Listen to the latest episode of Bramasol’s Insights to Action Podcast Series, in this episode we offer an overview on Day-Two accounting and what things affect Day-Two accounting?

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Also, below is a transcript of the podcast episode:

Jim Hunt: This is Jim hunt, hosting the next episode of Bramasol’s Insights to Action podcast series. Today, I’m really pleased that we have John Scott, who is senior technical accounting advisor with Bramasol. John got an extensive background with Big 4 CPA audit experience. He’s got a background in technical accounting, FCC reporting, business development, and over the years he has worked in many implementation projects for companies in the $100 million to $500 million range. Recently he’s been through RevRec and Leasing compliance implementation. So today, we’re really going to focus on having complied with RevRec and leasing, accounting changes. What do you do next to optimize and transform? So, John really great to have you. Thanks for joining us.

John Scott: I appreciate it. As Jim mentioned, I have a pretty extensive background on big4 auditing companies as well as helping them implement new accounting guidance. I’m going to go through a background to start with on this podcast. On kind of going through the history of ASC 606 IFRS 15 and ASC 842 IFRS 16 just brief kind of logic on both of these. The IFRS 15 ASC 606 was effective for public companies in 2018, private companies in 2019. It really was a single scope model that follows a five step process. And the guidelines are all about the results of your end to end processes starting with complex surprising quotes, orders, and then ending with the revenue recognition. It’s really all about trying to align the two standards as well as kind of get at a single model of revenue recognition.

And what really the big effects for organizations now that everybody’s got this implemented, is getting out of that manual kind of process because there’s some significant disclosures you have to make in your financial statements. On performance obligations, how you came up with certain revenue recognition criteria, etc,. And then how that affects kind of your departments. Legal departments have to get involved because they’re managing the customer contracts, managing risks, working out commercial terms, which is a real big impact on revenue recognition. And finance for instance has to be aligned with that and be able to capture that information. What’s your sales organization being involved because commissions, bonus, etc, can really impact what we call variable consideration. So that’s kind of ASC 606 kind of little background in a nutshell.

With 842 that was effective for public companies this year in 2019, it will be effective for private companies in 2020. The big change there is for operating leases will now be putting on the balance sheet for lessees and it’s, what we’re calling a capital leases are now called finance type leases. So before operating leases were just expensed, wasn’t big concern. It would show up in your five, your table is a contingency, but now you record an asset and a liability related to those. For less lessees, it’s not a big change. They added, the same terminology, operating lease direct financing and they’ve got per type lease called sales type places.

Now the big challenge is there obviously is getting and capturing all the leases. So, completeness is a big issue. Being able to go track them all down, particularly if you’re in a decentralized environment as well as capturing a lot of information on those leases. And also, you’ve got some other things called embedded leases, which were not a big deal, but now are because they are potentially operating leases, which need to go on the balance sheets. On embedded lease, what that really is you’re getting something basically free for buying services or buying goods. A good example of that is to like, you’ve got a coffee service, you’re getting a free coffee maker, those might be minimums and you never need to record them, but you got to show your audit firms that you’ve gone through the thinking process to capture all those embedded leases and evaluate them.

Jim Hunt:  Talk a little bit about, the various roads that could have led to compliance. There’s a lot of approaches that companies have taken to either treat it as kind of a separate activity, address it with spreadsheets, standalone apps, and then there’s other approaches that have looked down the road and treated it with more of an integrated approach. Could you take a couple of minutes and talk about those approaches?

John Scott: Yeah, absolutely. Let me start with 606. A lot of companies use a lot of spreadsheets to track all this information. It’s a very manual process. So, when ASC 606 was implemented, a lot of companies just got into compliance by just brute force, meaning they just captured the information they needed, particularly manually, complied, got their footnote disclosure information and moved on. As a tangible example, I came out of the healthcare industry, help them implement ASC 606 and healthcare has a lot what we call variable consideration, meaning they’ve got a history of price concessions that falls under the variable consideration. So, there’s a lot of data analyse because you record what you eventually think you’re going to collect, which in most cases is going to be a lot less than you build the client or the patient. So, for example, there was numerous activities related to information all handled in spreadsheets, very manual, prone to error, harder to audit, etc. A lot of companies are still in that boat. Now if I go turn to ASC 842 same deal. Most people track their leases in spreadsheets, mostly for the five-year-old table, but it wasn’t as big a deal. But now that you’ve got say 2-3000 leases, both equipment and real estate, you really need to get that tracked in the software because it involves a big calculation to put those leases on the books because your present value in the stream of future payments, that’s what’s recorded on your balance sheet for the right of use, asset and liability. And conversely, you’ve got future calculations to amortize those leases off the financial records. Now, now one particular thing about 842 is even though it doesn’t have income statement impact because it’s essentially the same thing you’ve been doing all along, it does have a big balance sheet, gross up impact to comply with the standard. And conversely, both standards need significant financial disclosure and that information needs to be captured, which is in most cases handled manually. So the big takeaway there is, you’re in compliance and for 842 compliance, particularly when you’re a private company, but do you have the processes and the ability to capture the needed data easily, which makes your financial close process goes smoothly and also is in compliance from a control and audibility standpoint.

