Friday, October 6, 2017

A few weeks ago Calcbench published a special report on the impending new standard for revenue recognition, and how it might affect the software sector.

The standard— ASC 606, Contracts With Customers— will give software firms more ability to recognize long-term subscription revenue all at once. That means many software firms dependent on subscription revenue are likely to experience a material change in the timing and nature of their revenue recognition when they implement the new standard.

That said, not all software firms that rely on subscription-based revenue expect a material change. We noticed a recent filing from Red Hat that serves as a good example. In its footnote about significant accounting policies, Red Hat had this to say about ASC 606:

The company currently recognizes subscription revenue ratably over the subscription period. Under the updated standard, these subscription attributes represent a series of performance obligations that are delivered over time, primarily on a stand-ready basis (for example, attributes such as updates, upgrades, and support are not forced upon subscribers but rather made available to subscribers). As a result, the company believes that its subscription revenue meets the criteria for revenue recognition over time and will continue to be recognized ratably under the updated standard.

The boldfaced emphasis above is from Calcbench, because we believe that’s a key point. Red Hat has structured its software contracts as a series of items customers can take, rather than a series of items customers willtake.

That’s quite different than what Microsoft did with its Windows 10 product, where upgrades, security patches, and the like are all automatically implemented for the customer. So essentially, at the time of Windows 10 purchase, the customer agrees to all future upgrades; they are part of what the customer buys. Under ASC 606, then, Microsoft can recognize all that revenue at once— which led to a material change in revenue recognition when Microsoft filed its last annual report over the summer.

If you’re a financial analyst trying to determine how software firms will treat revenue under ASC 606, you should be using our Interactive Disclosure Tool to search footnote disclosures of significant accounting policies. The most important keywords to seek, by far, will be “ratably” or “ratable.”

Ratable revenue is revenue spread across some long period of time— like, say, a multi-year contract for software services. Any firm talking about ratable revenue, or revenue it recognizes ratably, warrants a closer look for exactly what it’s saying about ASC 606 and possible changes to revenue recognition.

Many, as we noted in our software sector paper a few weeks back, will be bracing for material changes to the timing and nature of revenue recognition. Then again, as Red Hat shows, others are providing their services in such a way that ASC 606 won’t have a material effect.

It all depends on the details. Which, thankfully, Calcbench lets you research in spades.

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