Implementing a Revenue Recognition Plan

by John Yates



This memorandum provides practical pointers for technology companies and their professional advisors to consider in view of the impact that accounting guidelines, industry practices, and other revenue recognition requirements may have on their business. In many cases, these pointers will help to reduce the amount of time required to respond to future inquiries from third parties and accountants regarding a company’s understanding and implementation of revenue recognition policies.

1. Determine Revenue Recognition Goals.

The technology company should determine whether its goal is to recognize revenue as soon as possible or defer the recognition of revenue. If the goal is to defer revenue recognition, then the company should determine the desired time for revenue to be recognized.

2. Adopt and Refine Revenue Recognition Policies.

The technology company should work with its contract administrator, legal counsel, and accountants/auditors to create a written set of revenue recognition policies. The written standards should address:

* Differences between the company’s historical revenue recognition policies and its policies under current or pending requirements.

* The approval process for revising the company’s form agreements after the form agreements have been established.

* The process for setting a range of approved prices that the company’s products and services may be offered.

* The approval process for offering products and services at prices that are not within the company’s pre-approved price range.

3. Establish a Pricing Committee.

A company should consider establishing a Pricing Committee to implement and monitor compliance with its revenue recognition guidelines. This committee could include the company’s CFO, lawyer, contract administrator, and sales representatives.

The following are a suggested list of activities for the pricing committee to perform:

* Identify all types of products and services offered by the company.

* Establish the manner in which the product and services are described and priced in customer agreements and verify that such products and services are separately stated.

* Establish a fee range for each type of product that is offered by the company.

* Establish a fee range for each category of service that may be performed by the company.

* Conduct review prior to contract signing of all unique transactions involving elements that have not been previously offered to others.

* Establish standard acceptance testing and warranty periods taking into consideration terms typically offered in the marketplace for similar products.

* Conduct review prior to contract signing of any agreement with acceptance testing and warranty periods that exceed the standard warranty terms established by the Pricing Committee.

* Conduct prior review of any potential refunds for products.

* If customer agreements provide for software exchange or return rights, then determine whether products should be classified as an exchange (exchange of similar products with minimal differences in price, functionality, and features) or a return (exchange for dissimilar products or products with more than minimal differences in price, functionality, and features).

* Periodically review compliance with company revenue recognition policies and determine whether there is need for revision.

4. Revise Form Agreements.

The adoption of new and pending accounting requirements should lead to a review and revision of form agreements covering products and services. These revisions can be coordinated with the revamping of contracts to conform with any other changes in the law.

5. Prepare Pre-Approved Optional Clauses.

Certain clauses of customer agreements are almost always subject to negotiation and revision. These include the:

* scope of obligations

* pricing and payment terms

* termination and post-termination rights

* warranties

* remedy/damage provisions

Each of the above terms will affect a company’s ability to recognize revenue. Lawyers may consider working with their client to draft “pre-approved” optional clauses that meet management’s policies for revenue recognition.

6. Adopt and Enforce a Contract Approval Process.

It is important that a company adopt an approval process for its customer agreements given the multitude of “danger zones” resulting in the deferral of revenue recognition as described above. The company may consider establishing a contract approval process based on the dollar value of the agreement. Additionally, the company may consider a requirement that any agreement that deviates from its “pre-approved” pricing for products and services as established by the Pricing Committee must be submitted to the party identified by the Pricing Committee for approval of such deviations.


7. Implement Educational Programs for the Sales Force.

After the company has completed the above steps, it should train the sales force on the company’s efforts in implementing management’s policies for revenue recognition. The sales force should be particularly trained on the “danger zones” described above. A company’s sales force is critical to the success of the company’s revenue recognition policies. Therefore, a company may want to consider tying sales commission to recognized revenue to provide the company’s sales personnel incentive to further the company’s revenue recognition policies.

8. Maintain Specific Historical Information on Certain Areas.

Revenue recognition principles include a number of concepts that are based on whether a company has specific historical information on certain matters. A written record of these historical practices will be particularly important.

October 3, 2003