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2 My name is Neil MacDonald; I am a Solutions Consultant at Binary Stream Software, a Dynamics GP and AX ISV. I am a CPA, CMA having received my accounting designation over 20 years ago. In my career, I ve been a Credit Manager responsible for AR and collections for a multi-national trucking company; I ve led IT teams who built and ran multi-million dollar call centers the largest being over 99,000 square feet- as a PMP I ve run many large IT based projects, I ve been in sales, and most recently I am in a position where I provide and demo solutions to our clients in a presales role. 2

3 But how many sales in this economy are standard? As companies have to get more creative in how they sell, as sales guys create new and wonderful ways to bundle products or incent the customer to buy, things get more complex. What about sales where the product or service is delivered over time? Do you sell warranties? Do you have service or maintenance contracts included in your product prices? Do you sell systems that include both hardware and software? 4

4 If you answered yes to any of these questions, you are no doubt familiar with SOP 97-2 and EIFT 08-1, plus the standards that they evolved into. Terms like VSOE, TPE, BESP or Fair Value are familiar to you. For those of you unfamiliar with them, let s just take a minute to review them quickly. If you are selling items in a bundle, or at a discount, or as a BOGO type transaction, each item must be assigned a proportionate amount of revenue. But how do you determine what that amount should be? 5

5 These terms simply define the methods used to determine Fair Value: VSOE Vendor Specific Objective Evidence. Basically, this means, what evidence do you, as a vendor, have to determine the fair value to sell this item on its own? What is its standalone fair value? Using your specific evidence, you need to assign a Fair Value to each item in the bundle or in the contract. What if you have difficulty determining the fair value? Use TPE Third Party Evidence. In other words, what do other parties, other vendors, sell this item for? Unable to get that info? Then determine the BESP Best Estimated Selling Price, and use that value 6

6 The key to this is the term evidence. Since GAAP is very much rules based, you need to follow the rules and document every decision, then be consistent in applying it. Software has its own set of rules over and above this.sop 97-2 deals with that. This presentation is too short to go into the specifics of SOP 97-2, but basically, if you can determine a contract exists, you must either follow the VSOE rules, or in the absence of VSOE, the residual method can be used. Talk to your auditors for more details. Let s look at an example of a VSOE calculation: 7

7 Say you sell a computer system, with the following components: CPU, Monitor, KB/Mouse and a 1 year service contract. You sell it for $1,000. How do you allocate the revenue to those items? The really important one her is the service contact since it is a 12 month contract, it is deferred, and you need to be sure you claim the correct revenue for it. First, determine the Fair Value. Let s keep it simple and say you also sell these items as standalone components, like this: CPU $700 Monitor $300 KB/Mouse $100 Ser. Contract $100 Based on your Vendor Specific Objective Evidence, these values become the Fair Value used to reallocate the revenue. Total cost is $1200. To reallocate the revenue, we need to determine each components relative value, then express it as a factor of the $1,000 sale. CPU: $700/$1200 * $1000 = $ Monitor: $300/$1200 * $1000 = $ KB/Mouse: $100/$1200 * $1000 = $83.33 Ser Contract: $100/$1200 * $1000 = $83.33 Now this is a VERY simple example, but you can see how it works. 8

8 But now, businesses are having to prepare for a new standard FASB Topic 606 have been released as ASU and IFRS 15. While the release date has been pushed by one year, it is rapidly going to be upon us, especially considering that reporting requires 2 retrospective years, meaning you need to be learning how to apply this standard now.. The effective date for public companies and certain NFPs is for all fiscal periods beginning after 12/15/17. This includes both annual and interim (i.e. quarterly) reporting. For all other companies, the new standard is effective for fiscal periods beginning after 12/15/18 for annual reporting and 12/15/19 for interim (quarterly) reporting. 9

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10 So first off, what are the key differences between the existing standards and the new standards? Today s accounting standards are rule based there is a strict set of rules that you must follow. You must do this, you cannot do that The new standards are PRINCIPLE based. This means that there is much more interpretation allowed on the part of businesses in complying with the new standards. Of course, that also means that you need to justify and clearly document the decisions you have made and disclose them on your financials. Let s do a quick comparison. 11

11 Current US GAAP defines when revenue is realized and recognized as follows: There must be persuasive evidence of an arrangement. A contract, for example. There must be a fixed and determinable price for that arrangement. Delivery has occurred. Collectability is reasonably assured. If these elements are satisfied, you can recognize the revenue. Of course, if delivery has occurred, but over a period of time, then the revenue must be deferred over that time period. The new revenue standard, ASU and IFRS 15 define revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. It then defines 5 steps needed to determine revenue recognition, both amount and timing: You need to: Identify the contract Identify the performance obligations Determine the transaction price Allocate the transaction price Recognize revenue when (or as) performance obligations are satisfied. Notice that the term delivery is no longer used. And it calls for a well-documented judgement what are you entitled to? Let s look at the 5 steps a bit deeper: 12

