As a business leader in the technology industry, having every aspect of your organization working toward the same goals is ideal, but can be challenging. In a fast-paced environment, sometimes departments do not communicate effectively. When your sales, legal, and accounting teams do not coordinate on changes to standard contract terms and conditions, this lack of communication can impact revenue recognition and financial reporting—especially for software, technology, and services companies and their inherently complex revenue arrangements.
Organizations should establish standard Terms and Conditions, Purchase Orders, and/or Statements of Work along with processes that enable collaborative coordination among sales, legal, and accounting departments to manage revenue transactions. If any of these standard terms are changed, there could be an impact on revenue recognition. To avoid any unintended accounting consequences, any proposed changes should be closely reviewed by both legal and accounting teams. This review should ideally take place before the contract is executed to enable management to fully understand the impact, if any, of a proposed change in standard terms on revenue recognition.
Contract Modification Examples That Can Impact Revenue Recognition ASC 606
Consider the following list of important contract terms that, if modified, would require a reconsideration of the appropriate revenue accounting.
|Six Contract Term Changes That May Prompt Reconsideration of Revenue Recognition
- A non-cancelable term or termination without penalty with 30-day notice will impact the determination of contract term for revenue recognition.
- Right to payment for services performed to date including a reasonable margin upon contract termination may impact whether revenue should be recognized over time or at a point in time for certain contracts such as contract manufacturing.
|Right to take possession of a license during Software as a Service (SaaS) term
- The right to convert a SaaS contract to an on-premise arrangement can indicate the performance obligation is to provide a license rather than services (right to use versus a right to access) and, therefore, may change the timing of revenue recognition. This also could impact the accounting model that the company should use for the capitalization of software development costs.
|Payment terms and pricing
- Fixed price, time and material, milestone, or hybrid – Each type of pricing arrangement will require further analysis and drive the timing and amount of revenue being recognized.
- 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 or service can lead to different accounting conclusions.
- Discounts – Whether discounts to certain goods and services are given consistently or are randomly applied can make a difference when multiple promised goods and services are bundled and sold in one contract. 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, further analysis of whether the discount could be considered a material right will be required.
- Performance penalty or bonus – Performance penalties or bonuses are variable consideration in a contract for revenue recognition purposes and require judgment and further assessment of a contract’s transaction price at contract inception and, potentially, at each reporting date.
- Whether hardware or equipment is shipped under Free on Board (FOB) Shipping Point or FOB Destination terms may impact the timing of revenue to be recognized.
|Resale or third-party involvement
- 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.
- If the company obtains “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 are 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 revenue recognition standard provides factors to consider when performing this analysis, which often requires judgment.
|Other contract modifications such as changes to the performance obligation(s) and/or pricing
- Depending on how a contract modification or amendment is structured, the changes to contract terms also can impact revenue recognition, including accounting for the modified contract as the creation of a separate contract, termination of an existing contract and creation of a new contract, continuation of an existing contract requiring a potential cumulative revenue catch-up adjustment, or a mix of both termination and continuation of an 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 (ASC) 606, Revenue from Contracts with Customers, for all revenue contracts. When changes to standard contract terms are contemplated after the initial accounting framework for standard terms has been established, management should confirm that legal and accounting teams review the proposed changes and consider their impact on revenue recognition, ideally before the contract is executed.
How FORVIS Can Help With Complex Revenue Recognition Under ASC 606
These examples of contract modifications may be beyond the experience of your in-house resources. Professionals at FORVIS understand the nuances of revenue recognition and the complexities and pace of technology companies and can assist your team in navigating the complexities of ASC 606. We stand ready to apply our breadth of knowledge and industry experience to help customize a strategy for your business. For more information, contact a professional at FORVIS or use the Contact Us form.