The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have recently published important exposure drafts on “Revenue from Contracts with Customers.”  The proposed joint standard seeks to clarify the principles for recognizing revenue and to adopt a single revenue model for both International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP) reporters, across industries and markets.  If adopted, this would represent a significant step toward global convergence in financial reporting.

These proposed standards will likely result in significant changes in the key financial performance measures of many companies, in many industries.  For most, this will require changes to the business management systems that measure and recognize revenue, as well as updates to revenue recognition process controls.  Although the effective date is no earlier that January 1, 2015, it’s not too early to prepare, since this may take substantial planning and effort to implement, depending on your company’s current contract and revenue processes.

Tensoft will be providing further insight to our customers, partners and other interest parties, including an upcoming webcast on March 13 – just in time to help inform any additional comments that you’d like to make on the exposure drafts! 

 Revenue management functionality is available either as part of a few financial and accounting software solutions, or as an independent solution that provide some level of integration to your system of record.  Vendors on both sides can be glib about their product’s ability to handle anything that you can think of.  If your company is in either the technology or software industries, you’re probably well aware that your needs in this area are beyond what most solutions are designed to handle.  When in doubt, be sure that the vendors that you’re considering can demonstrate - not just talk about or give a slick slide presentation on - the following capabilities:

1)    Ability to handle multi-element arrangements.

2)    Robust support for fair value methodology.

3)    The system can match the transaction flow of your go-to-market model(s), providing, for example, contract administration or integration to your website or CRM system.  

This is just a starting point, of course, but these three points will help narrow the field a bit.

QUESTION: I am looking for a software service that allows me to track customer and product profitability.  I work for a SaaS company and we are trying to track engineering and marketing time along with any direct expenses attributed to a particular customer or product.  Since labor is the biggest cost, we are looking to track employee time at a very detailed layer.

What I am looking for is a system that does the tracking and then feeds into the overall system, so I can measure profitability against a specific customer or product.  Ideally, I just want the "one-press-of-the-button" concept.  I know there is stuff for manufacturing, but see no solution that handles more SaaS service-oriented (non-consulting) companies.  Any advice?

ANSWER: In my experience, some challenges require business trade-offs, especially given the reality of available solutions.  While anything is possible, the benefit you receive from tracking this information needs to be business-reasonable to collect, and it also needs to fit with your company’s culture and realities.

Take product cost for example.  The challenges of tracking engineering time to a specific end-customer and product line is monumental -- unless your company does only very large sales to a very few customers.  Obstacles include: accurate time-capture for employees’ timing differences (the time lag between events and labor cost and the revenue to be recognized) and matching challenges.  Some of the expenses will be cost-of-goods-sold (COGS), which is matched by definition to revenue.  Some of them will not be tracked as COGS – and would be challenging to track as COGS (both from a GAAP and a management perspective).

A solution that provides value while considering some of these challenges is a product line P&L.  Revenue, COGS, engineering time and marketing time are all tracked to a P&L by way of an account code or other financial designation.  The period of time considered is usually 3-5 years for analysis – allowing for R&D or other engineering and marketing costs to be captured along with the overall revenue and margin created.

- Bob Scarborough, President and CEO, Tensoft

 Thanks to everyone who attended "EITF 08-1 and the Relative Selling Price Method for Multiple Element Arrangements," another very informative webcast presentation by Silicon Valley revenue recognition expert, Jeffrey Werner.  Tensoft was pleased to host this event, and is looking forward to Jeffrey's upcoming revenue recognition online classes that we'll hosting in November - check Tensoft's website next week for more information about that. 

Meanwhile, here are the answers to attendees' questions from last week's webcast:

Q: How does this apply to Web Based Application Services, if at all?

JW: If the web-based application service includes multiple elements, we would use ESP to allocate revenue to each stand alone element and then generally recognize revenue when that element is delivered. There may be other considerations such as the requirement to recognize set up fees over the longer of the contract period and the expected customer relationship period.

Q: If a company sells software using an on premise subscription model and SAAS-on demand, how can you justify using different revenue recognition models for which is essentially the same business model. The primary difference is on is a time based license that is on premise at the customer's location and the other is time based whereby the customer's software is located at a data center? This is more a request, but it would be helpful to see similar examples where the multiple elements include services, on demand services that include support. Is there anywhere I can obtain this info

JW: If the on-premise subscription model meets the requirements for software revenue (customer has the right and ability to take possession without significant cost) it would be recognized under software revenue recognition (residual method using VSOE).

The SaaS on demand sales would be allocated and recognized under EITF 08-1.

