Workshop: ASC 606Application for Subscription Companies

June 2017

9 Overview and New Terminology

9 Transaction- or Volume-based Subscription

9 Standalone Selling Prices and Allocations

9 Contract Modifications

Agenda

1

The Model

Overview

2

Step 1• Contract with customer

Step 2• Performance obligations

Step 3• Expected transaction price

Step 4• Allocate

Step 5• Recognize revenue

Floccinaucinihilipilification?!New Terms:

• Stand-ready

• Distinct

• Series

• Variable consideration

• Variable consideration constraint

• Material right

• Contract term

Transition Methods

3

Full retrospective

• Recast all periods presented in financials• Disclosures for all periods presented• Adjustment to retained earnings at the beginning of

the first period presented

ModifiedRetrospective

• No change to prior periods• Dual reporting for year of adoption• Adjustment to retained earnings at the beginning

of initial application period

Current Status of Adoption

4

4%9%

87%

8%

42%50%

6%

43%51%

0%

20%

40%

60%

80%

100%

Material Not Material Still AssessingNov'16 Study Mar'17 Study May'17 Study (Current)

� Overall, no significant progress has been seen in companies’ disclosures about high-level adoption impacts.� 31% of the IFRS companies sampled and 52% of the US GAAP companies sampled have discussed their preliminary

conclusion as to whether there is significant adoption impact.� For the “still assessing” group, 25% of them (48 companies) have elected the modified retrospective method and 9% (18

companies) have elected the full retrospective method.� Many companies continue to caveat their potential impact disclosures that

(a) the company’s current assessment is preliminary, still ongoing, and subject to change and(b) resolution or evolvement of certain industry-specific open issues may result in changes to the current conclusions.

Delivery pattern: frequently straight-line

Stand-ready

ADelivery within a vendor’s control, but goods or services should be further developed

When-and-if-available updates

B Delivery is outside of the control of a vendor or customer

A vendor promises to merchant to process as many credit card transactions on its platform as may be initiated by consumers

C Delivery within the control of a customer Technical support

D A vendor makes goods or services continuously available

Infrastructure as a service, access to data center capacity

5

Distinct

Capable of being distinct

Can be used, consumed, sold, held for economic benefits

• On its own, or

• With resources already obtained from the vendor or from others, or

• With resources sold separately (by any entity)

Distinct

Distinct in context of the contract

Is NOT part of a combined output.

Indicators for assessment include:

• Significant integration

• Significantly modify or customize another item

• Each item is significantly affected by other item(s)

• Separable execution risks

6

Distinct Considerations

1 Implementation related to subscription

• Customer or others can do• No significant customization• Subscription can start prior to completion of

implementation• Non-refundable

2Different subscription offerings

• Customer can use and benefit separately• Can be purchased separately• Combined functionality is simply additive (not

transformative)• Not co-terminus

3SaaS and on-premise (off-line and on-line versions of ERP)

• On-premise is not simply a delivery mechanism

• Can be used separately from each other• Combined functionality is simply additive (not

transformative)

7

Series

Day 1 Day 2 Day 3 Day … Last Day

Single Performance Obligation comprising of a series of daily subscriptions

To be a Series, all below should be met:1. More than one distinct good or service2. Substantially the same3. Satisfied over time

To be a Series Simpler accounting for transaction based fees

8

• A portion or the entire consideration under a customer contract might vary

¾ Example:

– A SaaS billing processor charges $0.10 to its customer per each consumer bill processed.

– The price per bill during each specific month decreases to $0.075 for all bills in excess of 10,000,000 processed during that month.

Variable Consideration

9

• A portion or the entire consideration under a customer contract might vary

¾ Example:

– A credit card processer charges the bank 0.5% per each credit card transaction processed.

– If the total dollar amount of transactions processed during a year exceeds $0.5 billion, a rebate of $100,000 is provided.

Variable Consideration

10

• A portion or the entire consideration under a customer contract might vary

¾ Example:

– A vendor provides online storage solutions to its customers and charges $10 per each TB of managed storage.

– Each contract includes a committed minimum of $1,000 per year.

– However, the vendor has a past practice of not enforcing contractual minimum.

Variable Consideration

11

• A portion or the entire consideration under a customer contract might vary

¾ Example:

– Cloud-based ERP vendor implements its solution for a number of customer locations.

