The new Revenue from Contracts with Customers (ASC 606) accounting guidance impacts companies across many industries, but companies that sell software and related products or services will likely experience some of the biggest changes. In our ongoing attempt to help businesses make sense of this complex topic, we’ll look at the ways in which ASC 606 may change the way software and cloud services companies do business.
There are a number of changes, and we’ll cover just two of those areas in this article, with upcoming articles continuing the coverage.
Post Contract Support – What is it Really?
Under current GAAP guidelines, there is no accounting distinction between the various types of Post Contract Support (PCS) activities that software companies provide to their customers. Things like phone support, bug fixes, and delivery of product updates are all lumped together, with the portion of the contract fee allocated to PCS recognized monthly over the period that the services are supplied.
The new revenue rules require you to more closely analyze the various activities that comprise PCS. It is possible that you should consider some of these activities as distinct deliverables, which would change when you recognize the associated revenue.
For example, say your company sells a software license bundled with support services and the promise of routine updates to the product. Under ASC 606, you likely have three distinct performance obligations with three potentially separate approaches to recognizing revenue. The revenue allocated to the software license would be recognized when control is transferred to the client, while the support and maintenance components would likely each be recognized over time.
But here’s a twist. What if you promised your customer that an upcoming release would include significant specific functionality? In this situation, you might need to allocate a portion of the software license transaction price to this feature release and wait to record revenues from it until the specified upgrade is delivered.
Vendor-Specific Objective Evidence – Who Needs Evidence?
Vendor-Specific Objective Evidence or VSOE sounds imposing and confusing (and it is!), but since it’s all about to go out the window with the new revenue recognition principles, we won’t have to worry about it much longer. Essentially, VSOE comes into play for software vendors that sell bundled software and related products and services. Currently, there are industry-specific rules that prescribe when elements of the bundle can be accounted for as separate accounting units. If they are separated, the fees are to be allocated based on VSOE. These and other industry-specific accounting rules are precisely what ASC 606 sets out to change.
Under the new guidance, regardless of the industry you are in, you must determine whether the deliverables in your engagement are distinct or a bundle, and then allocate a portion of the engagement to each element. For many software firms, this represents a significant change in the terms and conditions of your engagements, and when and how you recognize revenue.
Principles over rules
Generally speaking, under ASC 606, it’s out with industry specific rules and in with broader principles. Yes, principles require more judgment, so it’s always good to seek out your professional accounting advisors when navigating the ASC 606 waters. Especially since some professionals argue that once the new guidance kicks in, companies will be judged guilty of mis-recognizing revenue until they prove themselves innocent.
By BTerrell Group, Texas- based Intacct Partner