Revenue recognition software helps tech vendors meet accounting rules

Changes in how companies must report revenue from bundled products creates huge accounting hassles; learn how revenue recognition software is helping CFOs with this struggle.

Apple Inc.'s impact on business has been substantial, thanks to designs created on its Macintosh computers and, more recently, the easy mobility of iPhones and iPads. But Apple's successful advocacy of new accounting rules could do more to boost the profitability of fellow technology vendors -- though not without significant pain along the way.

Three years ago, Apple convinced the Financial Accounting Standards Board (FASB) to change the way companies that sell multi-element products (often called bundles) can recognize revenue over time. Chiefly at issue was the software that Apple bundles with its mobile devices, including whether it should come under the revenue recognition rules of the software industry. The revised regulations have CFOs scrambling to handle the complex accounting, which in turn has created a demand for specialized revenue recognition software to do a job most ERP systems can't -- at least not without heavy customization.

The IT industry's shift from a hardware-centric to a services model is also driving the need for revenue recognition software, according to Stefan Ried, principal analyst at Forrester Research, which is based in Cambridge, Mass. In the past, "it was pretty easy," Ried said. "You might have a maintenance contract, and you would have revenue recognition by quarter. Today, in the decade of cloud computing, it is significantly different. You have a subscription model and customers might move up and down in the subscription. You have an unpredictable fluctuation of your subscriptions and therefore of your business."

Revenue recognition issues also affect more traditional industries that have fluctuating revenues, such as utilities, especially private ones that provide energy from renewable sources, like solar and wind, and aren't price-regulated monopolies, according to Ried.

Given FASB's stated intention to unify industry-specific rules into a single revenue recognition standard, and to merge that with the standards its global counterpart, the International Accounting Standards Board (IASB), promotes, most companies will soon fall under its purview, say software vendors and users familiar with the process.

While compliance issues are driving initial demand for revenue recognition software, companies can get additional benefits in the areas of financial planning and forecasting, Ried said. Software vendors that are gradually shifting from on-premises to cloud deployment are a prime example. "They know that if they shift over 10% of their customers into cloud subscriptions, they have a dip in the balance sheet, because the revenue gets shifted into a deferred model," Ried said. Without the more nuanced view that revenue recognition software allows, financial analysts might believe something is wrong and undervalue future opportunities to increase market share, for example. Good revenue recognition software can therefore be a change-management tool to transform traditional independent software vendors (ISVs) from the perpetual license business to the cloud business, he said.

Revenue recognition software could also boost companies' profitability, according to reports published around the time of the FASB changes. Under U.S. Generally Accepted Accounting Principles (GAAP) guidelines overseen by FASB, companies had to estimate a fair value for each element -- evidence of which could be hard to find. They would often wait for all the pieces to be delivered before counting any revenue on their books. Under the new rules that Apple and 33 other respondents argued for, companies can allocate the revenue based on certain percentages. In many cases, that means being able to report and use revenue much earlier than before. 

Revenue recognition software fills ERP gap

A small group of revenue recognition software vendors are seeking to automate the complicated bookkeeping process, sometimes in partnership with major enterprise resource planning (ERP) vendors that sell the tools as add-ons. 

Most accountants tried to deal with the issue in Microsoft Excel, in part because ERP systems had no direct support for it, according to Patrick Glenn, vice president of business development at Leeyo Software Inc., a maker of revenue recognition software based in Santa Clara, Calif. "Now they can automate the revenue recognition process, whereas in the past they have been doing this essentially manually," Glenn said.

Glenn agrees that revenue recognition software can go beyond its compliance purposes and help companies with their financial planning. "That's the next obvious step that our customers want and we clearly see as a priority item," he said.

"Most of where our opportunity lately has been is with companies required to report based on U.S. GAAP," he said. By the time the draft revenue-recognition requirements of the International Financial Reporting Standards (IFRS) are jointly completed by FASB and IASB, probably in early in 2013, revenue recognition compliance will become a global issue, Glenn said.

