Common trends in SEC comment letters for the cloud computing industry and the connections to ASC 606 revenue recognition disclosure requirements. This article explores revenue recognition solutions for the cloud computing industry with revenue recognition software and billing management software.
SEC comment letters and ASC 606
From July 1st of 2020 to July 1st of 2021, the U.S. Securities and Exchange Commission (SEC) uploaded a high number of filings related to ASC 606 revenue recognition disclosure requirements. While some disclosure requirements receive more attention than others, and some industries struggle more than others to remain compliant, there are several distinct key trends that emerge when looking at these SEC comment letters.
The most frequent ASC 606 topics within the SEC letters during this 12-month period are disclosures surrounding performance obligations, timing of revenue recognition, price allocation to unsatisfied performance obligations, and transaction price considerations.
Most commonly in recent letters, the SEC requested deeper explanations regarding the judgments that companies made to determine when control is transferred to the customer.
Additionally, the SEC asked many companies why the method used to determine the timing of revenue provides the most faithful depiction of the transfer of control. Methods, inputs, and estimates that companies used in measurements are among other areas that were commented on.
These patterns are pivotal in uncovering the issues that companies experienced with providing proper disclosures. For service providers looking to adopt the new standard, the letters serve to highlight the areas that entities within the cloud computing industry need to focus more attention on, to avoid facing similar circumstances.
ASC 606 compliance for cloud computing companies
The cloud computing industry in particular, has been significantly affected by the standard’s disclosure requirements. This includes the requirement for disclosures related to significant judgments and performance obligations, and disclosures commonly referred to as “backlog disclosures”.
The cloud computing industry relies upon several unique kinds of arrangements, many of which can require the use of significant judgments and estimates. Such challenges lead to particular difficulties that create greater opportunities for errors to be flagged by the SEC.
Cloud computing arrangements also often contain multiple deliverables, such as activation or setup fees, a software license, a hosting service, future upgrades, technical support, and customization costs. In order to adequately recognize revenue over the duration of a contract, it is important to identify each individual deliverable in a given contract.
Companies are required to disclose the nature and timing of the different aspects of performance obligations. Typically, when the SEC asked about the nature and timing of performance obligations, it was because companies failed to clearly explain the obligations to financial statement users.
Improper timing of revenue recognition is the most common type of accounting fraud the SEC has acted against under its whistleblower program.
To minimize the chances of being on the receiving end of an SEC comment letter, service providers looking to adopt the new standard will need to revisit, and in some cases revamp, their revenue recognition practices and processes to comply with the new guidance.
Failing to be ASC 606 compliant
While failing to be ASC 606 compliant comes with huge risks and consequences, remaining compliant is no easy feat without the tools in place to support the requirements. The process is akin to a long and painful school assignment. Not only are you required to show your work, but you have to go in-depth and explain your work in its entirety, including the approach that was chosen, why it was chosen, what assumptions were made, and what tools were used.
Without a system in place to utilize the tools needed to provide the necessary information to the SEC, there is a greater likelihood of inaccurately recognizing and reporting revenue generated from customer contracts. In these cases, the inevitable comment letter from the SEC can turn into a much larger issue and carry the potential to lead to situations that are impossible to bounce back from.
Damaged reputations, hefty fines, and criminal charges are some of the consequences companies have faced in recent years following restatements of their earnings.
In a case involving a technology company, the company was charged with “pulling in sales from future quarters to close the gap between actual and forecasted revenue. The pull-ins amounted to as much as 16% of the company's total quarterly revenues, according to the SEC. The company settled for $5.5 million.” Read more information regarding this case and more in an article by the CFO Dive.
Security with automation
Aside from the worst-case scenarios, for those who manage their revenue recognition on spreadsheets, responding to the SEC with the information they require is a challenge, guaranteed to eat up time, effort, and money.
With automated billing and revenue recognition processes in place, the pain points that companies have faced since the adoption of ASC 606 are avoided. Not only are companies able to respond to the comment letters with readily available information and reports, but the odds of receiving a comment letter in the first place are greatly reduced.
To review the letters, visit the SEC website.
To lower your risk of receiving a comment letter from the SEC and to learn more about SOFTRAX and the services that we provide to accomplish this, connect with a dedicated SOFTRAX representative.
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