White Paper: Revenue Regulatory Compliance Considerations in Business Software Implementation, By Bob Scarborough and Jeffrey Werner
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White Paper: Revenue Regulatory Compliance Considerations in Business Software Implementation, By Bob Scarborough and Jeffrey Werner

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Technology companies often have complex regulatory compliance and...

Technology companies often have complex regulatory compliance and
business process issues related to revenue recognition. Given the
importance of accurate and credible revenue, many companies use a
combination of business process steps and software solutions to help
consistently and accurately recognize revenue. The purpose of this paper
is to discuss important considerations for your business process and
software deployment to most effectively recognize revenue.
This paper starts with an overview of revenue for technology companies,
proposes a framework to organize your needed company processes,
considers process change requirements for revenue recognition, and
then proposes important considerations when you implement any software
solution for revenue recognition.

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White Paper: Revenue Regulatory Compliance Considerations in Business Software Implementation, By Bob Scarborough and Jeffrey Werner White Paper: Revenue Regulatory Compliance Considerations in Business Software Implementation, By Bob Scarborough and Jeffrey Werner Document Transcript

  • Revenue Regulatory Compliance Considerations in Business Software Implementation by Bob Scarborough & Jeffrey Werner INTRODUCTION Technology companies often have complex regulatory compliance and business process issues related to revenue recognition. Given the importance of accurate and credible revenue, many companies use a combination of business process steps and software solutions to help consistently and accurately recognize revenue. The purpose of this paper is to discuss important considerations for your business process and software deployment to most effectively recognize revenue. This paper starts with an overview of revenue for technology companies, proposes a framework to organize your needed company processes, considers process change requirements for revenue recognition, and then proposes important considerations when you implement any software solution for revenue recognition. REVENUE OVERVIEW The credibility of the revenue component is probably the most important aspect of a technology company’s financial reports. A company’s systems and procedures for recognizing revenue are of critical importance and they need to be carefully evaluated and examined. Accurate revenue recognition is key to managing and growing a company as well as providing visible integrity to investors, lenders, and customers. There are some basic concepts that revenue recognition rules attempt to follow. Revenue should be recognized when it is earned and realizable. To help define when these two premises have been met, four guide points have been established. To recognize revenue, a company needs to have: 1) Evidence of an arrangementTensoft specializes in innovative, 2) Fees need to be fixed and determinable end-to-end ERP solutions, 3) Fees need to be collectableincluding complex revenue, billing 4) Delivery or performance must have occurred and contract management.
  • Revenue Regulatory Compliance Considerations 2“The credibility of the revenue Technology company revenue recognition is a complex and difficult areacomponent is probably the most of accounting, with numerous, seemingly arbitrary rules and regulations to follow. In addition, revenue recognition rules are continually evolvingimportant aspect of a technology and changing. New business models continue to emerge and difficult-company’s financial reports. A to-account-for situations arise. Given this environment, it is no wondercompany’s systems and procedures that technology companies find revenue recognition rules complex andfor recognizing revenue are of challenging to support.critical importance and they need Since revenue recognition rules are constantly evolving, companyto be carefully evaluated and accounting systems and business processes need to continually beexamined. Accurate revenue updated to meet these new challenges. For example, when softwarerecognition is key to managing began to be sold separately in the early 1990s, some companiesand growing a company as well recognized revenue on a cash basis, even if they hadn’t written a lineas providing visible integrity to of the program code! More recently, the revenue recognition rules for multiple element arrangements at non-software technology companiesinvestors, lenders, and customers.” changed significantly. Accounting and ERP systems are still struggling to catch up to these new requirements. Failure to keep up with the new rules or adequately follow existing rules can be financially devastating – potentially causing financial restatements, SEC actions and legal problems. Inadequate reporting, poor visibility and misunderstood revenue recognition rules can also hinder management decision-making as well as negatively affect the company’s bottom-line. A FRAMEWORK FOR REVENUE RECOGNITION NEEDS ANALYSIS Complex regulatory requirements, combined with the challenging business models of the technology industry, can tax even the most flexible minds. Given this fact, it is helpful to have a framework to analyze your company revenue processes. Categorizing and organizing the company’s business needs will better prepare you to build the processes and systems required for accurate revenue recognition. The framework we recommend organizes the requirements into three distinct categories. These categories are based on the overall revenue process model which consists of: determining the revenue model, applying the revenue model to sales that occur, and recognizing revenue based on the revenue recognition concepts:
  • Revenue Regulatory Compliance Considerations 3“The framework we recommend 1) Determination. Effective revenue processes start by identifying theorganizes the requirements into appropriate compliance regulations and the revenue rules for the products sold based on these concepts. For many technology companies, anthree distinct categories. These independent analysis and valuation of the items sold in multi-elementcategories are based on the overall models is also necessary. Determination is usually completed annuallyrevenue process model which for private companies and quarterly for public companies, and may beconsists of: determining the revenue monitored during the year.model, applying the revenue model 2) Application. The determination occurs in a static environment.to sales that occur, and recognizing However it is only useful if the determined revenue rules and valuesrevenue based on the revenue are applied to real company transactions as they occur. Applicationrecognition concepts.” understands your sales model (how sales occur) and the transactions that are created to which the determined revenue rules are applied and automates the consistent processing of the revenue. 3) Recognition. If you have applied the revenue rules and policy to the appropriate sales transactions as they occur, revenue recognition becomes much more streamlined. Validation of sub-ledgers and manual review of special case or exception rules is also required. Establishing the fair value of a single element within a multi-element sale is a Determination need. Ensuring a consistent approach to revenue recognition based upon company policy and compliance requirements is an Application need. Our experience shows that addressing the requirements becomes significantly more manageable once the proposed framework is applied. The best starting point is a solid, documented understanding of the company’s go-to-market model(s). By go-to-market we mean the combination of channels, sales efforts, and customer actions that result in sales. This type of process, analysis and thinking may not be standard in many financial organizations, but it is critical when thinking about how to best manage and implement the required business processes and systems.
