Above: The Enron complex, photo courtesy Wikipedia
Revenue recognition, at its core, is an accounting principle that specifies the conditions where revenue is recognized or accounted for, and follows generally accepted accounting principles (GAAP). Revenue recognition can take a number of different shapes depending on the industry or type of business, but typically occurs only when a specific event has occurred, leading to a measurable amount of revenue.
Back in 2014, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), two private-sector market regulators, collaborated on ASC 606, Revenue From Contracts With Customers. This rule changes the ways in which companies need to recognize their revenue from contracts with their customers, and while it was supposed to be effective after December 15, 2016, the FASB deferred it for another year. That means that companies need to have their houses in order by December 15, 2017. That might seem like a long time from now, but it’s really not.
Want to read the full text? You can find it on the FASB Accounting Standards Codification. Happy reading!
But before we talk more about ASC 606, it’s important to take a step back and remember how, and why, revenue recognition became a hot topic in the first place.
The complicated history of revenue recognition
Most of us remember Enron, the Houston-based company that, in 2001, collapsed under its scheme of institutionalized and creative accounting fraud. The public company constantly misstaed its financial picture and tricked people—both shareholders and the SEC—that its incredible finances were completely sound. Those who invested in the company, which included many who trusted the company with their retirement savings, were investing in a house of cards.
The details of the collapse and the aftermath are far too complicated and complex to go into here, but what came out of the scandal is important to revenue recognition, even today. Those who monitored public companies and their accounting, along with watchdogs like the SEC, began to realize that there was far too much flexibility in how companies recognized and reported their revenue. Enron, for example, used a “merchant model” that allowed it to systematically overestimate their revenues. The company claimed its revenues expanded 65 percent per year, which was unheard of at the time.
In 2002, Congress and President George W. Bush worked together to make the Sarbanes–Oxley Act of 2002 (also known as SOX) into law. President Bush said, “The era of low standards and false profits is over; no boardroom in America is above or beyond the law.”
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What revenue recognition looks like in 2017
The push toward more standardized, realistic, and legal accounting practices have only accelerated since the implementation of SOX in 2002. The new rules as outlined by ASC 606 are a part of this larger effort, and companies need to be aware of how the changes might affect their business and their accounting practices.
Proper revenue recognition is more than complying with laws and regulations related to financial practices and accounting. It ensures that shareholders have an accurate picture of how their investment is performing, and ensures that company executives, or the board, have a single version of the truth when it comes to making big decisions about the company’s future. If revenues are grossly overestimated, relatively small errors might balloon into full-scale collapse.
And because of all these changes, we wanted to devote space, throughout the year, to investigating how the new revenue recognition rules will affect software and professional services companies in 2017 and beyond. We’ll be covering many different aspects of the topic in detail, beginning with a look into ASC 606’s new five-step model and how that will affect accounting and reporting. Be sure to check out our new Revenue Recognition Hub for more information as it becomes available.
If you have questions right away, and don’t want to wait, we’re ready to listen to your questions about revenue recognition, and help you understand how we can leverage top-tier financial software like NetSuite to help you take control of your finances, today and well into the future.