If a transaction had both on premise subscription and SaaS, the allocation would be done using EITF 08-1 and then on premise recognized using residual method and VSOE and the SaaS recognized as a service under 08-1.

Q: is EITF 03-5 no longer relevant?

JW: EITF 03-5 is superseded by EITFs 08-1 and 09-3.

Q: is ASU 2009-14 only used for tangible items w/ software?  What is used to determine how to account for a hosting engagement where software is sold? 

JW: If the hosting engagement meets the requirements for software revenue recognition because the customer has the right and ability to take possession and self-host without significant cost, then software revenue recognition would continue to be applied. If not, the multiple elements in the arrangement would be allocated revenue according to EITF 08-1.

Q: Would you use residual method for delivered software other than ESP?

JW: The residual method would only be used for the initial revenue allocation for software sales without other non-software elements. Software would use ESP and the relative selling price method for the allocation if the multiple element arrangement included non-software element.

Q: While I understand that contract terms and conditions affect the decision, I am wondering about his opinion on a particular transaction set.  If a company responds to an RFP which requires HW, SW & ongoing services (PCS & BPO, for example).

JW: This would appear to be a transaction that requires allocation of revenue to the separate elements using the relative selling price method. If some of the elements are determined to be software elements under the guidance of EITF 09-3, then the residual method would be applied to the allocated amount and VSOE would be required for any undelivered elements.

Q: Assume vendor responds to RFP requiring HW, SW and ongoing services (PCS & Business Process Outsourcing) and also assume that the vendor usually uses contract accounting & guidance of 97-2, an old fashion "Build & Run" scenario.  What's your opinion about using ASU 2009-14 to take the transaction outside of 97-2 guidance?

JW: If the hardware and software meet the requirements of EITF 09-3 to determine that the hardware and software work together to provide the functionality of the combined hardware and software product, then the transaction would be accounted for under EITF 08-1 for both the allocation and revenue recognition. If it is determined that there are both software and non-software elements, then revenue would be allocated using ESP and the relative selling price method and the software recognized under software revenue recognition and the non-software elements recognized under EITF 08-1.

Q: Does this mean that the software & PCS are taken outside of 97-2 with the hardware?

JW: It depends on whether the hardware and software meet the requirements of EITF 09-3 for treatment as non-software. If the hardware and software are always sold together and work together to provide the functionality, then the entire transaction would appear to be outside of software accounting. See Case A.

If the hardware is not always sold with the software, the determination might be that the hardware is a non-software element and the software is a software element. See Case B.

It would depend on the facts and circumstances.

Q: If your company has VSOE established for your product, can you choose to use BESP instead to avoid having to keep VSOE data and analysis?

JW: If a product currently has VSOE, the expectation is that the company would continue to use VSOE. The company would continue to use VSOE unless the situation changed and the company was no longer able to establish VSOE because the pattern of stand-alone sales no longer met the requirements of VSOE.

Q: If we have 2 different ways to sell our product - premise (where the customer buys a perpetual license and has it on site) and SaaS, the premise deals would be under SOP 97-2 and the SaaS deals would be under EITF 08-1, correct?

JW: For software only sales, the company would continue to use SOP 97-2 for allocation and revenue recognition.

For SaaS arrangements, the company would use ETIF 08-1 for allocation and revenue recognition.

If a transaction has both software and SaaS included in one sale, the revenue would be allocated to the separate elements using the relative selling price method of EITF 08-1 and ESP.

Then the software would be recognized using the residual method and VSOE and the SaaS would be recognized using EITF 08-1.

Q: In example 1, how is the ratable revenue split up between hardware, software, and support?

JW: Allocation of the ratable revenue should be on a reasonable and consistent manner to the different classes in the statement of operations/income statement. Pro rata allocation to each element based on contractual amount might be one method. The total revenue would be equal to the total ratable revenue for that period. Consideration would be given to each element. For example, the amount of revenue for support would probably be limited to 1/12^th for each month in the recognition period.

 Accounting for multi-element sales has quickly become one of the most complex areas of revenue recognition, a topic that affects most technology companies.  A multi-element sale occurs when two or more related product components are sold together at the same time.

The classic example of the multi-element sale is software plus maintenance. These are normally sold as two separate line items, but are inextricably related to each other, so they constitute a multi-element sale.  Beyond this relatively simple example of a multi-element sale, think of all of the everyday consumer products that we use where software is embedded, such as a mobile device.  Or think of an online subscription that includes setup as well as ongoing service.  In accounting terms, a mobile device is hardware, software and service. These multiple elements need to be treated separately in order to properly determine revenue.

