120 countries including the European Union which adopts IAS.
Al though 2018 may seem way off, the implementation date has been set because the entities will need significant time to prepare for the impact of new standards. In some cases the standards require system changes or the development of new systems or operations, internal controls etc. It is imperative that entities identify such impacts early on in the game.
In addition to accounting aspects, it may have a wider impact on the following items
a) Sales Operations
b) Internal Controls
c) Systems
d) Contract restructuring
e) Management Reporting
f) Tax
g) Stakeholders
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FinancialAcctingSystem
FinancialAcctingSystem
RevenueRecognition
Policy
RevenueRecognition
Policy
snoitarep
O laicnaniF
Sales O
perations
Revenue fromContracts
withCustomers
SpecificContract
Terms
CompanyPractice and
Customs
IndustryPractice and
Customs
Figure 2
Business Process Change
System Revamp
Data Modelling
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New Standards at a Glance
The core principle of the guidance is 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 provided goods or services.
The five steps of the revenue recognition model
Identify the contract with a customer
1 2Identify the performance obligations in the contract
3Determine the transaction price
4 Allocate the transaction price to separate performance obligations
5 Recognise revenue as the entity satisfies a performance obligation
Five Step Process And System Challenges
This New standard is based on a five-step model; it is more detailed and prescriptive than the existing guidance.
To achieve that core principle, an entity should apply the following 5 steps:
Figure 3
Figure 4
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The 5 steps have been detailed in this section below
Step 1 - Identify the Contract(s) with the Customer
For Recognizing Revenue – a contract can be unsigned also Provided criteria mentioned above are clearly understood/identified from the document.
Contracts with Group customer needs to be related either through Master contracts; this is to know if any special treatment is given in the price
If any Contract Amendments results in Distinct service and the Price of this service is standalone, it should be identified as separate contract.
Entities will additionally need to consider whether the contract should be combined with other contracts for accounting purposes and how to account for any subsequent modifications that may arise. Contract can be combined only if,
a) They are negotiated as a package with a single commercial objective
b) The amount of consideration to be paid in one contract depends on goods/services to be delivered on another contract
c) The goods and services are considered as single performance obligation
From a System perspect ive, in case of amendments, if this is identified as distinct service/goods then it should be separate contract else this will be added/modified in existing contract. There should be an identifier to trigger this change in the system.
Figure 5
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Step 2 - Identify the Separate Performance Obligations in the Contract
The Performance Obligation needs to be identified at contract inception
If distinct goods/services cannot be identified at this stage then entity should combine accounts for the same.
For a good or service to be distinct it should satisfy both of the following conditions
a) The customer can benef i t f rom the good/service either on their own or in combination with other available resources with the customer
b) The entity’s promises to transfer the good/service which is separable from other promises mentioned in the contract
Apart from this, the following points need to be kept in mind while determining whether a good/service is distinct or combined obligation:
The entity does not use the good or service as an input to produce the combined output specified by contract (or)
The good/service results in s ignif icant customization to make it usable to customer (or)
The good/service is not highly dependent /interrelated with other promised goods or services
Example
Assume Company A licenses software to a customer, promises to provide consulting services to implement and customize the software for a total consideration of $ 500,000.
Here Company A is providing a significant service of integrating these goods and services into the combined item
Hence the entity would account for the license and consulting together as a single performance obligation; So Licensing obligation can be recognized as revenue over the period of contract and NOT at the point of sale
From a System perspective, each obligation should be identified as a separate contract line to determine its pricing/revenue recognition amount.
Figure 6
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Step 2 - Identifying separate performance obligations
Figure 7
Step 3 - Determine the Transaction Price
Figure 8
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This step is deals with how to measure the total revenue and not just agreed contract value.
In other words revenue should be adjusted with discount, rebates, price concessions, incentives, penalties etc.
The System should be capable of identifying these elements and revenue should be reduced to this extent.
Figure 9
Step 4 - Allocate the Transaction Price to Performance Obligations
After determining the transaction price in step 3, we proceed to step 4 where it will be allocated between performance obligations identified in step 2;
If there are multiple obligations identified in single contract, the transaction price should be allocated based on relative stand-alone prices. Ideally this will be called as “Observable Price”.
