With Time and Materials engagements, reports and dashboards in Ruddr show revenue as the hours are worked. Note that you can only see revenue in Ruddr if your security role has permission to view revenue. In that T&M scenario, if a project team works 10 billable hours in a given day, the associated revenue will be immediately reflected on Ruddr's reports and dashboards. With fixed fee projects, however, revenue is recognized at specific points in time and not as billable hours are entered.
Why is Revenue Recognition Important?
Revenue recognition for fixed fee projects is important because it aligns revenue with the work that is being delivered. As an example, assume that your company sells a $100,000 project and the contract states that 50% of the fee will be invoiced up front and 50% will be invoiced one month after the project is completed. In that scenario, you invoice the client $50,000 today, even though you may not start the project until next month. Then, you invoice the final 50% one month after the project has been fully delivered. If you recognize the revenue as it is invoiced, your income statement will show $50,000 in two months in which your team did none of the project work. This creates a "lumpy" income statement and makes the business difficult to manage.
Without a proper revenue recognition approach, the revenue and profit figures for the firm tend to swing wildly from one month to the next. Since revenue is not aligned to the work that is being delivered, key performance indicators such as effective bill rate and services gross margin become skewed. For any firm of scale, proper revenue recognition of fixed fee projects becomes mandatory.
Brief Background on Accounting Standards in the United States
In the United States, the Financial Accounting Standards Board’s (FASB) most recent revenue recognition standard, ASC 606, outlines how companies should recognize revenue from customer contracts. ASC 606 is lengthy and most small-to-midsized professional services organizations are better served by following the AICPA's Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs). The FRF for SMEs is an alternative to accounting principles generally accepted in the U.S. (GAAP) with the goal of making it easier for privately owned businesses to prepare their financial statements. For U.S. services firms that are not publicly traded (and do not intend to become publicly traded), FRF for SMEs is likely a better choice than ASC 606. FRF for SMEs stipulates that revenue should be recognized using a percent complete method.
Most countries have similar standards related to revenue recognition and many are modeled after FASB's ASC 606 standard. Refer to your country's tax accounting and tax laws for guidance.
Revenue Recognition Methods in Ruddr
Revenue on a fixed fee project can be recognized in Ruddr using four distinct methods, two of which are automated. These methods are:
- As Invoiced
- Manual
- Automated - Percentage of Billable Hours
- Automated - Percentage of Time & Materials Revenue
The workspace's default method can be set within the Project Settings section (Figure 1) of workspace settings. The default can be overridden on a per-project basis as needed.
Figure 1 - Specify the Default Project Revenue Recognition Method in Workspace Settings
As Invoiced Method
Every fixed fee project, regardless of the revenue recognition method, has a Fixed Fee Billing Schedule on the Accounting tab of the Edit Project drawer. This is a schedule of the invoice milestones for the project and it includes the date and amount of each milestone. This ledger tells Ruddr when to include fixed fee invoice milestones on the Ready to Bill screen.
Figure 2 - Fixed Fee Billing Schedule
With the As Invoiced revenue recognition method, revenue for a milestone is recognized as of the Issued Date of the invoice that contains the milestone. This approach can work fine if the project will be invoiced in a manner that roughly aligns with the planned labor expenditure. But, if a significant portion of the fees will be invoiced in advance or at the end of the project, the As Invoiced method is not the best option. For those scenarios, one of the remaining three revenue recognition methods is optimal.
Manual Method
With the Manual revenue recognition method, a Revenue Recognition Ledger (Figure 3) will be shown on the Accounting tab of the Edit Project drawer. The manual method provides you with complete control over when revenue will be recognized on the project. Revenue will be recognized independent of the billing schedule, and a billing schedule is not even required in order to recognize revenue.
Figure 3 - Revenue Recognition Ledger
The manual revenue recognition method can be ideal for firms that want the project manager to determine the percent complete on a periodic basis and make the appropriate entry in the ledger.
Automated Methods
While calculating revenue recognition manually is often appropriate, it is usually a time-consuming and error-prone process. To alleviate those downsides, Ruddr provides two automated revenue recognition methods. These methods are Automated - Percentage of Billable Hours and Automated - Percentage of Time & Materials Revenue.
Ruddr performs automated revenue recognition either once per week or once per month, for all fixed fee projects in the workspace that use an automated method. The timing of the automated revenue recognition process can be set within the Project Settings of Workspace Settings, as shown below.
Figure 4 - Automated Revenue Recognition Process Configuration
Ruddr will run the process for fixed fee projects that use an automated method and create a revenue recognition entry for the previous week or month. Additionally, if a project leverages resource allocations, Ruddr will create the expected future revenue recognition ledger entries. Each time Ruddr runs the revenue recognition process, it will recreate the future revenue recognition ledger entries in order to keep the project's forecasted revenue accurate.
