What Does Topic 606, Revenue Recognition, Mean for VSOE?

The Financial Accounting Standards Board (FASB) released its new standards for revenue recognition back in May of 2014. The standard affects the manner in which all entities recognize revenue amounts they expect to receive for the exchange of goods or services. In terms of its implementation journey, the new standard of revenue recognition has been a rocky ride. The guidance has been amended and the effective date has been delayed a number of times, and the delay has not been standard across entity types. I want to help privately held companies in the technology sector avoid restatements and other noncompliance issues by looking at the accounting implications of the new revenue recognition standard on vendor specific objective evidence (VSOE) and the timeline for its effectiveness in your industry.

Vendor Specific Objective Evidence 

VSOE is an accounting method for revenue recognition to establish the fair value for software. Historically, this method has been employed by technology companies to recognize partial revenue before a contract is fulfilled in its entirety. Individual items were valued based on the fair value of contract components. Since most software revenue comes from license fees, this method helped software-as-a-service (SaaS) companies recognize associated revenue over the course of their contractual obligation. The FASB argues that issues arise, however, as some judgements are made based on ambiguities and unknowns. To increase transparency and standardize the process, the FASB’s standard, among other things, eliminated VSOE analysis. 

The New Standard

To determine fair value, the new standard essentially replaces the VSOE requirement with a requirement based on distinct, separate goods or services. On a contract-by contract basis, your company must consider whether a contract ultimately entails a single obligation or separate performance obligations, and, based on a transaction price, revenue is allocated to all performance obligations. I work with my clients to ensure they understand exactly what is considered a “contract” under the new standard, what constitutes a separate performance obligation, and how to account for contract amendments and side agreements. 

For many software companies, the new standard has been beneficial because it prompted the addition of upgrade rights to client contracts. Engaging in multiple agreements with the same customer brings about new considerations as well. I work with clients to determine whether, for the purposes of revenue recognition, combining certain contracts would be beneficial. 

In general technology companies are used to deferring revenue recognition until cash is received; however, even further deferral may be required under the new standard. When a contract involves licensing of intellectual property, whether for sales or usage, the new standard states that revenue must be recognized when it is sold or used. Term-based licenses and perpetual licenses also have their own unique considerations. 

In January of this year, the FASB released a Q&A document on revenue recognition.

Because the new revenue standard requires extensive disclosures, collection of more data, and processing both quantitative and qualitative information, I am working with my clients in the technology sector to modify their systems and processes appropriately. 

Effective Dates 

For most public business entities, the new standard has been in effect for years beginning after December 15, 2018. Earlier this year, the FASB issued an ASU delaying the effective date for non-public business entity franchisers, nonprofits, and entities that have not yet issued financial statements reflecting the change. This means, for these particular entity types, the standard may be deferred until fiscal years beginning after December 15, 2019 (interim periods within fiscal years beginning after December 15, 2020). If you have already implemented the standard, there may be opportunity for data collection and other procedural improvements, and, if you haven’t implemented the standard, there are preparatory and compliance actions to be considered as you transition.

Contact Livingston & Haynes 

The Technology & Entrepreneurial Team at L&H understands the challenges and needs of established businesses and startup ventures in the technology industry. My team can assist clients in the transition from VSOE, with calculations and compliance with revenue recognition standards, and with NEXUS and other hardware, software and cloud-computing issues. Contact me today to talk about your strategy.

by Steven Haynes, MBA

Steven J. Haynes, MBA, is an administrative partner at Livingston & Haynes and specializes in bookkeeping, payroll, and business advisory services for privately held businesses. Steve’s firm, Emerging Business Partners (EBPI), became an affiliate of L&H in 2007. EBPI was founded in September 1992, and, today, broadens the bookkeeping, payroll, and tax consulting services available to L&H clients.