– The scope of implementation services is clearly defined.

– The implementation services are billed on T&M basis.

Variable Consideration

12

Options: Material Right vs. Marketing Offer

1 Year Renewal at $1,000

Option is simply a marketing offer

Ignore renewal option until exercised

1 Year Renewal at $600

Estimated probability of exercise 90%

Option is a material right:Approach 1: Option price: (1,000 – 600) * 90% = 360% Allocation: 1,000 / (1,000 + 360) = 73.5%1st year Subscription: 1,000 * 73.5% = 735Approach 2:Transaction price: 1,000 + 600 * 90% = 1,5401st year Subscription: 1,540 / 2 = 770

Approach 3:Transaction price: 1,000 + 600 = 1,6001st year Subscription: 1,600 / 2 = 800

13

1 Year Subscription

at $1,000

1 Year Subscription

at $1,000

Contract Term

3 Year SaaS

No early termination 3 Years

3 Year SaaS

90-d notice termination

w/o significant

penalty

90 days

3 Year SaaS

Fully prepaid ???

Significant Termination

Penalty

Non-refundable

14

Revenue is not Constrained by Billings

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Quarter 5

Quarter 6

Quarter 7

Quarter 8

Bill $100

Bill $100

Bill $100

Bill $100

Bill $120

Bill $120

Bill $120

Bill $120

$110 $110 $110 $110 $110 $110 $110 $110

Revenue

$10 $20 $30 $40 $30 $20 $10 -

Contract Asset

15

Commission Deferral

Accrue Defer Amortize Test for impairment

• In most of the cases timing of accrual is not expected to change

• Should be incremental• Tiered and quota-

based may qualify• Required if the benefit

period is longer than 12 months after contract inception date

• Consider anticipated renewals

• Consider other related costs (payroll taxes)

• Consistent with benefits

• Consider anticipated renewals if no or smaller commissions are paid upon renewal

• Can be longer than contract term or product life

• May have to be allocated to different performance obligations

• Future receipts + deferred revenue

• Include expected variable consideration

16

9 Stand-ready

9 Distinct

9 Series

9 Variable Consideration

9 Material Right

9 Contract Term

9 Contract Asset

9 Commission Deferral

Recap

17

18

Questions?

When to Recognize as Earned

Subscription with transaction-based fees

Series

Variable consideration relates specifically to (i) efforts to transfer, or (ii) specific outcome from transferring

service within the Series

As “earned” is consistent with the “allocation objective”

ⱱ

ⱱ

ⱱ

Allocation Objective Factors

• Price is not required to be the same per transaction!

• Consistency in price per transaction

• Whether commensurate with the value to the customer

• Whether commensurate with the efforts to fulfill the service

• Consistency with the entity’s customary pricing practices

19

Allocation Objective is not Achieved

2-year SaaS contract:• $0.10 per transaction in year 1 (part of the fee is used to recoup certain expenditures

incurred by the vendor to customize the SaaS solution)• $0.06 per transaction in year 2

Estimate Transaction

PriceMeasure of Progress Recognize True-up

• 3 mln transactions in year 1

• 5 mln transactions in year 2

• Transaction price is $600,000

• Assume straight-line • 50% progress at the end of Year 1

• Revenue for Year 1 before true-up: $300,000

• 2 mln of actual transactions for year 1

• Revised estimate for year 2 is 3 mln

• Revised Transaction Price is $380,000

• Year 1 revenue: $190,000

• True-up: ($110,000)

20

Fixed Up-Front and Volume-based Fee

2-year SaaS contract:

• $120,000 fixed fee to recoup certain expenditures incurred by the vendor to customize the SaaS solution

• $0.06 per transaction fee

• N/A • Assume straight-line • Assume 2.0 mln actual transactions in Year 1

• Fixed fee revenue = $60,000

• Transaction revenue = $120,000

• Total = $180,000

• N/A

Estimate Transaction

PriceMeasure of Progress Recognize True-up

21

Cash Rebate

2-year subscription contract:• $0.10 per transaction fee• $100,000 cash rebate if cumulative volume exceeds 10 min transactions

• Estimated volume: 12 mln transactions

• Estimated Transaction Price: 12,000,000 * $0.10 -$100,000 = $1,100,000

• Number of transactions is the best measure of progress

• 4 mln actual transactions in Year 1

• Progress before true-up: 4/12 = 33.3%

• Revenue $1,100,000 * 33.3% = $366,667

• 5 mln estimated for Year 2

• Transaction Price = $900,000

• Progress: 4/9=44.4%• Cumulative revenue:

