Revenue Recognition Principle: Frequently Asked Questions
Below are answers to top questions about the new Revenue Recognition Principle and – specifically – how it impacts Commission Expense Accounting (CEA) for U.S. businesses. If you have other questions about Revenue Recognition not answered here, feel free to contact us or view our Revenue Recognition Accounting Standard Resources.
Why are Revenue Recognition Standards Changing?
The standards are changing due to significant differences between U.S. and international accounting, standards and processes. In the U.S., the Generally Accepted Accounting Principles, or GAAP, supported by the Financial Accounting Standards Board (FASB) do not provide an accurate comparison with the standards of the International Accounting Standards Board (IASB). Therefore, a revision of GAAP has become necessary to support IASB and FASB convergence and create compliance with the international system.
How are Revenue Recognition Standards Changing?
Unlike the IASB, whose standards are principle-based, U.S. accounting standards are rule-based, highly scripted, and extremely complex. The international standards provide for much more interpretation. The FASB is replacing GAAP’s existing rule-based methodology with a single revenue recognition principle.
What is the Impact on Accounting for Sales Commissions?
Within the new revenue recognition principle guidance is a small section called the “incremental cost of obtaining a contract” which changes how some organizations manage their accounting for sales commissions. While sales commissions represent the biggest and most obvious expense, these revenue acquisition costs can also include legal or contract arrangement fees and bonuses – basically, any expense that’s only incurred by a company when they close a sale. Here is more on the “before and after” requirements for commission processes under the new Revenue Recognition standard.
Who is Impacted by the Changes in CEA?
These CEA changes impact any company paying commissions (or other costs incremental to obtaining contracts) that is reporting under U.S. GAAP. Public companies are required to be GAAP-compliant by the FTC. However, many private U.S. businesses also need to produce GAAP-compliant accounting data, including companies preparing for an IPO or companies that need to provide financials to banks or investors. In all of these cases, companies will need to produce a GAAP-compliant record. Basically, any company that is trying to stay with the GAAP standards is affected. About 80 percent of Xactly’s customers, for example, expect they will require a certain level of change.
What Happens to Businesses That Don’t Comply?
If companies are paying commissions and don’t comply, they’ll need to include a non-GAAP disclosure on their financial statements saying that they’re not following the GAAP treatment; In weighing the investment and effort, smaller companies that don’t plan to go public may just go non-GAAP in this area. They can record in their financial statement disclosures the reasons they have chosen to depart from GAAP. However, for most companies, doing so can be a red flag for banks, investors, and the market.
When Do the New Revenue Recognition Standards go into Effect?
The new revenue recognition standards go into effect for companies whose fiscal year starts on or after December 15, 2017. This means that companies must adopt it for that year going forward which – for most companies – will be their 2018 or 2019 books. However, when they produce their 2018 statement, they also need to provide a comparison to the prior two years, including retroactively applying this new accounting method as if it was included in those periods originally.
Since a ‘look-back’ period must be adopted, most companies will need to rework their 2016 and 2017 commissions as well. Therefore, even though the standard ‘technically’ doesn’t require adoption until 2018, businesses must start thinking about it now so that they can report on it accurately and appropriately for 2016 and 2017.
What are the Transition Methods?
Many companies that have simply expensed commissions have to transition from expensing to making an asset on their balance sheet – which they must manage and evaluate over time so that they can expense that amount in accordance with the method adopted for amortization.
Some companies have already adopted methods where they already create an asset and expense it over time, however they will now need to evaluate those methods to ensure they meet the new requirements.
A few companies will be able to use one of the practical expedients described by the standard that will simplify the adoption. However, all indications at this time suggest this approach will be only be viable in a few circumstances.
How Does The New Process Compare to the Past?
In the past, the most practical application of the international CEA standard was to apply the commission over the same time as the revenue. For example, if a business sold a three-year contract, and they accrued the revenue over three years, they put the commission on the books over the three years. However, the new principle is more complex.
In managing CEA, companies must now apply the ‘matching principle’ to revenue recognition. The matching principle is an accounting concept that calls for a revenue or expense to be taken over the same timeframe from which you benefit from the revenue, or the expense provides you with some sort of service.
How Does the New Approach Change Existing Accounting Methodologies?
The matching principle requires that companies be able to judge how commissions are paid over the lifetime of the customer. This changes existing accounting methodologies – requiring accounting departments to understand sales commission strategy and make judgments based on that knowledge and available data. For example, in many cases, accountants will need to identify what is being paid to acquire customers, estimate the lifetime of that customer, and identify anticipated future sales to those customers to determine how to amortize commissions. In addition, each time a customer purchases additional goods or services, accounting may need to evaluate the impact of those transactions on the expense of commissions for that customer.
