Revenue Recognition

HelloYoungBoy

A software company supplies customised packages for the medical goods industry. Title passes to the customer on installation of the package, but a further three-month warranty period applies, during which all problems with the system must be eliminated at the expense of the software house. The company wants to recognise revenue once the package is installed.
Can it do so?

hivizman

HelloYoungBoy wrote: »

A software company supplies customised packages for the medical goods industry. Title passes to the customer on installation of the package, but a further three-month warranty period applies, during which all problems with the system must be eliminated at the expense of the software house. The company wants to recognise revenue once the package is installed.Can it do so?

This is a situation where it is necessary to consider the interaction between IAS 18 Revenue and IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Also, IAS 18 is currently being revised, and the most recent exposure draft clarifies this situation.

The first question to ask is whether the selling price of the software identifies separate amounts for the basic package and the warranty. If so, then IAS 18 illustrative example 11 suggests that the amount for the basic package should be recognised on installation but the amount for the warranty should be recognised over the period covered by the warranty.

If the selling price does not identify separate amounts, then it would be reasonable to recognise the whole selling price as revenue when the package is installed, but IAS 37 would require provision to be made for the best estimate of the costs of making good under the warranty products sold before the end of the reporting period (see illustrative example 1 in IAS 37).

Illustrative example 21 to the revised Exposure Draft Revenue from Contracts with Customers supports the IAS 37 treatment as above.

Under US GAAP I would say no

There are four criteria that must be met to recognize revenue:

Persuasive evidence that an agreement exists
Delivery has occurred or services have been rendered
The seller’s price is fixed and determinable
Collectability is reasonably assured

I don't think you could say for certain the services have been rendered until the warranty has run out.

HeinekenTicket

HelloYoungBoy wrote: »

A software company supplies customised packages for the medical goods industry. Title passes to the customer on installation of the package, but a further three-month warranty period applies, during which all problems with the system must be eliminated at the expense of the software house. The company wants to recognise revenue once the package is installed.
Can it do so?

It depends on the nature of warranty.

If it is a statutory warranty, i.e. right of return that we have by law for all goods, then the revenue can be fully recognised upon installation. None of the revenue is attributable to the statutory warranty because no-one would pay for warranty coverage that they get by law anyway. However, if there is evidence that costs are typically incurred during the warranty period (based on past experience), then the software company should recognise a provision at the reporting date for estimated costs to be incurred in relation to software already installed. See hivizman's reference to IAS 37.

If it is what is referred to as an extended warranty, this means that the software company is offering warranty coverage beyond basic statutory requirements. This in turn means that the company sold two things of value to a customer: (i) the software and (ii) the extended warranty coverage. In this case, only the revenue relating to the software can be recognised upon installation. The revenue relating to the warranty is recognised over the warranty period. The company must come up with a mechanism to split the total proceeds of the sale into bit that relates to software and bit that relates to warranty. Most commonly, this would be done by reference to fair values attributable to software and warranty coverage when they are sold independently of each other. See hivizman's references to IAS 18.

PhiliousPhogg

Agree with the above technical analyses. In my simplistic world, once it's invoiced & there is a high expectation of payment from the customer it's OK to recognise revenue as long as an adequate cost provision is made for the cost of warranty.

If it's an ongoing thing it would be easier to separate the invoicing lines into software provision and warranty and just defer the warranty revenue until the period is up (it should amount to a small portion assuming the software isn't shíte )

HelloYoungBoy

I leaning towards not being able to recognise it as revenue until the warrenty expires as the risk and reward is transfered to the customer then.