Revenue recognition is one of those accounting concerns that if implemented correctly is uneventful but can result in criminal prosecution, civil lawsuits, bad PR and large damage awards if botched. So, before you run off in mortal fear that this will be a post about obscure and arcane accounting processes, bear with me a bit more. Why? Revenue recognition is spreading beyond the world of technology (and the services often sold with it). In fact, it may be coming to your firm.
New accounting and regulatory requirements are seldom a welcome sight in any firm unless you’re an accounting firm. For the former, it can be an expensive, tiring and disruptive effort that rarely creates value for shareholders. For the latter, it can be a money-maker.
The newest compliance matters involve two standards: EITF 08-1 and EITF 09-3. Did I just hear your pulse quicken when I listed those standards? I thought so!
From my non-accounting background, these two new rules appear to mean that all sorts of businesses that make sales with some component of services and product sale combined, must separate these transactions, in an accounting sense, and book revenues appropriately for each component. Suppose you purchase a new computer with a 24-month extended warranty. The price for both is $600 with $350 going for the laptop and $250 for the warranty. The company that sold this system to you can recognize, effectively, $350 revenue today for the laptop and 1/24th of the $250 warranty. They can recognize additional revenues for the warranty as each of the subsequent months occur until the 24th month.
So what’s so tough about this? Well, suppose the retailer also threw in a year’s anti-virus subscription and a free installation of that software. When do you count those revenues? Will you have to pro-rate the one-year’s worth of anti-virus software over 12 months? Do you have to decrement some of the $350 product sale by the value of the anti-virus software? Likewise, does the free installation need to be valued separately and recorded as a service sale? See how complicated a ‘deal’ can get if you follow revenue recognition concepts?
Software vendors are trying to plug the automation and knowledge gap with new solutions. Last month, I chatted with NetSuite’s CFO Jim McGeever on this issue. His firm recently announced support for EITF 08-1 and 09-3. Their solution will break apart a contract into relevant (accounting) time periods and revenue types so that the correct accounting entries can be created for a given transaction. Their firm worked with some major high tech firms on the development of the solution. In NetSuite’s case, the software can be used with the NetSuite ERP software, as a stand-alone cloud solution or as an adjunct to an existing ERP software product.
Corefino, a provider of outsourced financial accounting processes in the cloud, has also developed capabilities to meet these evolving revenue recognition standards. As a side note, I spoke last week at an American Accounting Association meeting in San Francisco where Corefino founder Karen Watts also presented.
Revenue recognition becomes more and more important as the U.S. economy continues to shift from a product to a services economy. As a consequence, more and more companies are now selling combinations of products and services as part of the deals they cut with customers. Customers like the convenience of dealing with one firm. Don’t believe me? Look at some of the combo deals you’ve probably done:
- Signed up for new cable television or satellite service that included some kind of free installation - Upgraded to a new cell phone or cell phone service that included a discounted smart phone purchase - Bought a new car that came with a 100,000 mile warranty and three free years of oil changes
When we buy such things, we see it as a single transaction that we may pay for with one single payment or credit card charge. But, to accountants, it may represent a litany of big and small incremental revenue and liability journal entries.