Simplify compliance with the new IFRS 15 revenue recognition standardAutomate your revenue calculations for seamless, transparent reporting and disclosures

Technical Deep Dive

A new revenue recognition standard from the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) effective during 2018 means companies around the world will need to make significant adjustments to their financial systems.

Although the goal of International Financial Reporting Standard (IFRS) 15 and Accounting Standards Codification (ASC) 606 is to significantly reduce the complexity of the previous revenue recognition guidance, executing the provisions may initially seem anything but simple.

If you’re still performing calculations offline on spreadsheets — or even if you’re using an application such as SAP ERP Sales and Distribution (SD) Revenue Recognition — consider the new requirements as an opportunity to enhance your transformation journey and implement digital solutions that automate and streamline your revenue recognition process.

We have found that the new SAP Revenue Accounting and Reporting (RAR) application is a complete solution for complying with the IFRS 15/ASC 606 guidelines while simultaneously improving revenue accounting automation and aligning to SAP’s architectural roadmap.

Who is affected?

The new revenue recognition standard affects all entities — public, private and not-for-profit — that enter into customer contracts to transfer goods, services or nonfinancial assets (unless they are within the scope of other standards such as leases and insurance). Public companies needed to begin complying with the new revenue recognition standard as of January 1, 2018, and nonpublic entities reporting under the U.S. Securities and Exchange Commission’s Generally Accepted Accounting Principles (U.S. SEC. GAAP) must begin after December 15, 2018.

The new standard is designed to be industry neutral, but some industries are more affected than others due to the complexity of their contracts — particularly the media, professional services, telecommunications, high tech/IT, healthcare, engineering, construction and automotive industries. Their contracts typically include multiple-element arrangements involving appropriate revenue allocation, mass volume requiring rule-based revenue recognition, or accrued revenues from long-term projects and shipments. The new standard has less impact on businesses with straightforward, invoice-driven revenue recognition.

What is the new revenue recognition standard?

The IFRS 15/ASC 606 guidelines are intended to increase financial statement comparability across companies and industries and to provide clarity about the nature, amount, timing and uncertainty of contract revenue. The standard primarily affects the timing of revenue recognition: Revenue is recognized when a company satisfies a performance obligation by transferring a promised good or service to a customer, and the customer obtains control of it.

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The core principle is that revenue recognition should depict the transfer of goods or services to customers in an amount that reflects the payment it expects to be entitled to. The guidelines explain that to do this, an organization should perform five steps:

1. Identify the contract(s) with a customer

− Existence of the contract and contract combination

− Collectability (variable consideration)

− Contract modifications

2. Identify performance obligations in the contract

− Warranties

− Licenses

− Options that grant a material right

3. Determine the transaction price

− Variable considerations and constraints

− Significant financing components

− Concurrent transactions; principal vs. agent

− Foreign currency revenue contracts and embedded derivatives

4. Allocate the transaction price to the performance obligations

− Standalone selling price (SSP) and prices in a narrow range; renewal rate, residuals, SSP of options

− Allocation methods

5. Recognize revenue when or as a performance obligation is satisfied

− Percentage-of-completion (POC) method over time, at a point in time

− Return rights

− Acceptance clauses

− Customers’ unexercised rights (breakage, unexercised options)

According to the guidelines, when either party to a contract has performed its obligations, an entity should present the contract in the financial position statement as a contract asset or a contract liability. The position is an asset or receivable if the company transfers goods or services before the customer pays. It is a liability if the customer pays before delivery.

When applying the revenue recognition standard, it’s obviously important to consider the terms of the contract and all relevant facts and circumstances. It is also important to consistently apply the standard, including any practical expedients, to contracts with similar characteristics and circumstances.

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How does SAP Revenue Accounting and Reporting help?

The SAP RAR application is designed to meet the IFRS 15/ASC 606 guidelines, including new disclosures about contract balances and multiple-element arrangements. The application’s advanced capabilities automate and simplify compliance and adhere to multiple GAAP standards (Figure 1). The solution:

• Complies with new IFRS/U.S.-GAAP standard, “Revenue from Contracts with Customers”

• Covers advanced revenue recognition scenarios, such as multi-element arrangements

• Integrates with financials and multiple logistics systems (SAP and non-SAP systems)

• Decouples the revenue recognition process to sustain flexibility and increase efficiency

• Decreases TCO through a rules framework that allows flexible and highly automated processes

• Supports an end-to-end audit trail through transparent revenue recognition processing

SAP RAR is an add-on to ERP Financials, with an open interface to operational applications, e.g., SAP Sales and Distribution (SD). Data from different operational applications can be transferred to RAR — an integration component (IC) creates revenue accounting items (RAIs) containing all relevant data from operational items and events and sends them to RAR. RAR’s Adaptive Reuse Layer (ARL) receives the

Figure 1. Operational applications can be SAP or non-SAP connected via the open interface technology in the SAP Revenue Accounting and Reporting (RAR) architecture.

Source: sap.com

SAP SAP ERP

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POb Right of return

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management

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RAIs and transforms them into revenue accounting (RA) contracts and performance obligations (POBs). SAP provides Business Rule Framework plus (BRFplus) to facilitate rule-based transformation.

