Revenue Recognition in SAP
Revenue Recognition is the process of recognizing the income, when a sale contract is fulfilled and ownership of goods/service are transferred from the seller to the buyer or customer. Traditionally revenue recognition happens in SD through the billing invoice functionality in SAP. The traditional Revenue recognition functionality in SD works as below:
SAP SD offers an integrated Revenue recognition based on SD Documents. With SD Revenue Recognition, invoices are posted to Deferred Revenue (depending on Previous Recognized Revenue Items) with recognized revenue also posting to COPA.
What Changes with New Updates on IFRS 15?
IFRS 15 is an accounting standard promulgated by IASB providing guidance on accounting for revenue from Contracts with customers. It was adopted in 2014 and will become effective as mandatory for US and most of Europe from January 01, 2018. The IFRS 15 has new disclosure changes, both quantitative and qualitative information about the amount, timing and uncertainty of revenue from Contracts with customers. The New IFRS 15 and ASC 606 revenue accounting standard basically follows a five step model for recognition of revenue:
Drawbacks in Existing SD Revenue Recognition Process:
1) No multiple Element Arrangements: The traditional Revenue Recognition in SD does not offer allocation of transaction price, one of the fundamental step for New updates on IFRS 15. Revenue is always recognized separately for every SD Order Item according to its pricing conditions.
2) Parallel Accounting: The traditional Revenue Recognition cannot manage different accounting principles. With New GL, it makes an accounting postings to all the ledgers at the same time (Ledger group is blank on the accounting document header), negating automation and increasing the reconciliation efforts for accounting teams.
3) Cost Recognition: COGS is not reconciled with revenue recognized. However, SD can recognized the cost only at the time of PGI or billing depending on the set up of pricing schema in SD
4) Disclosures and Reporting capability: The traditional SD Revenue Recognition is not capable of meeting the new disclosure requirements for IFRS 15
Impact of the changes Accounting Standard IFRS 15 on Customers
The new accounting standards is a mandatory rule for US and Europe. Early adopters of IFRS can start earlier. The customers most impacted by the New Standard are as below:
Example of Revenue Recognition in case of Multiple Arrangements
Mr A buys a Phone for $ 1 from a telecom company with a guaranteed Service Contract of $ 20 per month for 24 Months. The total Transaction price for phone and service contract for Mr A will be = (1+(20×24)=$ 481)
Mr A can also buy the Mobile Phone on a standalone basis for $180. Mr A can also enter into a standalone service contract with the telecom company for $16 per month for 24 Months (Total Transaction Price = 16×24=$ 384)
In this case, if Mr A purchases the service contract and phone from the telecom company, the charge for the mobile and service contract has to be allocated over a period of 24 Months to recognize revenue as per IFRS 15.
Allocated Price of Mobile Phone = Standalone Selling Price of Mobile Phone/(Sum of all Stand Alone Selling Price)* Complete Transaction Price
The SAP Revenue Accounting and Recognition Component is based on the 5-step model of IFRS 15 and also meets the requirement of FAS 2014-09/ ASC 606:
Step 1: Revenue Accounting combines items from different operational systems like SD, CRM or non SAP Systems in one single revenue accounting contract. The contract is the operational object for the determination and allocation of Transaction Price
Step 2: The Performance Obligation (POB) is the level, where the Standard Selling Price (SSP) is determined or defined, price is allocated and fulfillment (POC) is determined. Most of the times it would correspond to a line item of an operational contract, but it may also be a combination of several items Eg, from a Sales BOM, implicit obligation ( Eg, Upgrade for a licensed Software)
Step 3: The transaction price is determined from Pricing Conditions of operational document such as a sales order.
Step 4: The Transaction Price is allocated to POB of a contract on a relative SSP basis
Step 5: Revenue is recognized on the completion of POB. The completion can be defined as an event or over time. The over time fulfillment can be calculated based on time based or based on Percentage of Completion.
With the above design principles, the SAP Revenue accounting and recognition (RAR) Component has been introduced. It is an optional download component on SAP ERP (ECC). The Component is the only possible component for Revenue Recognition in SAP S/4HANA Finance
The component can be downloaded by any customer with SAP S/4HANA
The Current version of RAR available is 1.1 and version 1.2 has been released to a select customers.
In the next part of this series I will talk about the set up of SAP RAR 1.1 and the accounting flow for revenue recognition through the same.