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CFOs prepare for new revenue recognition criteria

Some finance chiefs are gearing up for revenue recognition standards. The rules have important implications for companies that sell term licenses for on-premises software.

Finance leaders are starting to prepare for compliance with new revenue recognition standards.

CFOs were given time to prepare last year when the Financial Accounting Standards Board decided the standard must be adopted in 2018 for public companies and 2019 for private companies. The new standard includes all aspects of recognizing revenue from contracts with customers.

James Budge, CFO of San Francisco-based Anaplan Inc., which sells a cloud enterprise platform for budgeting, planning and forecasting, said the company is prepared for the new revenue recognition criteria. Budge said he expects the new revenue standard won't have much of an effect on Anaplan, or the majority of companies that deliver software as a service over the cloud.

New revenue rule won't affect everyone

As a cloud company, Anaplan provides a service over the period of time that it contracts with a customer, he said. Under the new revenue standard, Anaplan expects to recognize revenues over the period of the contract just as it does now, he said.

"A key component is whether you actually deliver a service and value over the contract period, which we believe we do," Budge said. "If we were to provide no meaningful service post-contract signing, the new standard would likely require us to recognize all the revenue upfront."

"But our entire business model," he said, "is for delivering value through a cloud subscription model over the periods of time that we contract with our customers -- typically anywhere from one to three years in length."

"As a result, when we book the transaction, we defer the revenue and recognize it over the service period. Since we contract to deliver a future service obligation to our customers, we need to match the revenue with the future obligation," Budge said.

"Companies will be more affected by the new standard if they sell premise-based term software licenses, with little to no obligation post-contract signing," he said.

Rule affects companies selling on-premises licenses

Such companies -- including Centage Corp., based in Natick, Mass. -- might currently be recognizing on-premises licenses over a defined term. When the new revenue recognition criteria take effect, any deferred revenue may need to be removed from the balance sheet and recognized as equity.

This would affect future income statement benefits, because any deferred revenue they might have been counting on can no longer be recognized. "This does positively affect us," said John Orlando, CFO of Centage, which provides automated budgeting and planning software products for small and medium-sized businesses.

Centage's business is currently about evenly split between cloud and on premises, but could be about 25% or less for on premises within a couple of years, he said, because Centage is transitioning to an almost total cloud business.

Orlando, who is looking to the company's outside CPA firm for guidance on the new revenue recognition criteria, said he likes the new revenue standard partly because it aims to put all companies on an equal playing field. The new standard is applied across all trades and available worldwide. It replaces guidance that tends to be implemented industry by industry.

Don't underestimate effort needed for compliance

A PwC report, issued in December, said businesses should not underestimate the effort for complying with the new revenue standard. The entire revenue process, from contract initiation to cash collection, will need to be aligned with a new five-step revenue model, the report said.

Dusty Stallings, partner in capital markets accounting and advisory services at New York-based PwC, said the new revenue recognition standard will significantly increase the amount of disclosures that some companies will need to make.

"Whether you are a small company, or a large company or a registered company, the fact is revenue is important to most people who read financial statements," she said. "You don't have to be that far off on the revenue line for it to be a significant difference once you get down to the net income line. That is why it is important that all companies take a hard look, and make sure that they understand the standard, understand all the aspects and terms and conditions in their contracts so that they are comfortable that they have caught what they need to catch and make the changes they need to make."

She said the standard may have a greater impact on certain technology companies. Current revenue guidance for the sale of software, for example, is very prescriptive, or based on rules with many clear lines that state when such companies can and cannot recognize revenues. "All that guidance goes away," she said. "It will be a very different model."

New guidance will include more judgments

The new guidance will include many more principles, or judgments on when a company actually transfers control of the software to a customer. "Is the software the element you are selling, or is it actually part of something else?" she said. "It is looking at it through a different lens."

John Kogan, CEO at Proformative Inc., an on-demand learning platform for the office of the CFO, based in San Jose, Calif., said that companies typically make incremental progress when complying with any major accounting change. He said finance and accounting departments tend to be understaffed.

"Companies will get there," Kogan said. "It is just going to be a scramble." Big companies might consider purchasing revenue recognition software to more effectively deal with the upcoming change, he said.

"If you have big multi-element contracts, and a mix of products and services, then things get more complex," he said. "If you have complexity and transactional volume, you will want that technology to help you out."

Anaplan, for example, is starting discussions with partners about building revenue recognition apps that comply with the approach in the new standard.

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