New Software Revenue Recognition Rules in 2015?

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New Software Revenue Recognition Rules in 2015?

The FASB issued an updated Revenue Recognition Exposure Draft on November 14, 2011. Comments are due by March 13, 2012. If you missed it, you can access the Revenue Recognition Exposure Draft that was issued on November 14, 2011 right here.

The FASB has been receiving several comments on the Exposure Draft.  The final form will likely be different than the form of the Exposure Draft.  However, if the basic principles of the Exposure Draft remain, the software revenue recognition rules will significantly relax!

How the Exposure Draft Will Change Software Revenue Recognition

The big difference the Exposure Draft will bring to software revenue recognition is the relaxation of the vendor specific objective evidence (VSOE) threshold.  The current rules (ASC 985-605) require the use of VSOE to separate the value of each element that you’re selling to your customers.  Establishing and maintaining VSOE represents a significant threshold, especially for start-up businesses.  If VSOE is not established, then the whole contract (or the elements without VSOE) is recognized using the most conservative revenue recognition criteria applicable to the contract (or those elements without VSOE).  This can mean that license, or other revenue, is recognized ratably over the contract period, instead of when the license is delivered. For those of you that follow this, you understand how painful this can be.

The new rules transform the requirement to use VSOE, into using the following hierarchy to separate a contract into separate elements:

  1. VSOE, if available
  2. Third-party evidence of the selling price, if available
  3. Management’s best estimate of the relative selling prices.

When Will the Change Take Place?

The new change will probably occur for calendar year 2015 financial statements, and thereafter.  On the FASB’s webcast dated December 8, 2011 regarding the Exposure Draft, the presenters mentioned that the FASB would like the effective date to be three fiscal years after the Exposure Draft becomes codified, or official US GAAP.  The FASB wants a long gap for the following reasons:

-Adoption will require restating prior periods.  All prior periods presented in your financial statements in the year of adoption will need to be restated using the new rules.

-For public companies that present three years of operations in their income statement, the FASB wants these companies to be able to track their revenue recognition concurrently using both the existing rules for software revenue recognition, and the new rules, during the gap from issuance of the new rules until their effective date.  This way, upon adoption of the new rules, restating prior periods won’t be as difficult as if it were effective in just one year from issuance.

As an example, assume that the FASB issues a final Accounting Standards Update for Revenue Recognition during 2012.  That way, companies will be able to track their revenue during 2013, 2014 and 2015 using both the old and new rules.  When the new rules become effective for fiscal years beginning in 2015, then you will have all the data needed to restate your 2013 and 2014 revenue.

To sum it up, the new rules represent a significant relaxation of the current VSOE rules.  Financial statements of software companies should make more common and economical sense after these new rules become effective.

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