Revenue Recognition for ABC Software Company under ASC 606
ABC COMPANY was stumped by U.S. accounting rules for revenue recognition and gave up trying to comply with them. The Japanese giant recognized this would lead to the delisting of its ADR shares on NASDAQ. ABC also said it would be able to file its 2006 annual report under U.S. GAAP and it couldn’t vouch for its financial statements since 2000. ABC COMPANY said a restatement was not practicable because of the complexities. ABC noted that its financial statements under Japanese GAAP are current and not affected by this announcement.
Under accounting principles generally accepted in the United States of America, revenue recognition rules are complicated for software companies whose contracts combine the sale of software with maintenance service agreements. Previously, a standard called SOP 97-2 for companies wishing to recognize the software-sales revenue up front must perform an analysis of such contracts that provides “vendor specific objective evidence” (VSOP) of consistent treatment of sales and service. That analysis, which ABC COMPANY says it has been unable to complete, required before portions of revenue from a single contract can be broken out and recognized at different times. ABC says it is unable to complete the VSOE analysis for its auditor in time to file the annual report for the year ending March 31, 2006 even though ABC had previously been warned by NASDAQ and received an extension.
On June 17, 2008 the Securities and Exchange Commission instituted proceedings against ABC pursuant to the Securities and Exchange Act of 1934. The resulting order revoked the U.S. registration of each class of ABC’s registered securities and ordered ABC to cease and desist from committing certain violations based on ABC’s failure to file annual reports and maintain sufficient internal controls, and failure to make and keep accurate books and records. Following the revocation order ABC securities remain listed for trading, and actively trade, in Japan. ABC’s American Depositary Receipt Program was subsequently terminated as of March 31, 2010.
Recently, new revenue recognition standards have been adopted in the USA. ABC’s management would like your advice on whether it might be a good time to apply for the company to be listed on a US stock exchange by complying with revenue recognition requirements.
ABC has the following sources of income that should be evaluated.
1. Licensing of product. Customers pay an upfront fee of $12,000 for 12 months to use ABC’s software. Customers can access ABC’s software at any time during the period. The contract term starts on July 1 and go through June 30. ABC provides hosting and maintenance of the site.
2. Implementation . ABC software will provide training, project management, data conversion and process consulting to onboard new clients. Implementation services typically require full-time work for 3-months on average with a team of 3 providing hourly billing at a rate of $150 per hour.
3. Hardware sales. ABC is a reseller of key components. ABC has no inventory obligations and drop ships produce from the manufacturer’s distribution site. The mark-up on hardware sales is 10% for ABC.