If stand-alone prices are not available then entity should estimate the same. Following estimation methods are allowed 1) Adjusted Market Assessment 2) Cost Plus Margin 3) Residual Approach (only in certain exception cases)
Figure 10
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System should be capable of deriving these values viz., Cost plus can be achieved through Project budgeting model.
Step 5 – Recognize Revenue
Figure 11
Figure 12
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Performance obligation considered to be “Point in time” when
a) The entity has transferred title to asset to customer
b) The entity transferred physical possession of the asset
c) The customer has full control of transferred asset
d) The customer has significant risks and rewards of ownership of the transferred asset
In all other cases the transfer is considered as “Over a period of time”.
The final step is to determine the revenue amount for each of the performance obligations.
This step deals with timing - Point in time v/s Over a period of time
This will have significant impact on the system as billing and revenue will not go together. It may impact financial reporting also.
From a system standpoint, application should be capable of delinking billing and revenue and revenue entries should be staggered over the period of contract in case of combined services.
Other Considerations
A. Contract Amendment
Contract modification scope price should be treated as adjustment to existing one or new contract will be based on performance obligation agreed between the parties.
If new performance obligation is distinct and reflects stand-alone price prevailing in the market then it should be new contract else continuation of the original contract accounted for on a cumulative catch-up basis
Contract Modications
(1) The additional goods and services are distinct from the goods and services in the original arrangement and
(2) The amount of consideration expected for the added goods and services reflects the standalone selling price of those goods or services
If Yes
Treat modification as a separate contract
If No
The additional goods and services subject to amendment are distinct from the other goods and services provided within the original contract but the consideration does not reflect the standalone selling price of those goods or services
If Yes
Prospective treatment - termination of the original contract and creation of a new contract
If No
The goods or services added or removed are not distinct from the goods and services already provided
If Yes
Re-allocation treatment - continuation of the original contract accounted for on a cumulative catch-up basis
Figure 13
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B. Disclosures
ContractAssets andLiabilities
RevenueObligations
Revenue classification
Receipt classification
Non cash elements
Disaggregationof revenue
Warranty Obligations
Contingent features
Reporting Requirements - Disaggregatin of revenue
System should be capable of capturing all these elements at the Master level and in some cases in the Transaction level to receive these reports. It may require data cleanup/development work.
Figure 14
Figure 15
R e p o r t i n g R e q u i r e m e n t s - Disaggregatin of revenue
Oracle’s ERP, like PeopleSoft ESA application 9.2 Suite has built in delivered functionalities in Contracts module viz.,
a) Separate Billing and Revenue model (required to meet combined services as per Step 2)
b) Bundling contracts which can be used for Grouping of related lines on a contract
c) Additional fields for contract classification for reporting requirements, including the “Supplemental Data Framework”
d) Have separate contract lines based on the service provided (Implementation, Support, License)
e) Various revenue recognition methodologies and bill ing plans (for e.g., Immediate, Milestone, As-incurred)
f) Amendment History
Figure 16
Conclusion
As elucidated in this document, new accounting standards will bring a paradigm shift from a system controls/reporting/internal process perspective for every business irrespective of the industry they operate in. With a set effective transition date of 1st January 2018, this provides businesses with an opportunity to give careful and timely consideration to adopt early and resolve any potential accounting issues in advance.
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About Cognizant
Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process outsourcing services, dedicated to helping the world's leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 100 development and delivery centers worldwide and approximately 233,000 employees as of March 31, 2016, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performing and fastest growing companies in the world. Visit us online at or follow www.cognizant.com us on Twitter: Cognizant.
About the Author
Balachander (Bala) Vaidyanathan is a PSFT FSCM Lead with Cognizant’s Oracle Solutions Practice and has over 16 years of industry experience. Bala has extensively worked with clients in Banking, Insurance, Retail and Information Technology industry domains. He is an expert in Implementing ESA Suite. Bala can be reached at [email protected]
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