It might upon adoption of ASC 606 if you have time-based software licenses.
Many software vendors today offer their customers a software license but restrict the customer’s use of the software to a short period of time, let’s say 3-5 years. This is often called a time-based or term-based license. For many companies, a time-based license is a preferred alternative to selling an unlimited software license without a time restriction (known as a perpetual license).
As you are probably aware, current accounting under US GAAP often requires deferral of upfront license revenue. Revenue recognition for time-based licenses is no exception.
Generally, if you sell a time-based license along with maintenance or support, you may be required to defer the license fee over the contractual term (or longer, in some cases). Certainly, there are exceptions to this rule. But many companies don’t qualify for the exceptions. In which case…bam…you defer your license revenue over time.
Here the new revenue standard under ASC 606 comes to the rescue. Under ASC 606, revenue from time-based licenses will generally be recognized upfront. This often holds true, even if your company is selling maintenance or support along with it.
Good news?
Not so fast.
On one hand, you (and many analysts) may prefer the predictability of recognizing license revenue over time. For many companies, ASC 606 will preclude over time recognition for deals that are currently accounted for in that way.
But even if you prefer the upfront recognition of license fees, there is a catch. When your company adopts ASC 606, you will have to apply the new guidance to open contracts at the date of adoption. For companies planning to adopt using a cumulative catch (prospective) approach, time-based license revenue previously deferred under current GAAP will magically disappear into a black hole. Well, not exactly a black hole—it’s called beginning retained earnings. But in either case, you and your shareholders may never see that deferred revenue hit the income statement.
What to do?
For those of you who appreciate the over-time model, there are provisions that may allow you to restructure your contracts to continue to recognize revenue over time under ASC 606.
As it relates to the black hole – one option is to adopt ASC 606 retrospectively. This likely releases your deferred revenue into the income statement for the back-years presented. But even with retrospective adoption, the black hole will still be there for the earliest year presented. Seeking relief, some companies reckon it’s better to re-negotiate their current time-based license contracts before ASC 606 adoption.
Granted, this may come with a little pain initially. But if done properly, your company may prefer releasing its deferred revenue into an actual reported income statement which everyone sees….rather than waiting for the new standard to flush the revenue into a black hole.
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Topics: Revenue Recognition, license revenue
Written by Sam Kerlin, Argon Advisors
Prior to joining The Argon Advisors, Sam was a partner at KPMG. Sam recently completed a rotation as an audit partner in KPMG’s Department of Professional Practice, the firm’s national technical office in New York City. Sam has served several global and public audit clients in software technology, pharmaceuticals and bio-manufacturing. Previously Sam also served as tax manager in KPMG’s Washington National Tax practice in D.C., specializing in mergers and acquisitions tax accounting. He spent several years abroad in Germany and Russia and is fluent in both languages.
