Implementing ASC 606: Lessons from new adopters
INSIGHT ARTICLE |
The Financial Accounting Standards Board’s new standard for revenue recognition―included within Accounting Standards Codification (ASC) Topic 606―is effective in 2018 for public entities and in 2019 for all other entities. Surveys of middle market business leadersi, however, indicate that many companies may not be aware of what it takes to implement the changes to systems and procedures brought on by ASC 606.
How much effort does it really take to adopt the new standard?
We spoke with Steve Keisling, director of revenue accounting at Imprivata, a health care IT security company, and Larry Penta, senior revenue manager at Monotype, which provides font design assets and technology. Both discussed their experiences leading up to and following their implementation of ASC 606. Their comments provide a glimpse into what private companies can expect as they approach adoption of the standard in 2018. Watch the video below or read on to understand the scope involved in adopting the standard.
When did you first start considering your approach to the new standard?
Steve Keisling: We did our initial assessment of the new standard back in 2016. Our chief financial officer at the time was concerned that our deferred revenue was going to continue to grow under the current 605 standard and that, the longer we waited to adopt the new standard, the larger the vaporized revenue amount was going to be at the time of ASC 606 adoption. Imprivata didn't want to end up losing that revenue.
Larry Penta: We just adopted it as a publicly traded company in January 2018. We started considering the approach to the new standard approximately two years prior to adoption. The first year was dedicated to scoping out the revenue streams, understanding the impact of the standard on those revenue streams and in general planning for the implementation of the standard.
Were the implications for your industry and your company fully understood?
SK: We did learn a lot as we dug into the new standard, particularly on the commission side. I think we knew what the effects were going to be from a revenue standpoint under ASC 606, but we didn't fully understand the implications for commissions.
LP: We did understand that it would have a material impact on our financial statements and that our current processes and systems would not be sufficient for implementing the standard. This meant that we needed to be sure that we rolled out the implementation with enough room in our timeline to absorb and roll out a new system and new finance processes.
Did you originally plan a full or modified retrospective approach to implementation?
SK: Under ASC 606 we originally planned to do a full retrospective. Back in 2016, our company was purchased by aprivate equity firm and that firm required that all of the companies within its portfolio use the full retrospective.
LP: Originally, we actually started planning for the full retrospective approach. But after scoping the entire project we realized that the modified retrospective would still provide investors with enough information to be useful to them. The other thing that we realized is that our business was really complex. We had a large number of revenue streams and, although the expectation was that the financial impact of the new standard would be material, it may not be as significant as we had originally anticipated. The workload included in scoping the system and process changes, SOX controls—and all that—would be absolutely a massive undertaking. So, in order to reduce the timing risk—and since missing the adoption day was not an option—we had to take the path to give us the best chance of success, and that was the modified retrospective.
Did you approach the adoption entirely in-house or did you use outside support?
SK: In the beginning of the process, we decide to work on the 606 project entirely in-house. But once we started to dig in and understand the amount of work and resources that it was going to take in order to meet our internal deadline of adopting by Jan. 1, 2018, we decided to reach out to RSM to help us with the implementation process. We figured it was going to probably take at least six to twelve months in order to be ready to go live as of Jan. 1. It ended up being less with RSM assisting us with the implementation.
LP: What we realized pretty early on is that the updates to our information systems, SAP in particular, were going to be a significant undertaking and we knew we didn't have the resources to do that in-house. We needed assistance from external folks, which ended up being RSM, among others.
How extensive were the updates or changes that you had to make?
SK: Most of our time was spent on the system side. We currently use NetSuite as our accounting system and, under 606, we had to implement Multi-Book. A lot of time was spent in getting that book up and running because, under Multi-Book, you have to take your primary book and copy it over into the ASC 606 book. So there was a lot of work performed on the system implementation side.
LP: I would specifically call out the pricing. Under our existing GAAP model at the time, not many of our offerings had the vendor-specific objective evidence, which meant that we recognized revenue as a combined unit of accounting; it was actually a very simple model. Under the new standard, we no longer had the VSOE requirements and we had to allocate each performance obligation and agreement based on standalone selling price. What we found very challenging was getting at and analyzing that pricing data. We compete against a number of different industries with a number of different types of customers, and our pricing varied quite significantly in certain parts of our business. So there was really a lot of analysis that went into that.
Were there any surprises during implementation, anything that came up that you weren’t expecting?
SK: As I mentioned, one of the biggest surprises was the impact of commissions as well as how we were going to end up breaking out our subscription products into the two components that get delivered—the delivery of the license and the delivery of the maintenance. Those two were probably the biggest effects that we saw along the way.
LP: I think we had a pretty good idea of what to expect after the initial scoping, but the devil is in the details. We had scoped the project and understood overall what the impact would be for certain groups of contracts, which mapped pretty consistently to our revenue streams. But the biggest level of effort—and what was the biggest surprise for us—was the system implementation. It took over 12 months, once we had mapped out the impact by revenue stream to operationalize these changes, to make sure that we had a controlled system that we could use to report the disclosures.
I remember during one of our working sessions, someone said, “You know, you can't just show what does change. You also have to show what didn't change and why.” I think that was a very good way of explaining the entire scoping process. It was actually a step-by-step analysis on every area that possibly could be affected by the revenue standard. Even if it didn't affect your organization, you had to document that and show that you had considered that from the Sarbanes-Oxley perspective. So what I thought would be a pretty straightforward scoping analysis actually became more significant, especially from a documentation standpoint.
Were there any new efficiencies you achieved via adoption? Has this had a positive impact on your financial accounting procedures or elsewhere?
SK: I would say the biggest positive impact thus far is ASC 606 gives the company a lot more flexibility when we're going out to customers and structuring deals. Whether it is giving the customer extended payment terms, or grouping our term licenses with our perpetual licenses, or selling all of our products as one product suite, it's really increased the flexibility that we have with our customers. I think as we continue to move along this year, we're going to see that positive impact continue in the growth of our sales.
LP: We have a diverse customer base where we sell both business-to-business as well as business-to-consumer. Going through this process allowed us to realize some operational improvements in how we price our products and services. The adoption of the standard essentially forced us to look at pricing because we needed to understand and analyze those pricing models to make sure that we could come up with an appropriate SSP. So it really forced us into a thorough analysis of our pricing model. There have been a number of different benefits that came out of that analysis.
What would you say to companies that are only now starting their initial assessments (or are very early in the process)?
SK: I would tell those companies that if they have not started, they need to start immediately. I've heard that some companies don't feel that this new 606 standard is going to affect them. From what I've seen, it's going to affect every single company. It may not affect them as much as it did us, but it definitely will affect them in some way. And it will cause companies to make changes in the way that they do things from a system standpoint as well as in auditing, internal procedures and controls.
LP: Do not underestimate the time that it's going to take. Even if your organization doesn’t believe the new standard will have a significant impact, you'd actually be surprised at the level of documentation and the level of SOX controls that you need to go through to ultimately determine that you don't have an impact. The other thing to consider as an organization is, of course, disclosures. You need to consider them, even if the adoption of the standard doesn't have a material impact in your company. So it's imperative to start that process as soon as possible.