RAR enables management of revenue recognition according to the five high-level steps outlined by IASB and FASB in the standard guidelines (Figure 2):

1. Identify contracts (in the operational system). Creates revenue accounting contracts corresponding to operational documents created on a back-end operational system.

2. Identify performance obligations (in the ARL). Identifies the performance obligations included in each contract, then creates POBs for items in the operational document and manages their relationships with each other.

3. Allocate the transaction price (in the ARL). Determines the total price by aggregating the pricing conditions passed from the back-end operational system, and then allocates the total price among the performance obligations.

4. Manage fulfillment of performance obligations (evaluated in the RA engine). Recognizes revenue for performance obligations as they are fulfilled.

5. Make revenue postings (interface between the RA engine and FI). The accrual run creates regular, aggregated postings to FI General Ledger, CO-PA and other relevant accounting components to reflect revenue-related transactions.

SAP RAR is an improvement over SAP SD Revenue Recognition, which does not accommodate multiple-element arrangements. (Revenue is recognized separately for each order item, with no transaction price allocation.) It also cannot manage different accounting principles for parallel accounting and does not provide interim cost recognition. (All costs are recognized either at goods issued — GI — or at billing.)

Figure 2. SAP Revenue Accounting and Reporting Solution addresses five-step legal requirements.

Source: sap.com

Order/Contract

Delivery/ goods issued service usage

Billing/ invoicing

Accounts receivable

Operational Process Stream

Revenue accounting stream

ERPOperational Systems

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3rd party systems

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innovation management

Step 1 Step 5Step 2 Step 3 Step 4

Fairvalues

Analytical executions

Management reporting

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contract

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SAP RAR introduced the following functionalities to meet the new standard:

• Decoupled from operational applications

• Accommodates multiple-element arrangements

− Allocates transaction price to distinct items, e.g., a contract’s performance obligations

− Combines items from different operational contracts, e.g., all SD orders into one SAR contract

− Combines items from different operational applications, e.g., SD order items and CRM items

• Parallel accounting

− Manages all data and valuations separately for parallel accounting principles

− Posts to different ledgers in New General Ledger (GL) or to different accounts

In the case of multiple-element arrangements, companies need to allocate the complete transaction price based on the relative standalone selling price (SSP). SAP RAR allows allocation of the transaction price among performance obligations in a contract.

The solution enables financial posting to the GL with respect to revenue, contract liabilities and contract assets. Postings can be carried out on demand, usually at the end of each accounting period. As under the new standard companies recognize revenue when a performance obligation is satisfied, fulfillment and event types play a key role in SAP RAR. Event types can be defined as GI, invoice, start date, end date, duration or manual.

The solution supports four ways to fulfill performance obligations:

• Event-based. A performance obligation can be fulfilled with a GI or other event by setting and defining the type of event.

• Time-based. A performance obligation can be fulfilled over a period of time by specifying a start date in combination with either the length of time or an end date. The fulfillment can be distributed evenly within the duration or in the last accounting period of the duration.

• Percentage-of-completion. In this scenario, revenue is recognized according to the percentage of the project that has been completed. Performance obligations are marked fulfilled by entering progress and specifying the percentage.

• Manual. This standard delivered fulfillment type allows flexibility to manually update progress at either a contract- or performance-obligation level.

Seamless, transparent reporting and disclosure

SAP RAR can significantly benefit companies most affected by the new revenue standard — organizations with scenarios involving multiple-element arrangements or differences in realization time. Yet even companies that rely on invoices to recognize revenue may want to use RAR for seamless, transparent reporting and disclosure. One of the solution’s key advantages is the ability to handle parallel accounting, allowing posts to different ledgers or accounts based on different methods of calculation. This feature can help any company avoid manual or offline effort.

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Revenue recognition is a sensitive topic, however, and proper accounting treatment is paramount to bookkeeping. Consult auditors or accounting advisors before implementing RAR to meet IFRS 15/ASC 606 requirements. Gain approval for the revenue recognition process from auditors and the head of finance.

Perform a sophisticated, upfront business analysis to fully determine the requirements the system will need to support. Plan thorough testing of all scenarios, and be sure to implement the latest release of the solution, since SAP RAR continues to evolve.

When executed thoughtfully, automating and simplifying revenue recognition to meet the new standard can improve your processes and jump-start your digital transformation initiatives.

Authors

Dinesh Chhabra, DXC Technology SAP S/4HANA Offering Leader

Kasi Raghavendra, DXC Technology SAP S/4HANA Finance Expert

Emerson Vieira, DXC Technology SAP S/4HANA LoB Finance Expert

Learn more at www.dxc.technology

About DXC Technology

DXC Technology (DXC: NYSE) is the world’s leading independent, end-to-end IT services company, serving nearly 6,000 private and public-sector clients from a diverse array of industries across 70 countries. The company’s technology independence, global talent and extensive partner network deliver transformative digital offerings and solutions that help clients harness the power of innovation to thrive on change. DXC Technology is recognized among the best corporate citizens globally. For more information, visit www.dxc.technology.

© 2018 DXC Technology Company. All rights reserved. MD_9055a-19. September 2018www.dxc.technology

Technical Deep Dive