Some Common Challenges in Revenue Recognition and how sap RAR solves them.

This article will discuss the key features Some Common Challenges in Revenue Recognition and How SAP Revenue Accounting and Reporting Module helps to resolve the challenges in Revenue Recognition.

SAP RAR provides the tools needed for companies of all sizes, locations, and industries to automate their revenue accounting processes, streamline financial reporting, and leverage real-time revenue visibility to make more informed decisions and maintain compliance with revenue recognition standards over time.

What is RAR in SAP?

SAP RAR (Revenue Accounting and Recognition) is an SAP solution designed to help users comply with evolving International Financial Reporting Standards (IFRS-15), support existing requirements, and promote more efficient revenue accounting and reporting functions across the entire enterprise.

With the SAP Revenue Accounting and Recognition module, companies in any industry can ensure accurate revenue recognition and reporting and maintain compliance with ever-changing accounting standards and performance obligations.

The IFRS 15 standard

IFRS 15 applies to all customer contracts from 2018 onwards, which concern the delivery of goods and services in standard business practice. Only a select number of exceptions are recognised, e.g. for leasing contracts within the scope of IAS 17. 

The goal is to put forward a unique revenue recognition concept across all sectors and industries. 

This revenue recognition concept is built around five steps: 

1. the identification of customer contracts, as defined by IFRS 15

2. the identification of all included commitments to the customer (‘performance obligations’ (POBs))

3. the determination of the contractual price of the obligations (‘transaction price’)

4. the allocation of the total transaction price to the different performance obligations, based on their fair value price (‘standalone selling price’ or SSP)

5. the recognition of the allocated price as revenue, upon fulfilment of the performance obligation 

Aside from the five-step revenue recognition model, the standard also provides regulations concerning, for example, contract modifications and combinations.

Figure : Demonstration revenue recognition model for a contract containing three items.

Common Challenges in Revenue Accounting and Reporting

Let’s take a closer look at a few of the key challenges associated with reporting revenues, managing billing systems, and supporting different performance obligation and revenue recognition types across organizations…

 1) Compliance Challenges: 

Implementing IFRS 15 (a standard for recognizing revenue) was challenging for many companies because the rules were complex and covered a lot of ground. While IFRS 15 helped reduce confusion by replacing several old rules, it also made understanding and applying the new rules more difficult.

The impact was especially hard on:

• Small to Medium-Sized Businesses: They often have fewer resources to handle big changes.

• Companies with Complex Products or Services: Such as those selling bundles of products and services together.

• Businesses with Long-Term Contracts: Like construction companies that work on projects over several years.

Industries that felt this impact the most include:

• Telecom: Where companies often sell packages combining phones, data, and services.

• Healthcare: Especially those offering multi-part services or long-term treatments.

• Construction: Where contracts are lengthy and may change over time.

The main challenges included:

• Identifying Performance Obligations: Understanding which parts of a contract need separate accounting.

• Handling Contract Changes: Knowing how to account for changes when contracts are combined or modified.

IFRS 15 introduced more detailed reporting requirements, which meant companies needed to collect and analyse more data than before.

For instance, the introduction of performance obligations and contract balance movements reports meant that a new level of data had to be identified, compiled, integrated or stored. It is often difficult for companies to predict what additional data will be required and whether their IT infrastructure will be able to meet the brief.

2) Meeting FASB requirements.

FASB, Financial Accounting Standards Board, ASC 606 is another financial reporting standard created to monitor revenue from contracts with customer, ASC 606 introduced changes to the GAAP (Generally Accepted Accounting Principles) rules, making it clearer how and when companies should report money earned from services.

To comply with ASC 606, companies must follow a five-step process to properly recognize revenue. These standards are created by FASB,

1.    Identify the Contract

2.    Identify Performance Obligations 

3.    Determine the Transaction Price

4.    Allocate the Transaction Price

5.    Recognize Revenue

Many companies find it challenging to report revenue correctly while also sticking to these specific steps. This is especially true for service-based businesses that need to match revenue recognition with service delivery accurately.

3) Recognizing time and event-based revenues.

One challenge in revenue recognition is deciding whether to use time-based or event-based methods to report revenue accurately.

a. Time-Based Revenue Recognition:

• In this method, revenue is recognized over a set period, like monthly or quarterly.