  • Revenue Regulatory Compliance Considerations 4“This process requires a team INCORPORATING REVENUE RECOGNITION INTOapproach, with sales, management, YOUR ORGANIZATIONorder fulfillment, development, So far, we have gained an understanding of the general nature of revenuemarketing and finance working recognition. We’ve also looked at internal processes and needs andtogether. Communication is organized them around a framework for analysis and application. Wecritical to keep all team members now need to look at incorporating and adapting this information to yourinformed and productively working specific company.to resolve business and revenue There are different revenue recognition methods depending on the type ofrecognition issues.” business, the nature of its transactions, the company’s sophistication and its ability to perform certain accounting procedures. The choices of revenue recognition will depend upon the company’s ability to produce dependable and reliable information to use in the revenue recognition process. Often, a company can choose more favorable accounting treatments based on its ability to make estimates, utilizing its history of past transactions and business practices. Revenue rules are guidelines that offer some interpretation and application flexibility to your company. It is important to align the accounting and revenue recognition methodologies to the company’s business style and objectives. If a company wants to emphasize upfront revenue recognition for delivered elements in multiple-element arrangements, it is important to have the data and discipline to establish VSOE (Vendor Specific Objective Evidence) or the value of elements when sold separately to value elements when sold together. If a company is involved with large service- or construction-type transactions, accounting must be able to estimate costs and outcomes in order to recognize revenue on a percentage basis as the work proceeds, rather than waiting until the project is completed. Business objectives, company imperatives, and regulatory requirements help to determine what will be needed to support independent (determined) element values and how you plan to recognize revenue. They also incorporate the company’s business model into the analysis and review process, so you can match systems and business processes to your company’s needs. This process requires a team approach, with sales, management, order fulfillment, development, marketing and finance working together. Communication is critical to keep all team members informed and productively working to resolve business and revenue recognition issues.
  • Revenue Regulatory Compliance Considerations 5“A complete understanding of a Teams can craft a fast-track or devise a standard approach to transactionscompany’s revenue recognition that can easily comply with revenue recognition requirements. Unusual or complex transactions will require a review process to develop the bestgoals, go-to-market models, and business and revenue approach before negotiating or signing contractsregulatory compliance needs is an with customers. Decisions can be made in advance with the revenueexcellent base for approaching recognition options and consequences in mind, rather than after-the-fact.system implementation.” Data collection and retention systems (financial, ERP CRM, and document , management) can facilitate the flow of information to support a company’s revenue processes. They can also substantiate and implement processes once these processes are determined. So it is important that IT and accounting systems are able to collect, distribute and analyze transaction information to maximize business and revenue recognition goals. INCORPORATING REVENUE RECOGNITION INTO SYSTEMS A complete understanding of a company’s revenue recognition goals, go-to-market models, and regulatory compliance needs is an excellent base for approaching system implementation. With this information in hand, we can now use the previously proposed framework to analyze and organize our approach to implementing business software which supports the revenue recognition process. Beginning with the determination requirement, one should know what information is required to support your determination needs. For example, as previously mentioned, if VSOE value determination is required for some elements, you need to make sure you are collecting the information for those elements clearly and apart from other sales elements. Most companies start with the need for SKUs to identify products. What additional information is needed about every SKU to support your determination? What about the transaction type and customer category? Defining and answering the required questions will help define your solution setup needs. It is important to group products and services by type, transaction timing and contractual terms. Determination, or establishing the independent value of your elements in multi-element sales arrangements, is an often an annual process for private companies and quarterly process for public companies. Once the value for your elements is set, you need to apply these values, along with
