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Revenue Recognition Considerations When Technology Companies Change Their Standard Contract Terms and Conditions

As a business leader in the technology industry, having every aspect of your organization working toward the same goals is the ideal, but can be challenging. In a fast-paced environment, sometimes departments do not always communicate effectively. When your sales, legal and accounting teams do not coordinate on changes in standard revenue contracts terms and conditions, it can impact revenue recognition and financial reporting — especially for software, technology and services companies and their inherently complex revenue arrangements and recognition.

Organizations should establish standard Terms and Conditions, Purchase Orders, and/or Statements of Work along with processes that enable collaborative efforts among sales, legal, and accounting departments to govern revenue transactions.  If any of these standard terms change, impacts to revenue recognition could occur and should be closely reviewed by legal and/or accounting teams.  This phase should ideally take place before the contract is executed to enable reconsideration of the change, which could drive a different revenue recognition accounting conclusion. Consider the following list of important contract terms that, if modified, would require a reconsideration of the appropriate revenue accounting.

List of Six Contract Term Changes That May Prompt Reconsideration of Revenue Recognition -- 1. Termination Clause / 2. Right to take possession of a license during SaaS term / 3. Payment terms and pricing / 4. Delivery term / 5. Resale or third-party involvement / 6. Performance obligation and/or pricing

1. Termination clause
  1. Non-cancellable term or termination at will with 30-day notice will impact the determination of contract term for revenue recognition.
  2. Right to payment for work performed to date including reasonable margin upon termination may impact whether revenue recognition should be recognized over time or at a point in time for certain contracts such as contract manufacturing. 
2. Right to take possession of a license during Software as a Service (SaaS) term
  1. This can indicate the performance obligation is a license rather than services and, therefore, may change the timing of revenue recognition. This could also impact the model that the company should use for the capitalization of software. 
3. Payment terms and pricing
  1. Fixed price, time and material, milestone, or hybrid - Each type of arrangement will require further analysis and drive the timing and amount of revenue being recognized.
  2. Pricing - Whether price changes deviate from a standard price list or are within the range of a standalone selling price that is set for such a product can lead to different accounting conclusions.
  3. Discounts - Whether discounts are given consistently to certain goods and services when multiple promised goods and services are bundled and sold in one contract or are randomly applied to goods and services. Different practices will impact how the discounts are allocated to performance obligations and, therefore, impact revenue recognition. Further, if discounts are offered for contract renewal options, it will require further analysis of whether material rights exist.
  4. Performance penalty or bonus - Performance penalties or bonuses are variable consideration in a contract for revenue recognition and require judgment and further assessment of transaction price at contract inception and, potentially, at each reporting date. 
4. Delivery terms
  1. Whether hardware or equipment is delivered on a Free on Board (FOB) Shipping Point or FOB Destination may impact the timing of revenue to be recognized. 
5. Resale or third-party involvement
  1. Resale of goods and services or having a third party involved in providing goods and services on behalf of a company may require further analysis of whether the company is a principal or an agent in the revenue transaction.
  2. If the company obtains the "control" of goods and services provided by third-party vendors prior to the delivery of such goods and services to its customers, the company acts as a principal in the transaction, and revenue is recognized gross. If the "control" criteria is not met, the company acts as an agent in the transaction and therefore revenue is reported net, which is the difference between the selling price to customers and the cost of such goods and services provided by third-party vendors. The standard provides factors to consider when performing this analysis and often requires judgment.  
6. Other contract modifications such as to the performance obligation and/or pricing
  1. Depending on how modifications or amendments are structured, the changes to contract terms can also impact revenue recognition including creation of a separate contract, termination of an existing contract and creation of a new contract, continuation of an existing contract requiring potential accumulative revenue catch-up adjustments, or a mixed of both termination and continuation of existing contract. 
The Role of Accounting Departments in Contract Changes

Accounting departments should utilize a comprehensive and up to date revenue recognition checklist and analyze the five-step model under Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, for all revenue contracts. When changes to contracts occur after the initial accounting has been established, teams should review the proposed changes and consider their impact on revenue recognition, ideally before the contract is executed.

How DHG Can Help

These examples might prompt scrutiny that is beyond the scope of your in-house professionals. With DHG, you gain a collaboration with professionals who understand all facets of revenue recognition and the complexities and pace of technology companies. We stand ready to apply our integrated knowledge and industry experience to customize a strategy for your business.

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