9th Oct 2018

Revenue Recognition in SaaS and Software Licensing

In looking at contracts in the technology sector, it is not enough to be aware of the usual contractual obligations – to pay, to perform etc.   Where the contractual obligations are subject to financial reporting, and especially where they are reported in the United States under US GAAP  ASC 606 for Financial Year 2018, there are specific parameters which we look for when advising NASDAQ listed clients.  As explained below, though, there are good reasons for privately owned busies ss to look ahead and be aware of the same discipline.

Revenue recognition got its wake up call in the wake of the Enron fiasco where revenue was accounted for even where it was not contractually binding. Whilst private companies may be less affected than public ones by these considerations, nonetheless if in due course they might be acquisition targets for US or other listed companies, or companies with a close eye on reportable earnings such as private equity vehicles, a lack of rigour in considering the recognition of revenue could prove costly.

We are not able to provide accounting or tax advice as such in this field, but from a commercial point of view our experience indicates that  some of the key issues to be aware of in this context  are:

  • Avoid conceding termination for convenience rights to customer; they have the effect of limiting reportable revenue to the notice period for exercising rights to terminate;
  • If any concession has to be made, ensure that it is subject to a termination payment that covers as much of the unpaid amount as you need to report as revenue – because this the limit that will  be reportable. It will be important that this payment is not described directly or indirectly as a penalty, since that could make the obligation unenforceable in English law.
  • Avoid  agreeing to refunds if acceptance if not achieved;
  • If any early termination rights have to be conceded to any degree, then strive to ensure that  these are limited to professional services or support-only, but do not extent to SaaS (Software as a Service) or software subscription payments
  • Time and materials (T & M) payments due monthly or quarterly allow for easier/faster revenue recognition on active projects; fixed fee milestones are less advantageous because the revenue may only be recognised at cost when a full statement of works has been completed and accepted. The revenue will only be recognised on invoice but not on hours incurred but uninvoiced.
  • Where acceptance is provided for in relation to professional services , whilst suppliers should look for deemed acceptance provisions, ideally there should be documented acceptance to trigger the contractual entitlement to revenue.  In the case of milestone payments, then evidence of milestone completion by way of a form of certificate of acceptance should be looked for.
  • Where there are multiple obligations between parties, where possible separate out the distinct performance obligations so as to be able to allocate the transaction price to each separate performance obligation; this will enable the revenue to be recognised as the business completes each performance obligation, rather than when all performance obligations have been completed.

Considerations such as these involve specialise technology lawyers such as ourselves advising technology businesses in a degree of commerciality beyond the law books, and is crucial for preserving value for those businesses. 

Paul Berwin is a leading technology and digital law specialist and heads Berwins Digital, the specialist IT and Technology division of Berwins.

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