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Project - Middle Road Media Case Study

This project is designed to enhance your research skills using the FASB Codification to research the accounting for software development, enhance your critical thinking skills, and provide an opportunity for you to improve your graduate level writing skills with the help of graduate writing tutors.

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Answer - Recognition of Transactions

May 13, 2019 ZD completes graphical user interface design and commences additional coding $1,135,000

July 23, 2019, ZD completes the working model for the software that is ready for beta testing with three confirmed customers $3,083,000

August 31, 2019 Beta testing is completed by ZD $3,758,000

September 15, 2019, Three customers purchase software $3,758,000

The above transactions will be associated with software cost will be clubbed and added to the cost of the final product that is software. Later, the sale of the software license to people will be considered as revenue of the company.

Recognition of Revenue from Software- Memo

1. Specified upgrades will no longer hold up revenue recognition.

You might have just sold a software license to a customer for $1M, and you might have also promised to upgrade the customer to the newest version coming out next year for free. Under existing GAAP, you're not going to recognize a dollar on that sale until the customer has upgraded (assuming of course that you fall in the most likely scenario of not having a history of standalone sales on the specified upgrade).

2. In many cases, post-contract support (PCS) will no longer be viewed as a single component.

24x7 customer support; when-and-if-available enhancements; bug fixes.

Each of these is typical of the kinds of activities that are recognized as a single component known as post-contract support (AKA maintenance) under existing GAAP.

The concept of post-contract support will soon vanish. ASC 606 doesn't explicitly define post-contract support as a single performance obligation, so you'll instead need to consider whether these post-contract support activities should be broken up into separate performance obligations.

So long, post-contract support. What a long, strange trip it's been.

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It gets slightly more convoluted when you consider that each of these components may not even be performance obligations to be recognized as revenue (Rashty, & O'Shaughnessy, 2010). A company could determine that bug fixes, for example, is merely an activity to ensure that the software complies with agreed-upon specifications, in which case it may be considered a non-revenue component of a warranty and should be accounted for under Subtopic 460-10 on Guarantees.

Bottom line: the term post-contract support will soon fall by the wayside much like curglaff, beef-witted, and snout-fair have in centuries past.

3. Extended payment terms will no longer prevent revenue recognition; you'll just have to present-value it.

You ever sold software with a 6-month implementation to go-live, at which point payments will become due in equal installments over the next year and a half?

While the concept of extended payment terms wasn't stated under the general existing revenue guidance; the software-specific ASC 985-605, Software: Revenue Recognition explicitly called it out.

And under that existing guidance, you probably would've had to put your auditor in a choke hold to recognize that revenue, as the fees likely wouldn't have been considered fixed or determinable.

Good news for you (better news for your auditor), you can recognize this revenue now. You just have to consider whether a significant financing component exists to the arrangement.

In general, you should recognize an amount as revenue reflective of what your customer would've paid for in cold, hard cash.

Accounting Standards Codification (ASC) 606, titled "Revenue from Contracts with Customers", became effective for public company reporting periods after Dec 2017. For 2018, the new standards are applicable and must be reported. The effective date for all other entities begins after December 15, 2018.

Objectives & improvements

The new standards aim to improve the financial reporting of revenue from contracts with customers. Previously, highly specific industry guidelines made comparability difficult, which have been simplified with ASC 606.

The standard now provides guidance on many transactions - specifically service transactions - that were previously lacking (non-public entities had to rely on the SEC and other entities for guidance).

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  • Under the old regulation, there were numerous ways of recognizing revenue depending on the industry and specific transactions. This led to the usage of different accounting methods and standards for the same transactions.
  • Under the new guidelines, revenue will be recognized using consistent principles regardless of the industry or region of businesses.
  • The new guideline requires companies to disclose a number of details that show users of the financial statement the company's contracts with its customers. This will be an improvement on the earlier guideline where most companies gave little information regarding revenue contracts.
  • The new guideline is effective from December 15, 2017, for public companies. They are, however, allowed to apply the new guideline early.
  • For Not-for-profit organizations and private companies, the new reporting standard will be effective from December 15, 2018, and early implementation is allowed.
  • The new guidelines will affect a number of industries, but the aerospace, software, construction, real estate, and telecommunication industries will be the most affected.

Most software companies don't do long right of return for exactly the reason you cite: it prevents revenue recognition (Bloom & Kamm, 2014). It also encourages unscrupulous customers with a short term need to take advantage of your generous return policy to get value from the software without paying for it -- really depends what the software does to know if that's even an issue.

Traditionally, for perpetually licensed software, B2B software companies have the concept of the license and maintenance. The customer purchases a license to use the software, typically in perpetuity -- hence "perpetual license" (RICK & CHURYK, 2016). The customer also purchases maintenance, entitling you to upgrades and bug fixes during a fixed time period. The "warranty" concept is covered by the maintenance instead of the right of return -- the company will fix bugs for the customer and improve the software.

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