SaaS Revenue  Recognition  Principles: How a SaaS  Company Should  Treat Setup / Implementation  Fees
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SaaS Revenue Recognition Principles: How a SaaS Company Should Treat Setup / Implementation Fees

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In 2010, when the new revenue standards1 were issued by the FASB, Armanino McKenna surveyed the early adopting public SaaS companies to see if implementation/setup fees were being recognized as......

In 2010, when the new revenue standards1 were issued by the FASB, Armanino McKenna surveyed the early adopting public SaaS companies to see if implementation/setup fees were being recognized as delivered, rather than deferred, as allowed under the new rules.

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  • 1. SaaS Revenue Recognition Principles How a SaaS Company Should Treat Setup / Implementation Fees Introduction In 2010, when the new revenue standards1 were issued by the FASB, Armanino McKenna surveyed the early adopting public SaaS companies to see if implementation/setup fees were being recognized as delivered, rather than deferred, as allowed under the new rules. In order to be eligible for separation and recognition independent of the SaaS subscription fees, the implementation/setup fees must meet the GAAP definition of stand-alone value. The new revenue rules relaxed the definition considerably, stating “the item(s) have value on a standalone basis if they are sold separately by any vendor or the customer could resell the delivered item(s) on a standalone basis.” The rules go on to state that there does not have to be an observable market for the item(s), and later use the language, “any competitor’s largely interchangeable products or services in standalone sales to similarly situated customers.” 1 ASU 2009-13, Codified in ASC 605-25 1Saas Revenue Recognition Principles: How a SaaS Company Should Treat Setup/Implementation Fees
  • 2. Initial SurveyOur initial survey of limited sample of early adopters (eight) found split results; four of theSaaS companies determined the professional services (delivered at the time of implemen-tation) had stand-alone value and therefore recognized these fees immediately, while theremaining four continued to defer these fees.At the time of the initial survey, we cautioned against recognizing implementation/setupfees immediately, stating that although such practice met the newly written FASB rules,doing so potentially conflicted with the economic reality of the transaction: it is unlikelythat a SaaS customer would buy implementation/setup services without the related SaaSsubscription. Furthermore, the new FASB rules do not supersede the SEC’s specific guid-ance on setup fees (issued in 2003).APPLICABLE SEC RULE “The terms, conditions, and amounts of these fees typically are negotiated in con- junction with the pricing of all the elements of the arrangement, and the customer would ascribe a significantly lower, and perhaps no, value to elements ostensibly as- sociated with the up-front fee in the absence of the registrant’s performance of other contract elements. The fact that the registrants do not sell the initial services sepa- rately (i. e., without the registrants’ continuing involvement) supports the staff’s view. The staff believes that the customers are purchasing the on-going rights, products, or services being provided through the registrants’ continuing involvement. Further, the staff believes that the earnings process is completed by performing under the terms of the arrangements, not simply by originating a revenue-generating arrangement.”22 SAB TOPIC 13.A, paragraph 3.f Q1 Q Response, sequence 171 2 Saas Revenue Recognition Principles: How a SaaS Company Should Treat Setup/Implementation Fees
  • 3. Second SurveyNow that a wider array of SaaS companies have adopted the new FASB revenue rules(January 1, 2011 mandatory adoption date for calendar year companies), we decided itwould be valuable to conduct a second survey to determine how practice has evolvedamong these companies. Additionally, the survey was expanded to ask a second question:“What is the amortization period for such deferred revenues?”The second survey results identified 47 public SaaS companies, with 25 disclosing theydefer implementation/setup fees. This rate of deferral, 53%, was consistent with the 50%found in the initial survey. Interestingly, we found that 10 of the SaaS companies disclosedthey defer and recognize fees over the initial contract period, while 15 recognize such de-ferred fees over the expected duration of “the customer relationship,” sometimes extendingto 12 years.APPLICABLE SEC RULE “The period over which the deferred upfront fee should be recognized should extend beyond the initial contractual period if the relationship with the customer is expected to extend beyond the initial term and the customer continues to benefit from the payment of the upfront fee (e.g., if subsequent renewals do not include a similar fee). In addition, customers may pay a higher upfront fee for additional services, custom features, or functionality. Upon renewal, the customers would continue to benefit from these incremental services, features, or functionality. Therefore, it would be ap- propriate to recognize the upfront fees over the expected customer relationship term rather than the initial term.”33 ASC 605-10-S99, A3f, ques. 1/SAB Topic 13A paragraph 3f, ques. 1 3 Saas Revenue Recognition Principles: How a SaaS Company Should Treat Setup/Implementation Fees
  • 4. Best Practice Recommendations The SEC rules offer a number of examples illustrating treatment for setup fees, but interpreting the examples and appropriately applying the rules against a con- tinually evolving SaaS company’s facts and circumstances is not an easy task. Given the diversity in practice among public SaaS companies, it is important that both private and public SaaS companies read and understand the FASB and SEC rules governing implementation/setup fees. An appropriate policy with fully documented rationale for the approach adopted by a company is the best practice. As always, we suggest you consult with an accounting professional and adopt practices that meet the words and spirit of the rules and mirror the economic sub- stance of the transaction as viewed through the eyes of the customer. A complete copy of the public company SaaS Revenue Recognition Database can be obtained by answering five quick question at: http://www.surveymonkey.com/s/SaaSRevenue View a sample of the survey database on the following page. Matt Perreault is a Partner with Armanino McKenna, a Top 40 CPA and Consult- ing firm, and is a recognized subject matter expert in the areas of SaaS and software revenue recognition, equity accounting and public company reporting rules. Contact Matt at mattp@amllp.com or (925) 790-2755. Ricardo D. Martinez is a Senior Manager with Armanino McKenna and has over 12 years of experience conducting audit and advisory services predominantly in the technology industry including seminconductor, software, internet and on- Armanino McKenna line educational segments. Contact Ricardo at ricardo.martinez@amllp.com or50 W. San Fernando St. (925) 790-2600 x7010 Suite 600 San Jose, CA 95113 4 www.amllp.com Saas Revenue Recognition Principles: How a SaaS Company Should Treat Setup/Implementation Fees