Revenue Recognition Challenges and How PSA Comes To Help

Every company needs to close its books every month, quarter, or year, depending on financial reporting requirements -whether internal or statutory. A company's revenue for the reporting period must be determined to close its accounts. Incomplete projects pose a problem here. While some work has been done and expenses incurred during the accounting period, corresponding bills have not been raised for various valid reasons. Companies estimate the unbilled revenues to avoid a mismatch of costs and sales.

Revenue recognition for a period, like a month, is the sum of billed and unbilled (estimated) revenue.

Most people think that it is the responsibility of the finance department alone.

It is not. Project and delivery managers are essential stakeholders, too. However, most companies rely on manual calculations of unbilled revenues. Finance people, therefore, must collect information from project managers a few days before the closing of accounts. Rushed collection of project data and spreadsheet-based manual calculations during the last days of a month ( or quarter, or a year) provide little assurance of the accuracy of the estimations.?

It is no wonder that non-finance people disassociate themselves from revenue recognition activity.

I will outline the difficulties encountered in estimating unbilled revenues, the adverse effects of the current manual calculations, and a solution to the challenges.

What are the challenges in recognizing revenue in project companies?

Estimating the revenue of ongoing projects is a matter of judgment. Companies use various methods to evaluate the work and expected billing amount. Different types of projects affect revenue recognition methods. Customers' rules about accounting for leave taken by people introduce one more dimension to the complexity of estimating accrued revenues.

All the above need extensive calculations and validation.?

T&M Projects

Approved billable hours multiplied by bill rate is the revenue in a T&M project. The calculation is simple, but the catch is 'approved timesheets.' Employees need to fill timesheets regularly. The 'hours' from the timesheets require the customer's approval, and they must comply with applicable local laws. Project contracts stipulate what should be done in case someone logs more hours in a month than the allowable hours, say 160 hours -should the billing be done at the same rate, is there any cap on the monthly hours, or should the billing rate be higher???

When you take into account the above, you can realize that estimating accrued revenue takes more work than it seems.

Revenue recognition of T&M projects that provide monthly bill rates ( e.g., retainers) must consider the leave taken by people working on the project. Some customers limit the allowable leave during a billable period, while others put a ceiling on it over a more extended period, e.g., three consecutive months.

Another factor is that employees have different bill rates depending on their pay grades.

Monthly fixed-price projects

Monthly billing is independent of hours spent working on such projects. Project contracts specify the permissible leave days for people allocated to such projects. Such rules need to be considered for recognizing revenues of monthly fixed-price projects.

Fixed-priced projects

Companies adopt a variety of methods to estimate revenues of ongoing fixed-price projects.

Some companies use the total estimated hours for the entire project to calculate revenues for a month's work. Suppose a project's total estimated hours are 2000 and 100 work hours have occurred in a particular month per the timesheets. In that case, the accrued revenue of the project is 100 divided by 2000 multiplied by the total project price.

Some other companies recognize revenues from fixed-price projects based on the hours allocated for such projects during a month. In such cases, the estimation does not depend on the timesheets.

A few other companies use a project's billing milestones per the project's contract to estimate the revenue to be recognized. Naturally, only revenue corresponding to the billing milestones reached during a month is recognized.

There are more challenges.

The above examples should convince you that recognizing revenues from ongoing projects is highly complex and time-consuming.??

Timesheets: Companies must have a culture of employees filling their timesheets regularly and accurately.

Book closure deadline: If the revenue of a month needs to be reported on the 1st of the next month, many companies don't consider timesheets for days after, say, the 26th of the billing month for their calculations.

Reporting deadline puts a severe constraint on all the above efforts.

Revenue recognition must comply with the International Financial Reporting Standard (IFRS).

The adverse effects of manual revenue recognition calculation methods

Burdening the finance department alone

The finance people frantically collect information from project or delivery managers during the few-day monthly book closing period. Even as the concerned managers furnish the data in the prescribed spreadsheets, they have little visibility into the process. Naturally, people in operations disassociate themselves from the activity.?

Accuracy suffers

When project managers must furnish data under pressure of book closures and have no visibility into the exercise, they don't have stakes in the accuracy. The accuracy of the revenue estimations suffers as a result.

Trust issues

The manual calculations dent employees' trust in the system. This lack of confidence affects the accuracy of their timesheets, whether knowingly or unknowingly.?

The ProductDossier PSA comes to help.

The PSA allows you to define various billing methods and comply with project contracts and the IFRS. Project setups cover all the applicable rules. The PSA will reduce the chances of customers not approving the timesheets and the effort needed for another round of calculations.

Since PSA has access to real-time information about the progress of various projects, filled timesheets, and employee leave, it can estimate the recognizable revenue quickly.

Project and delivery managers can be given visibility into the revenue estimation per the company's policies. Such visibility will make them accountable for the information they enter into the system. They won't see the above activity as the one that concerns only the finance department.?

The PSA can make the revenue recognition exercise a truly collaborative one.

The PSA helps you manage different project types, adhere to customer-specific rules, and ensure trust-worthy revenue recognition. It will save time and reduce stress during financial closures. The PSA will help you comply with the applicable reporting standards like the IFRS.

In the upcoming editions of this newsletter, I will explore some of the above types of projects and their variants in depth.

Do you wish to know more? Need a demo? Reach us at [email protected]