Revenue Recognition Considerations for SaaS Companies

© 2009-2016 Leeyo Software, Inc. CONFIDENTIAL AND PROPRIETARY - FOR INTERNAL USE ONLY - ALL RIGHTS RESERVED

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Revenue Recognition Considerations for SaaS Companies

Jagan Reddy – CEO & Founder of Leeyo

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Introduction

Vibhor Chandra

Senior Manager

Financial Accounting Advisory Services

Ernst & Young

[email protected]

Senior Manager based in San Jose in EY’s Accounting Advisory Practice. Vibhor works collaboratively with client teams to effectively work through

change, whether caused by a transaction or regulatory change. Advises engagement teams and technology companies on SEC reporting

compliance, financial statement disclosure and technical accounting matters.

His technical expertise in revenue recognition, especially with respect to software and life science companies, is extensive; he has helped instruct

courses on software revenue recognition principles and accounting for new product launch revenue recognition and gross vs. net in life sciences within

his office and has helped several non-audit clients with revenue recognition issues.

Vibhor has diverse client experience working in a variety of sectors including technology, life sciences and agro pharma. Vibhor also has experience in

audit including Sarbanes-Oxley and SEC filings for large-scale corporate clients.

Vibhor is a Chartered Accountant from India, has a Bachelors in Commerce and is also a Certified Public Accountant in California State.

Disclaimer:

The views expressed in this presentation are solely my own and not the views of the Firm.

Watch the webinar at:

https://goo.gl/Zg1SO1

Overview Why should you care about SaaS ?

Don’t Ask - What is SaaS …Ask - Why SaaS ?

Cloud/SaaS deals in 2015 were the largest in volume.

Interestingly,

most of the acquirers were NOT traditional software companies but hardware and other technology companies



New revenue recognition impactGood news ?

OVERALL – REVENUE RECOGNITION MODEL REMAINS THE SAME WITH MINOR CHANGES

The new standard, by way of an example, states that a license from which the customer can benefit only in

conjunction with a related service –e.g., an online hosting service provided by the entity –is not distinct from

the hosting service.

The Basis of conclusions para alludes to the fact that license may not be distinct where the customer does not

take control of the license and therefore, cannot benefit from the license on its own without the hosting service.

Depending on the specific facts and circumstances of an arrangement, it is possible that for some

arrangements that are hosting services under current U.S. GAAP, the software license is not distinct from the

hosting services under the new standard.



New revenue recognition impactWhy should you care about delivery/deployment models ?

Software - as - a - Service (SaaS)

Platform - as - a - Service (PaaS)

Infrastructure - as - a - Service (IaaS)

Public

Public

Public

Hybrid

Hybrid

Hybrid

Private

Private

Private

Clo

ud

Dep

loym

en

t m

od

els

Service delivery models

Deployment models could affect accounting if software license is transferred to the customer and customer can derive essential or significant functionality

Service delivery models could indicate essentiality of the professional services including number of services / elements that needs to be separated



New revenue recognition impactContract modifications

Modifications are accounted for differently, depending on the attributes of the remaining

goods and/or services

Occurs when parties approve a change in scope, price or both

Does it add goods or services that are distinct

from those already transferred ?

Is the modification approved ?

Account for as part of the original contract

(cumulative catch-up adjustment)

Are the additional goods or services priced

commensurate with their stand-alone selling

prices ?

Do not account for contract modification until

approved

Account for as

separate contract

(prospective)

Account for as

termination of existing

contract and creation of

new contract

(prospective)

No

Yes

No

Yes

Yes No

Points to consider

A contract modification

that only affects the

transaction price is either

accounted for

prospectively or on a

cumulative catch-up

basis. It is accounted for

prospectively if the

remaining goods or

services are distinct.

No retrospective

adjustment required.



New revenue recognition impactConsumption based or usage based structures

Although consideration paid for the use of software in many SaaS arrangements is typically a fixed monthly,

quarterly, or annual subscription, certain arrangements can be usage-based (e.g., fees are charged per

transaction processed though a software application).

Current accounting - In a multiple-element SaaS arrangement, revenue must be fixed and determinable in

accordance with ASC 605-25-30-1 before it is allocated to each identified unit of accounting. As a result,

revenue from SaaS arrangements that charge the customer on a usage basis is generally not allocated to

each unit of accounting until it is realized and considered fixed or determinable.

New standard – Revenues from software licenses that have sales- or usage-based fee structures will only be

recognized as the subsequent sales or usage occurs. It is an exception provided under variable consideration

guidance for sales-based or usage based royalties which can be extended to structures where royalty is

derived from license of IP or license of IP is predominant in the arrangement.



