As an owner of a small privately owned software company, you may have heard about the new revenue recognition standards issued by FASB (Financial Accounting Standards Board) in Topic 606 Revenue from Contracts with Customers. This may matter to you if you have GAAP reporting requirements for banking or other needs. Your tax return position may also be tied to your use of the accounting standard if you are deferring revenue from upfront customer payments.
GAAP revenue recognition standards historically provide that revenue is recognized as earned. Specific revenue guidance was provided for different industries. The general guidance in the software industry was, that there must be a valid contact, the software must be delivered, and the fees must be fixed or determinable and collectible.
The new revenue recognition standard now provides a framework that is applicable to all industries. The new revenue recognition standards (ASC 606) offer flexibility in revenue recognition interpretation and pricing strategies. The new standard also allows for judgements and estimates.
To comply with the new standards, 5 steps must be taken:
- Identify the contract with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price.
- Recognize revenue when or as the entity satisfies a performance obligations.
The accounting for many revenue streams in software companies may need to be reconsidered to properly apply the new standards. Some of examples of areas that could be impacted are:
- Enterprise software with add-on services
- Assigning value to services previously offered in bundled service packages
- Variable fees based upon future events (usage fees, etc)
- Post-contract support
- Intellectual property licenses
- Contract modifications
When do you need to implement the changes?
Public reporting entities must comply with the changes for reporting periods after December 15, 2017 (January 1, 2018 for a calendar-year entity). Nonpublic companies have until December 15, 2018 to comply (January 1, 2019 for a calendar-year entity).
Stay tuned for future articles providing more details on applying the new standard to specific software company situations.