Archive for March, 2016
We made it to the final stop! Is it time to actually recognize revenue now? Well, let’s see. What does it actually take to be able to recognize revenue? Satisfy your performance obligation(s). That’s what it takes. “What,” you ask, “does that mean?” Well, let’s look at what it means; let’s break it down.
Back at our second stop, we looked at what our performance obligations were and found that they represented what we’ve agreed to provide our customer in exchange for the contract price or sales price. Our performance obligation(s) could be as simple as handing over a pair of jeans that we’ve agreed to sell to our customer in exchange for their payment or as complex as delivering a software license with an annual maintenance agreement along with installing the software on the customer’s server.
Now, when do we recognize revenue? Our guidance, ASC 606, “Revenue from Contracts with Customers”, tells us that we “recognize revenue when (or as) the performance obligation is satisfied”. “How do we know when we’ve satisfied our performance obligation?”, you ask. When the customer has taken control of the good that we’ve sold or been provided the service we’ve promised, we have satisfied our performance obligation; completed our part of the deal. At this point in time we can recognize revenue.
Let’s take the example we looked at during our fourth stop a step further. In that example, you developed a software product and you license it to companies in the automotive industry. Your new customer is purchasing the software license, annual maintenance agreement, and 100 hours of implementation services for a total contract value of $75,000. Based upon the relative standalone selling price of each of these deliverables we allocated $44,118 of the total contract value to the software license, $22,059 to the installation services and $8,823 to the one-year annual maintenance services. Now the question is, when do we recognize revenue for each of these items? That depends on when each item is delivered to the customer and when the customer takes control of them. Let’s say that you deliver, via secure electronic file transfer, the software license to the customer upon contract signing and payment of 50% of the contract price. The installation services are scheduled to occur immediately after contract signing and will take approximately three weeks to complete. The one-year maintenance agreement begins immediately after the software license has been delivered. One thing that we need to figure out is do we deliver our goods and/or services at a point in time (once), or over time (as we complete work we deliver it to the customer or as we deliver our goods/services over time and the customer uses them as they are delivered).
Our recognition of revenue would look something like this:
This post is not intended to be all encompassing, but to just give you an idea of some of the complexities you may encounter in recognizing revenue for your company. As you can imagine, the effects of this new regulation can have a significant impact on your financial results, so I highly recommend that you seek out expert advice if you are in doubt or have complex customer arrangements.
This ends our journey down the revenue recognition highway. Thank you so much for joining me! Don’t hesitate to comment on my post or reach out to me directly with any questions.
Susan Nieland, CPA
CFO Solutions, LLC
Here we are again, back on the road to revenue. You’ll remember that we are working our way down the revenue road looking at ASC 606 (that’s accounting lingo for “Revenue from Contracts with Cust…
Here we are again, back on the road to revenue. You’ll remember that we are working our way down the revenue road looking at ASC 606 (that’s accounting lingo for “Revenue from Contracts with Customers”). Up to this point we’ve covered the first three stops on our five stop journey, with the five stops on the road being:
- Is there a contract?
- What do we need to deliver under that contract?
- What is the selling price we’ll get?
- How do we allocate the selling price to different items we’ll deliver under the contract?
- How do we ultimately recognize revenue?
We’ve taken a deeper look into what a contract is, how to determine what our performance obligations are and how to determine the price we’ll end up getting as a result of entering into the contract. Now, it’s time to take a look at how we slice up, or allocate, the selling price between the different performance obligations or items we are selling to our customer.
How do we allocate our selling price? Why is it important?
Let’s look at each of these questions individually. Under our current guidance, which we call ASC 605-25, “Revenue Recognition, Multi-Element Arrangements”, we allocate revenue based upon relative selling price. This is very similar to the new guidance where we will be allocating revenue based upon relative standalone selling price. This is where things can get a little dicey and confusing. In its simplest form, it can be quite easy. The standalone selling price is basically what we would sell the product or service to by itself. When we only have to deliver one thing (whether that “thing” is a piece of hardware or a service we perform for our customer), the entire selling price is allocated to the one deliverable. There are often cases when we bundle items together for sale, and this is when it can become a bit complex. If we have to deliver more than one good and/or service to our customer under our agreement, we are then required to carve up our selling price into sections and allocate a piece of the selling price to each deliverable based upon their standalone selling price relative to the total of all standalone selling prices that we are delivering to our customer under the contract. Think of it like this:
|Contract Price||X||Product A’s Standalone Price||=||Allocation of Contract Price to Product A|
|Total Standalone Price for all Products Sold|
Let’s step through an example:
Say you developed a software product and you license it to companies in the automotive industry. You have sold this product to customers in this industry on a standalone basis for $50,000. You also offer software installation services for those customers that would like to use your professional services division to install the software on their servers. You typically sell these services for $250 per hour. In addition, you offer annual maintenance agreements that cover software updates and support. Customers can purchase these alone, but typically purchase them with the software and renew them on an annual basis for $10,000. Now, you’ve got a new customer that wants to purchase the software, 100 hours of implementation services and one year of annual maintenance. You decide to sell this bundle of products and services for $75,000. If you sold each of these items individually your selling price would be $85,000, but because you want to land this important deal, you offer your customer a $10,000 discount for the bundle. Your $75,000 contract price, and $10,000 discount, would be split up like this:
This post is not intended to be all encompassing, but to give you an idea of some of the complex issues you may encounter with the new revenue recognition rules. “Why does this matter?” you say. It matters, because you will recognize the revenue for each of these products at different times. That’ll be covered in the next post.
Thank you for traveling down the revenue recognition road with me to our fourth stop. At our next stop will be looking at how we recognize revenue. Stay tuned!
Please feel free to comment on my post or reach out to me with comments or questions.
Susan Nieland, CPA