Revenue recognition overview
Companies in industries that sell multiple elements, such as products, services, subscriptions, and so on, must be able to itemize multi-element orders so that revenue can be recognized based on a set of company-specific and industry-specific guidelines.
Usually, the revenue recognition process can be used to perform the following tasks:
- Allocate revenue - To help guarantee that the appropriate revenue price is recognized, based on the value of the components on multi-element orders.
- Defer revenue - Based on a revenue schedule that represents the contractual time frame and percentages for recognizing revenue over time.
Revenue recognition provides a flexible framework that lets you define company-specific rules for recognizing the revenue price and the revenue schedule.
Released products are used to support revenue recognition on sales order documents. The released products contain the setup that is required to determine the revenue price and the revenue schedule. The sales order can originate from a Time and materials project.
Companies can use the revenue schedule functionality without using the revenue price functionality. Therefore, the price on the sales order lines will be used as either revenue or deferred revenue. If a revenue schedule exists on the sales order line, the price on the sales order line will be deferred. If a revenue schedule doesn't exist on the sales order line, the price on the sales order line will be posted to a revenue account when it's invoiced.
The revenue price is calculated either when the sales order is confirmed or when the invoice is posted. To preview the revenue price before the invoice is posted, you must confirm the sales order.
When the sales order is confirmed, an expected revenue schedule is also created if any sales order line has a revenue schedule. When the sales order is invoiced, the expected revenue schedule is deleted, and the expected revenue schedule is replaced with the actual revenue recognition schedule.
The details of the revenue recognition schedule are maintained for each sales order line. Therefore, the revenue recognition manager can view the details and can release lines to revenue when the contractual obligation has been completed. At the end of each period, the revenue recognition manager can create a revenue journal to release any schedule lines that are due on or before a date that they define. This revenue journal isn't posted immediately. Therefore, the revenue recognition manager can verify that the correct amounts are being released from deferred revenue to actual revenue.
If a contractual change causes a new sales order line to be added either to the existing sales order or a new sales order, a reallocation process can be run to correct the revenue price across all lines on the sales orders.
The Revenue recognition module in Finance includes menu items for all the setup that is required. This unit describes the setup options and their implications.
The Revenue recognition module has the following setup options:
- Revenue recognition journals
- Parameters for revenue recognition
- Revenue schedules
- Inventory setup
- Item groups and released products
- Defining revenue schedule
- Defining revenue price
- Posting profiles
- Bundles
- Bundle components
- Bundle item
- Project setup
Watch this video to learn how to use revenue recognition in Finance.
Revenue recognition journals
A journal type exists for revenue recognition, and it is required and used in two scenarios:
The first scenario occurs after all the contractual obligations are met, when the deferred revenue is recognized by creating a revenue recognition journal that is based on the details of the revenue schedule. The journal contains an accounting entry that moves the balance from the deferred revenue ledger account to the revenue ledger account.
The second scenario occurs when a journal is created after reallocation occurs. Reallocation occurs when a sales order line is added to a previously invoiced sales order, or when a new sales order is created that includes a line that is part of the original contract. If an invoice was posted before the new sales order line is added, a correcting accounting entry must be created for the posted customer invoice.
The journal is set up on the Journal names page (Revenue recognition > Setup > Journal names). The journal type must be set to Revenue recognition. The revenue recognition journal lets you select the posting layer to post to.
Parameters for revenue recognition
Revenue recognition settings are configured on the Revenue recognition tab of the General ledger parameters page (Revenue recognition > Setup > General ledger parameters). The following settings are available:
- Revenue recognition journal name – Select the journal that was created for revenue recognition. The journal is required when revenue is recognized from the revenue schedule or when you do reallocation for a sales order that has already been invoiced.
- Enable discount allocation method – Set this option to Yes to determine the revenue price through allocation of the fair market value that is defined in the revenue price for each released product. This allocation includes allocation of any line discounts across the items. If this option is set to No, the system uses the median price that is defined in the revenue price for each released product. If this option is set to No, but no median price is set up for the released products, allocation of the revenue price doesn't occur.
- Include header discounts – Set this option to Yes to determine the revenue price by allocating header discounts across products. If this option is set to No, the header discount isn't included in the revenue price allocation.
- Disable contract terms – Set this option to Yes if products that have a revenue type of Post contract support can be released even though contract start and end dates aren't defined for them. Typically, contract start and end dates are required for items of the Post contract support revenue type. When the contract start and end dates aren't defined, the details of the revenue schedule on the posting are calculated by using the number of occurrences and the invoice date.
- Post invoice corrections to Accounts receivable when reallocating – When you do reallocation for invoices that have already been posted, the accounting entry for the posted invoice must be corrected. Use this option to specify how the correction is done.
- Set this option to No to limit posting of the correcting transaction to General ledger. When this option is set to No, no additional documents are created in Accounts receivable for the internal accounting correction. When the invoice is paid, the settlement process uses the old accounting entry to post any cash discounts, or to post any realized gains or losses.
- Set this option to Yes to automatically create a reversing document and new invoice for the correcting transaction in Accounts receivable. Because this correction is an internal accounting correction, the new documents aren't sent or communicated to the customer. The reversing document is settled to the original invoice, and the new corrected invoice is paid by the customer. All three documents are shown on reports, such as the customer statement.
Inventory setup
You can recognize revenue for released products on sales orders, but not with sales categories on the sales orders or with free text invoices, if no items are included on the document. The selections that you make when you set up released products determine how the item's revenue is recognized. For example, the selections determine whether the revenue price is allocated and whether the revenue is deferred by using a revenue schedule.
The setup can begin on the Revenue recognition FastTab of the Item group page (Revenue recognition > Setup > Inventory and product setup > Item group). This page includes several setup fields. These fields are used to set default values only for new released products that are created in the system. As new products are created, the values that you set on this page are entered by default for the item group. You can override the default values for released products on the Released products page (Revenue recognition > Setup > Inventory and product setup > Released products). The default values that are set for the released products are then carried forward to the sales order.
Posting profiles
Three additional posting types support the ability to defer revenue. These posting types are set up on the Sales order tab of the Posting page (Revenue recognition > Setup > Inventory and product setup > Posting).
- Deferred revenue – Enter the main account for the revenue price that posts to deferred revenue (instead of revenue). The revenue price is deferred if the sales order line has a revenue schedule.
- Deferred cost of goods sold – Enter the main account for the cost of goods sold amount that posts to deferred cost of goods sold if the revenue is also deferred.
- Partial invoice revenue clearing – Enter the main account for the clearing account that is used either when the sales order is partially invoiced or when reallocation occurs. The balance in this account returns to 0 (zero) when the sales orders are fully invoiced.
Project setup
Revenue recognition can also be used for sales orders that are created through a Time and materials project. For sales orders that originate from projects, you have to define the main accounts in the project posting profiles that are used to post project invoices. The main accounts are defined on the Ledger posting setup page (Revenue recognition > Setup > Project setup > Ledger posting setup).
- Deferred invoice revenue (under Revenue accounts) – Enter the main account for the revenue price that posts to deferred revenue (instead of revenue). The revenue price is deferred if the sales order line has a revenue schedule.
- Deferred cost (under Cost accounts) – Enter the main account for the cost of goods sold amount that posts to deferred cost of goods sold if the revenue is also deferred.