Jim Hunt: Great summary. It sounds like if you’ve done a standalone spreadsheet or a standalone app, you are at risk of any efficiencies going forward and the inability to scale or to sustain it and inability to use automation. So, kind of some companies have found themselves compliant, but in a compliance dead end.

John Scott: Absolutely. That’s, the key. And so, what’s the next step? Now I noticed automation. How does that come into play? Well, ideally you want to automate these processes for ASC 842 most companies have gone and got me a software to do that and being able to input all that in software. So now you’ve got a trail for completeness for your auditors with that software and you’re also able to do all the calculations in automation. It also proves that SOX compliance and then you work your processes and controls around that. One thing that’s really good out there is is we have a great product called CLM that helps with the disclosure but also being able to handle all those leases. Conversely on ASC 606 the same deal, it’s able to, to capture the necessary information there, not only for your disclosures but also for things that come up like multi on it arrangements which involve being, having to calculate a standalone selling price and allocate those prices accordingly to each multi element to be able to effectively and in compliance record that revenue.

And also that it’s able to handle things like variable consideration, which I mentioned and health care is a big deal but at other effects other industries because anything that’s got a commission, rebate, any kind of discounting falls under the variable consideration standard and you need to be able to estimate what you’re going to record for that revenue. And that can be really onerous, particularly when you have thousands of transactions. You need to segregate and adjust that variable consideration potentially because the standards say you have to analyze at each reporting period whether you need to make any changes to your original estimate for the variable consideration. Other issues are our contract modifications, which changed the scope and where pricing of the contract arrangement involves having to go in there and make some adjustments to your revenue recording. So, Automation is a huge deal in this area.

Jim Hunt: And so essentially being, using CLM, contract lease management from SAP as your compliance mode gives you a lot more benefits than just compliance. It gives you an integration if you’re an SAP shop into a, all of the rest of the systems. And you mentioned, RAR revenue accounting and reporting another SAP app. So, both of those, give companies a leg up in integrating their compliance effort. But then looking forward, maybe take a few minutes and talk about if you’re in the SAP environment, you everybody knows that S/4 HANA is coming over the next few years and it makes sense to be able to look down the road and see what’s my implementation and integration strategy with regard to S/4 HANA.

John Scott: Absolutely. And you know, yes S/4 HANA will increase automation above your 606 and 842 efforts. You know that it’s got intelligent learning built into those. What that is, well you’re paying invoices, it’s able to recognize that this vendor and able to automate the payment of those vendors as you make the payments because it’s capturing what you’ve done in payments to that vendor in the past. Similarly, it can handle no multi element allocation. It also gives you better controls for cleaner SOX environment, which can lead to less audit costs. Also get you in compliance where you don’t have to worry about all the SOX kind of audits that your auditors perform as well as you do internally. And its more standardization in one’s program, less manual intervention, which will help your accounting team focus less on manual processes, more on revenue analysis, pricing strategies. It really takes you from just brute force manual compliance to be able to really step back and do your financial analysis, which takes you to the next level.

And in terms of ASC 606, as I mentioned, the product is able to capture those leases, do your calculations as well as we have a really good disclosure tool that Bramasol came up with. That’s based on the standard you’re able to drill into the required, 842 disclosure that the FASB recommends and be able to also get your five year table, but you’re also able to quickly pull up all the support for that disclosure, which you can give your auditors as well as it helps you do your analysis. And the next level on the S/4 HANA as they’re coming out with a lot of good KPIs that help you manage your business more effectively from lease cost standpoint, but also a revenue recognition standpoint. So you increase your efficiency as well as your profitability in the future.

Jim Hunt: So, what would you see as next steps for companies that are looking down the road and want to be able to optimize their compliance and ultimately use it to help them transform their business operations.

