Companies trust their tax departments with a highly sensitive and essential task. Direct (income) taxes usually are the second largest corporate expense, after salaries and wages. Failure to understand and manage this liability is expensive, whether because taxes are overpaid or because of fines and interest levied for underpayment. Moreover, taxes are a political issue, and corporations – especially larger ones – must be mindful of the reputational implications of their tax liabilities.

There are five interrelated requirements for the work that tax departments do:

  • The work must be absolutely accurate.
  • Corporate and tax executives must be certain that the numbers are right; therefore instilling confidence is key.
  • Certainty depends on transparency: Source data and calculations must be demonstrably accurate, and any questions about the numbers must be answerable without delay.
  • Speed is critical. All department tasks related to tax planning, analysis and provisioning can become sources of delay in core finance department processes. Being able to quickly execute data collection and calculations allows more time to explore the results and consider alternatives.
  • Control of the process is essential. Only particular trustworthy individuals can be permitted to access systems, perform tasks and check results. Control promotes accuracy, certainty and transparency.

In recent years it has become common for large and even midsize vr_Office_of_Finance_15_tax_depts_and_spreadsheetscompanies to automate their indirect tax management process. However, direct tax management has remained a backwater in its use of technology, a bastion of manual processes built on a heap of desktop spreadsheets. Our benchmark research on the Office of Finance finds that almost all tax departments in midsize and larger companies exclusively (52%) or mainly (38%) use spreadsheets for tax provisioning.

At one time desktop spreadsheets were the only practical tool available to tax departments. Today, however, there are alternatives and good reasons to use them. The inherent technology shortcomings of desktop spreadsheets make tax processes not only needlessly time-consuming (even using macros and other spreadsheet automation techniques) but also prone to errors and inconsistency. This is especially true if people must enter the same information multiple times, which increases the chances of mistakes. In addition, assumptions made and rationales behind formulas used in data transformations may not be documented or readily accessible to others in the organization. This legacy can be problematic even years later in an audit, especially if the individual who prepared the spreadsheet is no longer employed at the company. As with many spreadsheet-driven processes, auditing taxes and the underlying data and calculations is difficult and time-consuming. On top of all this, the effects of the desktop spreadsheet’s inherent shortcomings multiply with the size of a corporation. By their nature, spreadsheets hinder a corporation’s ability to understand tax issues and optimize related decisions.

Tax organizations shouldn’t put up with these outdated, counterproductive practices. New tools can help streamline tax processes and, along the way, give the tax department more clout in the company, as I have written. One dedicated tax management application is Vertex Enterprise, a single-platform approach to managing all types of taxes (direct and indirect) throughout the entire tax life cycle, from analysis through provisioning to audit defense, using a single data source. Calculating and accounting for direct taxes is complicated, largely because income tax laws can be convoluted, especially in certain industries. In addition, the larger the number of tax jurisdictions in which a business operates and the more numerous its subsidiary legal entities, the more complex tax management becomes.

Managing a company’s tax data well is essential to all tax-related processes because it can cut the tax department’s workloads, enhance visibility into tax calculations and facilitate tax planning. Vertex Enterprise includes a tax data warehouse (TDW). The basic rationale for a TDW is straightforward: It’s a data store that makes all tax data readily available and can be used to plan and provision a company’s taxes. However, handling tax-related data is a far more complex task than what’s required for statutory or management accounting. Until recently, that complexity overwhelmed available information technology. Today, however, the basic idea is finally realizable in a practical sense.

A TDW has several purposes: to ensure accuracy and consistency in tax analysis and calculations, improve visibility into tax provisioning and cut the time and effort required to execute tax processes. It can be useful because data management is one of the biggest operational challenges facing tax departments. That is, the information necessary for tax provisioning, planning, compliance and auditing may not be readily available to the tax department because accounting and other information is kept in multiple systems from multiple vendors. Our research on the financial close shows that 71 percent of companies with 1,000 or more employees use financial systems from multiple vendors. In addition, not all of the data necessary for tax department purposes is captured by the ERP system. In addition, data collected in a general finance department warehouse or pulled together in a financial consolidation system may not be sufficiently granular for the tax department’s purposes.

