ASC 606/IFRS 15, Revenue from Contracts with Customers, was the new revenue recognition standard issued by The Financial Accounting Standards Board (FASB). This standard affects all businesses, including public, private, and nonprofit entities, which use contracts with customers to transfer goods or services.
ASC 606 enforcement is especially relevant for software and SaaS companies as their revenue is often and primarily dependent on contracts between servicer and client.
ASC 606 outlines a five step process for revenue recognition:
- Identify the Contract
- Identify the Performance Obligations of said Contract
- Determine a Transaction Price
- Allocate a Transaction Price to Performance Obligations
- Recognize Revenue when and as the Entity Satisfies a Performance Obligation
At its core, ASC 606 states companies must: “recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” Therefore, the recorded timing of transactions should correlate with when the goods or services were rendered to the client.
ASC 606’s Impact on Technology Firms
The ASC 606 standard significantly affects revenue and cost regression models for technology firms compared to other industry groups. Within the tech sector, the degree of modification to previous revenue recognition standards varies depending on the nature of revenue. Companies operating software licenses are most likely to be impacted.
Software firms should devote significant time and energy addressing the following challenges as they move into compliance with ASC 606:
- Determining the standalone selling prices of software licenses in an arrangement
- Identifying performance obligations in hybrid cloud-based arrangements
- Eliminating the need for vendor-specific objective evidence of fair value
- Accessing variable consideration and termination provisions
- Capitalizing certain contract acquisition costs
- Including the requirement to discloses related to significant judgements and performance obligations (i.e., backlog disclosures)
There are some key implementation must-haves which ensure compliance for all SaaS and software providers.
Key ASC 606 Implementation Must-Haves for SaaS and Software Providers
Software firms often create contracts with customers that include multiple components like software licenses, SaaS, and post-contract customer support (PCS).
Be sure your accounting team, licensed accounting software and other accounting tools and resources follow these practices to ensure ASC 606 compliance.
Capitalization of Costs Associated with Obtaining and Executing a Contract
- Capitalize incremental costs amortized over a year that are incurred while securing such contracts.
- Capitalize costs directly associated with executing the contract over the expected period of benefit, including anticipated renewal terms. Do this even if the period exceeds a year.
Determining Transaction Price with Variable Consideration
- To determine transaction price in step 3 of the revenue recognition process outset by ASC 606, include the estimated variable consideration predicted to be received. Exceptions include sales or usage based on revenues like royalties.
- Sales and usage-based royalty revenues should not be estimated and recognized until sale or usage occurs, not when the actual amount is reported. Estimate and recognize these sales and usage-based royalty revenue in the period earned.
- End use of sell-through methods of revenue recognition for software sales, even if selling through resellers and distributors.
- Price concessions and returns may need to be estimated to determine total conversation to be recognized when revenue is earned at the time of transfer to reseller.
Vendor-Specific Objective Evidence of Fair Value
- Do not spend time establishing VSOE. It is not needed to recognize revenue separately for different components of a contract.
- Contracts often split between two components like software license and PCS can be split into more performance obligations to integrate into your native accounting practices more seamlessly.
- For example, PCS could be separated into customer support, software maintenance updates and software enhancement updates.
- Allocate the transaction price of the contract between the separately identified performance obligations.
- Because you will likely have an increased number of components in a given contract, revenue may be recognized earlier than previously.
- When clients terminate contracts without substantive cost or penalty account for only the noncancelable portion of the contract. This is true even if the customer is unlikely to use their termination right.
- For example, if a customer can terminate at any point and receive a pro rata refund, the arrangement should be accounted for as a daily contract.
- Exclude undelivered performance obligations from the deferred revenue and remaining performance obligations.
- If you describe the GAAP amount accurately, feel free to include amounts subject to termination in the notes to financial statements.
Nonrefundable Upfront Fees in Software Arrangements
- If you have a nonrefundable up-front fee, be sure to note whether this fee is associated with the transfer of promised goods or services or is an advance payment for future goods or services.
- Note if your company gives customers the option of terminating their contract at their convenience.
Contract Modifications of Licenses of IP
- Recognize revenue for license renewals no earlier than the beginning of the renewal period.
- Feel free to include an extension to the original license’s terms with the purchase of additional rights when a term license of intellectual property (IP) is changed. Such changes may include the ability to revoke licensing rights and to convert to a hosted solution.
- Consider using automation tools to overcome revenue recognition risks like contract changes.
Accounting for Software-Related Costs
- For your software related costs such as customer relationship management (CRM), human resources, payroll, finance, communication or collaboration tools, note whether the cost relates to:
- Selling, leasing or marketing the software
- Obtaining or developing the software for internal use
- Accessing the software in a cloud-based or hosting arrangement with a service contract
- Use the appropriate accounting guidance for each category of software cost
One of the best ways to ensure ASC 606 compliance as well as compliance with other FASB standards is to work with a robust revenue management system like Sage Intacct. Sage Intacct is unique in that it has been built in collaboration with FASB so it can best support ASC 606 compliance at your company. Sage Intacct is endorsed by AICPA and delivers customizable, prebuilt GAAP and SaaS metric dashboards.
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