New Revenue Accounting Standards on Customer Contracts and its impact on ERP systems

Transcription

1 Cognizant Solution Overview New Revenue Accounting Standards on Customer Contracts and its impact on ERP systems Convergence of US GAAP and IFRS 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: 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 New 5 Step Process US GAAP/IFRS Convergence Project Industry Specific Guidance Removed New Revenue Standard Final Standard Issued May 2014 Figure 1 US GAAP (US Standards) IFRS (International Standards) Effective 2017 public 2018 private solution overview july 2016

2 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. Although 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 Revenue from Contracts with Customers Specific Contract Terms Revenue Recognition Policy Business Process Change Sales Operations Financial Accting System Revenue Recognition Policy Financial Accting System Financial Operations System Revamp Data Modelling Industry Practice and Customs Company Practice and Customs Figure 2 solution overview 2

3 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. 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: The five steps of the revenue recognition model 1 2 Identify the Identify the contract with a performance customer obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to separate performance obligations 5 Recognise revenue as the entity satisfies a performance obligation Figure 3 Five Step Process And System Challenges Figure 4 solution overview 3

4 The 5 steps have been detailed in this section below Step 1 - Identify the Contract(s) with the Customer Figure 5 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 perspective, 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. solution overview 4

5 Step 2 - Identify the Separate Performance Obligations in the Contract Figure 6 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) Th e custo m e r ca n b e n efit f ro m t h e 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 significant 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. solution overview 5

6 Step 2 - Identifying separate performance obligations Figure 7 Step 3 - Determine the Transaction Price Figure 8 solution overview 6

7 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 solution overview 7

8 Figure 11 System should be capable of deriving these values viz., Cost plus can be achieved through Project budgeting model. Step 5 Recognize Revenue Figure 12 solution overview 8

9 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 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. In all other cases the transfer is considered as Over a period of time. 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 Figure 13 Re-allocation treatment - continuation of the original contract accounted for on a cumulative catch-up basis solution overview 9

10 B. Disclosures Contract Assets and Liabilities Revenue classification Receipt classification Non cash elements Warranty Obligations Contingent features Obligations Revenue Disaggregation of revenue Figure 14 Reporting Requirements - Disaggregatin of revenue Figure 15 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. solution overview 10

11 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 billing 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. solution overview 11

12 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 Balachander.vaidyanathan@cognizant.com 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 us on Twitter: Cognizant. World Headquarters 500 Frank W. Burr Blvd. Teaneck, NJ USA Phone: Fax: Toll Free: inquiry@cognizant.com European Headquarters 1 Kingdom Street Paddington, Central London W2 6BD Phone: Fax: infouk@cognizant.com India Operations Headquarters #5/535, Old Mahabalipuram Road Okkiyam Pettai, Thoraipakkam Chennai, India Phone: +91 (0) Fax: +91 (0) inquiryindia@cognizant.com Copyright 2016, Cognizant. All rights reserved. No part of this document may be reproduced, stored in a retrieval system, transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the express written permission from Cognizant. The information contained herein is subject to change without notice. All other trademarks mentioned herein are the property of their respective owners.