Executives in fast growing organizations are challenged to keep up with growth as they guide their organizations into the future. These business leaders tend to focus on the day-to-day operations and current financial stability of their companies and often do not consider the things they should be doing now to prepare for future strategies, such as an exit event. A key foundational element for any successful organization is a sound accounting strategy.
In the technology industry, rules and regulations are often complicated, so it’s imperative to develop procedures that consider these common issues:
• Accrual vs. cash-based accounting
• Sales commissions
• Capitalization of software development costs
• Revenue recognition
Choosing an accounting method — Accrual vs. cash
Most new businesses choose cash basis accounting, rather than accrual basis. The former is generally easier to track and understand. Such a method is tied to cash flow without regard to accounts receivable and accounts payable. It generally provides a greater opportunity to time revenue and expenses in comparison to the accrual method. The accrual method offers a more precise view of long-term financial health, but you must report income when earned, even if you haven’t yet collected the cash. Expenses are reported when incurred, even when cash isn’t paid.
Sales commissions
Another important accounting decision is how to structure sales commissions and determining your company’s accounting policies with respect to commissions. Do you follow the same commission structure for your entire sales team, or is each commission plan handled differently? Are commissions expensed when incurred, or are they capitalized and expensed over a future period of time? Whether the commission is based on a flat-fee arrangement or a percentage of revenue, careful analysis should be performed to determine the timing of the expense recognition. Additionally, commission payments should be tracked alongside the expenses to ensure the accrual or prepaid is accurately calculated on the balance sheet. Alternatively, with cash basis accounting, the commission would be expensed when it is paid out to the staff member.
Capitalization of software development costs
Software companies are required by the Financial Accounting Standards Board (FASB) ASC 985-20, “Costs of Software to Be Sold, Leased, or Marketed,” to capitalize costs incurred in the development of software to be sold, leased, or marketed once the software reaches technological feasibility. This concept of technological feasibility simply means you’re certain the software will work, and costs incurred are determined recoverable. As the determination of technological feasibility is a qualitative assessment, be prepared to fully support your point of technological feasibility, as well as costs to be capitalized, with thorough records. Once the software product goes to market, capitalization ends and costs are once again expensed.
New revenue recognition standards — What do you need to know?
In 2014, the FASB and International Accounting Standards Board (IASB) issued a joint new accounting standards update titled Revenue from Contracts with Customers. Due to the nature of their sales and contracts, technology companies are more likely than other industries to be affected by the new rules. As revenue can be the driving force behind many key management decisions, ensuring proper revenue recognition is vital. While the new guidelines don’t take effect until 2017 for public companies and 2018 for non-public companies — with a likely one-year deferral — it’s important to begin planning now, especially in light of long-term contracts. The following are a few key steps to prepare your company for the new regulations.
• Learn the new standard, and conduct an impact analysis for your specific business activities and contracts.
If your contracts contain multiple elements, it will be important to determine if each element represents a separate performance obligation, or if a group of elements represents one performance obligation.
• Review your current standard contract wording.
As each contract will need to be analyzed separately under the new standard, consistency in structure and wording across contracts, where appropriate, will reduce your time spent analyzing and modifying contracts. Long-term contracts entered into now may be subject to the new accounting guidance in later years of the contract.
• Determine and address potential business changes.
Establish who needs training and when. Consider needed changes to accounting procedures and internal controls. Identify compensation, loan, sales, and purchase agreements that have provisions based on earnings or other financial metrics that could be affected by the proposed guidance.
.jpg)
