I have a client who sells licences for a hosted service. The current licences are 1-year, 3-year or Lifetime. During the time of your licence you have online access to the service and can download any updates or fixes. You cannot download the licence and use it as a standalone product.
Up until recently we have always recognised the income immediately in the P&L regardless of the length of the licence. The costs associated with providing the service are minimal 1% per year of cost but a lot of expense goes into R&D and improving the product. The T&Cs state that the licence can be cancelled at any time and there is no obligation to continue the service for a specific number of years.
I am now questioning this approach and wondering if the P&L should be restated to show the revenue spread across the length of the license rather than immediately. And if that is the case how do you spread a lifetime licence?
Should I be creating a deferred income account on the balance sheet?
Any advice would be greatly appreciated. Thank you
Replies (5)
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IFRS, FRS 102 or 105?
The income recognition standards in the UK are beginning to diverge again as a consequence of IFRS 15
FRS 102
I've been reading up on IFRS 15 but I'm honestly just going round in circles.
Well, that's just confusing! I wouldn't worry about IFRS 15 it's not going to affect FRS 102 for at least 3 - 5 years depending on how quickly the FRC get round to recommending it as the next update, which potentially would bring in IFRS 16 too!
Extract from FRS 102
"When the selling price of a product includes an identifiable amount for subsequent servicing (eg after sales support and product enhancement on the sale of software), the seller defers that amount and recognises it as revenue over the period during which the service is performed. The amount deferred is that which will cover the expected costs of the services under the agreement, together with a reasonable profit on those services."
On this basis you would defer some of the income as you deem appropriate. The tricky issue will be the open ended licences and this will form part of the disclosures required in your revenue recognition and estimates disclosure policies. If it were me, I'd want to know from my client the churn rate of customers.
Evaluate the life licences a bit like companies provide for warranty claims on duff products, look at past history (if you have past history) and evaluate some metric to apply, each year revisit with updated information re average use years of the extended service (evaluate drop out rates) to hone your model.