Question

Revenue Recognition by software companies:
Microsoft, Inc. recognized revenues from its licensed software products at the “time of sale” or “time of installation”. Despite receiving such revenues in cash, Microsoft defers the recognition of a portion of its software revenue. The deferred portion represents the value of any future upgrades that might be distributed free of charge, as well as the value of any technical support services provided free of charge during the software warranty period. Do you agree with Microsoft’s revenue recognition policy? Discuss the company’s possible motivation for adopting this revenue recognition approach.

Answer 1

Software contracts typically comprises of:

· Software licenses·

· Unspecified or specified future updates or upgrades / enhancements

· Specified or unspecified additional software products

· Exchange and platform transfer rights

· PCS

· Installation

Other professional services

My analysis and solution of the given situation is explained below

The issue relates to  Microsoft deferring a portion of the revenue that relates to providing "upgrades" and value of " support" services and should these two pieces be deferred or not ?

Although the license and updates are capable of being distinct, the updates significantly modify the functionality of the software and are integral to maintaining the utility of the software. As a result, Software Co. should recognize revenue for the combined license and updates service over time using an appropriate measure of progress that reflects the transfer of control of the combined promise. Measures of progress might include time-based measures or measures based on costs of delivering the updates, among others.

The support services will also be recognized over time, which may or may not have the same measure of progress.

Another way of looking at it would be , that the software license is not distinct from the installation services because the installation services significantly customize the software. As such, the software license and the installation services are inputs into a combined output, which is a promise to deliver customized software. The company. should assess whether the promise is satisfied at a point in time (once the software is completed) or over time (as the customization is performed), which will depend on the contract-specific facts and circumstances.the updates and support are distinct and should be recognized over time using an appropriate measure of progress.