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How does a software company recognize revenue when providing a longer performance warranty for off-the-shelf software products?


Topic Expert
Bob Scarborough
Title: CEO
Company: Tensoft, Inc.
(CEO, Tensoft, Inc.) |

The first answer that comes to mind is probably the one you have already heard – which is it depends. That isn’t the most helpful answer – so I’ll try to outline some of the drivers which will impact the answer.

1) The warranty definition matters – and possibly more importantly the warranty remedies matter. If your remedy is a full refund for the warranty period that is more significant than a prorated warranty based on time deployed. If the period is 6 months instead of 3 months and the impact of the warranty outstanding at any point in time is not material that will have an impact as well.
2) Your demonstrated history matters as well. If you are in a high volume market with a history to demonstrate the likelihood of warranty claims you may be able to get your auditors to support an allowance rather than a full postponement of the revenue.
3) The size of each transaction matters. If you are selling multi-million dollar products where each has a significant impact on your revenue then you are unlikely to have any flexibility on warranty other than postponing revenue until the warranty period is completed. If you are selling high volume low dollar transactions you can probably negotiate something different – especially if you can support this by historical analysis.
4) Beyond the above you get into the compliance cross over questions. For example, are your sales subject to SOP 81.1 where your software revenue is handled as a percent complete? Or do you have a SOP 97.2 or EITF 08-01 impact on the fair value of the software? These would be integrated into your overall question. At times the use of a contingency value associated with the transaction (instead of an allowance) better supports the overall requirement.

My suggestion is to prepare your case – or at least understand the drivers that will impact you – and then approach your auditors ahead of time. Try to get an opinion on this before your audit to prevent a management surprise as well as to streamline your audit (preventing restatement).

Topic Expert
Joan Varrone
Title: CFO
Company: Cloud Cruiser
LinkedIn Profile
(CFO, Cloud Cruiser) |

As CFO of an enterprise software company we had a warranty provision but limited its impact by

1) Indicating that we are just warranting performance in our documentation
2) Limiting the warrantly period
3) Having a remedy that we will provide a work around
4) The claim needs to be made within the warranty period
5) No claim if the software is not used with the recommended hardware or has been modified.

Topic Expert
Doug Thompson
Title: Director of Revenue
Company: Castlight Health
(Director of Revenue, Castlight Health) |

Our contracts warrant that the software substantially conforms to the product documentation and is virus-free -- that's it. If either of these is not true, then the recourse is that we fix the software. Only if we are unable to do fix it would the customer get a refund. As this has never occurred over several years, we do not have to defer revenue even if the customer negotiates an extended period for the warranty.

This is for large-scale enterprise software.


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