Software companies, who historically sold software products, are increasingly gravitating towards the Software-as-a-Service (SaaS) business model. User demand for scalable solutions, shifts in perceptions regarding security, and the widespread availability of cloud computing resources are all trends that have contributed to the popularity of the SaaS delivery model.
But, how do accounting practices differ for SaaS companies compared to traditional software companies? BDO Tech shared some differences, including revenue and cost recognition. Details are below. You can view the full article here (PDF).
Revenue and Cost Recognition
The accounting rules that SaaS companies are required to follow pertaining to revenue and cost recognition are different than the accounting rules that software licensing companies are required to follow because the nature of the underlying transactions with customers is viewed as different. Software licensing is generally treated for accounting purposes as a sale of a product, and SaaS is treated as the sale of a service that is provided over a period of time. As a result, it is important to determine whether software company sales arrangements are considered licensing or SaaS arrangements.
Generally, for revenue recognition, software licensing companies can recognize a significant portion of the arrangement fee when the software is delivered to the customer, as long as certain criteria are met. On the other hand, SaaS companies are generally required to recognize arrangement fees ratably over the contract term or the estimated life that the customer is expected to use the hosted service.
There are two different types of costs incurred by SaaS companies that are relevant to consider from an accounting perspective:
1) costs to develop and maintain the underlying software used to provide the service
2) direct customer costs related to specific customers.
SaaS companies often struggle with assessing how to price their products and services because of their unique nature and the complex competitive landscape. Understanding the accounting implications of arrangement pricing is an important aspect, and SaaS companies now have much greater flexibility to price competitively under the new accounting rules.
Are you part of a software company? Brittenford Systems is now conducting a national survey aimed at software companies to fill the void of information about accounting best practices for software firms. Complete the survey here, or learn more here.