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Revenue recognition for SaaS and software companies
Key themes for executives to consider when applying the new revenue standard
While the new revenue recognition standard has and will affect entities differently depending on their facts and circumstances, we have briefly summarized for corporate executives (CXOs) some of the common significant themes associated with its application by entities in the software and software-as-a-service (SaaS) sectors, using insights and perspectives learned in the past year as public software and SaaS companies have finished their implementation and begun disclosing the effects on their financial statements.
Key themes for CXOs
The Financial Accounting Standards Board’s (FASB’s) new revenue recognition standard (ASC 606) was effective for annual reporting periods beginning after December 15, 2017, for public entities. As a result, many public entities have now disclosed the impact of adopting ASC 606 within their interim financial reports on Form 10-Q. For all other entities, it is effective for annual reporting periods beginning after December 15, 2018 and early adoption is permitted for annual reporting periods beginning after December 15, 2016.
As a result of the new standard, organizations have and continue to need to make significant changes—not just to their finance departments but also to their units responsible for strategy, IT, HR, sales and marketing, and taxes.
The standard’s effect on the revenue and cost recognition models of technology entities has generally been significant. The fundamental principle at the heart of the standard is that an entity must “recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration [that is, payment] to which the entity expects to be entitled in exchange for those goods or services.”
To help software and SaaS entities better understand this principle, these publications explore common themes related to the standard’s application.
The impact of the new standard on software entities may have been greater than that on any other industry group. For example, the standard results in the elimination of the requirement for vendor-specific objective evidence of fair value, introduces potential difficulty in determining the fair value of software licenses in an arrangement, in evaluating the appropriate accounting for hybrid license arrangements, in assessing hosting and term-based license arrangements, and in the timing of revenue recognition for royalty arrangements or arrangements with resellers, which can require the use of new judgments and estimates.
While SaaS entities may not expect the new revenue standard to affect them as much as other entities, the experiences of public SaaS entities in the past year has shown they should not underestimate its impact. Changes may include those related to the allocation of discounts in an arrangement, the elimination of certain restrictions that limited the amount of revenue that may be recognized when contracts had extended payment terms or increasing annual billings, and the accounting for set-up and activation fees.
Further, both software and SaaS entities will be significantly affected by the standard’s changes related to the accounting for costs to obtain contracts such as commission payments, internal controls over financial reporting, and disclosure requirements, including the requirement for disclosures about performance obligations (including disclosures commonly referred to as “backlog disclosures”), which will be new for many entities.
These and other themes related to applying the new revenue standard for software and SaaS companies are explored in these publications.
Deloitte Accounting Research Tool (DART)
Deloitte also provides the Deloitte Accounting Research Tool (DART), a comprehensive online library of accounting and financial disclosure literature to clients. Updated every business day, DART contains material from the FASB, Emerging Issues Task Force (EITF), American Institute of Certified Public Accountants (AICPA), Public Company Accounting Oversight Board (PCAOB), International Accounting Standards Board (IASB), and Securities and Exchange Commission (SEC), in addition to Deloitte’s own accounting manuals and other interpretive guidance and publications.
Flashpoint edition 7: Understanding the cross-organizational impacts