Moreover, U.S.-based companies’ ERP systems (the core technology for gathering transaction data) may not record transactions and journal entries at the legal entity level. If not, tax departments must repeatedly perform transformation steps to have data formatted and organized properly. (Other countries, such as Germany, mandate specifying the legal entity associated with every transaction.) Sometimes the data must undergo multiple transformations because, for example, the transaction information collected in an overseas subsidiary must be reported locally using the local currency and accounting standard, but it must be translated to the parent company’s tax books in a different currency using a different accounting standard. In some industries (such as financial services) there may be multiple local reporting standards, one for general statutory purposes and another reflecting specific rules for that industry demanded by some regulatory authority. In short, there are numerous data-driven headaches tax professionals have to address before they even get down to work. In addition, direct tax laws, regulations and rates change from year to year, requiring a company to make multiple adjustments to reflect those changes.

Managing tax-related data is especially difficult for larger companies with above-average tax complexity, as I’ve noted. Complexity is produced by the number of tax jurisdictions in which a company operates, the complexity of the tax codes of some jurisdictions (Brazil and India are notorious in this regard) and its own corporate structure (the number of legal entities and their ownership characteristics).

Vertex addresses data management issues with its Tax Data Warehouse, which brings together all financial data from multiple global general ledger systems. It collects all relevant data including subledgers, journal entries and transactions into a single authoritative repository for all open tax years that facilitates access and audit.

Another module, Vertex Tax Accounting, functions as a global tax consolidation system that provides provision and compliance functionality. It serves as a comprehensive tax subledger and automates the creation of routine tax journal entries, manages the creation of tax footnotes for regulatory filings. The software works with multiple vendors’ general ledger systems, under multiple accounting standards in multiple currencies. It automates tax-related calculations, including year-to-year adjustments, thereby improving the speed, control and accuracy of provision-related processes. Unlike spreadsheets, the system ties back to each individual general ledger.

Vertex Audit Support is built on the capabilities of its TDW, which makes all tax-related data readily available. Since it’s designed to serve the needs of the tax department, tax-related data for all open years is kept in an “as was” state, unlike data stored in general business data repositories, which may be deleted or modified for organizational purposes such as acquisitions, divestitures or reorganizations. Audit Support is designed to enable external tax auditors to drill down into individual transactions for supporting detail and examine individual calculations. This facilitates the audit process and reduces the tax department’s workloads in supporting audit requests.

vr_fcc_tax_insightCompanies that replace spreadsheets with dedicated tax software can spend less time on mechanical, repetitive tasks and more on those that make a difference. Tax data held in the TDW is available for modeling to explore the impact of different tax strategies. For example, modeling can help in determining the best approach to transfer pricing or gaining a clearer, more detailed understanding of the tax consequences of an acquisition or divestiture, or a legal entity reorganization. In our research a majority (53%) of companies said that having a better understanding of their tax positions could save them money.

As noted, direct taxes are a major cost to businesses. Corporations face an increasingly stringent environment as hard-pressed governments look for ways to increase their revenue. The evolving tax environment means that tax departments must be in the mainstream of finance organizations. Yet our research on the financial close finds that a majority of finance executives do not know how long it takes for their tax department to complete quarterly tax calculations. Executives who are not tax professionals usually do not appreciate the important difference between finance and tax data requirements. Corporations are constantly changing their organizational structure as well as acquiring and divesting business units. As these events occur, accounting and management reporting systems adapt to the changes in both the current and past periods. Tax data, on the other hand, must be stable. Legal obligations to pay taxes are based on facts as they exist in specific legal entities operating in a specific tax jurisdiction in a specific period. From a tax authority’s standpoint, these facts never change even as operating structures and ownershipVR_tech_award_winner_2013 evolve. Audit defense requires a corporation to assemble the facts and related calculations, sometimes years after the fact. A general finance data warehouse does not deliver this capability because it is not – and for all practical purposes cannot be – structured to satisfy the needs of a tax department, particularly those that operate in multiple jurisdictions.