12 5 Steps 13

13 Identify the contract An agreement between two or more parties that creates enforceable rights and obligations: If in doubt, talk to your legal counsel! The agreement must Have commercial substance Be approved by the parties orally, in writing or based on you normal business practice Have identifiable rights re the goods and services Have specific payment terms Have a probability of collection (US GAAP recommends 70-80% surety, IFRS 50%) If multiple related contracts are entered into at or around the same time with the same customer, an argument might be made that these are in fact a single contract or agreement. An example might be a hardware sale and a software sale, to be used on that hardware, on separate contracts. Are they negotiated as a package with a single commercial objective? Does consideration for one contract depend on successful performance, or on the price, of a related contract? Are the goods and / or services a single performance obligation? Quick example you enter into an agreement with a customer, but no contract has yet been signed. Work begins and you incur costs. Can you recognize the revenue? What if a deposit has been paid? Requires JUDGEMENT. Is this normal business practice? Is it a documented policy to begin work prior to signature? Even though there is no signature, are you confident you can collect the money owed? This also requires an on-going assessment to ensure your contracts continue to meet the definition of a contract despite any changes, add-ons etc. For example, it is possible for a contract amendment to actually create a new contract based on the definitions of the standard. In this case, the original contract is concluded, and a new one created; thus these steps start over for the new contract. If you are large enough to have a revenue group, keep them busy! If not, consult your legal counsel. 14

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15 Identify the Performance Obligation A promise (explicit or implied in a contract with a customer to transfer goods or services If a contract consists of more than one goods or service item, account for them separately only if they are DISTINCT, based on two conditions The customer can benefit from the obligation on its own, or with resources readily available to the customer. AND Each obligation is distinct in terms of the contract; in other words each one is separately identifiable form other obligations. Quick example you make and sell proprietary, highly customized software, specific to your client s needs. No other vendor makes or can modify the software. You work on and deliver a beta version for customer testing. Can you recognize any revenue up to this point? Is it distinct? Can the customer benefit from the software as it is, or with other readily available resources? Maybe it s beta, so if it doesn t work sufficiently for business use and no one else can make it work, then I would argue no. If it works such that the customer benefits, but just needs a few tweaks, then possibly yes. Was the software sold as a separately identifiable obligation? For example, according to the contract, did you sell software and support (two separate obligations) or did you sell a solution, which includes software and support? 16

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18 Determine the transaction price of each obligation This is the amount of consideration to which an entity is entitled for transferring the good or services to the customer The standard requires that these values be reassessed at each reporting period. Variable consideration Expected value, which is a probability weighted amount Most likely amount This is new to the rev rec literature Example: your contract contains a clause that promises a $10,000 bonus if you deliver the goods early; no bonus if not early. Probability weighted value is $5,000 (equal probability you will be early or you won t) but this is not an option you either get $10,000 or $0, so choose the scenario that is most likely. The one you EXPECT to happen; to the extent that it is probable that a significant reversal will not occur. Document it. Time value of money this is NEW to the literature as well Only if significant If the period of performance and payment is greater than 1 year Example: A three year pre-paid contract Treated as a loan, with income / expense There are exceptions see Non-cash consideration, treated at fair value Consideration payable rebates (treat as a reduction of the transaction price or revenue unless for a distinct good or service that the customer transfers to the entity; in which case treat as a purchase of that good or service ) Examples and considerations: Maintenance contracts: 1 year, 3 year, 5 year. What is included in revenue? What is considered significant to your business? Average contract is <1 year > $50,000 vs an oddball 2 year contract for $2,000. It depends on your business! What rate is used? The standard ( ) says The prevailing interest rate in the relevant market. Again, talk to your revenue team or your legal counsel! 19

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21 Allocate the transaction price Standalone selling price the observable price of a good or service where the entity sells that good or service separately; if it is not directly observable, estimate using all reasonably observable data Sound familiar? Who said VSOE, TPE, BESP was going away??? The terms may be gone from the literature, but you still need to decide on a standalone selling price, i.e. a fair value these methods might still apply. Estimates include: Market assessment (kind of like VSOE and TPE) Cost plus calculations Residual method (only for highly variable prices, or new products for which a price has not yet been established) 22

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23 Recognize revenue upon satisfaction of the obligations Recognition satisfaction of a performance obligation by transferring a promised good or service to a customer, specifically, when the customer gains control Satisfied at a point in time if delivery is complete, and your obligation to the customer is complete Satisfied over time if: Performance creates or enhances an asset that the customer controls as it is created or enhanced; Performance does not create an asset with an alternative use, IF you expect to get paid; Benefits are received and consumed as the performance takes place, i.e. services, warranties Can be straight-line, milestone or event based, or percentage of completion When does the customer gain control? When the customer: Has a present obligation to pay Has legal ownership or title Has physical possession Has risks and rewards of ownership Accepts the performance obligation 25

