Many software providers want to ‘recognize’ sales revenues in their financial statements as soon as possible. In the U.S., in the right circumstances, under generally accepted accounting principles (“GAAP”), a provider that sells a permanent license can recognize 100% of the license revenue right away.
Software maintenance, on the other hand, normally is recognized ratably as the maintenance period elapses. The theory, broadly speaking, is that you shouldn’t recognize revenue until you’ve completed the earnings process for that revenue; where software maintenance is concerned, the earnings process is not deemed complete until the maintenance period (e.g., a fiscal quarter) is over.
Many software companies sell permanent licenses in a ‘bundle’ together with one or more years of pre-paid maintenance. That can seriously complicate the revenue recognition question. Do the math incorrectly, and you may wind up having to restate earnings, with all the evils attendant thereon.
See the links below for further reading.
Software warranties and revenue recognition
If the provider’s warranty for the software is not “short-term” and “routine,” that fact can jeopardize the provider's ability to recognize all the license revenue immediately.
- Ninety-day warranties for software licenses seem to be accepted as routine.
- One-year warranties, however, might require deferral, and ratable recognition, of a portion of the license revenue corresponding to the cost of satisfying the warranty obligation.
- And if the provider does not have vendor-specific objective evidence (“VSOE”) to support a specific deferral amount, the entire amount of the revenue might need to be deferred until the end of the warranty period.
- Softrax Corp., What’s the Big Deal about VSOE? (2008) (accessed Apr. 1, 2009) (providing a readable general explanation of how VSOE rules work)
- Alix Stuart, Why VSOE Spells Trouble, CFO Magazine, Jan. 1, 2008 (accessed Apr. 1, 2009) (providing an overview of the VSOE rules and their history).
- Ashwinpaul C. Sondhi, New and Emerging Revenue Recognition Issues For Software and High-Technology Companies, Oct. 2005 (accessed Aug. 1, 2008)
- Greg Regan & Tim Regan, Software Revenue Recognition on the Rise, Journal of Accountancy, Dec. 2007 (accessed Aug. 1, 2008)
- John C. Yates, New Guidelines for Software Revenue Recognition (accessed Aug. 1, 2008)
- Steven T. Petra, Revenue Recognition for Software Products with Multiple Deliverables, The CPA Journal, Apr. 1, 2005 (accessed Aug. 1, 2008)
- Glenn A. Cheney, Making sense of revenue recognition (accessed Aug. 1, 2008).