What are the Major Challenges of Complying with the New Commission Expense Accounting Requirements?
There are three major challenges for companies that need to comply with the new CEA requirements:
- Getting the right data
- Making accounting estimates
- Managing amortization
What Type of Information is Needed to be GAAP Compliant?
Companies need the ability to access the right data in the form that’s needed by accounting to be GAAP compliant. To do this, they need to evaluate their current incentive calculation methods to make sure they can capture the intelligence needed – namely, comprehensive details about their transactions that allow them to organize and report on data in ways most haven’t yet anticipated.
But first, they need accounting to gain an understanding of the nature of their transactions and how they’re sold, so they can identify the right kinds of data for their particular circumstances. Companies must look at their commission plans, understand who’s getting paid commissions, what is being paid for, and why they are being paid in this manner. They need to understand what the commission amounts are by customer – and how much they’re paying for customer renewals, add-on sales, etc.
All of this data must be available and easily accessible, so accounting can make needed comparisons, i.e. comparing amounts paid for renewals against original commission expenses. This is quite different than what is done in commissions accounting today.
Can I setup Xactly to handle the new requirement?
Xactly Incent, Incent Express, and SimplyComp can be configured to easily support the detail calculations that will output the commission data in either a line item or aggregated approach, depending on your method to meeting the standard. All of the reporting necessary for accounting can be organized and managed via Xactly Analytics with integration support through Xactly Connect for seamless automation with ERP systems should you choose.
Should I provide aggregated data or line item detail to accounting for Commission Expense Accounting (CEA)?
This is a question each company should tackle early on and is answered by the approach your accounting team decides best meets the principle-based standard. The good news is that by using Xactly’s solutions you can provide the necessary detailed reports, saving many hours of complex accounting and calculation.
Does Prior Period Adjustment (PPA) work with Commission Expense Accounting?
Yes, every time you recalculate you can rerun your CEA reports to determine the differences and provide accounting the details to book any changes.
How do we handle impairments or contract extensions that change the expected amortization period?
There are several approaches to solving the ongoing maintenance for CEA, and Xactly can support them all. They range from doing an annual evaluation and a “true up” to improve the estimates over time to handling each change at the individual level and booking adjustments. Using Xactly, you can track the kinds of transactions that occur and require accounting adjustments and provide accounting with reporting at the level of detail they need to make the adjustments.
How Does Xactly Incent™ Track This Data?
For companies using Xactly Incent, this data can be tracked thru the system via existing fields in ‘Quotas’, on ‘Orders’ and in ‘Custom Fields’. In addition, companies can customize with ‘Rules’ that help refine that data to allow for new types of reporting. All of this data can be identified and traced through incentives calculation at a level of detail that will allow companies to organize, summarize, and report on data in meaningful ways to support the new requirements.
How Should Companies Amortize Compensation Costs?
Companies will need to evaluate how to amortize costs and expense commissions over the contract term. The challenge is that this will vary depending on different compensation strategies and a company might have several approaches for different categories of commissions and/or commission strategies. In the SaaS world, for example, companies must estimate and expense over an approximated life of the customer – which is typically longer than the term of initial contracts because of anticipated renewals. Then, those renewals and any add-on products need to be evaluated to determine if they impact the original estimates and, in some cases, will require that the company alter the remaining asset to change the expensing term.
Businesses must make sure they have the right info to make the right estimates and manage the amortization to give the accounting department the ability to make estimates, track the impact of subsequent transactions, and support long-term mathematical calculations to amortize these costs.
What Steps Should Companies Take Now to Prepare for the Revenue Recognition Standards?
To prepare, each company must take the time to research and understand its approach and strategy for paying commissions. Doing so will make everything much easier in the long run. Xactly Incent makes it simple for you to quickly access commission data over time so you can more accurately prepare commission data reports. The ability to produce this information is vital to fulfill the principle’s requirements on the capitalization and amortization of incremental costs of obtaining a contract.
What Steps Should Companies Take Now to Prepare for the Revenue Recognition Standards?
To help you prepare, the Xactly team just wrapped up a webinar series with Steve Giusti, CPA and VP, Corporate Controller at Xactly, and Caitlin Steel, CPA and Product Manager at Xactly. In them you’ll find:
- How the New Standard for Revenue from Contracts with Customers will Change Your Commission Accounting Approach (Part One)
- Customer Insights Around the Impact on Plan Design (Part Two)
- How to Approach These Changes within Xactly Incent (Part Three)
If you have other questions about Revenue Recognition not answered here, feel free to contact us or view our Revenue Recognition Accounting Standard Resources.
Managing Commissions Under the New Revenue Recognition Standard
The vast majority of businesses are unprepared for commission expense accounting, more commonly known as the costs of obtaining a contract.