During a Tensoft webcast entitled “Revenue Recognition Accounting for Software as a Service (SaaS)”, guest presenter Jeffrey Werner was asked the following question:
How are you seeing the “Best Estimated Selling Price” working in practice, especially where there is no pricing history and management doesn’t establish firm pricing methodologies? Should we just bundle everything together (setup, monthly service, etc.) and recognize over the longer of the contract or expected customer life?
Jeffrey Werner is a software revenue recognition expert, and one of Tensoft’s most popular guest presenters. We posted all of his responses to the questions asked during the webcast online, and this question has had the most views by far. So, what’s the big deal about BESP that this topic would generate so much interest?
I don’t think there’s any doubt that – once EITF 08-1 was finalized – the introduction of BESP was going to make life easier than having to determine fair value. However, revenue recognition professionals were left with little guidance on how to exactly calculate and use BESP in their revenue recognition analysis.
The first part of Werner’s response reminds us that the introduction of BESP did not change the requirement – the deliverables in question must still have standalone value. As a result, companies will still have transactions that result in single units of accounting because the delivered products or services do not have standalone value. An example of this would be setup fees.
Werner then discussed the three BESP methods that he has seen used in practice:
1. Gross Margin Approach: This approach takes the cost of each element of a transaction and adds the expected or average gross margin to arrive at the estimated selling price. The gross margin is often at a division or product family level. Some companies with fewer product offerings might use a company-wide gross margin.
2. Discount from List Price Approach: This works when the company has a consistent pricing approach and discount range by product or product family that has some consistency. Companies look at the average discount and then apply that to list price for each product to arrive at the BESP.
3. “Broken” VSOE Approach: These companies apply the same analysis as a VSOE study but allow greater variances in the conveyed population and the plus minus percentage. For example, if the pricing of a product is consistent for say 60% of the population with a 20% plus or minus margin variance, that might be a good indicator of a Best Estimated Selling Price. This would compare to the normal VSOE analysis of 80-85% of the population covered with a 10-15% variance.
Werner’s response amply demonstrates complexities involved in developing a reasonable BESP and shows that, while a better indication of the economics of a transaction, BESP was not a silver bullet solving the world’s revenue recognition problems. Careful consideration must be given to the specifics of each transaction and as Werner stated: “Companies should work with their consultants and auditors to develop a reasonable approach.”
Tensoft has had a great deal of experience helping software companies automate and streamline their revenue recognition processes. In fact, we use Tensoft Revenue Cycle Management (RCM) ourselves, which helps us keep on top of our own revenue recognition needs. To learn more about Tensoft RCM, please explore our website, or simply contact us. And, if you’d like us to notify you the next time that Tensoft offers CPE-eligible revenue recognition training, just let us know.
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