Revenue Recognitionfor Software and Services

IMA Regional Council

September 20, 2010- Mystic, CT

Anthony P. Pencek, CPA

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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

• 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

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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 post-

delivery 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!!!