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The Horrors of a Revenue Black Hole

Most people are afraid of snakes, spiders, or maybe clowns, but not CFOs. CFOs are afraid of missing revenue and earnings targets, budget overruns, and most of all, surprises. To that end, “revenue black holes” are fodder for CFO nightmares in the months to come.

Let me back up and explain. A “revenue black hole” is a catchy new phrase that early adopters of the new FASB/IASB Revenue Recognition standards (ASC 606 & IFRS 15) have created to define the revenue that never gets recognized after implementing ASC 606. Read in a scary voice: It never gets recognized!

Current guidance around software revenue recognition in the US is very prescriptive. Do you meet the four basic rev rec principles? Are there multiple elements? Did you offer a discount? Do you have VSOE? (BTW… this means Vendor Specific Objective Evidence, and if you didn’t know what that was, you are probably interesting at dinner parties). Is there post-customer support? There have been tomes written by rule makers, regulators, and auditors on the very smallest details of how to evaluate and recognize revenue under every possible scenario.

ASC 606 is principles-based and throws most of that prescriptive guidance out the window. There’s five steps, but basically organizations need to identify performance obligations and recognize revenue when they’ve met your performance obligations. No VSOE? No problem. Gone are the days of deferring PS revenue over hosted contract periods. We’ve yet to see many early adopters, but most agree this standard will allow us to recognize revenue faster.

Implementation of ASC 606 won’t be easy. There’s so much contract review work needed, 60% of attendees at a Big 4 firm’s ASC 606 implementation webinar last month hadn’t even started.

To get started, organizations will need to review all their contracts and re-evaluate revenue allocation and recognition for every customer contract. Then when they’re done with that, they’ll have to look at the requirement to capitalize sales costs and accrue reseller revenue. Finally, they’ll have to re-design their sales, revenue, and accounting system processes accordingly.

After they’ve done all that work and think they’ve made it through the first year, then comes the CFO’s nightmare of the (dramatic music please) revenue black hole. Implementers will have two choices: either show both years in the financials comparatively (meaning they would’ve needed to have been fully adopted 3 months ago – in January), or they can choose what most of us will do, show 2017 using current GAAP and present 2018 under ASC 606, with the adjustment to prior periods booked in retained earnings at Dec 31, 2017. For the non-accountants, retained earnings is a big bucket on the balance sheet where the entire history of the company gets shown as one number and nobody pays attention to it. To clarify this scenario with an example, if their revenue under one contract is $200 for 2017 using current GAAP, and $300 under ASC 606, they’ll show $200 in the 2017 P&L and put that extra $100 straight into retained earnings. That’s the nightmare! The revenue black hole.

To effectively report rev rec under ASC 606, it requires going through all your customer contracts to accurately track payments against deliveries of service and performance. If going through every customer contract sounds like your idea of a nightmare, we’re here to help. Seal discovers contracts from across the organization, extracts the terms, provisions, and data they hold, and then allows organizations to make better business decisions with the insights provided from contract data managed in Seal.

For ASC 606, Seal can help provide a clear picture of all revenues within single or multiple transactions, the payments received, and detailed performance obligations, so organizations can build the foundation for their compliance initiative. Without a platform like Seal’s, organizations are left doing manual reviews, which are extremely costly, disruptive, and time-consuming.

Starting an aggressive ASC 606 compliance initiative, with Seal as the first step, provides several major benefits. To be clear, we are now heading into Q2 so there will likely be a revenue black hole for most organizations. But, using Seal can give CFOs enough warning about how big that lost revenue number will be. Getting their contracts processed quickly can enable CFOs to give several months warning to the street — dramatically reducing the impact. With a manual review, they may never get any advance warning of how big the issue might be, and when they issue a new revenue forecast, their stock takes a hit. That’s the CFO’s nightmare.

ASC 606 is a dramatic new change in how organizations must recognize their review, and compliance requires large amounts of information that may be buried in customer contracts. Seal is the right way to get that data, so that organizations can quickly build and start executing on their ASC 606 compliance initiatives for 2017. With the right actions now, organizations can minimize the impact of the (imagine very dramatic music) revenue black hole, and CFOs can start sleeping soundly again.