• The company first records the revenue in an accrual account, which temporarily holds the money until it is officially recognized as revenue.

• Each period, a portion of this accrual is moved to revenue, showing steady income over time.

Example: Perfect for long-term service contracts like annual software subscriptions.

Challenge: The need to regularly post and adjust financial records can be time-consuming and prone to errors.

And, while time-based recognition is an ideal choice for long-term service contracts, the need for periodic posting poses a challenge for most teams.

b. Event-Based Revenue Recognition:

• Revenue is recognized when a specific event happens, not just over a set time.

• The accrual is moved to revenue when an event related to the service contract occurs.

Example: When a milestone in a construction project is completed or when a service is delivered.

Challenge: It requires precise tracking of events, which can be tricky if there are many variables involved.

4) Allocating transaction prices.

One big challenge in revenue recognition is allocating transaction prices. This means figuring out how to divide the total contract price among the different products or services promised to the customer.

Why Is This Challenging?

• Complex Contracts: Contracts often bundle multiple products and services, making it difficult to assign a fair value to each component.

• Judgment and Estimation: It can be challenging to apply the right level of professional judgment when determining the value of each performance obligation.

• Finding the Right Prices: Businesses must compare prices of similar products to make sure they’re allocating revenue correctly.

• Changing Contracts: When contracts change, companies must reassess and reallocate transaction prices, adding another layer of complexity.

  
  

The RAR add-on as SAP's solution

The SAP Revenue Accounting and Reporting (RAR) add-on is a tool that makes a revenue accountant’s job easier by automating many tasks. It helps companies follow accounting rules like IFRS 15.

SAP RAR transactions can be executed in the GUI, in Fiori and on NetWeaver. The add-on is available for SAP ECC systems (minimum prerequisite is release 6.05) and SAP S/4HANA systems.

The revenue recognition framework and key features in SAP’s Revenue Accounting and Recognition module provide the functionality and flexibility needed to solve common revenue accounting and reporting challenges.

Here are a few of the key Solutions Provided in SAP RAR

• Supports Different Accounting Standards: Allows companies to manage multiple accounting methods at once (parallel accounting).

• Syncs Costs with Revenue: Ensures costs and revenues are recorded in the same period for accurate financial reporting.

• Create revenue accounting contracts that correspond to documents in an organization’s back-end operational system

• Aggregate pricing conditions in the back-end system to determine total price

• Allocate total price across each individual performance obligation (POB)

• Automates Allocation: SAP RAR uses methods like Standalone Selling Prices (SSP) to automatically divide the transaction price accurately.

• Automates price calculations and handles complex pricing scenarios, ensuring the transaction price is accurate and aligned with the contract terms.

• Identify performance obligations in each contract and manage POB relationships

• Automates price calculations and handles complex pricing scenarios, ensuring the transaction price is accurate and aligned with the contract terms.

• Manage the fulfillment of performance obligations and recognize revenue once each POB has been fulfilled

• Make postings to the general ledger to accurately depict revenue-related transactions 

SAP RAR furthermore facilitates various additional faculties, such as cost recognition, right of return, contract modifications and contract combinations.

• Firstly, cost recognition can be activated for any chosen POB type. Non-accrued costs of goods sold are then regarded as planned costs and are only recognised upon fulfilment of the POB.

  
  

• Next, a right of return can be assigned to any distinct performance obligation with event-based fulfilment. The percentage of sales which is expected to be refunded is then deducted from the revenues and recorded as a refund liability. This posting will be reversed upon the expiration of the return privilege.

  
  

• Thirdly, alterations to the contract price, scope and characteristics result in either a retrospective or a prospective change, depending on the underlying business rules. A retrospective change constitutes changes to both fulfilled and unfulfilled parts of the contract (cumulative catch-up and altered future revenues). A prospective change affects only the unfulfilled parts of the contract (altered future revenues).

  
  

• Finally, it’s possible to combine two or more related contracts that are entered at or nearly at the same time, with the same customer. A single source contract comprising all POBs will remain, while the other contracts will be deleted.

  
  

• Flexibility: Works with both SAP and non-SAP systems, allowing businesses to manage revenue recognition seamlessly across their financial landscape.

I hope this blog was helpful.