The other day I saw an advertisement that said: “60% of the new products introduced in North America this year are ‘smart’ products – products with some sort of ‘smart’ or intelligent feature associated with them.”  As technology becomes more pervasive, more products become subject to the rules governing multi-element sales.  At what point do technology revenue recognition rules become the norm instead of the exception? 

I wanted to alert the Tensoft blog community that we’re now installing the Advanced Revenue Compliance Module for our Tensoft RCM Suite for customers who are currently running RCM, RDM or RDM-D. This is timely news, because this new module is designed to automate and streamline compliance with new FASB and AICPA rules that went into effect this month (January 2011).

If your company falls under the U.S. Financial Accounting Standards Board (FASB) rules for multi-element sales, known as EITF 08-01 and EITF 09-03, or statutes such as AICPA SOP 97-2 for software companies, the sooner you begin tracking the necessary data, the better. Available immediately as a cloud application or installed in-house, our new RCM Compliance Module plugs into your existing Tensoft software to flawlessly track all necessary data.

Now, of course, new customers are also welcome to add both the Tensoft RCM suite and the Compliance Module from scratch. If you have friends whose businesses fall under these new rules but are still tracking revenue longhand with spreadsheets, be sure to pass this information along to them. Sometimes it takes “one more onerous new regulation” to spur a company into finally automating their revenue compliance process. We’ve seen it time and time again.

Take a look at our recent press release for more details, and contact me at (888) 450-4030 x406 or via email for more information – or to jump-start the process of adding the RCM Compliance Module to your system. 

Happy New Year!

Our recent announcement of a strategic partnership with McGladrey, one of the leading providers of assurance, tax and consulting services in the U.S., has a “back story” that is almost as interesting as the news itself. In the Tensoft press release, dated August 24^th, I alluded to what an ideal partner McGladrey is to represent the Tensoft RCM Suite. The company combines both a strong vertical market focus on the technology sector with multi-faceted consulting services.

We felt that McGladrey’s extensive experience providing tax advice and consulting services to technology businesses was a great fit for the Tensoft RCM Suite. The Microsoft Dynamics-based solution brings together the specific revenue, billing and contract management functionality that software and other technology companies require. McGladrey brings both the strength of their Technology Services practice and the depth of their assurance, tax and consulting services expertise.

How did we get together? I’d like to think that two such ideal partners would just normally find each other out there in the world of business. However, in this case, we had some help.  The agreement was facilitated through Microsoft’s Partner Channel Accelerator Program – a unique program that Microsoft has devised to help its Microsoft Dynamics ISVs locate potential partners using a more refined and focused approach. We went into this with some ideas about what our ideal partner should be and what the market would look like. The program facilitator drew out of us how we should define who our partners should be – what’s in it for them and what's in it for us – to make this something truly real and valuable to both sides.

There was a serendipitous component to the match as well. Tensoft has had an excellent, long-term relationship with Caturano & Co., a company that McGladrey recently acquired. We've been working with Caturano for several years now. They've sold and installed Tensoft RDM as well as Tensoft MNC, so we're excited to have the opportunity to work with them to re-sell Tensoft RCM too, now that they’re part of McGladrey.

Stan Mork, Managing Director – Technology Services for McGladrey, highlighted the good fit from his perspective on his company’s website. “At McGladrey, we understand that technology companies face some of the most stringent regulatory requirements of any industry today, and often grow – and change – so quickly that it can be challenging to set up adequate business processes to address these. By partnering with Tensoft, McGladrey can deliver a scalable solution which meets the specific revenue, billing and contract management needs of these businesses, and can then provide the value-added consulting services that will provide significant strategic advantage.”

From my perspective, I’d say this is a story of three excellent companies, working together for the betterment of all. Truly a win-win-win situation.

Last week, Tensoft announced a strategic partnership with BroadPoint Technologies, a Washington, D.C.-based business consulting firm. Under this agreement, BroadPoint will promote and deliver the Tensoft RCM Suite to its customers and prospective customers. BroadPoint has a proven record of success serving the software industry, and they already understand the issues that these customers face.

I was able to meet with some of the BroadPoint team in person in DC in July, while our President and CEO Bob Scarborough and sales director Mike Chadwick met with them in March in Atlanta. I’m personally excited to be working with this DC area firm, since this is where I grew up!  

We felt that BroadPoint was a good fit for Tensoft, because we’re seeking partners committed to a vertical strategy  and BroadPoint’s CEO Lee Raesly feels much the same. He recently said: “Our charter is to help our customers surmount industry challenges and improve their bottom line with bright ideas for better performance. Tensoft RCM is truly one of those ‘bright ideas.’ Tensoft’s solution will help us address the increasing complexity of revenue recognition for our clients.”