One of the main purposes of the Financial Accounting Standards Board’s new revenue recognition standard, ASC 606 and IFRS 15, is to eliminate industry-specific guidance in order to create more consistent reporting across all types of organizations. That means its effect will vary depending on your industry, from “no big deal” to a “very big deal.” Software and technology fall very much into that latter category.
According to PwC, “revenue recognition within the software industry has historically been highly complex,” and under ASC 606, it’s “expected to be one of the areas most impacted by the new standards.”
Fortunately, automated solutions exist to help tech companies deal with these issues, and they are usually the most open (hopefully) to using technology to solve business problems and challenges. But more about that in a minute.
“Determining how to allocate consideration among elements of an arrangement and when to recognize revenue can be extremely complex,” PwC says. Here are some items that software and technology companies should be on the lookout for when dealing with 606.
Know what’s in the contract
Software deals often include side agreements, either verbal or in writing, which may create enforceable rights and obligations. These need to be considered when recognizing revenue.
“The assessment of whether a contract with a customer exists under the new revenue guidance is less driven by the form of the arrangement, but rather by whether an agreement between the parties (either written, oral, or implied) creates legally enforceable rights and obligations between them,” PwC says.
It’s also common in the industry to change the scope or price of the contract, such as when a vendor licenses additional software to the same customer after the original contract is signed. Suppliers must closely track any and all contract modifications.
Under the new guidance, your finance team will need to identify separate performance obligations in your contacts with clients. That’s “a significant change for companies in the software industry,” PwC says. There is also specific guidance on how to account for intellectual property licenses.
What’s the real price?
Determining the actual transaction price of a contract is more clear-cut when the contract price is fixed, but it can be more complex when there are variables, which is often the norm in software contracts. These can include things like discounts, rebates, refunds, credits and the like. Finance must be able to estimate all these to determine the transaction price, as well as any adjustable, non-cash considerations. It must also be able to evaluate whether a “significant financing component” exists.
Allocate the transaction price
Many contracts involve the sale of more than one good or service. Under 606, the price of each must be allocated to its corresponding performance obligation based on what each item was worth if sold separately. And of course, each allocation must consider any variables, like discounts.
Risks and rewards versus control
The current accounting guidance is more focused on the transfer of “risks and rewards” while 606 is more concerned with the transfer of “control.” So the timing of revenue recognition could change for some companies depending on the circumstances.
We recommend reading the PwC report for all the details.
An automated solution
As you can see just from this brief summary, there’s definitely a lot to consider. A revenue recognition system that automates the whole process can help address all of the various revenue recognition and sales expense challenges posed by ASC 606.
Learn more about how to use automation to address ASC 606 challenges here.