Last week, shares of Super Micro Computer (NASDAQ: SMCI) tumbled by 30 percent after the company disclosed the resignation of its public accounting firm, Ernst & Young (EY). The resignation, which was announced in a regulatory filing, resulted from issues that EY had with Super Micro Computer’s transparency, governance, and integrity in its financial reporting.
The resignation by EY adds validity to claims made in August by Hindenburg research (a noted short seller) of financial misrepresentation. In 2020, Super Micro had already paid a substantial, $17.5M, settlement with the SEC for premature recognition of revenue and improper expense handling.
The important take-away from these events is they are costly, both in terms of hefty fines as well as the impact on the stock price (not to mention a publicly embarrassing situation), but they could have been avoided. SaaS applications are emerging that are capable of processing complex revenue by policy that is configured within the system. Processing occurs with all the security, controls, and auditability available in a contemporary SaaS application.
Super Micro could have agreed on a policy for recognition of revenue with its auditors that would have then been configured into the system. From there, it is a simple matter to understand, via control reports provided by the system, if there were recent changes to the policy, and, if so, what they were, who made them, and when they were made. Similarly, it is a simple matter to understand if any revenue was tampered with manually (i.e., outside of the policy), and, if so, what the changes were, who made them, and when they were made. In this approach, there is no subjective judgement about when to recognize revenue, whether in aggregate or on a deal-by-deal basis. All revenue is recognized according to the agreed upon policy (also stated in the 10k), and the only remaining questions are around whether anyone touched anything to change the policy or process outside the policy.
If Super Micro had committed to recognizing revenue via system enforced policy, it would have given its accounting firm a set of controls to ensure that the policy was consistently applied. Although the details of the Super Micro Computer situation are not public, the situation serves as a reminder to companies on why transparency and consistency is important.
The Benefits of Adopting a Revenue Policy
Consistency and Accuracy
Standardized revenue recognition and reporting policies allow for consistency and accuracy for every involved entity, including accounting firms, investors, and regulatory agencies. This consistency makes reporting easier for compliance purposes and for key audiences, such as investors.
Compliance with Standards
Companies must meet the requirements of ASC 606 / IFRS 15, and a policy based around the five steps of the standard should have more accurate financial statements and better financial metrics.
Transparency and Comparability
A policy that is transparent, fully audited, and automatically applied within a system ensures that a company’s financial systems have necessary controls in place to avoid the situation listed in this article.
Minimizing Errors and Fraud
Having a standardized approach makes inconsistencies or manipulations easier to identify. By adhering to a clear, enforced, auditable policy, firms can better prevent errors or and have controls in place to prevent intentional misstatements that could be detrimental to the company.
Audit Readiness and Verification
A consistent policy makes it easier for auditors to verify revenues and detect potential discrepancies. This removes all manual touches thereby eliminating mystery, guesswork, and potential error-conditions (unintentional or otherwise) so consumers of a company’s financials can have confidence in the results.
What Should a Good Revenue Recognition Policy Contain?
Adherence to Standardized Guidelines (IFRS or FASB)
The revenue recognition practices should fall under the tenants of ASC 606 or IFRS 15, which follow a five-step process for recognizing revenue based on the contract with the customer. As part of the compliance adherence, the system should automate alignment with ASC 606 and IFRS 15 requirements. The company and auditor should confirm the five steps of the process are properly configured within the policy.
Detailed Contract Review Processes
Customer contracts should be managed to identify all performance obligations, terms, and pricing structures. The policy should include protocol on how to handle complex contracts, such as those with multiple performance obligations, variable considerations, or contingent terms.
Comprehensive Disclosure Requirements
These requirements help to achieve full transparency in financial disclosures, especially for areas where management judgment or estimates play a significant role in revenue recognition. These requirements should also provide clear details on any revenue deferrals, cost allocations, and criteria used for recognizing revenue. These disclosure statements should be derived directly from the calculations incorporated by the system as it executes the agreed upon policy driving the recognition of revenue.
Ongoing Monitoring and Audits
Companies should conduct regular internal audits and leverage available control reports to evaluate policy adherence, with particular care paid to high-risk transactions. In addition, the plan and approach should include time for external auditors to review and test revenue recognition practices.
Training and Ethical Standards for Staff
Finally, the company should include training for finance, sales, and accounting firms on acceptable practices, compliance, and ethical standards, with higher levels of training required for individuals with higher levels of access to the system.
By leveraging a systems controls structure to maintain strict adherence to these policies, a company can reduce the risk of financial misstatements and retain the confidence of auditors, investors, and other stakeholders.
In summary, leveraging a system to enforce a revenue recognition policy that is agreed to with your auditor removes the possibility for the types of questions that led to the costs and brand damage experienced by Super Micro. It would have helped Super Micro avoid the situation with EY. The policy would be automated in a secure, controlled, auditable system. The system, in turn, would eliminate the chance of malfeasance and allow for strong transparency of how revenue is processed by the system. The result would be a process that minimizes the chance for events that could be extremely expensive and damaging to the brand.
The SOFTRAX Advantage: Process by Policy
The SOFTRAX Revenue Management System (RMS) is designed to process by policy, making it a natural choice for enterprises and auditors alike. SOFTRAX RMS introduces enterprise-level automated functionality to streamline revenue lifecycle management from orders to billing and contract renewal management to automation of even the most complex requirements of ASC 606 and IFRS 15. SOFTRAX RMS is designed to advance your path toward continuous accounting. With SOFTRAX, companies drive far more consistency, security, controls, and transparency to their revenue processes with a single solution.
Don’t take our word for it. See these customer testimonials where full revenue recognition automation was achieved.
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