$900,000 * 44.4% = $400,000

• True-up: $33,333

Estimate Transaction

PriceMeasure of Progress Recognize True-up

22

Volume-based Discount

Series

Variable consideration relates specifically to (i) efforts to transfer, or (ii) specific outcome from transferring

service within the Series

As “earned” is consistent with the “allocation objective”

ⱱ

ⱱ

Diversity in practice:• Whether the magnitude of difference in

rates may be considered• How to assess the significance

2-year SaaS contract:

• $0.10 per transaction fee

• $0.09 for each transaction in excess of 10 million on a cumulative basis

23

Volume-based Discount

Outcome 1: As earned is NOT acceptable

Estimate Transaction

PriceMeasure of Progress Recognize True-up

• Estimated volume: 12 mln transactions

• Estimated Transaction Price: 10,000,000 * $0.10 + 2,000,000 * $0.09 = $1,180,000

• Number of transactions is the best measure of progress

• 4 mln actual transactions in Year 1

• Progress before true-up: 4 / 12 = 33.3%

• Revenue $1,180,000 * 33.3% = $393,333

• 5 mln estimated for Year 2

• Transaction Price = $900,000

• Progress: 4 / 9 = 44.4%

• Cumulative revenue: $900,000 * 44.4% = $400,000

• True-up: $6,667

24

Volume-based Discount

Outcome 2: As earned is acceptable

Estimate Transaction

PriceMeasure of Progress Recognize True-up

• N/A • N/A • Assume 4.0 mln actual transactions in Year 1

• Revenue: 4,000,000 * $0.10 = $400,000

• N/A

25

26

Questions?

Standalone Selling Price – SSP

SaaS

• 2 Performance Obligations (“PO”) with different pattern

• Transaction price is allocated based on SSPs

• Standalone Selling Price (SSP): selling price for an item if it is sold by itself¾ Replaces VSOE, TPE and BESP¾ Determined at the outset of contract¾ Must allow to meet allocation objective (depict expected

consideration for the item)¾ Consider all information, maximize observable inputs

Distinct Implement

SSP range is

OK

27

Standalone Selling Price – SSP

PerformanceObligation

Common SSP metrics Methods to determine SSP

Implementation services

• $ amount• % discount from list price• $ rate per hour per level and

estimated hours per level• % discount from list price and

estimated hours per level

¾ Historical pricing of standalone consulting

¾ Historical rates in T&M arrangements¾ Historical pricing across all types of

transactions¾ Rates charged by third parties¾ Cost plus reasonable margin

Subscription • $ amount per year or per month• $ amount per user or per node• $ amount per transaction or per

dollar value processed• % discount from list price• Hybrid: $ amount per year

+ $ amount per transaction

¾ Renewal pricing¾ Historical pricing across all types of

transactions¾ By reference to SSP for subscriptions

with a shorter or longer contract term

28

Free Implementation

SaaS

• 2 Performance Obligations (“PO”) with different pattern

• Transaction price is allocated based on SSPs

Distinct Implement

PO Contractprice SSP % Allocated Duration Billing

Implementation $ - $ 500,000 20% $ 400,000 6 months N/A

Subscription 2,000,000 2,000,000 80% 1,600,000 2 years after implementation

Annual in advance

Total $2,000,000 $2,500,000 100% $2,000,000

29

Free Implementation

0 - 6 month

7 - 18 month

19 - 30 month Cumulative

Services (400,000)

Subscription

Cash

(400,000)

400,000C. Asset

(800,000)

1,000,000

(200,000)

(800,000)

1,000,000

(200,000)

(1,600,000)

2,000,000

-

30

Implementation & Variable Subscription

• 2 Performance Obligations (“PO”) with different pattern

• Transaction price is allocated based on SSPs

Distinct Implement

• Contractual: $450,000

• SSP: $500,000

• Duration: 6 months

• Contractual: $0.09 per transaction

• SSP: $0.10 per transaction

• Duration: 2 years after implementation

• Actual transactions:Year 1: 10 mlnYear 2: 15 mln

ⱱ

ⱱ

ⱱ

Is Subscription?

