Revenue Recognition Challenges in the Software Industry

Recognizing revenue can be particularly challenging in the software industry. The challenges can arise from the sales process, the volume / complexity of the sales transactions, the number of inputs required in the revenue process, or from the appropriate accounting standards that apply to your business.  Occasionally you may have all of the above! I’ll summarize some of these challenges here:

Accounting standards and regulatory requirements can add complexity in a number of ways. If you sell multiple related items there are specific guidelines for fair value allocation to each of the items on the sale. Related items would be products or services you would not purchase without each other – for example, a setup fee and a subscription fee which are both needed for a customer to move forward with the purchase. The accounting standards can also impact the timing of revenue if, for example, you have a required customer acceptance process, or if there is substantial dependence on a related event. You could have items that are based on management’s estimate and therefore would need to deal with the potential complexity of a change in the estimate. You could have warranties, or discounts, or any of a number of complexities that require clearly demonstrating compliance with the accounting standards. These types of challenges, if not properly managed, can materially impact revenue reported. They can also slow the velocity and reportability of revenue due to extra manual review of the transactions, and can also substantially increase audit costs.

How you sell to your customers must be considered as part of accounting standards requirement. It is also important for efficient and effective information flow. Accounting standards will require the appropriate sale, or customer agreement, to be represented on a single revenue agreement. In this respect the accounting standards would state: if your agreement is a sales order, then that needs to be the revenue document the standards are applied to. It is important to clearly identify ff your agreement is an invoice, a contract, or an eCommerce transaction. Understanding your sales process, or your go-to-market-model, is important for accounting department productivity as well. If you have a high volume eCommerce-based go-to-market model, you need effective ways to capture data efficiently from that process for revenue recognition. If you have a multi-part contract with the customer that has multiple lines and deliverables and schedules, it is equally important that you efficiently support and integrate with that process. Not all financial professionals have spent time thinking about how you go to market. For revenue recognition, a clear understanding of this is essential.

With the transition requirement for the new revenue recognition standards looming, now is a perfect time to review your sales and revenue recognition policies and procedures.  Many companies are revisiting the systems that impact the revenue cycle to ensure they have the ability to efficiently track and measure sales transactions through the new five step model of:  Identifying the contract, identifying the performance obligations (deliverables), determining the transaction price, allocating the transaction price and recognizing the revenue.  Because the new revenue standard is more principles based, it will require more company judgment and disclosures.  This further heightens the importance of maintaining consistent and reliable revenue information for your company and your auditors.

The volume or complexity of your go-to-market transactions, and the related volume of sales transactions, can add their own challenges. Even simple revenue requirements can become complex with enough volume. Basic contract management (setup fee and subscription for example) becomes challenging when you exceed 100 contracts, while eCommerce transactions can become complex for 1000s of transactions. I have seen customers who have very basic transactions; maybe they sell two SKUs that are amortized over two different periods of time. However, when you consider they are doing 500,000 of these transactions every month – and that there are the occasional returns or other customer support challenges – what is conceptually simple can also be a significant accounting challenge.

The final area that can challenge revenue recognition efficiency is a dependence on outside inputs. There are a variety of these types of required inputs. Sometimes they are part of the billing challenge; for example usage charges, overages, or true-ups. These types of inputs from external systems need to be run through contractual terms for pricing and billing. Another type of requirement leverages work management inputs. This can be from your onboarding system for go live or change events, from your professional services group for percent complete or delivery dependent requirements, or from field technicians or customers for confirmation of go live events. An additional set of inputs can be from your helpdesk or customer support systems where the type of inputs could be everything from customer activation to granting the customer an extended support period or a later start date. All of these types of challenges can require inter-departmental coordination and detailed data movement to accurately support your revenue recognition process.

With these complexities as well as the importance of revenue to financial statement users, it is no surprise that we see so many companies in the news highlighting revenue recognition issues.  We can recall the days of Enron, WorldCom, and the creation of the Sarbanes-Oxley Act, but examples can still be found today with companies like Valeant and Monsanto restating revenue by over $200 million and being fined almost $100 million.  Even large companies like IBM and Boeing are under SEC investigation for potentially record level revenue restatements.  Revenue recognition consistently ranks in the top five accounting issues with approximately 1,300 companies filing restatements with the SEC between 2005 and 2014.

Today, nearly every company sells their software slightly differently, using variations and combinations of several basic go-to-market models. While there are certain guidelines that all companies must follow, it’s the variety and combinations of go-to-market models employed, the required accounting standard compliance, and the level and potential complexity of internal department events and actions that can create so much complexity around software revenue recognition.

This is why it’s very important to our customers that Tensoft understands these issues and has worked with many other companies who have dealt with the same challenges. When choosing revenue recognition software for your software company, it is critically important that the solution you choose has been designed to handle your industry’s needs. Otherwise, awkward customizations will likely slow down and complicate your revenue recognition process, leaving you with not much of an improvement over the spreadsheets that you’d been using!

For more information about Tensoft’s products and services, please contact us. If you’d like to comment on this article, I encourage you to Tweet, post to Facebook or blog about it!

Find out more:
Revenue Recognition for Technology Companies: Q & A
eCommerce Revenue Recognition Pitfalls for Technology Companies