Revenue Recognition Standard: The Software Sector Calcbench enthusiasts already know we’ve been keeping a close eye on the new accounting standard for revenue recognition, going into effect at the end of this year. Today we’re going to set our sights on the software sector, which may have a more difficult time than most adjusting to life under the new standard.
Why software? Because the new revenue recognition standard redefines business transactions as a series of performance obligations, and you can only recognize revenue from a transaction as each performance obligation within it gets fulfilled.
For a sector like retail, that concept won’t bring much change. The performance obligation is that you, the retailer, hand over an item to the customer at the cash register; and the customer hands back money to you. Obligation fulfilled, revenue recognized. Little surprise, then, that retailers like Walmart say the new standard isn’t expected to cause any material change in the timing or nature of their revenue recognition.
Transactions in the software sector can be far more complex—so some firms, like Microsoft, have already warned that the new standard will have a material effect on their revenue recognition patterns. Microsoft, for example, says that revenue recognition for its Windows 10 operating system will change because Microsoft will now recognize most of the revenue from a Windows 10 installation at the time of sale. Under the old revenue standard, Microsoft recognized only some revenue at time of installation, and the rest across the lifetime of a contract as Microsoft provided regular Windows OS updates.
Hmmm, we thought. If that is what Microsoft is saying about the new revenue standard—what about all the other software companies out there, operating along similar models?
Future revenue from long-term software contracts would be reported as deferred revenue, and listed on the balance sheet as a liability. So we visited the Calcbench Data Query Tool, created a sample group of all companies that identify Microsoft as a peer, and pulled their deferred revenues and current liabilities as reported on their 2016 annual reports.
We wanted to express those deferred revenues as a percentage of current liabilities. If that ratio is above industry norms, or rising over time, that could suggest big changes to the company’s revenue picture when the new standard takes effect.
The result: we found 52 companies with deferred revenues that equalled at least 70 percent of current liabilities; and 11 whose deferred revenue exceeded current liabilities—that is, the percentage was above 100 percent. Here are the 11 largest, in order.
Armed with that list, we then jumped over to our Interactive Disclosure tool. Using those 11 companies as our sample group, what have they been saying about the potential impact of the new revenue standard?
As one might expect, disclosure varied. First we counted the number of words in each company’s disclosure. Then we looked to see whether the company expected a material change because of the new standard. The results, below.
That’s a lot of “still evaluating” out there, for some very large (in relative terms) amounts of money. Falconstor Software had nothing to say about the new standard at all—like, no mention anywhere in its 10-K about impending new accounting standards. Most others had at least some sense of possible impact, but cautioned that they were still trying to digest all the consequences.
Should analysts be alarmed at that uncertainty? That’s your call. For example, Qualys still expects to implement the new standard in the first quarter of 2018, but hasn’t yet determined an adoption method, nevermind materiality. On the other hand, Hortonworks hasn’t fully assessed the new standard either—but it did have nearly 1,100 words to say about possible effects, which is a lot. (We’re only at 770 words in this post right now, for example.)
The crack Calcbench research team will have a more in-depth look at the software sector later this summer. (You know about all our cool research on our cool Research page, right?) Meanwhile, this is one example of how you can conduct your own research into companies’ financial reporting, including the new revenue standard that is probably going to tie lots of companies into knots.