Six Questions Tech Companies Should be Asking About Revenue Recognition
The start of the new year is also the date of initial application for the new revenue recognition standard for calendar year end private companies. Several provisions released under ASC Topic 606, Revenue from Contracts with Customers, have unique implications for the technology sector. Given the complexities involved in adopting the revenue recognition changes, technology companies may want to check on their revenue recognition preparedness now by asking themselves the following six questions.
Are My Contract Modifications Classified Correctly?
Technology companies regularly modify contracts to provide additional goods or services, such as extending the maintenance period from the original contract. Under the new revenue recognition standard, any change to an existing contract is generally considered to be a contract modification when the parties to the contract approve the modification based on customary business practices. A new contract with an existing customer could also be viewed as the modification of an existing contract depending on the facts and circumstances. Judgment will be required to determine when a contract modification becomes a separate, standalone contract.
Are Material Rights Captured and Accounted for?
Renewal rights and options for free or future discounted goods or services might be material rights. If your contracts contain material rights, they should be accounted for as separate performance obligations. Typically, a customer pays for a material right for future goods or services in advance, and the entity recognizes revenue when those future goods or services are transferred or when the option expires.
Have I Included Variable Consideration in My Transaction Price?
Technology contracts tend to include a lot of provisions that meet the definition of variable consideration, including discounts, rebates, price concessions, refunds, credits, incentives, and performance bonuses. Determining an estimate of the variable consideration is a significant step in determining the transaction price. Technology companies include variable consideration estimates in the transaction price when it is probable that the variable consideration would not result in a significant reversal of cumulative revenue in the future. The term “probable” under U.S. Generally Accepted Accounting Principles (GAAP) is generally interpreted as about a 75 to 80 percent likelihood of occurring.
Have I Correctly Accounted for Financing Components?
Much like the accounting for payables and receivables, sales transactions must now be evaluated to determine whether a financing component exists. If technology company contracts contain financing elements, interest income or expense will be implicit in the transaction price and recognized separately from revenue. However, determining whether a financing component exists will require judgment. One indicator is extended payment terms (often found in software arrangements), but this is not the case in all situations. A practical expedient is provided for contracts with payments terms of 12 months or less.
How am I Establishing Standalone Selling Prices?
Prior to Topic 606, technology companies may have used the concepts of Vendor Specific Objective Evidence (VSOE) and the existing ASC Topic 605 allocation hierarchy to allocate the transaction price in their transaction. The concepts of VSOE and the allocation hierarchy are going away. However, given that many technology companies have established an internal process of tracking historical sales prices, such evidence may continue to be acceptable evidence of standalone selling prices. Technology companies will have much more latitude in establishing standalone selling price under the new standard when compared to past practices. The additional latitude may permit technology companies to apply new sales strategies and techniques throughout their business.
How do Acceptance Clauses Affect My Contracts?
The existence and impact of a contractual acceptance clause is part of the determination of when control has been obtained by the customer, and therefore, affects when revenue will be recognized. Under the new standard, entities recognize revenue when the customer gains control of a good or service. In addition to the acceptance clause, there are other factors that indicate a customer has control, including the customer’s ability to direct the use of the good or service, and obtain substantially all of the remaining benefits from the good or service.
When in Doubt, Seek Help
An experienced accounting provider can help technology companies ensure they are up to speed with the new requirements. Working with an external party can also help technology companies prepare for the transition to the new standard, including ensuring that the transition method selected is appropriately applied.
For specific comments, questions, or concerns about the revenue recognition standard, please contact us. Published on November 20, 2018