While some of these arrangements may qualify to practically continue to treat such offerings as a single unit of account, not all of them will. This is especially true of companies that place substantive limits on the amount of support that customers are eligible to receive. Those companies will likely find that they need to separate these services into separate performance obligations for accounting purposes.
Specialized guidance exists for licenses of intellectual property that frequently applies to on-premise software licenses. As a result, one significant area of judgment that some SaaS companies may encounter in applying the new guidance is determining whether a hybrid offering that includes an on-premise software license and a SaaS application or a SaaS application with an offline mode include a single bundled performance obligation, or whether the offerings are distinct.
SaaS companies frequently sell services that can be renewed or provide other customer options. To the extent that significant renewal or other discounts are offered to customers, the guidance requires assessment of such offers to determine whether they transfer a material right to the customer that should be accounted for as a distinct performance obligation.
Many companies may find that even if they do not ultimately reach the conclusion that additional units of accounting exist, significant effort may be required to perform the analysis to reach that conclusion. Variable consideration — The new guidance considers any variability in pricing subject to change to constitute variable consideration.
SaaS companies often encounter contract terms such as usage-based fees or volume discounts, may sell software through resellers with rights of return, or may have business practices of frequently providing price concessions to customers. In many cases, such amounts may be deferred until known or identified under current guidance. While practical expedients in the new guidance are available to companies to allow for administrative ease in applying the new guidance primarily to allow companies to recognize transaction-based fees as they are earned in specific circumstances , many SaaS companies may find that the structure of their contracts is such that they are precluded from using such expedients.
For usage-based fees, the inclusion of minimum or maximum usage levels may preclude taking advantage of such practical expedients. Without the ability to take advantage of recognition as invoiced, companies will be required to develop estimates of total variable consideration within a contract, which is often a burdensome endeavor. Also, companies that sell through resellers and currently apply a sell-through model for revenue recognition purposes may accelerate recognition upon the initial transaction with the reseller and will accordingly be required to estimate the related variable consideration under the new model.
Such estimates then may be recognized only to the extent it is probable there won't be a significant subsequent downward adjustment. However, developing and allocating revenues for some performance obligations can require the application of significant judgment. Companies should be aware that while developing the related policies for allocation is generally not the most resource-intensive step in the new model, the application of those policies may require the development of new processes and controls on an ongoing basis that could be resource-intensive.
Recognition pattern — Many SaaS companies may conclude that the pattern of recognition for services that provide continuous access, generally on a subscription basis, will continue to be recognized on a straight-line basis over a period of time. However, many SaaS companies may also conclude that their contracts include other performance obligations that should be assessed for the appropriate pattern of recognition.
These may commonly include specified upgrades, a specified amount of technical support, set-up and training activities, and other professional services. SaaS companies should be aware that each identified performance obligation will need to be reassessed to determine which attribution method will best depict the pattern of transfer to the customer of the related goods or services, which may differ from the subscription or license period, and this assessment could change the pattern of recognition from current practice.
Principal vs. The analysis of whether an entity acts as a principal or an agent in a transaction must be revisited for companies with performance obligations in which a third party is involved in delivering the product or service to the customer.
Such analyses often require significant judgment when services are being analyzed. Many software companies that provide their products through third-party hosting arrangements or provide a marketplace service offering may find application of the relevant guidance to be challenging and may potentially change previous conclusions and resulting financial statement presentation.
When a contract contains the right to make additional purchases, a SaaS provider must determine whether those purchases represent material rights. A material right results when the SaaS provider offers an optional benefit that the customer would not have received without entering into the contract.
For example, by entering into a contract, a customer might obtain the right to purchase a good or service at a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market. Material rights commonly arise in SaaS arrangements when the contract includes a price list detailing other goods and services that the customer may purchase, and the pricing for those optional items are at a significant incremental discount.
That is, the price list included in the contract provides the customer with discounts that are incremental to the range typically given for those goods or services when sold on a standalone basis to similar classes of customers. A material right is a performance obligation under ASC It must be allocated a portion of the transaction price based on its relative standalone selling price, although ASC does provide an alternative that SaaS providers can use instead of estimating the standalone selling price of a material right.
Revenue from the material right would be recognized at the earlier of when the purchase right expires or, if exercised, when the underlying good or service is transferred to the customer. Lab does not offer this type of discount to similar classes of customers. Accordingly, the option to purchase additional licenses is a material right. However, ASC allows companies to use an alternative approach to allocating arrangement consideration to a material right.
Rather than determining the stand alone selling price of the material right using sophisticated option pricing models, an entity can allocate the transaction price by referencing the goods or services expected to be provided, in this case the additional licenses.
Assume Lab estimates that there is a high likelihood that the customer will purchase three additional licenses. For simplicity, also assume that the discounted pricing is not offered in connection with any renewals of the for the platform seats purchased at discounted pricing.
If the customer decides not to exercise any of the options, Lab would recognize the revenue upon expiration of the options. ASC requires that incremental costs to obtain a contract be deferred and amortized on a systematic basis consistent with the pattern in which revenue related to the contract is being recognized.
However, as a practical expedient, a company may recognize the incremental costs of obtaining a contract as a period expense if the amortization period would have been one year or less. ASC defines the incremental costs of obtaining a contract as those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained.