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26 These are the 5 steps outlined in the new standard 28

27 CONSIDERATIONS With the introduction of the new standard, there are no more specific standards for Construction Contracts, Software sales, or Real Estate. Basically most industry specific guidance goes away. The elimination of software-specific guidance means a possible acceleration in the timing of rev rec in situations where revenue was deferred due to a lack of VSOE of fair value. 29

28 Lots of JUDGEMENT needed; more principles, less rules. Variable consideration, contingent on service level guarantees should these be included in the transaction price? Can there be a significant reversal? Judgement on allocation of prices to each service obligation in a multiple element transaction; based on relative standalone price of each performance obligation. Allocation and recognition of revenue on a delivered item can only occur if that item is not contingent on another obligation (undelivered item or future performance obligations). Consulting services revenue recognition is contingent on whether the performance obligation has been satisfied as of a point in time. Measuring progress toward satisfaction is based on the transfer of control to the customer. Intellectual Property licenses ( to 10-65) The licensor may receive money up front for licenses (software, media rights, franchises, patents, trademarks, copyrights). But license arrangements might include other obligations such as support, professional services etc. Based on the type of licensing, the timing of rev rec can change. 30

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31 Now, we re here to talk about Dynamics GP How do you handle deferrals today? How do you handle VSOE Fair Value calculations? Where do you store the Fair Value, or Standalone Selling Price, amounts? How do you calculate and track milestone recognition? How do you calculate and track percentage of completion recognition? Are you ready for the future revenue standards, which are more judgement based? How are you going to store and record the transaction price for each performance obligation? 33

32 Number 1 answer EXCEL 34

33 Most of this can t be done in Dynamics GP today, so I posed these questions on the GPUG forum and got literally zero responses. I was looking for solutions from the ISV community in general, and found nothing! An I got from Microsoft says that based on what they know of the accounting standard, they have no plans to change the way Dynamics GP works. So what s the solution? Some of these things, such as basic straight line revenue recognition can be handled in the Dynamics GP Revenue and Expense Deferrals module. But most of these require a lot of manual effort moving dollars to Excel, then manually building the VSOE Fair Value calculations, and the recognition waterfall reports, or tracking the milestones and percentage of completion, followed by a complex reconciliation at month end, leading to a manual journal entry. And when the auditors come.that s when the real fun starts. 35

34 There are other options GP Project Accounting; GP Contract Admin. Complex, overkill for many situations. Options outside GP such as Softrax, Tennsoft etc. Expensive, outside GP. Another system to manage, upgrade, maintain. At Binary Stream, we have built a few products to make your life easier. 36

35 Our Advanced Revenue and Expense Deferrals (ARED) can create straight line deferrals, not by distribution, but by the line item. So if you have a 1 year and a 2 year item on the same invoice, you don t need to manually calculate how many dollars to attach to each deferral profile, ARED does it for you. And, ARED does not post all those journal entries in advance! (What accountant in his/her right mind wants journal entries posted into the next year, or two or more?) Using ARED, one of our customers, who had over 35,000 deferrals in Excel, is now able to close their monthly financials 11 days early every month! 37

36 Our Advanced Revenue and Expense Deferrals (ARED) can create straight line deferrals, not by distribution, but by the line item. So if you have a 1 year and a 2 year item on the same invoice, you don t need to manually calculate how many dollars to attach to each deferral profile, ARED does it for you. And, ARED does not post all those journal entries in advance! (What accountant in his/her right mind wants journal entries posted into the next year, or two or more?) Using ARED, one of our customers, who had over 35,000 deferrals in Excel, is now able to close their monthly financials 11 days early every month! 38

37 How about handling VSOE Fair Value calculations? Maybe this has not been an issue for you in the past, but the new accounting standard will touch many more businesses than the old standards did. Think about it business that fall under US GAAP are affected; companies that fall under IFRS are affected. No matter what business you are in, do you ever create a contract with a customer? If you sell them something, then you absolutely do! And unless you are selling strictly over the counter type goods, your business is affected! So how will you manage the calculations required to allocate the revenue properly? I see a big run on Excel licenses and Excel lessons coming up! Or. Binary Stream just released a new product called Multiple Element Revenue Allocation, or MERA, that stores or calculates both VSOE Fair Value amounts or Standalone selling prices, by Amount, based on List Price, based on the Invoice Amount, or as a Percentage of one or more other items. Again, this is a fully integrated Dynamics GP module that can be used on its own inside GP, or with our Advanced Revenue and Expense Deferrals. It simplifies the complex calculations required to remain compliant with the accounting standards both today and into the future. 39

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39 Summary Existing standards New standards How we handle deferrals and price allocations today mainly in Excel Discussed solutions to manage these transaction inside Dynamics GP. Come see me later to discuss Binary Stream solutions in detail and see how they can benefit your business 41

40 Questions 42