Recent revenue-recognition guidance from the Financial Accounting Standards Board could lead to accounting software glitches unless affected companies make adjustments, experts warn.
The potential problem relates to how enterprise resource planning (ERP) systems allocate revenue for bundled products and services. Bundled products, also called multiple-element arrangements, deliver the full value of a contract over time. For example, an Apple iPhone, which includes automatic software upgrades for one year, is considered a bundled product. So is an industrial turbine that is sold under a contract covering equipment-installation services and a year-long maintenance contract.
According to Kelley Wall, a senior consultant with consulting firm RoseRyan, most installed ERP systems are programmed to handle the residual allocation method, which assigns a straight dollar amount of revenue to each element of a bundled product. Companies have been permitted to use the residual method instead of the preferred “relative selling price,” or fair value, method if they cannot estimate the fair value of an element that isn’t sold separately, says Wall. And in fact most companies do so, she adds, since estimating the fair value of something that doesn’t have a market price is a complicated task.
But guidance issued last September by FASB’s Emerging Issues Task Force (EITF) makes it easier for companies to estimate the fair value of elements not sold separately, notes Ed Hackert, a partner at accounting firm Marcum. Starting in January for those on calendar fiscal years, companies will be pushed to use the relative selling price method, which allocates revenue for bundled products based on a percentage.
To deal with the potential inability of ERP systems to handle this method, Wall suggests that companies evaluate their systems and work with their vendors to upgrade software, institute
work-arounds, or find alternative software that can be layered on top of the existing system. As for companies that use spreadsheets to manage revenue recognition for bundled products, Wall says they will also have to manipulate some of the formulas to comply with the relative selling price method.
SAP, for one, is confident that its ERP systems will be able to handle any accounting changes, either through “standard functionality or customization,” says James Fisher, senior director of solution marketing for the company. His colleague Pete Graham points out that SAP is currently working with FASB to sort out issues related to technology and the final revenue-recognition rule that is due out during the second quarter of 2011.
Oracle has also been working with FASB, business partners, and customers to develop “responses that will enable our customers to file their accounts as needed,” says Seamus Moran, director of application development for Oracle’s financial products. As for Microsoft, a spokesperson declined to respond to queries from CFO about whether its installed ERP systems can handle the relative selling price method, saying the company does not comment on rumors or speculation.
Not surprisingly, those who offer solutions for the allocation snag are dubious about the ability of ERP systems to handle the rule change. Jim McGeever, chief operating officer of NetSuite, asserts that “there are no ERP systems out there today that are capable of doing this reallocation.” He thinks upgrading the various ERP systems that multinational companies run in subsidiaries or newly acquired businesses will be a daunting task. (NetSuite offers a service-based solution, using proprietary software to crunch customers’ raw order data and return journal-entry-level answers to them.)
McGeever says the only systems capable of making the percentage allocation are those that were designed specifically to handle revenue recognition for the software industry — a sector that already follows the relative selling price method. But he also estimates that about 90% of software companies use spreadsheets instead. When the proposed rules take effect, “these will be some of the most complicated spreadsheets that you will ever see,” he warns.
Software companies won’t be the only ones affected by the rule change, though. Hackert expects industries that use “milestone” payments — such as the construction, pharmaceutical, and biotech sectors — to be affected, as well as industrial-equipment manufacturers that sell aftermarket services bundled with the machinery. McGeever notes that even consultants that sell multiple-element arrangements, such as advice, software, and outsourcing services, will have to determine if the relative selling price method applies to their business.
The EITF guidance was issued ahead of a full rewrite of revenue-recognition rules, in response to finance executives’ requests for clarification on issues related to bundled products. FASB and the International Accounting Standards Board jointly released the complete draft rule, called Topic 605 by FASB, in June; it is open to public comment until October 22. If adopted, the rule would create a single revenue-recognition standard that can be used under both international financial reporting standards and U.S. GAAP. Most experts say the final version of Topic 605 will almost certainly mirror the EITF guidance.
For now, the revenue-recognition rule is still a work in progress, notes SAP’s Graham, so it’s difficult to say what ERP adjustments will eventually be needed. In any case, SAP has handled rule-change tweaks before, he points out, including adjustments related to Europe’s new payroll-tax rules and electronic-payment mandates, as well as switching European companies from local GAAPs to IFRS in 2005.
FASB spokesperson Christine Klimek says the board is keenly aware that the proposed revenue model contained in Topic 605 is a departure from the existing standards, and therefore would require process and systems changes for many companies. “That’s why we encourage our constituents to take advantage of the public comment period and participate in our due process by providing feedback,” says Klimek.