Revenue Standard Could Have Major Impact on Software Industry

October 4, 2017

With the Financial Accounting Standards Board’s (“FASB”) new revenue recognition rules becoming effective in three months, the Accounting Standards Update (“ASU”) could have a major effect on the bottom lines of companies in the software industry. Under ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), software companies will have to recognize more revenue when the sale occurs. However, companies in the software industry have long-term arrangements with customers, meaning revenue is usually recognized over the life of the contract.

One software company already feeling the impact is Microsoft, which was an early adopter of the standard. Under the new rules, Microsoft recorded revenue of over $96.5 billion for its fiscal year ending June 30, 2017. According to its annual filing, Microsoft would have recorded $89.9 billion in revenue using the old guidance.

Revenue results under ASU No. 2014-09 could differ among other companies in the software industry. The standard eliminates nearly 200 pieces of industry-related revenue accounting rules, and introduces a single standard for recognizing the top line in a company’s income statement. For instance, the standard erases the need for a company in the software industry to show “vendor-specific objective evidence” for undelivered elements of a contract, which means revenue from such elements cannot be recognized. An August 23 report by Calcbench and Radical Compliance says the elimination of this requirement will allow companies to immediately recognize additional revenue from a long-term contract. As a result, companies will likely recognize revenue from a contract faster, but earnings could become more unpredictable between each period.

The report also notes that it is difficult to guess the exact impact of the FASB’s revenue standard on the software industry. The reason is because while several software companies said in their 2016 financial statements that ASU No. 2014-09 would create a material effect, other companies were still in the evaluation phase.

In a warning to analysts and investors, the CFA Institute’s Vincent Papa, said it is tough to assess the impact of the new standard across multiple industries. Only a handful of companies have adopted the standard early, and the rest have not elaborated how the accounting changes will affect financial results. Papa also cautioned against believing that the standard’s impact will be of little effect to companies.