But Leeyo will have company in direct competitors RevStream, Softrax and Zuora (which recently moved into revenue recognition with its Z-Finance product), and in cloud ERP maker NetSuite, which is offering a package that integrates with other ERP platforms, according to Ried. The entanglements don't end there. Ried said Leeyo's technology is the revenue recognition software in Business ByDesign, SAP's cloud ERP platform. And Leeyo touts SuccessFactors, a talent management software company recently acquired by SAP, as a marquee customer.

Oracle users forgo customization for niche tool

Two tech companies that do their accounting in Oracle E-Business Suite and chose Leeyo described a vastly streamlined workflow -- but one that takes considerable work to set up.

Kathy Pearson, director of revenue at Harmonic Inc., a manufacturer of video delivery software and equipment based in San Jose, Calif., said she struggled to address the new rules in approximately 10 Excel spreadsheets. "Everything has to be allocated under a best estimate of selling price," Pearson said. "You have to allocate almost every transaction."

With 90% of Harmonic's transactions affected, the company didn't expect their mostly manual process to handle the sheer volume. "There are some companies we are aware of who have really tried to customize Oracle to do this, but I doubt that that was an option here," she said.

Pearson's revenue team instead runs Leeyo's entry-level RevPro module for revenue allocation in the cloud. The software has shortened the process from several weeks to several days, she said.

Though RevPro has an application programming interface (API), Harmonic chose not to integrate the software with its Oracle E-Business Suite 11i and Oracle database. The company uses Salesforce.com for customer relationship management but hasn't directly integrated that either.

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The integration process instead involved Harmonic staff working closely with Leeyo's services team on the details of the price, sales agreement, contract and product data that must be shared with E-Business Suite's order management and accounts receivable modules. Pearson said Harmonic's IT team wrote the staging tables that extracted the Oracle sales order and income data and added a flex field in Oracle to calculate software versus non-software revenue allocations.

Because the software is a pared down version of RevPro Enterprise, Pearson said, it can't do some things Harmonic needs, such as calculating best estimate of sales price, a key figure under the new rules. So Harmonic continues to do that calculation in Excel.

Pearson would like some enhancements in reporting -- including, for example, the ability to tie reports from journal entries to sales orders. "It's just being able to get more fields available to the reports," she said.

Still, the result has been undeniably positive. Now Pearson's team visits the RevPro site to view revenue at any stage and create reports, rather than waiting for quarterly closes, and the seven- to nine-day close cycle is down to six, she said.

For Brian O'Donnell, senior director of finance at Sonus Networks Inc., a vendor of IP networking equipment based in Westford, Mass., the company's decision to adopt the new guidance in June 2011 created an immediate need for more "manualized" processes in Oracle E-Business Suite.

The company considered switching to NetSuite but found it difficult to evaluate Software as a Service (SaaS) without doing all the business logic for the actual application, O'Donnell said. "I kind of came to the conclusion that a one-time perpetual license and maintenance fee was better than the option of being able to pull the plug."

After a couple of months of due diligence and drawing up extensive requirements and system-design documents, Sonus chose the on-premises version of RevPro's revenue allocation and fair-value modules. "It's some pretty comprehensive logic," O'Donnell said, describing the system design process. "It took some time, some interaction, because of the need for us to identify some stuff we needed to clear up."

The company was also undergoing an upgrade to Oracle Release 12 at the time and had to push the RevPro data into a staging table, O'Donnell said. "We had to do a lot of work to reconcile the historical data. You have to get a starting point."

A Leeyo customer service representative with extensive finance experience worked with Sonus to create custom reports, including some it needs for managing contractual obligations and policies that affect revenue recognition, though O'Donnell said the canned reports are generally good.

After three phrases of tests that included a trial run on a quarter's worth of actual transactional data, an August soft closing went off without a hitch.

O'Donnell, who formerly worked for a Big Four accounting firm, described a striking contrast in the before-and-after processes. "It would take you a couple of days at the end of the quarter to do a pivot" on 24 months of historical data, he said. Now, "the allocation tool just works."

O'Donnell saved special praise for RevPro's revenue recognition management tool for contractual contingencies, which can read data from the cash-recognition module in E-Business Suite. "It actually functions as a subtransfer within Oracle. It doesn't require a lot of interfacing."

The tool "has been great for us," O'Donnell said, especially compared to Excel. "You'd be doing these complicated calculations all offline. That's being done in the system now."

This was first published in November 2012

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