Magazine article Strategic Finance

Recognizing Software Revenue: ASU 2014-09 Likely Will Lead to More Aggressive Revenue Recognition for Software Companies

Magazine article Strategic Finance

Recognizing Software Revenue: ASU 2014-09 Likely Will Lead to More Aggressive Revenue Recognition for Software Companies

Article excerpt

The Financial Accounting Standards Board (FASB) in conjunction with the International Accounting Standards Board (IASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, in May 2014. Although much of the new standard is similar to existing guidance, there are a number of important changes. The new standard will likely impact most companies reporting under U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

One affected area is software revenue. The updated standard uses a different process to allocate the contract value and related discounts with the contract by eliminating the need to establish vendor-specific objective evidence (VSOE), which may produce more aggressive revenue recognition. The new guidance also relaxes other requirements that could accelerate revenue recognition depending on the company and contract-specific factors. These changes can increase revenue substantially.

ASU 2014-09 (as amended by ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date) is effective for annual and interim periods beginning after December 15, 2017, with earlier application for annual periods beginning after December 15, 2016, currently permitted by IFRS and U.S. GAAP Because companies must present comparative years' financial statements, they must design systems to collect information now. Table 1 summarizes the main differences between the current and the new standard that will appear in our discussion.

THE NEW STANDARD

ASU 2014-09 affects all companies with contractual goods and services and supersedes the revenue recognition guidance of Accounting Standards Codification[R] (ASC) Topic 605, Revenue Recognition, and most current industry-specific guidance.

Under the new standard, companies must follow a five-step process to reflect entitled revenue under the contract:

1. Identify the contract,

2. Identify performance obligations,

3. Determine the transaction price,

4. Allocate the transaction price to the performance obligations, and

5. Recognize revenue as performance obligations are satisfied.

Companies selling perpetual licenses must also consider additional factors before recognizing revenue. They include:

* Using a stand-alone selling price (SSP) to recognize revenue rather than VSOE. (SSP is a typical product sales price when the company sells each component separately)

* Allocating the contract price to interest income for contracts with extended payment terms.

* Deciding whether a contract exists for accounting purposes if collectibility is in question.

Per the current software accounting rules under ASC Topic 985, Software, companies must examine software contracts that include multiple deliverables for separate units of accounting to allocate the transaction price to each separate deliverable based on VSOE. If a contract includes both software and nonsoftware deliverables, first allocate the total contract price between the software (as a group) and nonsoftware components (as a group) using the relative selling price method. Then allocate total consideration to the software deliverables (as a group) among the software elements using the VSOE guidance outlined in ASC Topic 985. If VSOE isn't established for one or more contract elements, the residual value typically allocated to the software element must be combined into a single unit of accounting and recognized upon satisfying the revenue recognition criteria for all elements lacking VSOE, delaying revenue recognition allocated to the software over the longest period of time.

REVENUE RECOGNITION SCENARIO

Let's examine a hypothetical example that compares the current revenue recognition standard for software (ASC Topic 985) to ASU 2014-09, particularly (1) applying VSOE when allocating the contract price to multiple deliverables, (2) accounting for contracts when collectibility is questionable, and (3) allocating the contract value when deliverables lack VSOE. …

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