| Follow-up Q & A from "Structuring Software Sales Transactions for Optimal Revenue Recognition" Webcast, Part 2
| by Jeffrey Werner
||5/16/2013 9:33:00 AM
| On April 17th, Tensoft hosted a webcast with Silicon Valley software revenue recognition expert Jeffrey Werner entitled “Structuring Software Sales Transactions for Optimal Revenue Recognition.” This post covers Jeffrey’s responses to audience questions posed during the webcast.
(If you missed the live webcast, you can still view it any time by clicking here.)
Question: If a perpetual license is sold along with support, do you get to recognize the license revenue up-front or ratably over the support period?
Response: This depends on whether you have vendor-specific objective evidence (VSOE) for the support. In the case where you have VSOE, you would defer that amount for the support services based on the VSOE and you would recognize the remaining amount -- or the residual amount -- on delivery of the license. If you have a perpetual license which you’re selling with support, and you don’t have VSOE, then you’re going to recognize both the license and the support fees ratably over the support period. This is why it is so critical and so important that you establish VSOE if you have software licenses because most software companies sell their licenses with support in the initial transaction.
Question: How are companies accounting for sales of apps through their online app store?
Response: In the four principles of revenue recognition, we’re going to look at delivery. When someone logs into that application store and downloads the app, that would generally be the point in time where we consider delivery to have occurred. Then we would need to look at the price that the company will receive for that app, which is generally less than the full retail price. In general, public companies or other companies that are selling apps through an online application store recognize the net revenue from the sale of the app. The company would generally recognize revenue at the point the app was delivered or downloaded by the user, provided all the other revenue recognition considerations are met. Here are some examples of other considerations: 1) Collectability - Is the app store credit-worthy such that the company is going to collect the fees? 2) Delivery - Are there any other future obligations as part of that transaction? If so, revenue would need to be deferred for those obligations.
Question: Can you highlight any best-practices for companies that have value-based pricing on software?
Response: With regards to discounting, most software companies have list prices but the net sales price has significant discounts. So, your pricing methodology is going to be based on the value that you think you can get from your customers, or that your customers are willing to pay for, rather than the list price. Therefore, you are typically going to find your software licenses at a discount or at a significant discount from their list prices. One of the best practices that companies do is price their support and maintenance based on the net license fee, rather than some other set dollar amount or a percentage of the list price. We’ll talk about some other aspects of how to structure and price the contracts so that you have clear and understandable arrangements and can get the desired outcome.
Question: Can you describe the difference between subscriptions vs. SAAS?
Response: With SAAS the software isn’t actually licensed to the customer, it’s just accessed by the customer or the user over the internet; it’s clearly a service. A subscription would be where a software license is licensed and transferred to the customer and is hosted by the customer on their server. The customer has a software license agreement with the vendor and they are allowed to use the software on their server over a period of time. As I mentioned, a lot of folks use the terms “term license” and “subscriptions” as if they’re synonymous but there can be significant differences. “Term license” is a license used for the software over a specific period of time, and a subscription sometimes includes whatever is available during a particular time period, such that the customer subscribes to a suite of software over a period of time. In a subscription, if new elements are added to that suite, the customer gets those elements without an additional fee. I use the analogy, it’s like the subscription to a magazine. You get whatever is in the magazine in each issue for the next 12 months if you subscribe for a year. That’s similar to a company that has a subscription license where you get over that period of the subscription, whatever elements, modules or apps that are in this particular family. Subscription and SAAS arrangements generally both have ratable revenue recognition, but the subscription is a software license and therefore follows software revenue recognition rules while a SAAS arrangement follows the relative selling price method. Those are the significant differences between a subscription and a SAAS.
Question: Have you observed any cases of auditors requiring valuing an indemnity as an element?
Response: Generally no, I haven’t. Generally, indemnification for intellectual property rights happens when the vendor says: “You, the user, are indemnified if a third party comes and declares that you’re infringing on their software or intellectual property by using the product of the vendor.” Typically the vendor has indemnified their customers and the vendor is responsible for either defending against the infringement situation or reimbursing legal costs of the customers to defend against the infringement claim. Typically those intellectual property indemnifications are excluded from revenue recognition. There may be other indemnifications other than intellectual property rights that are associated with levels of service or performance that have a revenue recognition impact.