Revenue Recognition
for Software and Services
IMA Regional Council
September 20, 2010- Mystic, CT
Anthony P. Pencek, CPA
Cartoon ESL
Cartoon GPS
Codification of US GAAP
• Statement Of Position (SOP) 97-2 no
longer exists
• A new format to obtain authoritative
information for justifying your position
• FASB Codification now will be used, find it
at Code # 985-605-25
Link to AICPA Codification
• Look up the Revenue Recognition of
Software –
• Easier than having the hard copy
• www.aicpa.org/becomeACPA/CPAexam
Definitions for Software Revenue
Recognition
• Postcontract Customer Support (PCS)
• Vendor Specific Objective Evidence
(VSOE)
• Maintenance
• Bundled Package
• Percentage of Completion Contract
• Completed Contract
• Multiple Elements Package
General Rules for Revenue
Recognition
• Persuasive Evidence that an arrangement or
contract exists
• Delivery has occurred
• Seller’s fee is fixed or determinable
• Collectibility is probable or certain.
• Overall, was it earned and realizable as well as
– Transfer of risk of ownership
– Collectibility is certain
US GAAP Methods of Revenue
recognition
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Deposit Method- Cash
Installment Method
Cost Recovery Method
Percentage of Completion Method
Completed or Long Term Contract Method
Accrual Method- Normal
– Matching of revenue with expense
REVENUE RECOGNITION-GAAP
Flow Chart of SOP 97-2
Operational Rules for Software
Recognition
• Key questions to ask is:
• Physical delivery of the software.
• Does it requires significant modification or
customization of software?
-If so, then Long Term Percentage of
Completion Accounting over installation
period should be used– If not, then recognize immediately- previous
slide
Single Canned Package
• Peachtree, Quickbooks and other similar
packages.
• Service Contracts for updates
• Payroll Modules, etc.
• Recognize revenue when purchased and
customer has taken the package
Multiple Elements Example
• Contract includes software installation,
modification and customization to be
useful to purchaser.
• Maintenance and Updates of the software
• Training of the company personnel
• Product Service Contracts for years.
• Number of hard copies given to buyer if
any
Multiple Elements Revenue
Recognition
• Fair Value of each elements if the values
exist according to VSOE allocation.
• Is there a market for the element allocation
– Surrogate prices of other competitors
published amount or industry norm.
– Does company sell each element separately
to other customers?
Hold Off Recognition of Revenue
• Are there any fees that could be forfeited if
not completed?
• Retain percentage by buyer until satisfied
with work.
• Chance of return for refund.
• Collection of Selling Price is uncertain.
• When and if available Basis
– Microsoft projected date of availability
Service Contract Amount
• Amortized over the life of months/years for
the maintenance is supporting the
software
• Stated separately or stated in other
contracts.
Discounts on Multiple Elements
• Allocation based on the Fair Market value
of the elements.
• No allocation to updates to be delivered
later.
Recognition of Loss
• Immediately when determined that the
project is generating a loss for the seller
• Why??? --- Conservatism
Financial Disclosures of Software
Revenue Recognition
• Policy for separating the various elements
of the software and how recognized.
• Example:
– Company states it recognizes software
portion on delivery
– Company states that it recognized
maintenance portion of contracts over the life
of the contract and initially records this portion
into an account called Unrecognized
Maintenance Service Revenue.
Financial Disclosures of Software
Revenue Recognition- (Cont’d)
• Then, the income is recognized ratably over the
period that has lapsed.
• If software arrangements that include rights to
multiple software products, specified upgrades,
maintenance, the company allocates the total
arrangement fee among each deliverable using
the fair value of each of the deliverables
determined by the VSOE, if the price is stated
separately in other contracts. If not available
then it is deferred to when the deliverable
elements are completed.
Google Income Statement
British Airlines
Income Statement
Google Revenue Recognition
Google Revenue Recognition
Google Revenue Recognition
British Airlines Revenue
Recognition
British Airlines Revenue
Recognition
Latest IFRS and US GAAP on
Revenue Recognition Project
– Where it stands:
– The FASB and IASB agreed to a joint project to
develop concepts for revenue recognition and a
standard based on those concepts.
– The Boards (FASB and IASB) issued a discussion
paper in late December 2008 with comment period
closed June 19, 2009.
– The Boards confirmed that the revenue recognition
project is a high priority.
– Their goal is to issue a general revenue recognition
standard by June 2011.
