Where the value of an invoice does not relate to revenue 100% earned in the period of the invoice, some degree of deferred revenue treatment is necessary. Without making a process separation between revenue recognition and cash-flow, period accounting will be incorrect and so misleading.
Worse, the effect of this at year end will lead to an overstatement of revenue, in turn driving the business to pay more corporation tax than is necessary.
Lastly, under ASC606, ensuring revenue is taken over the life of a contract is key to accounts compliance.
So, deferred revenue management matters, but do you sell in such a way that this is a concern for your business? Many companies believe that by billing every month, they don’t need to consider this problem. Certainly, with monthly billing, these considerations are minimised. However, below are some examples of where it can still be a concern:
- Monthly service contracts that don’t start on the start of the month. If you start a contract on the 24th (say) is it right to place the full month’s revenue in that month?
- Monthly recurring pre-payment agreements that provide for carry-over of un-used time into the following period(s)
- Project work that includes stage payments (say a % fee upfront and a retained amount for acceptance)
Of course, if you bill quarterly or annually, you will already be aware of the need to spread the revenue, but managing this process manually can be more complex than it seems at first.
Consider how you manage the following use-cases:
- Early (mid-invoice period) termination, leading to a credit note and the reversal of outstanding deferred revenue balance
- Mid-term increase or change in usage (however your product is sold, varying that quantity)
- Bad debt write-offs
- Changes to FX rate (if you bill in other currencies to your base currency). For instance, if the credit note is raised at a different rate to the invoice, you will have a FX leg to deal with in the deferred revenue clean-up
- Goodwill credit notes, say to compensate for poor service in a period
- General date arithmetic around different months and period lengths
- Delayed invoicing (where the invoice follows the first period(s) of service)
As a general case, managing deferred revenue is complex and can be error prone. Tracking this all manually on spreadsheets and manual journals can rapidly become unwieldy and lead to revenue mis-statements that are time consuming to diagnose and rectify.
If only there was a system that simply takes the order form and just manages the process for you, with all the complex edge cases covered. A system that also handles prepayment and work in progress accounting, allowing you to worry about sales and service, not spreadsheet-based contract tracking.
Your search for deferred revenue automation is over. HarmonyPSA will manage your balance sheet for you, while you focus on customer service.
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. Follow HarmonyPSA on Twitter, LinkedIn or Website