John Scott: Next steps for a company is to go out there and look at those tools that takes you out of that manual environment to more of a cleaner automation environment, get a good product that’s able to increase your efficiency for your organization as well as to lead some more analysis skills etc,. I mean SAP has got a great product, you know, Bramasol has a lot of experience implementing these products and it’s a really a good next step for these organization. It takes you out of just basic compliance to optimization and then in the future with the KPIs into transformation, which helps you really get a handle on your business. How much your leases are costing? You know what’s the best well purchase of my leases? Because you’re able to see when all those leases terminate easily. You’re also to see what you’re paying per square foot for real estate helps you get better prices there in terms of revenue recognition, you’re able to go out, figure out where are your revenues coming from, what the best price. So that revenue should be also be able to get those disclosures that are required, which are very onerous from a GAP standpoint, IFRS standpoint that need to be in the financial statements. You can easily produce those cuts down on your time that your people are spending working on. This reduces errors because you’re getting out of that spreadsheet environment to more automated environment. And it’s just a very good thing all around. So for next steps for me, I’m already complying. So now let’s go out and get the tools we need to automate this.

Jim Hunt: Sounds great. And, the a few minutes that we have left, you wanted to talk some about day two accounting and I’d love to hear your perspective on what day two accounting is and how it becomes enabled based on everything we just discussed.

John Scott: Absolutely. So, as I mentioned early in day two accounting, now that everybody’s in compliance with 606, now they’re looking to say, okay, what things affect day two accounting? And as I mentioned, there’s kind of three basic big items that affect day two accounting for ASC 606 compliance, one multi element arrangements. Well you recorded that initially, but now you’ve got maybe changes to that, to that vendor invoice where you added additional services or products. Now you’ve got to go out and calculate that standalone selling price. You’ve got to allocate that standing on selling prize to each element in the contract. And to be able to do that from an automated standpoint saves you a lot of time and money. Secondarily it’s variable consideration that’s a big deal. As I mentioned, every reporting period you have to go back and analyze to make sure your initial estimate for variable consideration sales has not changed.

If it’s changed, you’ve got to make adjustments to that, so being able to isolate which type contracts have variable consideration and being able to easily capture those and make adjustments to those and now analyze those is a big deal. The third is contract modifications from an ASC 606 stamp one as I mentioned, it’s a change in scope and pricing. You got to go in and make the necessary adjustments for those type contracts. Now from an ASC 842 you’re always entering in a new lease. You want to be able to easily track those leases for completeness, so you want your payable system linked to your lease accounting system to make sure you’re capturing all those. Somebody entered in a new lease, they may contain it, it doesn’t match what you have in your system. That’s day two. You got to make sure you’re capturing all those and that the amounts are the same. This is particular big important for real estate contracts, which have cam etc,. You only entered into a real estate lease and recorded what you can call just the base payment well that are going to change through your AP system because you’re paying cam, you want to be able to isolate those and make sure that those are just truly expensed items or are they new leases. So you’re able to capture that completeness standpoint from a standpoint of using automation easily as well as I mentioned earlier that the calculations are very onerous on go forwards just because you recorded them all at implementation day. Now you’ve got to capture all that information you need to properly account for all these leases in the future.

Jim Hunt: And essentially using the tools we’ve discussed in this conversation, it frees up your accounting staff to do at that higher level day two tasks rather than struggling with all of the non-automated brute force calculations. Essentially, the tools allow you to focus on what’s really important to exception focus and analysis rather than, struggling with the brute force. So it actually probably improves the work environment for your accounting staff as well because they’re not doing the ground work as much as they’re doing higher level value added work.

John Scott: It’s more interesting, you get out of that long gruelling hours at quarterly and you’re in close. It also improves audit efficiency, so which can take down your audit budgets, particularly to those external auditors who are expensive, and it also improves your future profitability for your organization because you’re able to do that transformation analysis that I’m talking about. So the S/4 HANA tools and our CLM disclosure package enables you to do that really efficiently.

Jim Hunt::Yeah and it sounds like it reduces your risk and improves your audit ability and the bargain as well.

John Scott: Absolutely. Absolutely.

Jim Hunt: That’s fantastic. This has been a really great discussion. John, anything that you want to add that you think we missed or in way of summary of what people should be looking at doing next?

John Scott: You know, as well summary, what people should be doing is going out and looking at these great tools we have and then looking at Bramasol, that’s have lot of experience implementing these because it’s a real big deal and I think it will really improve your organization from all of the things that just previously mentioned, efficiency, more accurate, reduction in costs, happier people able to really increase your profitability in the future.

Jim Hunt: That sounds great. Thank you very much for your time, John today. It’s really been informative. I know that our w listeners will appreciate it and I look forward to exploring more topics with you in the future. Thank you.

John Scott: Me too. I really appreciate the invite. Thank you so much.

Thank you for listening to this episode of Insight to Action podcast series. We hope that you found it helpful to ensure that you never miss a future episode. You can subscribe to Bramasol at iTunes or wherever you get your podcasts. For more information about Bramasol and detail on our solutions for compliance optimization and financial transformation. Please visit www.bramasol.com or email us at [email protected]

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