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Sarbanes Oxley : Technology : Business Process Management
Sarbanes-Oxley and Business Model Innovation Part 2
A practical guide to establishing key controls
By
Robert O'Connor
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Robert O'Connor
CEO
Softrax
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This is the second in a three-part series on the impact of Sarbanes-Oxley. This article addresses compliance issues specific to services and support revenue streams. The next installment will address licensing, subscription, and utility/usage based models.
Introduction
Sarbox compliance is a tremendous challenge because it requires companies to document and certify all the business processes and internal controls associated with their financial reporting. The task is made all the more daunting by the fact that it has come into effect at a time when many companies are adopting innovative business models that introduce brand new revenue and reporting streams. The key to successful compliance is, of course, making sure that those revenue processes are well defined and properly implemented?otherwise all the documentation in the world isn?t going to save you.
The business models covered in the final two parts of this series are:
? Services
? Support
? Licensing
? Subscription
? Utility/Usage
When some or all of these models are sold as part of the same customer relationship, the revenue accounting requirements can be extremely daunting. Allocation issues may stipulate that deliverables made under one model trigger revenue carve outs from items previously delivered under another model. Many factors can directly impact the revenue accounting including currency fluctuations, addendums and additions to original agreements, product upgrades, and tiered pricing schedules, to name a few. The implications for regulatory compliance should not be underestimated in their scope or complexity.
The following discussion outlines some of the key issues for managing revenue from services and support.
Services
The Services model generally applies to contracted labor used either to develop solutions or implement solutions. Under these arrangements it is necessary to define:
The term of the contract: The length of term will dictate the period over which to recognize revenue. Abnormal contract lengths will typically be flagged for exception processing. Multi-year arrangements require additional scrutiny to determine the relationship between revenue and delivered items. For many complex contracts no single term exists. Each part of the contract may refer to a special provision that covers only those items, and their unique impact on revenue recognition. Therefore the simple capture of single elements relating to start, end, notification, renewal dates, etc. is seldom sufficient. The addition of amendments during the life cycle of the contract may also affect how revenue has been booked historically, calling for adjustments to be made.
The interpretation of SOP 81-1: This AICPA Statement of Position (SOP) defines the rules for applying contract accounting. The exact methodology will depend on the exact nature and terms of the contract. The details of the contract that will dictate the exact method are typically defined in policy documents and as part of the internal audit recommendations.
Calculation and origin of percent complete: The percent complete calculation can be varied and complicated. Data should be sourced at the project level? for example from a professional services automation (PSA) application?with the appropriate contract terms needed to define revenue associated with the project. While only the final numbers are needed for correct accounting, Sarbanes-Oxley section 404 requirements make it important to maintain a consistent audit trail.
Revaluation process: Changes in the contract, including time and scope can cause a revaluation of the revenue to be executed. As a result, changes in items must be documented and revaluation or rescheduling must be performed.
Assignment of value to milestones: Milestones are usually defined in the contract or at the project level. In many cases these are tied to billing. These milestones must be documented along with the amount of revenue established for each milestone. In many cases the revenue amounts will differ from the billing amounts. The milestones associated with a contract can include:
? Delivery of a work-packet
? Legal sign off of performance
? A reached date
? The passage of cancellation and rights clauses
? The reaching of a pricing milestone
? The reaching of minimum quantities
Milestone and event tracking: Any milestone or significant event that impacts revenue must be tracked and the associated process documented. These events will trigger revenue recognition and are critical for reliable backlog forecasting. Unfortunately, milestones and events are typically sourced form a variety of legacy systems. The interplay between each of these sources requires that a centralized workflow and management functionality.
Application of payments and prepayments: The timing of payments and any prepayments against the project must be identified, and the policy used to assign payment amounts to items must be defined. Payments for services may originate from a variety of disperse billing systems. In some cases, it is easy to tie the payments to specific items within the contract, while in other cases this is less obvious. In both cases it is necessary to bring sufficient invoice detail to perform invoice matching and allocation of billing to revenue.
Support
Support is generally provided to customers to facilitate the operation of installed products. In many cases, the support relationship can be leveraged to sell/up-sell offerings from other business models (e.g. increase users, upgrade products, deliver add-on products and services, etc.). It is important, therefore, that support transactions be integrated with the enterprise accounting workflows.
Term of support: The length of term and start of the term are critical. In many cases the start of support is tied to external events and delivery. Support terms can be unique to the customer and the nature of the contract. With the implementation of Sarbanes-Oxley 404, many questions have been raised around latitudes in support agreements that allow support after the stated terms on a ?customary? basis. In general, the factors affecting support terms are:
? Date of acceptance
? Date of receipt
? Length of support after warranty
Pre-paid incident support: The commitment for incidents or the prepayment of support incidents will typically require additional treatment. In most cases the timeframe for these incidents to be used must be captured. Pre-paid incident support is becoming increasingly prevalent after the initial support term. However, the incident fee is often waived. This could cause an extension of the original term for revenue purposes, or some other accounting consideration.
Support bundling: The value of support and how it is bundled with the other items must be identified. Overriding support contracts may require additional treatment. Additional complications are caused by support co-termination arrangements. Although the support term is often specified, it is necessary to maintain detailed records to substantiate the support offering.
Renewal terms: The renewal terms and any commitments to future pricing must often be considered in the initial valuation of the support. As discussed above, the commitment to future discounted revenue, even if the support agreement is renewable, will affect the initial revenue recognition. On the anniversary date, the revenue will need to be adjusted (typically upwards) if the maintenance is not renewed. Since the renewal term may vary product to product or product group to product group this information must be maintained on a detailed basis.
Closing Thoughts
Finance is under pressure to get new business models to market and support them with the same efficiencies and compliance standards that have already been applied to traditional revenue streams. Increasingly, companies are operating two or more business models, frequently within the same customer agreement. As a result, the financial infrastructure?systems, process, and personnel?must manage an increasingly diverse set of challenges. The operational implications should not be underestimated in their scope or complexity.
Coming up next: licensing, subscription, and utility/usage models
Robert O'Connor
CEO
Softrax
Robert O?Connor is President and CEO of Softrax Corporation, a leading provider of enterprise billing and revenue management solutions.
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