Question on Deferred Revenues

[cdogsteve99]

Hello all, new member here.

I'm looking into investment on a company, but some of the financial statements are confusing me and my accounting knowledge is a bit rusty.

The company sells a piece of software which allows the user free use of it over one year.

The customer can renew after the one year is over for one year or get better pricing for 3 years.

According to the company, "Revenue is reconized from sales of the product over the license period associated with the initial 12 month license period. The revenue associated with a license for additional years is deferred and recognized ratably over the extended license period."

Additionaly it is stated that "Revenue from sales of hardware and the company's proprietary software meeting the criteria for recognition upon shipment are recognized at the time of shipment to customers"

On the income statement, the company books "Sales of Units" and "License Renewals" as two separate line items.

On the balance sheet, under liabilities there are deferred revenues (current) and then deferred revenue (net of Current Portfion).

How do i interpret all of this?

If the company sells 100 units in one quarter, am I to assume that only 25% is accounted for in Sales? And then the rest goes into deferred revenues? What happens to the deferred revenue once it is earned? Does it move to the income statement under sales?

 

[bklynboy]

Deferred revenue refers to having collected cash but not yet providing the services or goods to warrant recognition as income. This is set up as a liability since further performance is required by the company. As the service or goods are provided, the liability is released into income.

In your example (note that I am not in the software industry) they are likely deferring some of the revenue since the contracts include post contract services (PCS) - usually these relate to upgrades, customer support, set up and the like such that the company has an ongoing responsibility to the buyer to perform additional work and therefore cannot fully recognize the revenue day 1. I dont think its a straight 25% but depends on the contract and what additional services are required.

If its a straight license with no PCS, then I would think its recognized in full day 1 as no further services are required.

You can refer to SOP 97-2 for an indepth discussion linked here:
Revenue Recognition for Software Products with Multiple Deliverables