ASC 606 For Software Companies: Step 5 - Recognizing Revenue. August 16, 2018 MEMBER OF ALLINIAL GLOBAL, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS

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1 ASC 606 For Software Companies: Step 5 - Recognizing Revenue August 16, 2018 MEMBER OF ALLINIAL GLOBAL, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS 2018 Wolf & Company, P.C.

2 Before we get started Today s presentation slides can be downloaded at The session will last about 45 minutes, and we ll then have time for Q & A. Our audience will be muted during the session. Please send your questions in using the Questions Box located on the webinar s control panel. 2

3 About Wolf & Company, P.C. Established in 1911 Offers Audit, Tax, and Risk Management Services Offices located in: Boston, Massachusetts Springfield, Massachusetts Albany, New York Livingston, New Jersey Over 250 professionals As a leading regional firm founded in 1911, we provide our clients with specialized industry expertise and responsive service. 3

4 Introduction Scott Goodwin, CPA Member of the Firm and Technology Services Team Leader Phone: (617) Cecilia Frerotte, CPA Audit Principal and Software Sector Leader Phone: (617)

5 Agenda Recognizing revenue - Concept of over time vs. point in time Licenses of intellectual property - Sales or usage-based royalties SaaS subscriptions Principal vs. Agent considerations 5

6 The Five Step Model Core Principle Recognize revenue to depict the transfer of promised 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 6

7 Over time vs. Point in time Transferring a promised good or service to a customer satisfies a performance obligation occurs either: Over time or at a point in time An entity transfers control over an asset over time if one of the following criteria is met: 1. Customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs 2. Entity s performance creates or enhances an asset that the customer controls as the asset is created/enhanced 3. Entity s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date 7

8 Licenses of Intellectual Property A license arrangement establishes a customer s rights related to a company s intellectual property and the obligations of the company to provide those rights. Critical questions for software companies: 1. Does the arrangement include a license of IP? 2. If so, is that license distinct?» VSOE is dead» Consequences of distinct vs. not distinct 3. If so, is the license functional or symbolic?» Revenue recognition for each 8

9 Licenses of Intellectual Property Does the arrangement include a license of IP? A separate promise of a license exists when: (1) the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty, and (2) the customer can run the software on its own hardware or contract with another party unrelated to the vendor to host the software 9

10 Licenses of Intellectual Property Is that license distinct? Must be both: (1) capable of being distinct, and if a customer can benefit from the license either on its own or together with other resources that are readily available to the customer (2) distinct within the context of the contract separately identifiable 10

11 Licenses of Intellectual Property Is that license distinct? Vendor-specific objective evidence (VSOE) VSOE of fair value is no longer required to identify the unit of accounting May lead to the identification of additional performance obligations and earlier recognition of revenue If not distinct, 11

12 Scenario 1 Sample Co. enters into a contract with WorkCo for on-premise data analysis software and cloud data storage. The software utilizes WorkCo s data stored on the cloud to provide data analysis. The software can also utilize data stored on the WorkCo s premises or data stored by other vendors. Is the license distinct? 12

13 Scenario 1 Yes. The on-premise software license is distinct from the cloud data storage service. The software license and cloud data storage service are not highly interrelated or interdependent. If data was stored on WorkCo s premises or with another vendor, WorkCo would still get all of the benefits of the software. The cloud data storage could be provided by other vendors and is capable of being distinct. 13

14 Scenario 2 Sample Co. contracts with WorkCo for A perpetual software license, installation services, 2 years of technical support. The installation services include significant customization of the software to interface with WorkCo s data sources. The technical support is not critical to maintaining the ongoing utility of the software. Is the license distinct? 14

15 Scenario 2 No. The software license is not distinct from the installation services because the installation services significantly customize the software. The software and installation services create a combined output, customized software. Therefore Sample Co. needs to assess whether control is transferred at a point in time (once the software is completed) or over time (as the customization is performed) The tech support is distinct and should be recognized over time 15

16 Licenses of Intellectual Property Is the license functional or symbolic? Companies provide their customers with either: A right to access the entity s intellectual property as it exists throughout the license period, including any changes to that intellectual property A right to use the entity s intellectual property as it exists at the point in time at which the license is granted 16

17 Licenses of Intellectual Property Functional Significant standalone functionality Derives a substantial portion of its utility from its significant standalone functionality Software, drug formulas or compounds, completed media content, specialized and patents Functional IP is a right to use IP because the IP has standalone functionality and the customer can use the IP as it exists at a point in time. Revenue from Functional IP is recognized at a point in time. Symbolic Does not have significant standalone functionality Substantially all of the utility of symbolic intellectual property is derived from its association with the entity s past or ongoing activities, including its ordinary business activities Brands, logos, team names, and franchise rights Symbolic IP is a right to access IP because of the entity s obligation to support or maintain the IP over time. Revenue from symbolic IP is recognized over the license period, or the remaining economic life of the IP, if shorter. 17

18 Scenario 3 Sample Co provides a 5 year term software license to WorkCo. The terms of the arrangement allow Work Co to download the software by using a key provided by Sample Co. Work Co can use the software on its own server and the software is functional when it transfers to Work Co. Work Co also purchases post-contract customer support (PCS) with the software license. The license and PCS are distinct as Work Co can benefit from the license on its own and the license is separable from the PCS. How should revenue from the license be recognized? 18

