Cloud-based revenue recognition for technology companies

Understanding the accounting for cloud-based services

Companies selling cloud-based or hosted software solutions, such as software-as-a-service (SaaS), are faced with challenges, such as identifying performance obligations and accounting for variable consideration, as they implement the new revenue recognition standard (ASC 606). Explore our Technology Spotlight series that address a broad range of questions about the accounting for cloud-computing arrangements and other cloud-based services.

Applying the ASC 606 revenue standard to software licenses when adopting cloud services and forfeiting on-premise rights

Some software licensing contracts include an option for customers to convert from on-premise to cloud-based hosted software (e.g., SaaS). Often, when a customer converts from on-premise software to a cloud-hosted service arrangement, the customer forfeits rights to the on-premise version of the software. Views differ on how to account for the revocation of the initial licensing rights and the conversion to a hosted solution.

In this Technology Spotlight, we examine how software providers can better understand how to apply the ASC 606 revenue standard when accounting for arrangements that enable customers to convert on-premise software licenses to cloud-based or hosted software solutions.

Applying the revenue standard to identify performance obligations in arrangements including smart devices, updates, and cloud-based services

Many technology organizations offer solutions in which a customer purchases:

  • A smart device with embedded software components (firmware);
  • Maintenance and support (postcontract customer support, or PCS); or
  • A cloud-based service.

But these arrangements often present challenges when entities need to identify performance obligations, including when leasing smart devices with related PCS and cloud-based service, as opposed to simply selling the smart device. Accounting outcomes can differ significantly depending on whether an entity identifies a combined performance obligation or multiple performance obligations in an arrangement.

In this Technology Spotlight, we explore factors that organizations should consider in applying the revenue standard to identify performance obligations and discuss situations in which a smart device is subject to a lease under ASC 842.

Accounting for implementation services related to a cloud-based or hosted software arrangement

Entities that sell a cloud-based or hosted software solution—such as a SaaS arrangement—often include implementation services that are performed either at the outset of the customer arrangement or during the SaaS term.

Depending on the facts and circumstances of the arrangement, an entity may need to use judgment to determine whether the implementation services represent:

  • Activities that don’t transfer a good or service to the customer
  • A promise that isn’t distinct from the SaaS
  • A distinct performance obligation

In this Technology Spotlight, you’ll find Q&As addressing factors that an entity may consider when making that determination and applying the appropriate accounting for cloud-computing or other cloud-based arrangements.

Accounting for cloud-based or hosted software arrangements with variable consideration

Entities that sell cloud-based or hosted software solutions often require the customer to pay them a variable amount, usually based on the underlying usage of the SaaS technology. ASC 606 generally requires entities to estimate variable consideration subject to a constraint, but it also provides a practical expedient and a variable consideration allocation exception.

In addition, while ASC 606 includes an exception to the general model for variable consideration in the form of a sales- or usage-based royalty related to licenses of intellectual property, SaaS arrangements often don’t qualify for the exception because a license typically isn’t transferred to the customer in such cases.

The questions and answers in this Technology Spotlight provide interpretive guidance intended to help entities address certain challenges associated with applying the revenue recognition model in ASC 606 to SaaS and other cloud-based arrangements that include variable consideration.

Identifying the performance obligations in a hybrid cloud-based arrangement

Many software entities offer hybrid solutions in which a customer may have the right to deploy the software:

  • As either on-premise software or a cloud-based service
  • Or by using the on-premise software together with the cloud-based service

On-premise software is installed and runs on the customer’s devices or is hosted by a third party under a separate contract between the customer and that third party. A cloud-based service involves software that’s physically hosted on the software entity’s systems (or hosted by the software entity’s cloud-computing vendor) and accessed by the customer over the internet.

This Technology Spotlight addresses these hybrid solutions and the factors to consider for identifying the performance obligations when accounting for cloud-based services.

Blend-and-extend modifications related to a cloud-based or hosted software arrangement

An entity that sells a cloud-based or hosted software solution may modify its arrangements before the end of the initial contract term by renewing the initial contract and revising the pricing on a “blended” basis for the remaining term. In such circumstances, the entity and its customer agree to extend the contract term and “blend” the remaining original, higher contract rate with the lower rate of the extension period for the remainder of the combined term.

In a typical blend-and-extend modification in the SaaS industry, the entity would account for such a modification as either:

  • A separate contract for the added services under ASC 606-10-25-12, or
  • A termination of the existing contract and the creation of a new contract under ASC 606-10-25-13(a)

The determination of which model to apply is based on whether the additional services are priced at their stand-alone selling prices. This Technology Spotlight discusses three alternatives for an entity to consider in determining how to account for a blend-and-extend modification.

Cloud Accounting: Dealing with the ever-growing complexity podcast is now available here.
In this episode, David Linthicum and senior consultation partner Sandie Kim discuss the complexities of accounting for cloud.

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