Latest IFRS and US GAAP on
Revenue Recognition Project
– Revenue Recognition Project Objectives
– To develop coherent conceptual guidance for revenue
recognition and a Comprehensive Statement on
revenue recognition based on those concepts.
– To improve financial reporting by:
• Eliminating inconsistencies in the existing conceptual
guidance on revenue recognition
• Providing conceptual guidance that would be useful in
addressing future revenue recognition issues
• Eliminating inconsistencies in existing standards-level
authoritative literature and accepted practices
• Filling voids in revenue recognition guidance that have
developed over time
• Establishing a single comprehensive standard on revenue
recognition to improve comparability across
Latest IFRS and US GAAP on
Revenue Recognition Project
– Summary of Boards’ Proposals:
– Contract-based Revenue Recognition Principle
– When an entity becomes a party to a contract with a customer,
the combination of the rights and obligations in that contract
gives rise to a net contract position
– Whether that net contract position is a contract asset, a contract
liability, or a net nil position depends on the measurement of the
remaining rights and obligations in the contract.
– Revenue should be recognized on the basis of increases in an
entity’s net position in a contract with a customer.
– Revenue is recognized when a contract asset increases or a
contract liability decreases. That occurs when an entity performs
by satisfying an obligation in the contract.
Latest IFRS and US GAAP on
Revenue Recognition Project
– Summary of Boards’ Proposals (cont):
– Identification of Performance Obligations
– An entity’s performance obligation is a promise in a contract with
a customer to transfer an asset (such as a good or service) to
that customer
– When an entity promises to provide a good or services, it is
promising to transfer an asset to a customer.
– An entity accounts for performance obligations separately if the
promised goods or services are transferred to the customer at
different times. The objective of separating performance
obligations is to ensure that an entity’s revenue faithfully
represents the pattern of the transfer of assets to the customer
over the life of the contract.
Latest IFRS and US GAAP on
Revenue Recognition Project
– Summary of Boards’ Proposals (cont):
– Satisfaction of Performance Obligations
– An entity satisfies a performance obligation and recognizes
revenue when it transfers a promised good or service to the
customer. An entity has transferred that promised asset when
the customer obtains control of it.
– For goods, an entity satisfies a performance obligation when the
customer obtains control of the good so that the good is the
customer’s asset. That occurs when the customer takes
physical control of the good.
– For services, an entity satisfies a performance obligation when
the service is the customer’s asset. That occurs when the
customer has received the promised service.
Latest IFRS and US GAAP on
Revenue Recognition Project
– Summary of Boards’ Proposals (cont):
– Measurement
– To recognize a contract, an entity measures its rights and its
performance obligations in the contract. Measurement of the rights
would be based on transaction price.
– Performance obligations initially should also be measured at the
transaction price. If a contract comprises more than one performance
obligation, an entity would allocate the transaction price to the
performance obligations on the basis of the relative standalone selling
prices of the goods and services underlying those performance
obligations.
– When a performance obligation is satisfied, the amount of revenue
recognized is the amount of the transaction price that was allocated to
the satisfied performance obligation at contract inception.
– After contract inception, the measurement of a performance obligation
should not be updated unless that performance obligation is deemed
onerous.
Latest IFRS and US GAAP on
Revenue Recognition Project
– Potential Effects on Present Practice
– Instances in which the proposed model may differ from present
practice:
– Use of a contract-based revenue recognition principle
• may impact revenue recognition for construction-type contracts
– Identification of performance obligations
• may impact revenue recognition for warranties and other postdelivery services
– Use of estimates
• May be required as opposed to present where not currently
permitted under existing standards in some situations
– Capitalization of costs
• May cause a mismatching of revenue and costs to obtain contracts
Bibliography
• Colleen Cunningham, CPA, talk at IMA National
Conference, June 2010
• Steven M. Bragg, CPA, “Revenue Recognition, Rules
and Scenarios”, 2nd Edition, 2010.
• Delotte, Software Revenue Recognition, A Roadmap to
Applying AICPA SOP 97-2, Second Edition
• Annual financial reports from Google, Inc. and British
Airlines
• Intermediate Accounting: Nikolai & Bazley; 9th
Edition, Thomson-Southwestern Companies, 2004
• SOP 97-2 Revenue Recognition for Software
Questions ????
• Thank You!!!
• Enjoy the Rest of the Conference!!!