I recommend that companies with even moderately complex tax requirements look into dedicated software such as Vertex Enterprise. It was recognized with a 2013 Ventana Research Technology Innovation Award in Office of Finance.  The readily accessible authoritative data set makes tax department operations more efficient. Reducing the time and effort to execute the tax department’s core functions frees tax professionals to conduct more useful analysis. In this challenging tax-levying environment, having tax data and tax calculations that are immediately traceable, reproducible and permanently accessible provides company executives with greater certainty and reduces the risk of noncompliance and the attendant costs and reputation issues. Having an accurate and consistent tax data warehouse of record gives corporations and their tax departments the ability to execute better in tax planning, provisioning and compliance.

Regards,

Robert Kugel – SVP Research

Revenue recognition standards for companies that use contracts are in the process of changing, as I covered in an earlier perspective. As part of managing their transition to these standards, CFOs and controllers should initiate a full-scale review of their order-to-cash cycle. This should include examination of their company’s sales contracts and their contracting process. They also should examine how well their contracting processes are integrated with invoicing and billing and any other elements of their order-to-cash cycle, especially as these relate to revenue recognition. They must recognize that how their company structures, writes and modifies these contracts and handles the full order-to-cash cycle will have a direct impact on workloads in the finance and accounting department as well as on external audit costs. Companies that will be affected by the new standards also should investigate whether they can benefit from using software to automate contract management or in some cases an application that supports their configure, price and quote (CPQ) function by facilitating standardization and automation of their contracting processes.

The soon-to-be-implemented revenue recognition standards (called ASC 606 or “Topic 606” in the U.S. and IFRS 15 in most other developed countries) will fundamentally change how companies that use contracts in business account for revenue from them. They will not affect those that rarely if ever use formal or implied contracts in the normal course of business. And almost all corporations that use standard contracts that cover a straightforward transaction (such as a one-time sale of some good or service) where the terms are satisfied within a relatively short period of time are likely to find little change to their accounting treatments and processes. However, corporations that don’t fall into these categories will benefit from a thorough re-examination of the structure and wording of their sales contracts and the processes they use for creating, negotiating and reviewing sales contracts.

To minimize the impact of the new revenue recognition standards on finance department workloads, companies ought to standardize sales contracts and automate as much of the order-to-cash cycle as possible. Although strictly speaking the new revenue recognition process requires companies to manage contracts one-by-one, companies can treat sets of similar contracts or similar performance obligations that are part of a contract in the same way if the overall impact on its financial statements will not be materially different from applying the same approach to the individual contracts or individual performance obligations. In other words, the specific wording of the sales contract is irrelevant if the substance of the contract or individual performance obligations that are part of that contract are substantially the same. Thus the objective of reviewing a company’s sales contracts is to find ways to achieve the highest possible degree of standardization (that is, making contracts, parts of contracts and performance obligations under those contracts identical) or commonality (achieving sufficient similarity to apply the identical accounting treatment). At the end of the review, controllers should be able to implement a process that can map all contract elements to a set of accounting treatments that are at least plausible under the new principles. (Compared to current U.S. accounting standards, the new approach to revenue recognition is more principles-based and far less prescriptive.) Such standardization is extremely helpful in a principles-based accounting approach because it will ensure consistency in how the company treats specific types of contracts and their specific elements. Doing so will facilitate internal reviews and external audits. It will also lay the groundwork for automating the classification of contracts and contract elements, which can reduce finance department workloads as well.

