Online professional resource provider Proformative is known for sponsoring in-depth, informative, and industry-specific events and webinars geared toward the financial industry. This time they’ve set their sights on the often enigmatic area of software revenue recognition—they have created an extremely helpful and actionable seminar titled, “Revenue Recognition Regulations Webinar, Primer and Best Practices.”
The talk is given by accounting professional and firm partner Timothy Perotti and NetSuite Senior Director of Financial Planning and Analysis Eileen Tobias, who together bring a wide range of expertise on the subject at hand.
What is revenue recognition?
Revenue recognition is an accounting concept that determines when specific revenues can be considered “earned,” even if the cash hasn’t actually been yet received. Essentially, revenue is recognized once goods have been transferred from seller to buyer or services have been rendered from provider to customer. The IFRS (International Financial Reporting Standards) has detailed regulations as to when revenue can be considered recognized revenue.
Software Revenue Recognition
In 1997, a new set of guidelines titled SOP 97-2 was introduced as the very first revenue recognition guide specific to the software industry. It applies to products wherein the use of software is more than incidental and makes up a significant aspect of the product itself.
As time went on and software became more integral to many products, more and more companies found their products falling under the umbrella of SOP 97-2, so compliance with the guidelines within became a more common auditing concern.
The IFRS is responsible for bringing “transparency, accountability and efficiency to financial markets around the world.” They offer their own set of regulations that define revenue recognition as a whole, though software makes the application of some of those regulations a bit more complicated.
The IFRS defines recognized revenue very carefully, and understanding those regulations is key to compliance. Here is a basic outline for how the IFRS defines recognized revenue.
All risk is now transferred from the seller to the customer, meaning that the buyer is now completely responsible for either the goods or service rendered by the seller as a part of the transaction.
When it comes to software sales, this comes once software has been purchased and installed as specified by the seller. This is made more complicated in situations of Software as a Service (SaaS), where customers pay ongoing subscription rates in exchange for use of cloud-based software.
The seller no longer has any control over whatever was sold. This rule ties in closely with the first. The seller must no longer be able to manipulate or change the goods or services rendered to the customer.
The seller can be reasonably sure that they will be able to collect payment. Because recognized revenue is counted on funds that might not yet have been received, there must be at least reasonable expectation that the funds will in fact be received. Factors that increase this likelihood are past successful transactions with this buyer, overall buyer reputation, and success of similar transactions in the past.
In terms of software, proving reasonable expectations of payment is made easier with a subscription model because one can look at the consistency of past subscription payments to judge how much revenue can be reasonably expected from future subscriptions.
The dollar amount of the expected revenue can be accurately predicted. This is important in reporting recognized revenue, which can be made more difficult if the final purchase price has the potential to change.
With subscription software services, that dollar amount is generally level, unless companies offer multiple price points that allow differing access to software features.
Costs associated with the transaction generating revenue can be reasonably measured. These costs can range from production costs to any costs associated with the execution of a transaction.
Becoming Compliant with IFRS Regulations
Many auditors faced with the complicated task of handling software revenue recognition wonder what tools are available to make their jobs easier, or at least more straightforward. One tool that is extremely effective in handling compliance and best practices is that of enterprise content management, or ECM. This category encompasses any software solutions used by finance organizations to manage, organize, and optimize the data within their company in order to become more effective.
These tools provide a wide range of uses, but in this case they can be used to track, securely store, and report the many elements of a transaction that apply to the determination of recognizable revenue. By using these tools effectively, revenue recognition in the software sector doesn’t have to be a complex process.