In: Accounting
Revenue Recognition for ABC Software Company under ASC 606
ABC COMPANY was stumped by U.S. accounting rules for revenue recognition and gave up trying to comply with them. The Japanese giant recognized this would lead to the delisting of its ADR shares on NASDAQ. ABC also said it would be able to file its 2006 annual report under U.S. GAAP and it couldn’t vouch for its financial statements since 2000. ABC COMPANY said a restatement was not practicable because of the complexities. ABC noted that its financial statements under Japanese GAAP are current and not affected by this announcement.
Under accounting principles generally accepted in the United States of America, revenue recognition rules are complicated for software companies whose contracts combine the sale of software with maintenance service agreements. Previously, a standard called SOP 97-2 for companies wishing to recognize the software-sales revenue up front must perform an analysis of such contracts that provides “vendor specific objective evidence” (VSOP) of consistent treatment of sales and service. That analysis, which ABC COMPANY says it has been unable to complete, required before portions of revenue from a single contract can be broken out and recognized at different times. ABC says it is unable to complete the VSOE analysis for its auditor in time to file the annual report for the year ending March 31, 2006 even though ABC had previously been warned by NASDAQ and received an extension.
On June 17, 2008 the Securities and Exchange Commission instituted proceedings against ABC pursuant to the Securities and Exchange Act of 1934. The resulting order revoked the U.S. registration of each class of ABC’s registered securities and ordered ABC to cease and desist from committing certain violations based on ABC’s failure to file annual reports and maintain sufficient internal controls, and failure to make and keep accurate books and records. Following the revocation order ABC securities remain listed for trading, and actively trade, in Japan. ABC's American Depositary Receipt Program was subsequently terminated as of March 31, 2010.
Recently, new revenue recognition standards have been adopted in the USA. ABC’s management would like your advice on whether it might be a good time to apply for the company to be listed on a US stock exchange by complying with revenue recognition requirements.
ABC has the following sources of income that should be evaluated.
Other considerations:
Does the customer have the ability to
forgo the hosting provided by the Company and instead host it on
their own servers, or some other remote server (e.g., AWS,
Microsoft Azure)
Yes, this is an option we make available, though we highly
discourage it. Out of 2000+ customers, less than two dozen forgo
the hosting services.
· How integral
are the implementation services to using the software?
Highly integral. We provide no generic services. For example, as
part of implementation, we provide an overview of the ABC database,
but we do not educate customers on relational database management
systems.
· Could the
customer source the implementation services from some other third
party?
A customer has only one option for sourcing implementation
services: 1) Company ABC if the system was purchased through direct
sales, or 2) a channel partner if the system was purchased through
that channel partner.
· Does ABC
perform regular upgrades to the software?
Yes
· Does the
customer have to pay separately to get access to such
upgrades?
No, upgrades are included as part of the annual license
subscription.
· If ABC
provides upgrades, are they promised (explicitly or implicitly) at
any sort of regular cadence?
Releases (i.e., upgrades) are delivered every four weeks like
clockwork.
· Is there a
minimum number of upgrades promised or implied during the term of
the contract?
License subscriptions run on an annual basis, though contracts are
often times multiple-year subscriptions. Thirteen releases per year
are implied in an annual subscription.
Explain the following
B. Would the license be classified as a license of functional intellectual property or symbolic intellectual property?
C. Would the revenue be recognized at the point in time that access to the license is granted to the customer or over the license term?
2. Discuss the revenue recognition for Implementation
3. Discuss revenue recognition for Hardware sales.
4. Discuss a factor that could change one of your answers.