New revenue recognition impactService Level agreements

• SLAs are commonly used by SaaS companies that sell services that are critical to the customer's

operations, where the customer cannot afford to have product failures, service outages, or service

• interruptions.

• The terms and conditions of the SLA determine the accounting model. For example, an SLA requiring an

entity to repair equipment to restore it to original specified production levels could be a warranty. SLAs that

are not warranties and could result in payments to a customer are variable consideration.

• Currently, Diversity exists in industry– some companies defer the full penalty amount. The new standard will

required SaaS companies to estimate SLA reserve using expected value or most likely approach.



New revenue recognition impactCosts to obtain a contract

• Current guidance allows capitalizing or expensing certain costs to obtain a contract – accounting policy

election

• While a lot of SaaS companies would like to capitalize sales commission costs, a recent survey found 2/3rd

of SaaS companies expense sales commission cost as incurred.

• Primarily because it requires complex tracking system

• The new standard requires capitalization of costs to obtain a contract that are:

- Are incremental, due only to obtaining a contract;

- Relate directly to a contract; and

- Are expected to be recovered.

will be capitalized.

• Cost deferral election is not longer allowed.

• An entity can elect to expense costs of obtaining a contract if the amortization period is one year or less



New revenue recognition impactUpfront fees

New guidance – SaaS vendors would be required to recognize up-front fees over a period extending beyond the initial

contract period only if the customer has the option to renew the SaaS contract and the renewal option provides the

customer with a material right. The new standard’s requirement to incorporate only renewal options that represent

material rights into their estimation of a customer relationship period may not always be consistent with current GAAP,

which may take into account renewal options that are not necessarily considered material rights.

Set-up/

Implementation

Initial term Renewal term

Customer life

Types of Professional Services

• Under the current standard, If the

professional service fees do not have

standalone value and represent

instead, a nonrefundable upfront

fees, then the contractual value of

those fees are recognized as

revenue over the customer

relationship period.

Points to consider

Depending upon the cloud offering i.e. IaaS,

PaaS or SaaS, the nature and number of

professional services vary - generally PaaS

and IaaS provide greater opportunity to provide

additional services.

Do any of these services have standalone value, if No, recognize over time ?



New revenue recognition impact Concluding thoughts

Cloud Services

Recognized ratably over the term of the services in accordance with SAB 104

Software & maintenan

ceRecognized in accordance with 985-605

Professional services

Recognized as delivered in accordance with SEC guidance (SAB 104)

HardwareRecognized as shipped in accordance with

SEC guidance (SAB 104)

Upfront fees

Recognized over the customer relationship period

Recognize each of the elements based on the relevant literature

CURRENT GUIDANCE NEW GUIDANCE

Recognized ratably over the term of the services in accordance with ASC 606

Recognized in accordance with ASC 606

Recognized as delivered in accordance with ASC 606

Recognized as shipped in accordance with ASC 606

Recognized over the contract period if renewal right is not a material right



EY | Assurance | Tax | Transactions | Advisory

About EY

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guarantee, does not provide services to clients. For more information about our organization, please visit

ey.com.

Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.

About EY’s Advisory Services

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your focus is on broad business transformation or more specifically on achieving growth, optimizing or protecting

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the value your business needs.

© 2016 Ernst & Young LLP.

All Rights Reserved.

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ASC 606 & IFRS 15 – Ready!

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Works Well in Your Financial Systems

14



Why RevPro, What we do, Where we fit ?

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Lead / Opportunity

Quotes Orders Fulfillment BillingRevenue

RecognitionCash

Collection

Quote to Cash process

• Competitive landscape complicates pricing and product offering• Revenue recognition is not simple anymore• Revenue rules / guidance are changing soon• Billing is not the only source of data for revenue recognition• Why Leeyo is the leader in this space ?

• We solve complex revenue problems• We keep customers in compliance with rules• RevPro is developed by revenue people



Subscription economy & Revenue complexity

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SaaS Company Pain Points

• Separation of billing and revenue. Rev. Rec. independent of billing• Frequent upgrades / downgrades• Usage based revenue recognition with payments in advance/ overages• Amortization of upfront fees• Multiple element arrangements requiring allocations/services with standalone value• Reporting specific requirements MRR, ARR• New revenue rules adds more complexity to SaaS businesses



RevPro – Comprehensive RevRec Automation

17


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+ Website: http://Leeyo.com

+ Email: [email protected]

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LeeyoSoftware



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Revenue Recognition Considerations for SaaS Companies

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