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The Revenue Recognition Standard and Its Impact on Private Software Companies

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By: Pratibha Lakshmanan

GAAP accounting standards (US Generally Accepted Accounting Principles) underwent some big changes at the beginning of 2019 that impacted private companies. In particular, provisions for software companies were removed which led to big changes in how they recognize revenue. While the deadline for compliance is long past, this tricky standard impacts many levels of an organization and regular process checks are critical.

Changes to Revenue Calculation for Software COmpanies

Every company needs to account for the revenue it receives during the year in exchange for services rendered or goods provided. For the past 20 years, software companies had their own separate revenue accounting standard (ASC sub-topic 985-605). As of January 2019, US GAAP removed this rule (ASU 2014-09). This means that the general principles that other industries now apply for software companies, too.

Software companies must thus follow five steps to adjust their revenue processes, including:

  1. Determine the contracts entered with customers
  2. Identify the company’s performance obligations to the customer in each contract
  3. Determine the price of the transaction in the contract
  4. Allocate the price to the contract’s performance requirements
  5. Recognize revenue only when the contract’s products or services are delivered

While the steps may seem simple, the full standard involves a lot of intricacies and contains guidance on specific revenue recognition and disclosure issues.

The new standard may change your company’s revenue. Usually, software companies need to record the date that services are provided, rather than the date that revenue is received. However, some software services like licenses are paid for at the beginning of the term but are utilized by customers for years. This creates complications on how to allocate the revenue. Expenses may also be impacted. For example, sales commission is now recorded as an asset, amortized over the life of an ongoing contract, rather than reported as a cost immediately.

Companies should continue to work with an experienced attorney and accounting professional to develop precise contract terms and accurately recognize revenue in each of their contracts. Any interdependent or interrelated services should be clearly outlined, so it is easy to record revenue appropriately.

Ongoing Compliance with Gaap Standards

Private companies have needed to comply with new GAAP standards since the beginning of 2019. This means that you should already have a new system in place to recognize revenue, draft your contracts, disclose revenue to investors, and pay sales commission for new business. Management should have processes in place to determine how to apply the new principles to your specific sales and services.

However, ongoing compliance is important. A team of accounting and legal professionals can help you draft new contracts and examine existing ones. It is also critical to report your revenue correctly for tax purposes. Performing internal and professional audits on a regular basis is another good way to keep accounting processes, such as new revenue recording requirements, on track.

Public companies in the US are required to follow Generally Accepted Accounting Principles (GAAP). Although GAAP is optional for private companies, creditors and investors prefer this standard. However, it is critical to report your revenue correctly for tax purposes if you follow the accrual method of reporting. An incorrect recognition could lead to severe consequences like tax audits and penalties.

, we would advise a three-phase approach: (1) Assess, (2) Convert, and (3) Embed. First, check your documents in line with the five principles and determine how revenue is impacted. Next, educate all your teams that may be impacted and make them aware of the colossal nature of change. Finally, take a trial run and check the extent of change it creates in your revenue.

Conclusion

Changes to GAAP standards have a big impact on how software companies calculate their revenue. While many companies have already made the transition to the new standards, ongoing compliance is key. With the right professionals and a clear process approach, we’re confident that your company can adhere to the new standards. With good planning, it’s never too late to begin following the GAAP standards, either. Consult with an experienced Chugh accounting professional to recognize revenue compliantly at every level of your organization.