Revenue recognition equation for traditional industries

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In more traditional industries, the above equation captures the ease of revenue recognition. In the software industry, where the production process ends and delivery occurs is often less than straightforward. Software revenue recognition rules require that companies determine and maintain VSOE compliance or defer all revenue until final delivery is made. In our previous posts, we have shown how companies can determine VSOE using the bell curve method. In this post, we will be providing 5 tips and suggestions on coping with software revenue recognition rules.

  1. Track the sales price – As we have mentioned in previous posts, it is not enough to list a price for something in a price book. The firm has to be able to show that the market accepts the price and considers it “fair value.” This means that the actual sales price after discounts for a product or service needs to be tracked if you are interested in establishing VSOE.
  2. Involve both sales and finance early – The salespeople usually are focused on one thing; closing the deal. Although this is an excellent quality for a salesperson, a single minded focus on closing deals may lead to one-off pricing negotiations that do not fall within the expected 80/15 of the bell curve. For this reason, firms should also involve finance early in the sales process. If finance is tracking the sales price to eventually establish VSOE, then they will be able to provide pricing guidance to the sales force. Working together is the best way for firms to establish VSOE compliance.

    VSOE can be split by region

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  3. Create VSOE Segments – If a software company is selling in different geographical regions or to different customer types, they may want to consider creating multiple VSOE’s. A different VSOE can be established for each country or for large and small customer types. First, determine how customers can be segmented and then track the sales price by segment. Second, make sure that the pricing for each customer segmentation falls within the 80/15 bell curve rule. Last, after a significant sample has been established, maintain the VSOE curve to support your decision.
  4. Be aware of when to apply VSOE – Firms not in the software industry believe that they are immune to VSOE requirements. However, SOP 97-2 software revenue recognition rules states that VSOE applies to any product or service where software is “more than incidental.”

    Understand Financial Statement effects without VSOE

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  5. Explain the Consequences – Managers need to be prepared to explain the debts and credits associated with each type of transaction and the effects deferred revenue has on both the balance sheet and the income statement. The more managers understand the rules and can explain to others the need to establish VSOE compliance, the more successful they will be at implementing it.

Establishing VSOE and maintaining it are not easy. By following the recommendations above, firms have a better chance of establishing VSOE for each element they sell. At Bi101, our concern is keeping firms in compliance with software revenue recognition rules so they do not end up having to settle false claims in court. If your firm is struggling with VSOE, please let us help.