Revenue Recognition for Software Sales

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Apr29

Revenue Recognition for Software Sales

Linda Chan

Know More: Accounting fraud 2.0, Accounting fraud

The following is provided for information purposes, and not meant to be legal or other advice.

Revenue recognition for software sales requires four elements:

1. Persuasive evidence of an agreement
2. Delivery occurring or services rendered
3. Price fixed or determinable
4. Collection of an amount to be paid probable

Revenue is overstated by:

a. Reporting transactions that do not happen or do not generate any revenues
b. Recognizing revenue before the appropriate time to do so such as backdating a contract
c. Failing to follow technical accounting rules on when and how much revenue to record
Phony contracts and side letters involve inventing transactions or draft contracts that do not reflect real terms of an agreement. For instance, a side letter that offers free services to offset a contract’s price.

To establish persuasive evidence of an agreement, GAAP generally requires that the contract be signed by both parties. Also under GAAP, revenue from a services agreement, such as software maintenance must be recognized proportionally over the service period whereas revenue from the license can be recognized upon delivery of the software.

Avoid problems associated with revenue recognition by:

I. Developing standard contracts and an a contract approval process
II. Implementing internal controls
III. Adhering to GAAP and not tolerating side letters or the backdating of sales
IV. Tying sales commissions to the collection of receivables, not revenue recognition

related entries

Freddie Mac Nov 22, 2007
100 Fastest Growing Companies Sep 10, 2007
International Financial Reporting Standards May 28, 2007
Valuation Metrics Nov 1, 2006
Management’s Discussion and Analysis (MD & A) Part II Oct 28, 2006

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