19 Scenario 3 The IP underlying the license in this example is functional IP, because the software has significant standalone functionality. Sample Co will recognize revenue at a point in time when Work Co is able to use and benefit from the license (no earlier than the beginning of the license term). PCS is a separate performance obligation in this arrangement and does not impact the assessment of the nature of the license. 19

20 Sales or usage-based royalties Some licenses of IP include sales or usage-based royalties. There is an exception for revenue recognition for these arrangements as follows: Recognize revenue as the sales or usage occurs unless doing so accelerates revenue recognition ahead of the entity s satisfaction of the performance obligation to which the royalty relates. Sales or usage based licenses of IP do not follow variable consideration rules Cannot defer until customer reporting is available, must estimate sales or usage prior to customer reporting Royalty minimum = fixed consideration 20

21 Scenario 4 Sample Co. licenses software on an annual basis to its customers and promises to provide training on the use of the software. In exchange for the software license and training, the customer promises to pay Sample Co. $1.00 per transaction processed. Sample Co. concludes that the software license and training are each distinct. Does the sales- or usage-based royalty guidance apply to this arrangement? 21

22 Scenario 4 Yes. The license of IP is predominant in the arrangement because the customer would ascribe significantly more value to the software license than to the training. Therefore Sample Co. will recognize revenue as the usage occurs, assuming this approach does not accelerate revenue ahead of performance. 22

23 Scenario 5 Sample Co licenses patented software for a term of 3 years with no upfront fee and 1% of future product sales. However, Sample Co is entitled to at least $5 million at the end of each year, regardless of actual sales. Technology in this area is changing rapidly so the possible consideration from product sales ranges from $0 to $25 million, depending on whether new technology is developed. Management has concluded that the license transfers at a point in time when the license period commences. Management has also concluded that it is probable it will collect the consideration to which it is entitled, and there are no further obligations remaining after the license is transferred. How should Sample Co account for the transaction? 23

24 Scenario 5 Sample Co will recognize royalty revenue when the future product sales occur. However, since Sample Co is entitled to at least $5 million at the end of each year, this amount of consideration is not variable. Therefore, Software Co. should recognize as revenue the fixed amount (the minimum payment of $15 million) at license inception. Any consideration from royalties in excess of $5 million in any given year will be recognized as those sales occur. 24

25 Licenses of Intellectual Property Does the contract involving software include a license Yes License of IP No Apply general model SaaS Is the license distinct? No Yes Apply the general guidance to the combined bundle Does the customer have a right to access the entity s IP? Yes No Sales or usage-based royalties are estimated and subject to variable consideration (Step 3) No If the contract includes a sales or usage-based royalty, is the license the predominant item to which the royalty relates? Over-time perf. obligation Point-intime perf. obligation Yes Sales or usage-based royalties recognized at later of when sales or usage occurs and satisfaction of performance obligation 25

26 SaaS Subscriptions Question Is a performance obligation to provide software-as-a-service satisfied over time? Answer Yes (in general) Why? Customer continuously consumes and receives the benefit throughout the contract period Similar answer to other service-type contracts 26

27 SaaS Subscriptions Question Is a performance obligation to provide implementation services in conjunction with a software-as-a-service arrangement satisfied over time? Answer Yes (in general) Why? May create or enhance an asset that the customer controls Even if no asset is created, may still be satisfied over time But not always! 27

28 SaaS Subscriptions Example - Facts SaaS Co enters into a three-year SaaS arrangement with Customer Customer pays fixed quarterly amount for the SaaS SaaS Co agrees to provide the following services: Training Data migration Building an interface to Customer s GL system SaaS Co has already concluded that each service meets the definition of a performance obligation Interface will reside on Customer s network and will represent an asset for Customer Other services do not create assets 28

29 SaaS Subscriptions Example Analysis Interface Recognized over time Creates an asset controlled by Customer Other services SaaS Recognized over time Customer consumes and receives the benefit from each service as SaaS Co. performs Recognized over time 29

30 Principal versus Agent ASC 606 requires a similar analysis as current GAAP requires No longer consider credit risk as an indicator of being a principal Focus of analysis is on obtaining control of the good/service before transferring it to the customer Factors for being a principal Primary responsibility for providing good/service Assumes inventory risk Having discretion in setting prices Each promised good/service needs to be evaluated Could have some where you are principal and others where you are agent 30

31 Principal versus Agent Example - Facts SampleCo provides customer with cloud storage services Services include access to a 3 rd party s SaaS product SampleCo contracts directly with 3 rd party SaaS company for the right to access the SaaS platform SampleCo provides a significant service of integrating the various services into an integrated service Therefore, customer contract contains a single performance obligation as the SaaS and other services are not separately identifiable Is SampleCo the principal or agent for the cloud services? 31

32 Principal versus Agent Example - Analysis SampleCo appears to be the principal in this arrangement Recognize revenue gross for the fee received from the customer SaaS is one input into the integrated cloud services SampleCo obtains control of the inputs, including the SaaS platform SampleCo directs the inputs use to deliver a combined output 32

33 Questions? Scott Goodwin, CPA Member of the Firm and Technology Services Team Leader Phone: (617) Cecilia Frerotte, CPA Audit Principal and Software Sector Leader Phone: (617)