Series

Variable consideration relates specifically to

(i) efforts to transfer, or (ii) specific outcome from

transferring service within the Series

As “earned” is consistent with the “allocation objective”

Variable Subscription

31

Implementation & Variable Subscription

0 - 6 month

7 - 18 month

19 - 30 month Cumulative

Services

Subscription

Cash

C. Asset

(450,000) (450,000)

450,000

(900,000)

900,000

(1,350,000)

1,350,000

(2,250,000)

2,700,000

-

32

Free Implementation & Variable Subscription

• 2 Performance Obligations (“PO”) with different pattern

• Transaction price is allocated based on SSPs

Distinct Implement

ⱱ

ⱱ

Series

Variable consideration relates specifically to

(i) efforts to transfer, or (ii) specific outcome from

transferring service within the Series

As “earned” is consistent with the “allocation objective”

Variable Subscription

• Contractual: $ -

• SSP: $500,000

• Duration: 6 months

• Contractual: $0.10 per transaction

• SSP: $0.10 per transaction

• Duration: 2 years after implementation

PO SSP %Implementation $ 500,000 20%

SaaS 2,000,000 80%

Total $ 2,500,000 100%

33

0 - 6 month 0 - 18 month 0 - 30 monthEstimated future transactions 20,000,000 20,000,000 -Actual transactions - 10,000,000 25,000,000Total transactions 20,000,000 30,000,000 25,000,000Transaction price ($0.10) $ 2,000,000 $ 3,000,000 $ 2,500,000

Allocated to implementation (20%) $ 400,000 $ 600,000 $ 500,000Allocated to subscription (80%) $ 1,600,000 $ 2,400,000 $ 2,000,000Subscription progress* 0.0% 33.3% 100%Subscription cumulative revenue $ - $ 800,000 $ 2,000,000

* Assume the most appropriate measure of progress is the number of transactions

34

Free Implementation & Variable Subscription

Free Implementation & Variable Subscription

0 - 6 month

7 - 18 month

19 - 30 month Cumulative

Services

Subscription

Cash

C. Asset

(400,000) (500,000)

400,000

(800,000)

1,000,000

(1,200,000)

1,500,000

(2,000,000)

2,500,000

-

(200,000) 100,000

(400,000)

Re-estimateRe-measureRe-allocate

35

Implementation & Variable SaaS

(a) Implementation is priced at SSP, and

(b) SaaS rate is at SSP

Yes

• No estimate• No reallocation• No true-up

Implementation and SaaS rate have the same discount

Yes

• No estimate• No reallocation• No true-up

SaaS rate has higher discount

Yes

• Initial estimate and allocation may be necessary

• No reallocation• No true-up

No No No

• Estimate• Reallocation• True-up

36

37

Questions?

Contract Modifications

Initial contract:• 2-year SaaS • Distinct implementation

Modification:• Add implementation for

5 more locations at SSP

Separate Initial contract:• 2-year SaaS • Distinct implementation

Modification:• Add free implementation

for 5 more locations

Prospective

Initial contract:• Turnkey implementation

Modification:• Change agreed scope

for turnkey implementation when implementation is still in process.

Retro Hybrid Rare

38

Separate vs. Other

Modification only ADDS DISTINCT goods or services

No

Additional goods or services are at SSPs

Yes

Initial contract influenced negotiation on pricing

Yes

Yes No No

Separate Separate Separate

Separate

39

Prospective ExampleContract:• 2-year SaaS billing processing• Upfront fee of $2,000,000 plus $0.10 per

transaction• 10 mln transactions were processed in

Year 1

Modification:• Executed on the 1st day of Year 2.• Extended the contract for Year 3• New rate is $0.08 per transaction and is applicable

immediately• 10 mln transactions were processed in Year 2• 20 mln transactions were processed in Year 3

Post modification: 2-year single SaaS contract at $0.08 per transaction and fixed amount of $1,000,000 (Why?)

Year 1 Year 2 Year 3 Cumulative

Revenue

Cash

C. Liability

(2,000,000) (5,400,000)

3,000,000 800,000

500,000

1,600,000

500,000

5,400,000

-(1,000,000)

(1,300,000) (2,100,000)

40

Timing of Modification

Contract ExecutedPriced: $0.10 per transaction

Parties agreed to adjust the per transaction rate

The contract amendment was signed by both parties

Contract ExecutedIncludes implementation

The parties revised the scope but were still working on finalizing pricing

The contract amendment with revised pricing was executed

41

• Key Considerations for Subscription

9 Timing of Recognition for Variable Consideration

9 Timing of Recognition for Fixed Fee

9 Allocation

9 Contract Modifications

9 Renewal Options

9 Commissions

Recap

42

43

Questions?

