Magazine article Business Credit

SOP 97-2 and Revenue Recognition: Should Credit Executives Know or Care What It Is?

Magazine article Business Credit

SOP 97-2 and Revenue Recognition: Should Credit Executives Know or Care What It Is?

Article excerpt

The proper recognition of revenue has become a hot issue for many firms during recent months. Especially within the software industry. In 1997, a number of companies made business and economic headlines due to difficulties created by improper recognition of revenue and the reporting of such revenues in their quarterly and annual reports. The publicly traded firms involved suffered significant losses on the NASDAQ and NYSE when their corrected revenue results were published. In at least one instance, several individuals were dismissed as a result of improperly reporting revenues of a foreign division.

Whether they realize it or not, virtually every credit executive is touched by revenue recognition. One oversimplified example is a credit executive's responsibility for his or her firm's reserve for bad and doubtful accounts. This reserve is impacted by accounts that were considered as collectable when billed, but when they become seriously past due, must be reclassified as doubtful because collection is no longer predictable. Revenue recognition can be relatively simple, or simply complicated. It depends on the type of products a company sells.

The guidelines for properly recognizing revenues are set out by the FASB (Financial and Accounting Standards Board) and AICPA (American Institute of Certified Public Accounts' SOPs (Statement of Position). Almost everyone in the credit industry knows the acronyms GAAP (Generally Accepted Accounting Practices) and GAAS (Generally Accepted Accounting Standards). In simple layman's terms, SOPs are guidelines to proper accounting procedures under GAAP and GAAS.

As an accounting procedure, revenue recognition is the moment when the dollars generated by the sale of product(s) or service(s) are "recognized" as revenue. This is not to imply that recognition and recording of revenue means the same thing and/or occurs simultaneously. So, why has revenue recognition become such a concern? Most businesses, other than those in the software industry, recognize revenue at the time of shipment. Sounds simple doesn't it? Ship the product - whatever it is - and recognize the revenue.

Revenue recognition is important to the functions of reporting, budgeting, profitability and taxation (as outlined in figure 1).

Information from revenue recognition reporting provides management with the ability to manage investments and/or expenditures on a smooth, well-planned basis. Earnings become more predictable.

SOP 97-2 (American Institute of Certified Public Accounts Statement of Position) applies to companies that earn revenue from licensing, selling or otherwise marketing computer software. SOP 97-2 supercedes SOP 91-1. All transactions occurring in fiscal years beginning after December 15, 1997 fall under the guidelines of SOP 97-2. It does not apply to revenue earned from products and services containing software that is incidental to the products or services as a whole. As an example, if you sell hardware which includes incidental software, SOP 97-2 requirements do not apply.

SOP 97-2 sets out four criteria that must be met before a software company can recognize revenue:

* Evidence of agreement - contract

* Fixed vendor pricing or agreement

* Deliverable product

* Collectability is probable

Within the software industry, all of the above criteria may often be met simultaneously. Revenue recognition does not simply occur upon billing as it does in other industries.

Additionally, under SOP 97-2, revenue from multiple element arrangements - arrangements including additional software products, upgrades or enhancements, rights of return or exchange software and PCS (post-contract customer support) - must be recognized as the four criteria listed above are met for each element separately.

In response to SOP 97-2, many software companies have taken the following steps:

* Rewritten their finance policies and procedures to include the new requirements of revenue recognition. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.