It was just last year that the accounting governing boards FASB and IASB jointly issued the new ASU 2014-09, “Revenue from Contracts with Customers” which outlines a single all-inclusive model for accounting for revenue from customer contracts. The effective date of this new standard will be somewhere after December 2016, at least for FASB pending official agreement in the coming months. This is when the new standard will replace most existing revenue recognition guidance. The aim of a converged standard is to ensure consistency across all industries which currently operate under separate isolated revenue recognition processes. This obviously also helps consistency between the U.S. GAAP and IFRS.
LLPs are bracing for the fact that these new standards will have a major impact on U.S. software companies and foreign software companies filing on U.S. securities exchanges. The New SOP is intended to address important software licensing and business issues not included in SOP 91-1 and offer clearer guidance to reduce the inconsistent application of SOP 91-1 in software transactions. In a case where a lawyer is in an advisory position for technology companies on software transactions, he or she will play a critical role in the client’s ability to recognize revenue. A software agreement will be the first place an accountant will look when determining the accounting treatment for a software transaction. Further, some of the basic revenue criteria for recognizing revenue is dependent on the structure and terms of the software agreement.
If you’re reading this you’re more than likely in the legal profession, so:
Why should lawyers care?
There are plenty of reasons why law firms can choose to ignore the new jointly issues #RevRec standards.
Number one, it’s accounting at the end of the day, not law, right?
Number two, there is a long time before it actually gets implemented, 2017, right? We have time!
Number three, we already divulged in our 10-K that the adoption of ASU 2014-09 “may impact our financial statements” and “we are currently appraising implementation methods and the extent of the impact that implementation will have upon adoption.” Isn’t that enough?
But there are some key items lawyers need to have their eyes on right now:
- The new revenue control could impact performance-based compensation arrangements. Long-term performance goals should be set and evaluated with an eye on the impact of the new standards. Your compensation consultant may need to be brought into the discussion.
- Although the new revenue recognition standards apply to the 2017 financial statements, most companies are expected to retrospectively confirm their 2015 and 2016 financial statements to provide presentation consistency and avoid prior-year comparison disclosure in their 2017 financial notes. Therefore, it’s important to know now how the new standard might impact 2015 and 2016 earnings once it becomes effective.
- Confirm the new standard will not affect the company’s ability to meet financial promises contained in credit facilities, indentures or elsewhere, or impact terms of long-term customer agreements.
- Be sure management is prepared to address anticipatory questions from analysts and investors within the bounds of regulation FD.
- Consider whether the new standard could impact the company’s long-term tax strategies.
- Consider whether changes will be required for the company’s IT systems and internal controls, and whether they might require corresponding cash flow, capital expense or risk factor disclosures.
For some companies, the effect of ASU 2014-09 will be minimal or non-existent. For others, it could be real, tangible and material.
In order to avoid surprises as a result of these consequences, it’s essential to be aware and understand now where your company might be on that spectrum.
Lawyers play a very important role in helping software companies recognize revenue and handle legal issues arising thereafter.
Experts have recognized key areas in revenue recognition (from a lawyer’s perspective):
- Acceptance. It is essential to ensure that the license agreement or order states clearly that the software is ‘accepted’ on the order date.
- Warranties with refund rights. This is a pretty barbed issue, but in general, other than a standard limited duration performance warranty that the software will perform in material accordance with its documentation, any additional warranty with refund rights could create a real revenue recognition risk.
- Future deliverables. The customer is buying the license for the software (as it currently exists), so there should not be any commitment regarding future enhancements (other than standard maintenance/support), in the contract or outside the contract. This is sort of an easy one!
- Signed agreement. While this should not come as a surprise, having a signed agreement (that means by BOTH parties) is critical to a final deal. Most folks focus on getting the deal done, yet it is really not done until the agreement is signed. Electronic signatures are also workable with.
- Fee is clear and collectible. The license agreement and order should be clear about what the customer will receive and what they will pay for. This seems pretty basic, but it should not be overlooked with vague descriptions of what will be provided, or unclear and definite payment/fee terms.
Lawyers have to care about the recent changes as their advice to clients will be of immense help, especially in the early adoption stage. There is time for legal minds to prepare as the actual implementation kicks in late 2016. In the meantime, lawyers can keep track of TRG meetings and their discussions to understand upcoming challenges. As we recommend to all parties when it comes to the new guidelines, however, there is no time like the present to prepare!
Continue staying tune to this space to keep abreast of the latest happenings in revenue recognition and follow us on social media for quick updates!