Let me put the disclaimers in up front. The following is my personal opinion. It is not an official Gartner position. In addition, I am not an accountant. This is also a bit of a rant (so my apologies in advance).
Taleo announced on November 10, 2008 that its Deloitte & Touche LLP, the company’s independent registered public accounting firm, requested that the company re-evaluate whether the company’s historical and current practices with respect to the timing for recognition of application and consulting revenues were appropriate under generally accepted accounting principles (GAAP). Brian Sommer has some good posts here and here that provide some additional color on the situation. As of the time of writing this post, Deloitte had still not rendered an opinion if Taleo needs to do a financial restatement (or what the scope of that restatement may be) based on the revenue recognition timing. There are two major revenue recognition issues that Deloitte is investigating:
- when should Taleo start to recognize revenue ratably over the term of the contract?
- should its services revenue also be recognized ratably over the term of the contract?
I am going to focus on the first issue in this post.
Taleo’s policy has been to "start the clock" (when it can start to recognize revenue) when it provides customers access to its software. My understanding is that, according to GAAP revenue recognition, a vendor cannot begin until it has "delivered" the software to the customer. In the perpetual license/on-premise installation world, this was pretty easy to define. When the vendor shipped a disk (CD, DVD) and it was received by the customer, it was "delivered" (unless there were specific services that were also tied to that delivery). "Delivery" in the SaaS world is more complex. There is nothing physically delivered to the customer. The customer accesses the service online.
An informal look at other vendor’s revenue recognition policies shows that there are differences in "when the clock starts". Many do what Taleo does. However, some SaaS vendors do not start recognizing revenue until the customer access the software for the first time. I know of one vendor that does not start to recognize revenue until the customer is using the software in production (and the implementation services have been delivered).
I personally believe "delivery" is when the customer has access to the solution. The reasons are simple. The customers can use the software at that point and it makes it consistent with the perpetual license/on-premise install (the traditional) world. In the traditional world, a customer could not start to use the software until it received it. Once it received the software, the customer could choose to implement it or not (if they chose not use it, that is what is commonly referred to as "shelfware"). Regardless of whether or not the customer chooses to implement the software, the software vendor in the traditional world was able to recognize the license revenue (all of it) because they "delivered" it.
Now, why should SaaS be different in this regard? Once access is provided, the customer can choose whether or not it wants to use the licensed service. Remember, no matter "when the clock starts", the revenue must be recognized ratably over the term of the contract (so the vendor must make good on its service delivery before all of the revenue can be recognized), so the only question is when can they start to recognize the revenue.
It will be interesting to see what Deloitte recommends to Taleo. It has been its auditor for seven years (approximately three years as a public company) and the revenue recognition policy has been the same. If Deloitte tells Taleo, that the clock starts later, it will have ramifications for many other SaaS providers who recognize revenue in the same manner. In addition, it should also have ramifications for vendors that offer perpetual licenses. If SaaS provider cannot start to recognize revenue until the software has been accessed, then will vendors that offer perpetual licenses with on-premise implementations also be required to recognize license revenues only when a customer has accessed or implemented the software (so should they have been able to recognize revenue for "shelfware"?)? In my view, there should be consistency.
What do you think? When are SaaS solutions "delivered" in the GAAP context? If SaaS vendors cannot start to recognize revenue until the software has been accessed (or is in production), should traditional vendors be held to the same standard?
3 responses so far ↓
1 Jim Holincheck: SaaS Revenue Recognition // Dec 16, 2008 at 1:36 pm
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2 Jeffrey Mann // Dec 31, 2008 at 9:08 am
Revenue recognition policies and rules have a bigger impact on the software industry than many people realize. I once worked for a vendor, and had to think deeply about how our license policies would affect our cash flow. As an analyst, I’ve had to tell customers that the clauses they want to put into contracts would severely hamper the vendor’s ability to do business. A clause saying that they can get their license fee back if the vendor doesn’t deliver an upgrade two years later can mean that the money has to sit in the bank unused and unrecognized for two years or until they deliver on the promise. No one can run a business that way.
3 Kevin Lennox // Jul 9, 2009 at 5:34 pm
The issue of revenue recognition for SaaS vendors goes far beyond the discussion of when the clock should start on a monthly recurring pricing plan. Many SaaS vendors will have have a portfolio of services. Some lending themselves to usage and rating, some being one time and some being a simple monthly fee for value. They will also have many different ways of bundling and pricing those services which will require them to recognize the revenue in several ways.
If a SaaS vendor collects a payment up front front for a usage based service, then revenue probably needs to be recognized as the services are consumed, i.e. on a usage basis. This will require them to keep track of usage and then apply it to a spreadsheet or rating engine to determine what can be recognized
If a SaaS vendor combines hardware, one time services such as implementation or training and monthly software usage fees but charges the customer only a monthly fee (i.e. does not charge up front for hardware or other one time services as in the classic commit to a 3 year contract and get the phone for free). How is revenue and cost recognized.
Using automated billing systems and having the ability to attach revenue recognition codes to each type of service to be sold is a start in helping to make sure you can manage the legal complexities of GaaP and revenue recognition.
Referring back to Jeffrey Mann’s comments you need to be very careful about anything in your contract that allows a long term or indefinite ability for your customers to dispute the invoice for the services provided. This is typically covered by an acceptance of services clause (I am neither a lawyer or an accountant so please realize this is not legal advice) that requires a customer to agree that the services have been deemed delivered as agreed after a period of time. Typically this would be something such as with 15 days of reciept of invoice, however in an enterprise customer agreement, it could be as long as a period to envelop a quarterly audit.
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