Up to now, a major concern in drafting sales contracts has been covering all the legal bases. Typically, how to organize a contract has been at best an afterthought. This will need to change. CFOs and controllers should insist that all of their sales contracts (or contract templates) be structured in a fashion to make it easy to account for them. By analogy, in the manufacturing world, engineers often constrain their designs to make a product easier or less expensive to produce (for instance, by using similar components across multiple products or relaxing tolerances) or cheaper to maintain (by making replaceable components easier to access). With the advent of the new revenue recognition standards, legal departments or outside counsel must now pay attention to the structure and wording of contracts to facilitate accounting and auditing processes. In negotiating the wording of a sales contract, company representatives must be trained to be sensitive to changes that can have a material impact on revenue recognition from the standard and also to understand when such changes will not make a difference. In the new revenue recognition regime, “sloppy drafting” now includes needless complexity or lack of standardization in a sales contract, not just ambiguities and omissions. Moreover, as much as possible, the wording of the contract should include language that clarifies the accounting treatment by the seller. For example, explicitly stating whether intellectual property that is part of a performance obligation is either symbolic or functional simplifies accounting and auditing by eliminating a potential ambiguity. Making the distinction explicit is useful because that characteristic determines whether revenue from that intellectual property must be recognized over the term of the contract (if it’s symbolic) or at a point in time (if it’s functional). It’s important for finance executives to work with their legal department or outside counsel to appreciate the importance of having sales contracts that minimize workloads for their department. Our benchmark research on recurring revenue suggests thatvr_Recurring_Revenue_06_finance_less_satisfied_with_invoicing it’s common for people working in one part of a business to be unaware of issues their colleagues in other parts face. For example, when it comes to invoicing the research finds a major disconnect between the finance department and the rest of the company. Nearly half (47%) of participants working outside of finance and accounting said they are satisfied with their company’s ability to produce invoices for their recurring charges, compared to only 29 percent of those in accounting roles. The gulf between the two reflects the reality that when parts of a business process are performed without regard to their impact on finance department operations, invoicing becomes a highly labor-intensive effort. Indeed, of those not satisfied with their invoicing, four out of five (79%) said it requires too much work, two-thirds (68%) said it involves too many resources, and more than half (54%) said it takes too long.

To be sure, standardization is either difficulipt or impractical for very large or complex transactions. And, in some cases, customers will insist (successfully) on writing the sales contract “on their paper.” (That is, the buyer’s side provides the contract that forms the basis of the negotiated result in order to better control the negotiating process and minimize the risk of the buyer being subjected to unfavorable terms and conditions.) However, unless these instances are common and unavoidable, they amount to exceptions that do not affect the need for consistency and commonality in a company’s sales contracts. Even in the case of exceptions, corporations should define and document a standardized framework and process for determining how to handle the accounting in the five-step revenue recognition framework laid out in the standards as easily and consistently as possible.

Invoicing and billing are a part of the order-to-cash process that benefits from automation. This process is relatively straightforward for companies that exclusively or mainly have contracts for stand-alone transactions where the performance obligations to the customer are met over a relatively short period of time (no more than a month or two). Generally, ERP or corporate financial management systems will be able to automate the process and related accounting.

vr_Recurring_Revenue_07_dedicated_system_users_are_more_satisfiedHowever, companies that engage in subscription or recurring revenue relationships with customers, or those that have contracts covering longer-lived transactions (such as projects), will find it useful to have dedicated software to automate their invoicing and billing and serve as an authoritative source system that drives revenue recognition. Subscription and recurring revenue relationships often involve frequent changes to deliverables, which complicate invoicing and billing as well as the revenue recognition process under the new standards. In our research more than twice as many (86%) companies that use a third-party dedicated billing system said they are satisfied or somewhat satisfied with the software they use for invoicing as those that use spreadsheets (40%).

Finance executives in companies that will be subject to the new revenue recognition standards should not overlook the impact that the structure of their sales contracts and contracting process can have on their accounting department.  I recommend that they scrutinize their contracts and contracting processes to determine how their design can be used to minimize finance department workloads under the new standards. They should examine how well their contracting processes are integrated with invoicing and billing and any other elements of their order-to-cash cycle, especially as these relate to revenue recognition.

Regards,

Robert Kugel – SVP Research

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