Risk & Compliance

Ready or Not, Here It (Rev Rec Standard) Comes

Many companies are underestimating the need to establish a stable, sustainable revenue recognition process under the new standard, says SAP's CAO.
David McCannMarch 22, 2018
Ready or Not, Here It (Rev Rec Standard) Comes

The first financial statements required to present revenue calculated under the new revenue recognition standard will begin appearing in April.

Christoph Hütten, SAP

That doesn’t mean, though, that all companies are “ready” to do so. That’s according to someone who is decidedly in the know: Christoph Hütten, chief accounting officer for the mammoth, Germany-based business software firm SAP.

Hütten played a key role in the development of the new international revenue recognition standard, IFRS 15 (which is nearly identical to the new ASC 606 under U.S. GAAP).

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He served from 2009 to 2014 on the IFRS Advisory Council for the International Accounting Standards Board. During that time period IASB issued two exposure drafts of the new standard and published the final rule. For the past four years Hütten has been part of the Joint Transition Resource Group for Revenue Recognition, formed by the U.S. and international standard setters after the standard’s 2014 publication to answer questions and clarify uncertainties around its application.

Asked to characterize companies’ overall readiness to effectively deal with the standard, Hütten laughs. “I’ve had this conversation a few times before,” he says.

Answering the question is a matter of how one defines readiness, he notes. “Is a company ready to produce a revenue number, through manual processes and using thousands of Excel spreadsheets, that is materially correct for one fiscal quarter? Or is the company ready only when it can say it has a stable, sustainable process with much less manual effort?” [Editor’s note: SAP sells software that includes functionality for automating revenue-recognition processes.]

Most companies, Hütten adds, are ready to produce a revenue number for the first quarter. But a majority of those are using what he describes as “interim processes.”

Lots of companies have gone for a two-step approach, he says, setting new accounting policies first and then later applying automation to improve and stabilize processes.

Misjudging the Complexity?

In the software industry, a majority of vendors, including SAP, today derive most or all of their revenue from customer contracts. Such contracts are what the new revenue recognition standards apply to. However, even in the software field, readiness for the new standard is a bit spotty, according to Hütten.

“Most [software] companies I’ve talked to are finished analyzing their most typical deal structures,” he says. “But we all know there’s not a high level of deal standardization in the software industry. There are lots of scenarios that don’t happen frequently, and I think companies will take a ‘cross that bridge when we come to it’ approach.”

Still, software firms do tend to be ahead of other companies when it comes to dealing with the revenue recognition standard.

“I see a lot of [non-software] companies underestimating it,” says Hütten. “They don’t see a big issue for revenue on the face of their income statement. But at some point somebody will be looking at the very detailed disclosures that are required and realize they’re not prepared to make them.”

For that reason, Hütten advises companies not to judge the new standard’s importance by its impact on the revenue line in the income statement.

Also, he counsels, even companies that take the two-step approach described above should not delay implementing automation longer than necessary. Complying with the standard requires complex accounting with regard to, for example, the allocation of fees among the various deliverables stipulated in customer contracts, he notes.

“I fully understand climbing the accounting hurdle first,” Hütten says. “But I can only tell those companies not to think, ‘oh, we did OK manually for the first  quarter, so that will be sufficient for further quarters.’ That’s risky, especially if you have complicated customer contracts.”

Errors in financial statements could, of course, lead to companies having to file restated financials, which normally don’t sit well with investors. In the United States, if errors are egregious enough a company could be forced to admit a material weakness in controls over its revenue processes, under Section 404 of the Sarbanes-Oxley Act.