Connor Group professionals deliver to our global clients Technical Accounting, IPO support, Mergers and Acquisitions, and Financial Operations services from our bases in Silicon Valley, San Francisco,New York, Salt Lake City, Boston and Europe.

A Premier Professional Services Advisory Firm Thought Leaders Since 2006

Denis KozhevnikovPartner

Denis.kozhevnikov@connorgp.com

Denis is a Partner in Connor Technical Accounting Interpretations(professional practice). He is a subject matter specialist in softwareand technology revenue recognition; SEC reporting; businesscombinations and other technical accounting areas. Denis serves asa technical accounting advisor to our engagement teams on complexaccounting matters and leads special projects, includingimplementation of new accounting standards and structuring. As a co-leader of Connor Technical Accounting Interpretations, Denis is alsoresponsible for quality and continuing education for our professionals.He has instructed multiple internal and external trainings on a varietyof accounting topics, including ASC 606 updates, software revenuerecognition, revenue recognition, SEC reporting and others.

Denis is a former director at PricewaterhouseCoopers in TransactionServices, Accounting Advisory group (San Jose). Denis is a CertifiedPublic Accountant in California and a Fellow Chartered CertifiedAccountant in the United Kingdom. Denis graduated with honors fromMoscow Institute of Physics and Technology with a degree in appliedmathematics and physics. He also has a Master in FinancialManagement degree from an international master program organizedby University of Catania (Italy) and Erasmus University Rotterdam(Netherlands).

Connor Group professionals deliver to our global clients Technical Accounting, IPO support, Mergers and Acquisitions, and Financial Operations services from our bases in Silicon Valley, San Francisco,New York, Salt Lake City, Boston and Europe.

A Premier Professional Services Advisory Firm Thought Leaders Since 2006

Ravi KumarPartner

Ravi.Kumar@connorgp.com

Ravi is a Partner in Connor Group’s Technical Accounting and IPO Services practice providing technical accounting assistance on complex, structured transactions and helping clients achieve IPO readiness. Ravi has extensive experience in working with complex debt and equity transactions, consolidations, business combinations, leasing, revenue recognition (including ASC 606/IFRS 15), and public private partnerships (PPPs) under both US GAAP and IFRS.

Prior to joining Connor Group, Ravi was a Senior Manager in Ernst & Young’s Financial Accounting Advisory Services practice. Ravi’s career background includes cross-functional and multi-national Big-4 experience consisting of on-call technical accounting advice, new accounting standards implementation assistance, preparation of gap assessments between financial statements prepared under US GAAP and IFRS, financial due diligence for mergers and acquisitions, IPO readiness and financial statement and integrated audits for private and publicly-traded companies.

Ravi is a licensed Certified Public Accountant in the state of California, a member of the AICPA, and has passed Level I of the Chartered Financial Analyst (.CFA) exam.

Connor Group professionals deliver to our global clients Technical Accounting, IPO support, Mergers and Acquisitions, and Financial Operations services from our bases in Silicon Valley, San Francisco,New York, Salt Lake City, Boston and Europe.

A Premier Professional Services Advisory Firm Thought Leaders Since 2006

Caroline YanManager

Caroline.Yan@connorgp.comLinkedin.com/in/carolineyan

Caroline is a Manager in Connor Technical Accounting Interpretations(professional practice). During her time at Connor Group, she hasworked on engagements such as IPO readiness, S-1 filings, andvarious accounting assessments in complex transactions. She hasdeveloped in-depth technical knowledge of revenue recognition,stock-based compensation, financing transactions, embeddedderivatives, and variable interest entities.

Prior to joining Connor Group, Caroline worked forPricewaterhouseCoopers with client engagements acrosssemiconductor, software and internet, medical device and startupcompanies. Caroline is a Certified Public Accountant (California) andhas also passed CFA Level I. She has a Master of Accountancy fromWashington University in Saint Louis (Missouri) and Master ofScience in Business Administration from Erasmus UniversityRotterdam (Netherlands).