A common example of a qualifying cost is a sales commission payable to a sales agent or employee upon contract signing. In practice, SaaS providers may sometimes find it challenging to determine the period over which qualifying costs should be amortized and the pattern in which amortization should be recorded.
In situations where commissions paid at inception of a customer contract exceed those paid upon contract renewal, careful consideration should be given as to whether GP may apply the practical expedient of immediately recording the incremental commission payments as a period expense. Instead, a renewal commission is commensurate with an initial commission if the two commissions are reasonably proportionate to the respective contract values e.
If a contract does not contain commensurate commissions, the initial commission may relate to a contract period beyond the initial term of a customer contract. In this example, the initial and renewal commissions are not commensurate.
Accordingly, GP would not qualify for the practical expedient. Instead, GP would defer and amortize the initial commissions. The amortization period should consider both the initial contract term and any expected renewals. In practice, estimating future contractual renewals is highly judgmental and should consider factors such as historical renewal rates, expected obsolescence of the underlying software platform, and anticipated changes in technology, competition, and other economic factors.
SaaS providers may find it appropriate to estimate the amortization period using a portfolio of similar contracts. When determining the amortization period, preparers of financial statements should consider whether the customer relationship life, based on historical attrition, is longer than the technology life cycle for the underlying product.
If the cumulative technology changes to the product being renewed are expected to be significant, the amortization period should be based on the shorter product life cycle, rather than the customer relationship period. For purposes of this example, assume that GP determines that the contract will be renewed four times.
The pattern in which amortization is recorded should be proportionate to the revenues recognized over that period. Therefore, any deferred costs should be recognized on a similar straight-line basis. Other approaches for amortizing the commission costs may be acceptable, provided they comply with the principles in ASC BDO is well-equipped to help preparers navigate the myriad of complex accounting, SEC reporting, tax, and audit considerations needed to be addressed by SaaS providers as they determine the proper accounting for revenue.
BDO professionals have a wealth of experience working with "best in class" SaaS providers. By leveraging our extensive experience with companies of all sizes across a wide range of industries, we have the ability to offer a comprehensive range of services to assist and complement your internal accounting functions through a collaborative and tailored approach. Forgot my password. The Evolving SaaS Model As the SaaS delivery model matures so does its business model in order to satisfy customer demands as well as retain profitability.
The matters addressed in this publication are as follows: Determining the contract term Evaluating professional services with the SaaS arrangements Applying the series guidance Usage-based pricing Evaluating optional purchases Accounting for commissions and other similar costs of obtaining a customer contract Brief Refresher — The Main Principles of ASC Under ASC , a SaaS provider recognizes revenue when it transfers a service to the customer.
Create a BDO Account to manage your subscriptions. Email Address username. Please enter a user name. Your login attempt was not successful. Please try again. When both parties can opt out of the contract at any time for convenience, the contract effectively becomes a day-to-day contract for accounting purposes. This means that the SaaS provider should not consider any future variable consideration in determining the transaction price.
The term of the contract is limited to the notice period, if any, that the customer must provide when electing its right to opt out of the contract. Moreover, if the customer initially paid a nonrefundable fee at the commencement of the contract, the SaaS contract might contain a material right, since the customer can effectively opt to remain in the contract i. The concept of material rights is explained in more detail later in this publication.
The PS will be evaluated as a potential performance obligation if it transfers a good or service to the customer. Moreover, the PS will be a distinct performance obligation—i. The customer can benefit from the PS on its own, or together with resources that are readily available to the customer 2.
The promise to provide PS is separately identifiable from other promises in the contract The first criterion is typically met when the SaaS provider or others regularly sell the PS separately, without also requiring the customer to purchase the hosting services. In some cases, this criterion can also be met even if the PS is only sold in conjunction with the hosted software, depending on facts and circumstances.
For example, if the PS will be provided after the hosting services have commenced, the customer can benefit from PS together with resources readily available to the customer, namely the hosting services that have already been transferred. The objective of the second criterion is to assess whether the nature of the promise in the customer contract is to deliver PS and other goods and services individually or, instead, to transfer a combined item.
Factors suggesting that the PS is not separately identifiable from the hosting and other services in the contract and therefore not a separate performance obligation include: a. The PS is an input necessary to fulfill a promise of delivering a combined output to the customer, i. The PS significantly modifies or customizes the hosting solution, or vice versa. The PS and other goods and services in the contract are highly interrelated or interdependent. This means that the SaaS provider would not be able to fulfill its contractual promise by transferring each of the goods or services independently.
The IRS and U. Department of the Treasury have clarified several issues relating to internal-use software IUS and qualified research…. Related Industries. Software as a Service SaaS. Identify the contract To recognize revenue from a contract, the contract must: Be approved by the parties to the contract Have parties that are each committed to performing obligations under the contract Have identifiable rights for each party Have payment terms that can be identified Have commercial substance Have a transaction price likely to be substantially collected Identify separate performance obligations Types of performance obligations specific to technology and software entities Software as a service SaaS On-premises software Hardware or networking equipment Post-contract support PCS Professional services Does the contract contain a promise of a license?
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