Revenue Recognition: Why is This So Difficult?

According to a recent article in Fortune magazine, the SEC questioned 88 percent of companies in the technology, media and telecommunications industries that went public in 2014 regarding their revenue recognition policies. That’s up from 79 percent the year before in the same industries, and substantially more than companies outside of these industries. Overall, approximately 46 percent of all companies had to provide clarification to the SEC about their revenue recognition policies.

Errors in revenue recognition continue to impact all industries, but companies in the technology industries seem to be impacted the most.  I would also argue that any company selling a product that requires ongoing involvement after delivery must deal with some level of complication in its revenue recognition model.

The statistics above certainly support the need for the new revenue recognition standard.  As I have previously commented, even the simplest of transaction can become complicated when it comes to applying the accounting. 

I often ask myself, “Why is this so difficult?”

Call me naïve, but I believe 99.9 percent of companies want to get it right the first time and have no desire to mislead their investors, analysts, or anyone else for that matter.

So, why is revenue recognition accounting so difficult?  The short answer is that revenue recognition is complicated, and policies don’t necessarily transfer across industries. As the standards have been modified through the years, they have become more difficult to apply in specific situations. I think developing new standards was a good idea, and we have to tip our hat to the effort that has been put into writing them.

In some cases, however, companies just don’t know what they don’t know.  Start-up companies are focused on growing the business and creating cash flow for future growth.  Whether or not certain revenue needs to be deferred is not top of mind.  In some cases, revenue recognition issues may not be fully vetted until years down the road.  Even then, companies may not possess the in-house resources necessary to gain a complete understanding of the revenue transactions and related accounting. 

The next thing you know a company is being acquired by a venture capital group or is thinking about going public.  The process of due diligence begins and, all of a sudden, the company is restating three years of financial information. And the company gets stuck with the fees incurred to properly reflect the numbers, or worse, the valuation is significantly impacted.

So back to our question – why is this so difficult? I think it’s difficult because we wait until we are knee deep in transactions before we address the issues. It’s a given that revenues are some of the most important numbers in your financial statements, and asking for help from the beginning will eliminate most your problems down the road.  Have someone assist your company in putting your revenue recognition policies and procedures on paper.

You should seek input from others in your industry.  Industry associations or publications can be a great resource for your accounting department.  Also, read the revenue recognition policies of established, publicly traded companies in your industry.  Many of these companies have been through the exercise of addressing questions from the SEC, and they will give you some level of comfort that your policies are in line with industry standards and SEC expectations.  Finally, align your company with a service provider with specialized expertise that can help you develop appropriate policies and procedures as well as assist you in evaluating current and proposed customer agreements.

So in summary, let make this easy:

• Put it on paper
• Reach out to your friends in the industry
• Follow publicly traded companies in your industry
• Engage experts that understand your business.

The new revenue recognition standards will help us all to clarify our policies and procedures, but don’t wait to start putting yours in writing now. 

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