I am frequently asked why a tool such as our Advanced Contract Management solution is necessary for handling complex revenue recognition challenges, when Microsoft Dynamics 365 (or AX) already has some native revenue recognition capabilities.
Dynamics 365 does handle some - very limited - revenue recognition scenarios, such as when there is a ship-and-bill situation and the revenue is recognized immediately. It will also handle simple maintenance amortization in projects.
However, it doesn't manage more complex revenue recognition scenarios. Revenue recognition is all about timing and amount. Timing is when you get to recognize the revenue and the amount is how much you get to recognize. How "much" is not necessarily what is on the PO, in the contract or even on the invoice.
Timing of Revenue Recognition
Typically revenue can be recognized one of three ways:
- At a point in time, such as when you're delivering hardware or a ship‑and‑bill item that is shipped out of the warehouse, you have completed your obligation and can recognize revenue immediately.
- Recognized over time, such as is the case with maintenance. In a maintenance contract, the maintenance contract may cover a period from January to December. Twelve months is typical. You can recognize one‑twelfth of the revenue each month.
- The third way to recognize revenue is to defer it. For example, if you're shipping several products to a customer and can ship all except for one which is back‑ordered. You will send the invoice to the customer for the whole amount even though you haven't delivered that one item. In this case, the one item would have deferred revenue until it is delivered. There are various other reasons for deferring revenue, such as:
- Acceptance for a completed contract deal
- Milestone billing per contractual terms where you don't get to recognize the revenue until you've completed the deal
- FOB destination where you ship to the customer, but the title and risk of loss really doesn't transfer ownership until the customer actually signs off for it. These are common scenarios for deferral and a good case for using ACM to manage the release of those deferrals.
Amount of Revenue to be Recognized
The other difficult revenue question is how much revenue to recognize. Many assume that you can recognize the revenue that is the amount stated on the PO or the amount on the contract.
Unfortunately, it's not always that simple. The amount on the PO isn't necessarily what ends up being reported in your books for each deliverable. There are Generally Accepted Accounting Principles (GAAP) rules that have changed the amount that actually gets recognized for revenue, so it doesn't necessarily match what is in the contract or on the PO.
As a side note, a contract doesn't have to be a formal written contract in the "spirit" of the guidance on revenue recognition. A contract is any form that you use to negotiate or perform a deal for a customer and the customer agrees to pay. It can be a purchase order. It can be a sales order. A contract can be a written statement of work (SOW). It depends on what your customary business practice is.
The question is, how much revenue gets recognized? Is it the amount in the contract, or the PO, or the sales order?
Let's take a scenario where you're selling a product like a piece of hardware with a maintenance contract. Perhaps you discounted the total deal 20 percent. Prior to 2003, many vendors were actually accelerating the recognition of revenue upfront on the hardware and putting all the discount on the undelivered element (maintenance, in this case).
The standard‑setters that determine GAAP realized this and said, "Hey, that's really not right. We need to be able to allocate that discount amongst all the deliverables or all of the elements including the maintenance in that contract."
That resulted in a GAAP rule that requires allocation of the discounts amongst all the deliverables in a contract. Companies have to go through the tedious process of figuring out what the fair value of items are on a stand-alone basis and using that value to allocate the discount to all deliverables in the contract. Gathering and applying estimated stand-alone value requires that a lot of data be analyzed and the right value gets assigned to the deliverables in each sale to determine how much discount goes to each element. Microsoft Dynamics 365 and AX are not configured to do these discount allocations – but our ACM solution is. Imagine having to calculate the proportionate discount among every element of every deal you sell, and what a lot of manual work that would entail. ACM automates this process, reallocates the discount and sends the adjusting entry to the books for posting.
The other situation where determining the amount to recognize is tricky is with variable consideration. We have some new guidance becoming effective in 2018 that changes some of the accounting for variable consideration. For example, if you've sold a customer a project that starts in April, and they say, "Hey, if by June you've done everything like we've asked, on schedule, I'm going to give you a $10,000 performance bonus."
That performance bonus is called variable consideration. Under the new rules, we don't wait until June to see if we have earned that variable consideration to begin accounting for it. We need to start accounting for it at the start of the deal and recognizing revenue on it in April when we sign the deal with the customer. In prior accounting, you didn't need to account for something that is not fixed and determinable at the beginning of a contract. An order manager or a customer placing an order would not have variable consideration listed as an item on the PO or contract. Tribridge ACM helps address this situation by creating another deliverable in the order or PO to account for the variable consideration and has been designed to manage these type of variable items in a contract.
In the end, Microsoft Dynamics 365 and AX perform simple revenue recognition scenarios. When complexity in the form of deferrals, allocations, and variable consideration are part of the sales process, ACM has additional functionality to handle those scenarios. ACM automates even the most difficult scenarios making your revenue recognition accounting more efficient, accurate and timely.
You don't need to have numerous revenue accountants clicking away at spreadsheets when you can use the Tribridge ACM & Revenue Recognition solution and let it do the work for you.