So, I’m starting this blog with a question, as a business owner, should you care about using the balance sheet to make your monthly profit and loss account more accurate?
Probably most of you reading this will say No and stop reading now, and that would have been fine until ASC606 came along.
If you bill everything monthly and you only bill for work completed in the month, then under ASC606, you don’t need to care about using balance sheet suspense accounting as part of your financial accounting view. True, at year end, your accountant may well make some corrections to ensure you don’t pay too much corporation tax, but really yours is a business model that can stick with cash-book accounting and be happy.
But if any of the following apply to your delivery model, then this blog has direct relevance to your being ASC6060 compliant:
- Prepayment funds: increasingly professional services businesses are making use of pre-payment fund models where they bill in advance and then do the work. Now, by definition, this contract model makes a deliberate separation between the cash-flow (the invoice/payment) and earning the money. Under ASC606 you can only attribute these funds to your P&L account once you have done the work. In particular, if like most people, you allow un-used funds to carry-over to a subsequent period, using invoicing as revenue will be over-stating your income, and understating your liabilities. One or two customers may not be material, 100 customers could be a serious over-statement.
- Term-based contract billing: MSPs are using contract billing more and more, often this is monthly billed, though not necessarily calendar monthly. Billing periods that exceed monthly will need deferred revenue treatment, commencement of billing during a month will misstate revenue. Both need adjustment via balance sheet suspense accounts to comply with ASC606 which requires revenue to be evenly distributed across the life of the contract (aka liability).
- Work in Progress project work: if you’ve ever taken on a project and invoiced a down-payment, or had payment held back awaiting approval, you’ve probably operated a project in a manner that strictly speaking requires work in progress accounting. Only projects where the billing is exactly aligned with the rate of earning (basically assignment T&M projects) can operate without WIP accounting treatment. Under ASC606 any fixed price job will need to consider WIP suspense accounting treatment and even T&M projects may require it if the rate of progress measurement differs from time expended (something that is very common). If this is rare in your world, it can be handled with a spreadsheet and manual journals. If this happens a lot, serious misstatements of revenue can easily creep in and lead to a breach of ASC606. The year-end could then become quite a shock as your accountant will require evidence of earning to support the revenue position going forward.
These simple and common business models all require consideration of revenue suspense, a process that it being tightened up by ASC606. The relationship between earnings and revenue now must be evidentiary and auditable, so reliance on spreadsheet models without audit trails is now being actively discouraged, with emphasis being placed on the use of correctly configured software to control and evidence revenue recognition.
Revenue accounting has a much higher threshold of evidence and greater process requirements under ASC606.
Harmony is the only PSA tool that automates the whole process without your needing to change your accounting system. Problem solved!
About the Author: Harmony Business Systems Ltd (HBS) is the company behind HarmonyPSA, the most complete cloud PSA software on the market. Developed with functionality to cater for even the most complex needs of MSPs, VARs, ISVs and Professional Services organisations, HarmonyPSA truly is the next generation of PSA systems. HBS is an independent company based in the UK. Follow HarmonyPSA on Twitter or LinkedIn