ASC 985-605: Software Licensing Revenue Recognition Journal Entries

ASC 985-605: Software Licensing Revenue Recognition Journal Entries

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In today's digital era, software products are an integral part of many businesses and consumer applications. The Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 985-605, "Software - Revenue Recognition," provides guidance on the accounting for revenue from software licensing arrangements. This article will explore the guidelines for recognizing software licensing revenue under ASC 985-605 and provide examples of journal entries to illustrate the accounting process for software companies.

 

ASC 985-605 Overview

ASC 985-605 provides guidance on when and how to recognize revenue from software licensing arrangements. The primary objective of ASC 985-605 is to ensure consistent and transparent financial reporting for software companies. The standard stipulates that revenue from software licensing arrangements should be recognized when the following four criteria are met:

 

  1. Persuasive evidence of an arrangement exists.

  2. Delivery of the software product has occurred.

  3. The fee is fixed or determinable.

  4. Collection of the fee is probable.

 

Journal Entries for Software Licensing Transactions

To illustrate the accounting process for software licensing revenue under ASC 985-605, let's consider a hypothetical software company, XYZ Software, that enters into a software licensing arrangement for $50,000.

Here's how the journal entries for this software licensing transaction would look:
 

Record the software licensing arrangement

        Dr. Accounts Receivable $50,000

        Cr. Unearned Revenue $50,000

At this point, XYZ Software has entered into a licensing arrangement with a customer, but the revenue recognition criteria have not yet been met.
 

Record the software delivery

Once the software is delivered to the customer and the revenue recognition criteria are met, the software licensing revenue can be recognized:

        Dr. Unearned Revenue $50,000

        Cr. Software Licensing Revenue $50,000
 

Record the cash collection

When XYZ Software collects the cash from the customer, the following journal entry is recorded:

       Dr. Cash $50,000

      Cr. Accounts Receivable $50,000
 

Expanding on the ASC 985-605 Software Licensing Transactions


In addition to the basic software licensing transaction, software companies may also encounter situations where additional performance obligations exist, such as post-contract customer support (PCS), installation services, or customization. In these cases, the total arrangement fee needs to be allocated to the different performance obligations based on their relative standalone selling prices. Revenue recognition for each obligation then follows the specific criteria for that obligation.

 

For example, let's consider a case where XYZ Software enters into a software licensing arrangement for $100,000, which includes the software license, one-year customer support, and installation services. The standalone selling prices for these components are $50,000 for the software license, $30,000 for customer support, and $20,000 for installation services.

 

Allocation of arrangement fee to performance obligations:

 

  1. Software License: $50,000 / $100,000 * $100,000 = $50,000

  2. Customer Support: $30,000 / $100,000 * $100,000 = $30,000

  3. Installation Services: $20,000 / $100,000 * $100,000 = $20,000

 

Journal Entries for this software licensing transaction would look like:

Record the software licensing arrangement:
 

Dr. Accounts Receivable $100,000

Cr. Unearned Revenue - Software License $50,000

Cr. Unearned Revenue - Customer Support $30,000

Cr. Unearned Revenue - Installation Services $20,000
 

Record the software delivery and installation:

Dr. Unearned Revenue - Software License $50,000

Cr. Software Licensing Revenue $50,000

Dr. Unearned Revenue - Installation Services $20,000

Cr. Installation Service Revenue $20,000
 

Record the cash collection:

Dr. Cash $100,000

Cr. Accounts Receivable $100,000
 

Record the customer support revenue (assuming straight-line recognition over one year):

Monthly Journal Entry:

Dr. Unearned Revenue - Customer Support $2,500

Cr. Customer Support Revenue $2,500
 

When additional performance obligations are included in a software licensing arrangement, ASC 985-605 requires the allocation of the arrangement fee to each obligation based on relative standalone selling prices. By doing so, software companies can ensure that the revenue recognition for each obligation accurately reflects the value provided to the customer. Understanding the journal entries involved in these more complex software licensing transactions is essential for software companies to maintain accurate financial records and comply with accounting standards.