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The Tech Behind Revenue Recognition, and How It's Replacing Spreadsheets

Ed Zwirn | March 1, 2012
CFOs search through a variety of software options available to help them manage the complex processes and stay compliant.

As rapidly as technology has evolved, so has the accounting that goes with it. But isolating the software and hardware revenue components connected with products like iPhones is prompting big public companies and growing private startups alike to seek out advanced ways to help them cope with issues that once would have been solved in an Excel spreadsheet --- or perhaps on the back of an envelope.

At the same time, of course, revenue-recognition accounting rules grow more complex all the time. And that's part of the mix for CFOs.

Many companies are only just beginning to cope with FASB's ASU 2009-13, which established, starting in 2011, a complicated hierarchy of evidence, requiring, if possible, vendor-specific objective evidence, or VSOE, the third-party evidence that is part of the quest to determine the amount of revenue to book for a given item or service.

Isolating the Elements
"Our sweet spot is technology companies. We manage the billing and revenue recognition processes," says Graham Hulme, product manager at Softrax, a provider of billing and revenue management software solutions. As he explains it, "an order might have X number of products and services."

For example, a software company might say, "Buy our software for $50,000 and we'll give you six months of free maintenance," Hulme explains. "You can't just recognize it line by line; you need to isolate each element of that agreement: What am I selling my product for, what am I selling my services for?"

He goes on: "Look at what you have on the order. One line item may equal three or four deliverables. You may be selling this line for $100 but you can recognize only $80."

And it is more than just a question of separating te deliverable items on a contract. Under the current FASB guidance, companies need to document that they at least tried to determine a specific price for each item. The VSOE evidence -- the price a competitor is charging for the same product or service -- often is very difficult to ascertain, given the extent to which products and services are in fact embedded with one another.

Providers, though, are keeping up, offering tools and data feeds to document the price determination to satisfy an audience of regulators, auditors and investors.

What's the VSOE?
"In the past, applications like ours would tell the customer 'you need to tell us what VSOE is," Hulme says. "The user was essentially on the hook for that."

Instead, now users are demanding that providers "calculate the price for us, and bring it into your system according to the guidance," he adds. "This takes it out of their hands in terms of calculating that using spreadsheets. The market's really changed from 'give us your pricing and we'll handle it'."

Jim McGeever, NetSuite chief operating officer, says that his services, which are cloud-based, also "preload the estimated selling prices."

"There are to types of revenue recognition," says McGeever, noting that NetSuite capability allows a software company to account for both pure software rules and the more complicated multiple-element revenue-recognition rules.

Although he has clients from many different sectors, it is this complexity that has driven demand from tech companies. "Our company is organized by verticals," he says. "Software is one of our biggest verticals."

Tom Frank, CFO and chief accounting officer of Nobel Learning Communities, represents one user, from one of NetSuite's smaller verticals. His company provides pre-kindergarten to middle-school private schools, as well as an online high school program.

"The education business is the first business I've been in where you don't have product," says Frank, who started his career with BDO Seidman LLP and was CFO of Alpha Shirt Co. and its subsequent owner, Broder Bros., before moving to the world of education at Nobel in 2004. "It's as pure a service business as you can get."

And while Nobel is able to avoid the complexities of multiple-element revenue recognition, there are complexities all the same that drive him to software.

Most of Nobel Learning's business relates to a standard 10-month school year. "We collect revenue up front and recognize it over the school year," says Frank. But for Nobel's newest business -- an online high school with upwards of 1,000 students -- the school year can "start at any time, so the system needs to be really nimble."

He uses NetSuite to monitor this through regular reports. "Typically, we just look at them month to month when we're going through the close," he says.

Reactive Customers
Going beyond monthly reports, revenue recognition accounting standards are set to undergo another set of changes soon.

FASB, as part of its "convergence" effort with the International Accounting Standards Board, released Proposed Accounting Standards Update (Revised)--Revenue Recognition (Topic 605) in November. The standard, which would go into effect as soon as 2015, with full retrospective application going back to 2013, will notably scrap the VSOE concept and instead require public companies throughout the world to "recognize revenue to depict the transfer of goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services."

Despite the immensity of the proposed changes, and the likelihood that companies will have to in effect keep parallel records to facilitate their retrospective application, revenue recognition product providers have apparently spent little time bracing themselves.

"We haven't had anybody come to us and say they need the functionality" based on the exposure draft, says NetSuite's McGeever. But, being serviced through the cloud, "people will get it automatically," he says. "They'll show up one day and it will be there."

Adds Hulme of Softrax: "What we're doing right now is keeping an eye on this," as his customers have yet to ask him much about the likely accounting standard revisions. "The dust hasn't settled on ASU 2009-13," he says. "I still have conversations with my customers about how to meet this standard."

He says of his customers: "I don't think they're reactive because they want to be. I think they're reactive because they have to be."

In any case, he says, companies like Softrax need to avoid being reactive themselves.

"What our competitors are doing and what we're doing is taking a step back and saying 'instead of making our product such and such as we are coding it in," says Hulme. The new model needs to be "open ended and flexible, so we can tweak products."

 

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