Advantages of Weekly Automated Revenue Recognition
When a project recognizes revenue once per month, specific metrics on the project can become skewed throughout the month. For example, if you are recognizing revenue on the last day of each month, labor costs accrue throughout the month (as time is entered) but there is no revenue until the end of the month. This causes the effective bill rate and services gross margin metrics to get worse until the end-of-month revenue recognition entry is created.
By setting the automated revenue recognition process to run weekly, revenue will accrue more frequently and project metrics will be more accurate throughout life of the project.
Percentage of Billable Hours Method
Requirements:
- Services Revenue Budget (Summary or Detailed)
- Billable Hours Budget (Summary or Detailed)
Please refer to the Create a Project Budget for more on these required budgets, including information on Summary and Detailed budgets.
The Percentage of Billable Hours automated revenue recognition method requires that the project is configured with a services revenue budget and a billable hours budget. The budget can be either a summary budget or a detailed budget.
When Ruddr calculates revenue recognition based on the percentage of billable hours, it performs the following steps:
- Ruddr first determines the total billable hours that have been worked on the project to date through the end of the recognition period.
- Ruddr then calculates the total projected billable hours to complete the project. This is the greater of 1) the project's budgeted billable hours; or 2) the project's actual billable hours plus future allocated billable hours (if the project is using allocations).
- Ruddr divides the total worked hours through the period by the total projected hours calculated in the previous step. This yields the percentage of the projected hours that have been delivered through the period.
- Ruddr multiplies the services revenue budget by this percentage to determine the amount of services revenue that should be recognized through the end of the period.
- Ruddr then subtracts the sum of the previously recognized revenue from the total calculated in the previous step in order to determine the amount of revenue to recognize for the given period.
If the project has allocations, Ruddr will follow this same process to generate future forecasted revenue recognition. All revenue recognition entries will be shown in the Revenue Recognition Ledger and can be updated by any member that has permissions to edit the project.
Percentage of Time & Materials Revenue Method
Requirements:
- Each project member or project role must have a bill rate
- Detailed Budget with billable hours budgets set for each role or member
For more on these requirements, please refer to the Project Bill Rates and / or Create a Project Budget Help Center articles.
The Percentage of Time & Materials Revenue automated revenue recognition method requires more information than the previous method. With this method, the project must use a detailed budget with the appropriate billable hours budget set for each role or member (depending on whether or not the project uses roles). Also, this method requires that each role or member have a bill rate. While bill rates do not impact the invoice amounts of a fixed fee project, they do impact revenue recognition under this method.
When Ruddr calculates revenue recognition based on the percentage of time and materials revenue, it performs the following steps:
- Ruddr first determines what the budget services revenue on the project would be if the project had used a Time & Materials billing type. Ruddr can calculate this T&M services revenue budget by using the budgeted hours per role/member and the associated bill rate per role/member.
- Ruddr then determines what the T&M services revenue for the project to date would be through the end of the given period.
- Ruddr calculates the total projected T&M services revenue for the entire project. This is the greater of 1) the budget T&M services revenue from the first step above; or 2) the past T&M services revenue plus the future forecasted T&M services revenue based on the project's resource allocations.
- Ruddr divides the T&M services revenue to date by the total projected T&M services revenue calculated in the previous step. This yields a percentage of the T&M services revenue that has been delivered through the period.
- Ruddr multiplies the actual services revenue budget for the fixed fee project by this percentage to determine the total amount of services revenue that should be recognized through the end of the period.
- Ruddr then subtracts the sum of the previously recognized revenue from the total calculated in the previous step in order to determine the amount of revenue to recognize for the given period.
As with the previous automated method, Ruddr will generate future forecasted revenue recognition entries based on the project's resource allocations. However, the percentage of time and materials revenue process will be followed in generating these future entries.
The Percentage of Time & Materials Revenue method is particularly useful for companies that have widely varying labor rates. For example, if a company has offshore labor at lower effective bill rates, Ruddr will recognize revenue more accurately using the percentage of time & materials revenue approach.
Negative Revenue Recognition
With either of the automated revenue recognition methods, it is possible that Ruddr will create a negative revenue recognition entry for the given period. This would happen if Ruddr determines that too much revenue has previously been recognized through the period. There are a variety of reasons as to why that could happen, including scenarios where the services budget was decreased, the hours budget was increased, or the allocated hours were increased.
Past Revenue Recognition Entries will not be Updated
It is important to point out that Ruddr will only create or replace revenue recognition ledger entries for the current period and future periods as part of the automated revenue recognition methods. Ruddr will never modify or delete prior revenue recognition ledger entries. This is important as finance personnel typically do not want values of closed accounting periods to be changed.
Completing a Fixed Fee Project
When a fixed fee project that uses manual revenue recognition or either of the automated methods is set to Completed, Ruddr will check to see if there is remaining budget services revenue to be recognized. If there is, Ruddr will ask the user if it should recognize that remaining revenue (Figure 5). If the user confirms, a row will be added to the revenue recognition ledger to recognize the remaining budget services revenue.
Figure 5 - Recognize Remaining Budgeted Services Revenue