The new revenue recognition standard codified in FASB Accounting Standards Codification (ASC) 606 resulted in a number of changes for privately owned software and SaaS companies when it became effective on January 1, 2019.
Now that many companies have completed their December 31, 2019, financial reporting, we have identified three common revenue recognition challenges that software and SaaS companies struggle with as they continue to implement the new guidance.
1. Implementation Services
Implementation services within a software or SaaS arrangement often relate to installation, integration, data migration and other professional services. Often, these services are bundled together in the arrangement and are referred to as implementation services.
One of the more challenging aspects of implementing the new guidance for software and SaaS companies has been the assumption that all implementation services result in an “over time” revenue recognition pattern. Companies assume these services are so interrelated and integrated with the related software or subscription that they don’t meet the definition of being distinct with respect to the software.
To properly recognize revenue, it’s important for a vendor to fully understand the nature of the services being provided. The vendor also must determine whether a customer is required to purchase these services to obtain the desired features and functions of the software, or whether the customer is simply outsourcing these services to the vendor as a matter of convenience, resource constraints or complexity. If the customer can self-implement the software, but chooses to outsource to the vendor, it is an indication that the services are distinct from the software and most likely will be recorded as revenue at the point in time the service performance obligation has been completed. Otherwise, the services aren’t distinct from the software and revenue from these services will be recognized over time.
2. Professional Services
Similar to implementation services, companies engage software and SaaS vendors to conduct training services, custom development and other professional services. To properly recognize revenue, a vendor must evaluate whether these services are also distinct with respect to the software or SaaS subscription. A vendor will need to determine if they sell these services on a stand-alone basis or if the customer can hire a third party to perform these services. If either of these circumstances exist, it’s probably an indication that the services are distinct from the software or SaaS and the professional services revenue can be recognized at the point in time the service obligation is complete.
Furthermore, certain services may be delivered over a period of time and include contractual provisions that require a vendor to meet certain milestones or achieve other metrics before the customer will accept the services as complete. In these instances, the vendor will need to evaluate if control of the output of those services has transferred to the customer as the vendor has reached the milestone or other metric, and if the customer has the ability to receive the benefits of those services. If so, and the vendor has an enforceable right to payment for services performed to date, the vendor can recognize revenue at that point in time. If control has not transferred and an enforceable right to payment does not exist, the vendor must defer revenue recognition until those criteria are met.
3. Estimating Stand-Alone Selling Price
Arrangements between vendors and their customers often include multiple performance obligations with a single contract price. Vendors are required to determine the stand-alone selling price for each performance obligation to properly allocate and recognize revenue, yet they struggle to determine these prices because they lack adequate information.
The best evidence of a standalone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. Historical selling prices for separate performance obligations, if available, are generally the best evidence of stand-alone selling price. Alternatively, evidence of competitor pricing for similar products to similar customers is an important consideration for establishing stand-alone selling price. Establishing price lists for separate performance obligations and developing relevant pricing policies and procedures specific to the company and its customers can provide clarity when determining stand-alone selling price and improve revenue recognition decisions.
Contact Kaitlin Mansfield at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.