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What’s all this fuss about revenue recognition with agencies? Isn’t revenue recognized when we just bill the client???
What do accountants know about financial reporting for advertising and marketing firms anyway?
We will further discuss the technical definition of revenue recognition from the authorities at the AICPA in a moment.
In the meantime, here are some examples of agency activities rendered and to ponder WHEN the associated revenue should show up on your income statement.
- Is the work related to a new marketing strategy that took 6 months to create and execute?
- Does this have anything to do with 20 separate layouts that were rendered in a week and only billed to the client one month later?
- We just advance billed the client 100% of the estimated amount. Isn’t that all revenue the day we invoice it?
- We tend to only bill the client every other month because they will only accept invoices every 60 days. Does this impact revenue?
The question to ask yourself is at WHAT POINT IN TIME does one recognize revenue on your income statement in this wacky industry?
In part, each of those marketing efforts above has a connection to revenue recognition.
Before we talk further about this topic, let’s clarify the industry definition of revenue as Adjusted Gross Income (otherwise known as Gross Billing less direct Costs of billing) (AGI). The industry compares AGI to their salaries and benefits as well as their overhead costs. In this article, we will refer to revenue as AGI for purposes of the revenue recognition discussion.
Differences in understanding revenue between two sets of people in an agency
Let’s put a framework around our discussion. The accountants in the agency (otherwise known as the department receiving the least amount of recognition and respect) often have a disconnect with the rest of the agency.
Their job is to report financial results while the rest of the agency is busy doing the work. Oddly enough, the two areas often do not speak the same language, particularly regarding revenue recognition.
In part, it’s because account management didn’t have to worry about this topic when they were being educated. The accountants, on the other hand, had this drilled into their heads when they were trained to do accounting!
Direct agency personnel are primarily concerned with getting signoffs from the client, scheduling the projects, and delivering the work while the folks in accounting are responsible for recording these activities financially. Although…I just had a thought. Imagine if the roles were reversed…oh boy.
Oftentimes these two groups of people tend to have different interpretations about revenue recognition. Many account management people “feel” that revenue should be recognized when it is billed. Well...that is not quite accurate.
For those of you who have not yet read ASC 606 (this article may compete heavily with a Zoom status call attended by 25 staffers), this is something that owners, account people and even accountants need to read to best understand revenue recognition.
It was specifically called Accounting Standards Codification 606 or if you want to be cool with senior management, you would just call it ASC 606.
Here it is in all of its glory;
This pronouncement was created by the American Institute of Certified Public Accountants in 2014 regarding Revenue Recognition for public and private companies.
Sadly, there was NO specific exclusion for the ad industry.
Why is this worth a read before the end of the year? Because it goes into a long conversation about revenue recognition and then you can better understand if you comply with this reporting methodology or nowhere even close to it. By the way, this article is about financial reporting and not about income tax minimization.
ASC 606 lays out a 5-step process for Revenue Recognition;
- Step 1 Identify the contract with the customer.
- Step 2 Identify the performance obligations in the contract.
- Step 3 Determine the transaction price.
- Step 4 Allocate the transaction price.
- Step 5 Recognize revenue when or as the entity satisfies the performance obligation.
Note how step five emphasizes “performance obligation” and not merely billing the client.
All ad agencies should follow the same revenue recognition methodology to capture and report financial data consistently so that readers of this financial information do not have to attempt to interpret revenue in several different ways but they don’t for a myriad of reasons.
When I travel across North America engaging with agencies it's altogether another thing. In many cases, it is as if managers/owners report revenue in their very own special way without paying any attention to how it is supposed to be recorded. You know who your culprits are…
Here are several examples of how agencies incorrectly recognize revenue;
- Agencies often advance bill clients for work-yet-to-be-performed and they post it all to revenue. The mere act of issuing an invoice to a client is not the trigger point for revenue recognition. The operative phrase is “work-yet-to-be-performed”. A violation of Step 5 above.
- Some agencies will invoice their clients a periodic “retainer” at the beginning of the month and recognize the entire amount as revenue and not compare the billable hours or the deliverables during the month. Agencies need to see if they have rightfully earned this revenue. A violation of Step 5 above. Again.
- Upon visiting one of my clients, I learned that they only recognize revenue at the completion of the job when they invoice the client. Over the lifetime of the job that might run for months, salaries and rent continue to be paid out month after month and no revenue is recorded in any of the previous months. Agencies need to record revenue as it is being earned. This is a violation of Step 4 AND Step 5 above.
- I have seen some agencies gross bill their clients inclusive of reimbursable media or production costs (with or without a markup (or commission)) and record the revenue in the period they invoiced their clients with no offsetting accounting for the related cost of sales. The related cost of sales is often recorded in a subsequent month. Therefore, the AGI is misstated in both periods. This not only violates the matching principle in accounting but also Step 5 above.
The four examples above are what I see every...blinking…day in my travels.
How does an agency do a better job at reporting revenue?
Here are some tangible thoughts to do so;
- Have a more experienced accountant (inside or outside) who knows the accounting rules, have a look at how you are currently recording revenue compared to ASC 606. A billing manager (and I have the greatest respect for a billing manager), is not interested in reporting. They just want to get the client invoice out. They will not necessarily understand the subtle nuances of ASC 606. An experienced accountant will.
- Have an all-inclusive Project Management/Accounting Software program that can keep an eye on billable hours against advance bills. Then an internal client invoice may be generated monthly to apply the billable time for the month against the advance billing and carryover the unused balance…unless your client contract states differently.
- The same as above but one would look to see how many tasks were completed compared to the total required tasks to see what percentage of the job was completed for a percentage of the advance billing to be recorded as income. Revenue could, once again be recorded internally similar to the example above with an internal client invoice.
- Account for unbilled time if you do not advance the bill to clients. Why? If you have satisfied the performance obligations for your client, then you can recognize revenue on those particular jobs. You will have to start accounting for this using Work-in-Process (WIP) as well (please refer to my WIP article from January 2023.
- Have a revenue recognition training session with ownership/executive leadership and the head of accounting so that something so important as revenue recognition can be trained, discussed and everyone can be on the same page so that the financial reporting starting in 2024 can be accurate, complete, and even follow ASC 606! Do NOT start me on the cash basis of accounting by the way…
- In the meantime, HAPPY HOLIDAYS all, and more than pleased to clarify or further expand on this very important topic for enquiring minds in the industry!
Vincent G. Dong, CPA