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Program your future: Four considerations for sound financial planning

July 31, 2015 Article 3 min read
John O'Connor

Executives in fast growing organizations are challenged to keep up with growth as they guide their organizations into the future. A key foundational element for any successful organization is a sound accounting strategy.

In the technology industry, rules and regulations are often complicated, so it’s imperative to develop procedures that consider these common issues:

  • Accrual vs. cash-based accounting
  • Sales commissions
  • Capitalization of software development costs
  • Revenue recognition

Accrual vs. cash — Choosing an accounting method

Most new businesses choose to keep their books initially on a cash basis method of accounting, rather than accrual. The former is generally easier to track and understand. Such a method is tied to cash flow without regard to accounts receivable and accounts payable. It generally provides a greater opportunity to time revenue and expenses in comparison to the accrual method.

The accrual method offers a more precise view of long-term financial health, but you must report income when earned, even if you haven’t yet collected the cash. Expenses are reported when incurred, even when cash isn’t paid.

For tax purposes, a great deal of new companies elect to be on a cash basis for tax reporting purposes. This can provide for greater deferral of income. However, if you have deferred income and it becomes significant, it usually makes sense to switch to the accrual method.

Sales commissions

Other important accounting decisions are structuring sales commissions and determining your company’s accounting policies with respect to commissions. Do you follow the same commission structure for your entire sales team, or is each commission plan handled differently? Are commissions expensed when incurred, or are they capitalized and expensed over a future period of time? Whether the commission is based on a flat-fee arrangement or a percentage of revenue, careful analysis should be performed to determine the timing of the expense recognition. Additionally, commission payments should be tracked alongside the expenses to ensure the accrual or prepaid is accurately calculated on the balance sheet. Alternatively, with cash basis accounting, the commission would be expensed when it is paid out to the staff member.

Capitalization of software development costs

Companies that develop software that is to be sold, leased, or licensed are required to capitalize costs incurred once the software reaches technological feasibility. Technological feasibility means you’re certain the software will work, and costs incurred are determined recoverable.

Because this determination is a qualitative assessment, be prepared to fully support your point with thorough records. Once the software product goes to market, capitalization ends and costs are once again expensed.

A large percentage of technology companies today are developing software platforms marketed as Software as a Service (SaaS). The capitalization of SaaS falls under a different set of accounting guidelines known as Internal Use Software (IUS). Capitalization of (IUS) begins when the preliminary project stage is completed and management, with the relevant authority, implicitly or explicitly authorizes and commits to funding a computer software project and it is probable that the project will be completed and the software will be used to perform the function intended. Similarly to external use software, capitalization shall cease when the software project is substantially complete and ready for its intended use.

New revenue recognition standards — What do you need to know?

In 2014, the FASB and International Accounting Standards Board (IASB) issued a joint new accounting standards update, Revenue from Contracts with Customers. Due to their specialized nature, technology companies are more likely to be affected by the new rules. As revenue can be the driving force behind many key management decisions, ensuring proper revenue recognition is vital. While the new guidelines don’t take effect until 2018 for public companies and 2019 for non-public companies — with a likely one-year deferral — it’s important to begin planning now, especially in light of long-term contracts. The following are a few key steps to prepare your company for the new regulations.
  • Learn the new standard, and conduct an impact analysis for your specific business activities and contracts.
    If your contracts contain multiple elements, determine if each element represents a separate performance obligation, or if a group of elements represents one performance obligation.
  • Review your current standard contract wording.
    Each contract needs to be analyzed separately under the new standard. Consistency in structure and wording across contracts will reduce time spent modifying contracts. Long-term contracts entered into now may be subject to the new accounting guidance in later years of the contract.
  • Determine and address potential business changes.
    Establish who needs training and when. Consider needed changes to accounting procedures and internal controls. Identify compensation, loan, sales, and purchase agreements that have provisions based on earnings or other financial metrics that could be affected by the proposed guidance.

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