  • Revenue Regulatory Compliance Considerations 6“Even the simplest multiple-element the appropriate regulatory requirements, to the appropriate transactions forrevenue recognition becomes revenue recognition. The residual method (SOP 97-2) or the relative selling price method (EITF 08-01) requires specific approaches to applying thecomplex when you add substantial transaction face value to the individual elements of a sale.transaction volume. Complexgo-to-market models and customer Application and recognition are where the bulk of your system’s supporttransaction models definitely benefit resides. Successfully deploying a system to automatically support both offrom a consistent, repeatable these needs offers numerous benefits: from streamlined auditability, to improved confidence in your revenue numbers, enhanced productivity forapproach to revenue.” your financial team, and improved valuation of your organization through substantiated revenue numbers. Application, or the consistent use of your determined revenue policy to transactions that occur requires a combination of business process and systems support. Straightforward revenue recognition policies (sales = revenue) require little effort here. Multiple element sales, along with the impact of other rules that define when revenue is earned and realizable, create more complex application needs. There are also issues of revenue allocation and recognition when the elements in a sale are delivered at different times. Ideally your business software will support the variety of scenarios that your company requires. At a minimum you will need to make sure that sales transactions are captured and processed in a manner that supports application (and determination) analysis. Recognition of revenue, after analysis and implementation of the preceding steps, often appears to be easy. This is often a misleading perception for a number of reasons: Reason #1 is the need for transaction auditability and traceability. The ideal scenario should be a direct flow from the sales transaction through the policy application to the deferred and recognized revenue ledgers. Reason #2 is the need for consistency and simplicity in the revenue recognition process. Even the simplest multiple-element revenue recognition becomes complex when you add substantial transaction volume. Complex go-to-market models and customer transaction models definitely benefit from a consistent, repeatable approach to revenue. Reason #3 is visibility – for financial reporting, for forecasting and for detailed sales and customer analytics. Extracting the requirements for consistent and repeatable revenue journals, traceability, and visibility will help to complete the requirements set needed for your company.
  • Revenue Regulatory Compliance Considerations 7FOR MORE CONCLUSIONSINFORMATION In this paper we looked at revenue recognition and the factors that impact revenue. We proposed a framework for organizing and understanding the revenue recognition requirements in your company. We discussed applying compliance and revenue goals to your company’s specific policies and approach. Finally we looked at how all of these tools can be combined to help you select a business software solution that most effectively meetsCONTACT TENSOFT: your business’s ongoing needs.2121-B Ringwood Ave.San Jose, CA 95131 Revenue recognition for technology companies is complex and ever-changing. Pressures for speed and resolution are often at odds with the analysis,www.tensoft.com visibility and accuracy required for legal compliance and corporate integrity.E-mail: solutions@tensoft.com But done logically, and supported by intelligent business systems, efficientTelephone: (888) 450-4030 and effective revenue recognition can do much to improve a company’s top and bottom lines. Tensoft President and CEO, Bob Scarborough provides leadership for the company’s strategic direction and day-to-day operations. His background includes roles in software solution product marketing, business development, business process automation and project implementation. He has managed over 200 business software solutions and designed a number of highly sophisticated custom and out-of-the-box software applications. Before co-founding Tensoft, Bob was the Vice President for West Coast Operations of Deltek Systems (PROJ). He established Delteks first successful California field office, growing regional revenue over 500% in five years. Prior to that, Bob was the CFO of a Washington, D.C. consulting organization. He holds a BS in Finance from the University of Maryland, and an Executive MBA from the Anderson School at UCLA.© 2011 Tensoft, Inc. All rights reserved. Jeffrey Werner is an acknowledged expert in the area of software revenueTensoft is a trademark of Tensoft, Inc. The recognition. He’s been providing revenue recognition consulting services to softwarenames of actual companies and products and high tech companies since 2001. Earlier, he was the CFO for Antrim Designmentioned herein may be the trademarks Systems, a Silicon Valley mixed-signal synthesis company. He also served as V.P .of their respective owners. of finance for TelePost, a Web-based communications services company andThis document is for informational spent 11 years as a senior manager at the KPMG Silicon Valley office. He regularlypurposes only. TENSOFT INC. MAKES teaches software revenue recognition classes in the San Francisco Bay AreaNO WARRANTIES, EXPRESS OR and has over 15 years of experience helping companies comply with revenueIMPLIED, IN THIS SUMMARY. recognition regulations through sound policies and best-practices.