Blog Series: ASC 606 - What it Means for Software Companies

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A new FASB revenue recognition rule, ASC 606 (ASU 2014-09), and IFRS rule, IFRS 15 places renewed pressure on your accounting team and processes. Lack of readiness risks a multitude of issues, from reduced accounting productivity, to unforeseen revenue impact, to risk of restatement. These rules impact revenue recognition on a broad range of contractual agreements with customers. They have a far reaching impact, for example, companies with bundled products and services, variable discounts, different payment and renewal terms, sales commissions, royalties, or other specific contract commitments should be especially cognizant of the new rules.

For public companies, adoption is effectively 2018, while for private companies, it’s 2019. If you’re a private company, you may think you’ve still got plenty of time. But the reality is that contracts you are writing now will likely be impacted by the new rules, so it’s essential to make sure revenue recognition processes are running smoothly when the time comes. And in the meantime, you need to understand what the potentially significant impact will be on revenue, and compare old versus new, sooner rather than later.

Accounting systems need to separate and time revenue and related expenses accordingly — and ideally automatically, while also helping finance and accounting understand the impact on the income statement. If these systems can’t, accounting teams will get dragged down into the weeds into the contract ― and spreadsheet - detail, wasting time and creating significant compliance risk.

The standards will likely affect entities’ financial statements, business processes and internal control over financial reporting. While some entities will be able to implement the new standards with limited effort, others may find implementation to be a significant undertaking. Successful implementation will require an assessment and a plan for managing the change.
— Ernst & Young

These rules are particularly relevant for subscription based software companies. Companies who have extensive contract negotiation cycles, will want to make sure everything is documented – from sales, to service, to finance, because contract items like discounts, payment and renewal terms, multiple inter-related contracts, activation fees, even sales commissions can make a profound difference to how revenue and expenses look under the new rules. In a nutshell, accounting systems need to be more connected, more intelligent, more automated than ever before.

Let’s start with timing. With ASC 606 and IFRS 15, there are a number of dates to think about. For public companies it’s effectively 2018, while for private companies, adoption begins for accounting periods starting mid-December 2018 or later. Although the effective date is still a few years out, with retrospective adoption, it applies to contracts prior to the adoption date, with the need to show comparative financial statements in the years prior to adoption.

The new standards provide accounting guidance for all revenue arising from contracts with customers, from goods, to services. For contracts your organization is writing today or that already extend into the adoption date, or for those that have renewal terms, you need to understand how they look under the new guidance. The key is to understand your exposure, compare revenue under existing and new guidance, adjust the business processes that delay revenue, and reduce compliance risk through automation.

The core principle is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
— AICPA

While some companies will be able to implement the new standards with limited effort, most will find implementation to be a significant undertaking, especially if their internal accounting systems lack built in readiness.  Successful implementation will require an assessment and a plan for managing the change.

As a result of the new standard, entities will need to comprehensively reassess their current revenue accounting and determine whether changes are necessary.
— Deloitte

Technology companies must take special care with these rule[A1] [A2] s. They have broad impacts on multiple components of a high tech company’s typical contractual touchpoints and levers.  Whether you are a public company or a private company planning on going public, looking for additional funding, or planning to be acquired, this rule has the potential to reshape your revenue, and your valuation.

The FASB and IASB guidelines detail five steps to adoption  and each of these steps has specific implementations and considerations for technology companies.

Each of these steps has important implications for software companies and their business processes. In the next posts, we'll check out each of these steps and what it means for your revenue recognition processes, and your accounting systems.