In May of 2014 the FASB and IASB issued a press release offering joint recommendations regarding revenue recognition (link to press release). This recommendation is especially important for software companies when dealing with customer contracts. Until this guidance was available there was no agreed upon standard between GAAP and IFRS standards.
Why is revenue recognition important for software companies?
Reporting revenue recognition is especially important for software companies in order to understand and assess a company’s current performance and growth potential. Many software companies sell different products and services such as annual subscription agreements, maintenance fees, custom software development, training, and consulting. It is important to clearly define these elements in your contracts and to also recognize the revenue for each of these properly.
Software companies who might pursue investment from venture capital firms will most likely be asked to provide financials that follow these guidelines. It’s beneficial to start doing this early to avoid re-stating revenue for past years.
Financial institutions, much like venture capitalists, will require revenue to be reported that meet these standards. You may be required to prepare statements in accordance to GAAP and provide these as part of your terms for financing.
How should a software company recognize revenue?
The basic criteria for recognizing revenue are:
- persuasive evidence of an arrangement exists
- delivery has occurred
- the software vendor’s fee is fixed or determinable
- collection of fees is probable
Revenue Recognition for Annual Subscriptions
Revenue for annual subscriptions that are paid up-front should be recognized over the life of the subscription. For instance, a $1,200 annual subscription that starts in January should have $100 of revenue recognized each month for 12 months.
Recognizing Revenue for Software Maintenance Fees
Maintenance fees that are charged to customers should also be recognized ratably over the period of the term, just like annual subscriptions. If you charge $480/year for maintenance fees, then $40 of revenue needs to be recognized each month.
Revenue Recognition for Custom Software Development
If you charge for custom development then based on the criteria for recognizing revenue, you should recognize after the client’s customization have been completed and delivered. In addition, your contract should clearly state when the customer will be billed and how much.
How does ProRata help with revenue recognition?
ProRata is a web-based financial application that works in conjunction with QuickBooks Online to aid companies in revenue recognition.
- ProRata can be configured to meet all the recommendations outlined above.
- After a one-time setup, entering new subscriptions and other services takes less than a minute.
- ProRata integrates directly with QuickBooks to create journal entries, invoices and sales receipts; keeping your books up to date with the current standards
- Anyone, even those without a financial background, can use ProRata.