Background
A consulting company working with Fortune 500 companies decided to develop and market software that would enable it to increase revenue, margins, and shareholder value. In the early stages of development, the intention was that the software would be sold as a perpetual license product. Based on this decision, management concluded that the appropriate treatment of the costs incurred to build the licensed software would be accounted for using the standard of Costs of Software to be Sold, Leased, or Marketed. However, in the late stages of development, as the company was finalizing the product for launch and beginning negotiations with customers, it decided to launch the product as a hosted subscription and use a software-as-a-service (SaaS) revenue model. The company successfully launched the new software product.
Challenge
When the company changed the delivery method of the software by switching to a SaaS model, they didn’t revisit how costs were capitalized. The company accounted for software development costs as if the product was sold via a license, rather than under a SaaS model. Capitalized software was new accounting territory and they weren’t aware that the revenue model underlying the sale of the software determines the accounting standard to be followed for capitalization.
Outcome
During Wolf & Company’s ongoing communications with the client regarding the status of the software development, the Wolf team was made aware of the change in the revenue model. They noted that the company was not applying the Internal-Use Software accounting standard as required for a SaaS revenue model.
The Wolf team informed the client’s CFO of the relevant accounting standards on software revenue recognition and capitalization, and provided clarifying guidance on the intricacies of the standards. Wolf also provided accounting policy disclosure excerpts from publicly-traded companies as further guidance regarding disclosures and industry practices.
Takeaway
Because of Wolf’s expertise with software accounting issues and its consultative service style, our team was able to help the client’s CFO transition a consulting firm into the software industry. By capitalizing software development costs under the appropriate standard and including proper accounting policy disclosures, the company can now build accurate business forecasts and withstand the rigors of due diligence on such costs as it relates to any future sale of the business.
