Image Courtesy of 123rf.com
The early maritime explorers faced a difficult challenge when they left the safe harbors of Europe; how not to get lost. To navigate their way across the seas, they relied upon constants within the physical objects around them – like the sun, the moon, and the stars. Using these constants, early explorers were able to circumnavigate the globe.
Like these early explorers, software and professional service firms are looking for constants to help navigate the shifting rules of revenue recognition. Trade winds, like ASU 2009-13 and the FASB and IASB joint revenue recognition project, create new accounting rules that change how revenue will be recognized by these types of firms in the future. CFOs and finance managers need to understand the complicated new rules in a timely manner or risk a shipwreck on the rocks of a restatement.
From our perspective, software and professional service firms need to have a thorough understanding of the following three areas:
1.Understand when to use the correct accounting model: The accounting rules are different if a firm is following a more traditional enterprise software model verse a Software as a Service (SaaS) model. In the more traditional environment, customers obtain the right to install software on their in-house computers. According to GAAP revenue recognition rules, under this more traditional model, the selling firm would be able to recognize more revenue upfront (assuming completion of delivery and contract terms). However, if the software company offers a SaaS arrangement, the customer is buying a hosted service, not an individual license. Firms engaged in a SaaS model need to allocate revenue over the life of the contract. To select which model is appropriate for their business, managers need a qualified navigator who understands revenue recognition and can evaluate which standard is appropriate for their business model.
2. Applying Vendor Specific Objective Evidence, or VSOE: (SOP) 97-2, software revenue recognition introduced the concept of “multiple-element arrangements.” These rules apply to software or professional service firms that bundle software or services with training, upgrades, and/or other elements all at a single price. To recognize revenue, firms need to determine what percentage of the final sales price belongs to each element and recognize the revenue for each separately, once delivery or completion of the element is made. The key to navigating this process is in allocating revenue amongst the elements based upon a percentage calculation. A simple example of the VSOE calculation is as follows:
Not calculating VSOE correctly can lead to devastating results. NEC Corp., a Japanese electronics company, was delisted from the NASDAQ Stock Market in October 2007 because of improperly recognizing revenue on bundled services. The SEC claimed that the company did not separate the bundled revenue on sales containing a hardware and software component.
3. Planning for new regulation and rules: According to the latest announcements, the joint project between the FASB and the IASB in regards to new revenue recognition rules may be complete as early as September of this year. The new rules will replace all of the accounting methods mentioned above with a single new concept called “Performance Obligations.” Under these new rules, all elements are assigned a specific price and accounted for using that price. So instead of calculating a percentage of the sales price for each element like you would under VSOE, each element will now be priced and accounted for individually. These new changes will impact everyone since the rule essentially replaces all of the old accounting standards and forces people to set a specific price for all elements of a sale.
Fortunately Bi101 is here to provide you with a navigational constant. In the same way that the explorers of old relied upon the North Star for direction, we offer guidance and an explanation of the tools that can be used to maneuver through the tricky waters of revenue recognition. Whether you are a software company, a professional service firm, or in an industry that needs to understand the accounting behind revenue, we can help. Click on our live chat button now if you would like to learn more about our services.
