I work for a start-up company that sells SAAS software company. We sold a three-year subscription software license to a company. The total contract was let's say $200K. The first year was free, no payments are due. Year 2 is $100K and Year 3 is $100K with payments being received in Year 2 and 3 net - 60 days. Should I be taking the $200K over the 36 months and recognizing the revenue this way ahead of the receipt of the actual funds? Since the cash collection timeframe is so far out I was researching and that it might not meet the revenue recognition criteria- collection is reasonably assured. We have never sold anything to this company before. But up front, they did issue us the purchase order for years 2 & 3. What should I do in this situation?
Revenue Recognition- SAAS Software Contract
Answers
Recognize ratably beginning Year 2, not in advance of cash.
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Thanks Doug, that is what my initial thought in the beginning was.
Revenue recognition has nothing to do with Cash collection in terms of when revenue is recognized.
Depending on how robust your credit review process is you might be able to recognize some of the year 1 revenue w/ some reserve contingency.
Rev rev is not based on cash, GAAP revenue cycle is independent of your cash cycle. Your revenue is based on the delivery of goods or services, what is now known as 'performance obligations' under the new GAAP guidance. You have a 3 year contract, it sounds like, with $200k of revenue as per your initial statement. Reasonable assurance is important, and you might reserve for it. New guidance, adopted by 2018 for most companies or early in 2017 (but with look-back reporting periods to 2016), would say that the collectibility question is addressed earlier in the very definition of whether you have a contract in the first place.
Assuming the agreement is noncancellable (i.e., the customer has no ability to walk away early and not be liable for the full $200K), I would record ratably over the three years. Similar to the concept of straightlining lease payments over the lease term, including free rent periods. But, as Ken Stumder points out, you would need to assess credit
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Correct, the customer has no ability to walk away. They are a rather a big company and they have issued us a PO for the total contract upfront so I would believe our credit risk to be rather low here.