Revenue recognition for cloud software providers

The days of desktop versions of software files downloaded and installed on local computers (remember MYOB desktop?) are numbered and providers of software applications such as accounting applications, software security systems, ERPs and a myriad of others are moving to cloud deployments.

This presents complexity for the provider of the software in relation to the correct treatment of revenue earned from the provision of cloud software services. This method of providing software via the cloud for use by the customer without the requirement for a physical download is known as ‘Software as a Service’ (SaaS).

In the bad old days of ‘on-premise’ deployments, being the situation where a software license was installed on a single machine or server at a customer’s premises or physically downloaded via an internet link by the customer, revenue recognition was simple given the customer obtained ownership and control of the license as soon as the install occurred, and revenue was recognised in full at that point in time. The situation is now far cloudier (pun intended) with the emergence of SaaS deployments. A common question arises as to who exactly ‘owns’ the cloud license? And when, if at all, does ownership and control transfer to the customer?

To address the above-mentioned complexity, AASB 15 has dedicated paragraphs specifically outlining the correct method of revenue recognition in relation to the provision of SaaS licenses. Not to be confused with terminology already included in AASB 16 ‘Leases’, AASB 15 distinguishes between licenses that give the customer a ‘right to use’ a license as it exists at a point in time, or a ‘right to access’ the license over a specified period.

AASB 15 paragraph B58 lists the factors that determine whether the license constitutes a ‘right to access’ license. Where these criteria are not met, the license is classified as ‘right to use’ license. The performance obligation in respect of ‘right to access’ licenses (i.e. SaaS licenses) is recognised over time, typically over the period of the license subscription, whereas the performance obligation in respect of a ‘right to use’ license is recognised at the point in time at which the customer is granted use of the license.

Now to the tricky part – namely the wording in paragraph B58. In a nutshell, the standard effectively says that where the customer expects that the software provider will ‘undertake activities’ that impact the license in either a positive or negative manner to which the customer is exposed, but those activities do not transfer any additional good or service to the customer, the license is classified as a ‘right to access’ license. A classic example of this is where you open your PC on a cloudy Monday morning (pun again intended), attempt to open your cloud-based ERP system and are met with a pesky ‘application update required’ dialog box. You then divert to reading the paper and sipping your morning coffee, and once the update finishes, you re-open the system and notice additional menu options and new and bright interfaces. This process of regular upgrades is within the realm of the paragraph B58 intended reach and indicates the existence of a ‘right to access’ license. Most SaaS license applications fall within this basket, including applications we all know and love, such as Microsoft 365. The prevalence of ‘Right to Use’ licenses, being those not fitting the criteria in paragraph B58 (e.g., our MYOB desktop example), are decreasing as cloud-based SaaS deployments become the norm.

For any advice or assistance, please contact your local PKF Audit and Assurance team.