Understanding the New Revenue Recognition Standard—an Illustrative Example

In the first part of this blog series, we looked at the big picture changes of the new revenue recognition standard and provided pointers to some good general resources. Now, let’s take a look at an example on how the removal of industry specific guidance will impact software companies.

In their publication, PWC provides the example of sale of a perpetual software license with post-contract support (PCS). For this example, none of the goods and services are sold on a standalone basis, and there is no stated renewal fee for the PCS services.

Under the old model, a company would try to establish the vendor specific objective evidence (VSOE) of fair value for each element of the contract to avoid deferring the license revenue over the contract length of the PCS. However, in this example, establishing VSOE of fair value might be very difficult as no standalone prices exist and the company could face the dreaded full deferral of the license revenue.

So under the old model, the stringent VSOE requirement creates the risk of full deferral for software companies. Does that mean under the new rules, without VSOE, we can avoid the risk of full deferral? As always, the answer is… it depends.

PWC states that under the new rules the software company should account for the license and PCS as separate performance obligations in accordance with the principle based approach. The transaction price for each obligation then needs to be estimated and allocated to the license and PCS of the contract. In this example, the new standard will accelerate the recognition of revenue if VSOE of fair value was not previously established.

So that’s good news for software companies, right? Well, it depends—in the above example, full deferral is avoided because the PCS and license were identified as separate performance obligations. However, in certain situations separation might not be appropriate, especially when products and services are ‘highly dependent’ on each other. It will be interesting to see more industry specific use cases published in the coming months to understand how the industry will interpret the various business use cases.

For more technology related accounting examples, especially around the determination and allocation of transaction prices, please refer to the full PWC report.