Vendor A provides a customer with access to its SaaS platform for three years, for a total fee of C90,000. The customer can terminate the contract for convenience with 30 days notice and is only required to pay for the period over which the customer received services.

What is the contract term for purposes of applying the revenue standard?

Because revenue from a SaaS arrangement is generally recognised over the contract term, the recognition of revenue might not be impacted by a termination right. The contract between vendor A and the customer would be treated as a month-to-month service contract despite the three-year stated term. The parties do not have enforceable rights and obligations beyond the 30-day notice period. From a revenue recognition perspective, if the vendor determines that straight-line revenue recognition is appropriate, it would recognise C2,500 (C90,000/36 months) per month regardless of whether the contract term is one month or three years.

There are certain scenarios where the contract term determination could impact revenue recognition for a SaaS arrangement. For example, if the contract has other performance obligations in addition to the SaaS, only the non-cancellable SaaS term and related fee (that is, C2,500 for one month of SaaS) should be included when allocating the transaction price to the performance obligations.

Additionally, if the price of the SaaS increases over the stated term, the transaction price is limited to the fee for the non-cancellable SaaS term. In contrast, if the price of the SaaS decreases over the stated term, the vendor should assess whether the future discounts provide the customer with a material right.

Customer termination rights might impact an entity's required disclosures. Paragraph 120 of IFRS 15 requires disclosure of information about the transaction price allocated to remaining performance obligations. This disclosure should only include the non-cancellable term of the SaaS. In this example, vendor A would include C2,500 in the disclosure required by IFRS 15 paragraph 120 for the SaaS arrangement. This is because it is a month-to-month contract with a 30-day notice period (that is, at year end if no notice has been given, the non-cancellable term is 30 days) even though the stated term is three years.

A SaaS vendor enters into a three-year non-cancellable SaaS contract for C900,000 per year. At the end of the second year, the parties agree to modify the contract to: 1) extend the service contract for an additional year and 2) lower the price to a “blended” rate of C850,000 per year for the remaining two years.

How should the SaaS vendor account for the modification?

The parties in a SaaS arrangement agree to modify a contract prior to the end of the initial contract term to
1) extend the contract term and 2) revise the contract pricing for the remaining term (that is, a ‘blend-and-extend’ modification). Generally, in a ‘blend-and-extend’ modification, the customer immediately takes advantage of a lower price.

A promise to provide access to SaaS is typically a series of distinct goods or services accounted for as a single performance obligation. This is because each distinct period is substantially the same, and has the same pattern of transfer to the customer. An entity will account for a contract modification prospectively, because the remaining goods and services to be provided in the future are distinct, even if the series of distinct goods or services is accounted for as a single performance obligation. The accounting of such a modification depends on whether the additional consideration reflects the SSP of the additional services added to the contract. Therefore, the modification of a SaaS arrangement is generally accounted for as either (a) a separate contract in accordance with IFRS 15 paragraph 20, if the additional services are priced at SSP; or (b) as if it were the termination of the existing contract and the creation of a new contract in accordance with IFRS 15 paragraph 21(a), if the additional services are not priced at SSP.

In this example, the SaaS vendor agreed to add distinct services for additional consideration that reflects C800,000 for year 4 (C850,000 for the extension term, less C50,000 decrease in price for the original remaining term).

If C800,000 for the additional year of services reflects the current SSP, the SaaS vendor would account for the modification as a separate contract. In this case, the SaaS vendor would continue to recognise revenue of C900,000 in the third year of the original contract and recognise C800,000 in the fourth year. This would result in a contract asset balance built up over the third year, which will unwind over the fourth year.

If C800,000 for the additional year of services does not reflect the current SSP, the SaaS vendor would account for the modification as the termination of the existing contract and creation of a new contract. In this case, the SaaS vendor would recognise revenue based on the blended price (C850,000 per year) for the third and fourth years.

Entity A sells a three-year term software licence with a term from 1 January 20X1 to 31 December 20X3 for C3m. This is assessed to be a ‘right to use’ licence, and so control of the licence transfers at a point in time. Entity A recognises C3m of revenue on 1 January 20X1, which is the beginning of the period during which the customer is able to use and benefit from the licence.

Entity A and the customer agree to renew the licence for an additional year on 1 December 20X3 for C1m. The renewal is irrevocable and is priced at a stand-alone selling price.

How should entity A recognise revenue for the renewal?

Paragraph B61 of IFRS 15 states that revenue cannot be recognised for a licence that provides a right to use the entity’s intellectual property before the beginning of the period during which the customer is able to use and benefit from the licence. However, there is no specific guidance on licence renewals. Entities will need to assess whether a renewal or extension agreed to after the initial licence is transferred should be accounted for as a new licence or a change in the attributes of an existing licence. This assessment might result in recognition of revenue from renewals as illustrated below:

In many cases, a number of factors will need to be considered in making the assessment of whether the renewal is a new licence or a change in an attribute of an existing licence. Such factors would include whether additional functionality is added, whether that functionality is a separate performance obligation, and the pricing of the renewal.

In this simple scenario (that is, renewal at a stand-alone selling price with no additional rights), either judgement might be acceptable. However, the approach taken should be applied consistently to similar transactions.

Renewals might be structured as either (1) an amendment to the original agreement or (2) a cancellation of the original agreement and execution of a new agreement. The accounting should be based on the substance of the arrangement and not solely on the contractual form.

Entities should also consider whether a renewal right offered at the contract inception provides a material right and, therefore, a portion of the transaction price should be deferred.

ASC 606 has specific guidance on accounting for renewals that specifically requires revenue to be deferred until the renewal period begins; as a result, the accounting might be different under US GAAP.

An emerging trend in the software industry is to transition customers from on-premises software to a SaaS solution. This might be achieved by modifying an existing software agreement to revoke the rights to the on-premises licence and converting the arrangement to a SaaS. Revenue from a software licence is typically recognised at a point in time (that is, at contract inception), while revenue from a SaaS arrangement is typically recognised over time. Therefore, questions have arisen on accounting for the conversion of a point-in-time licence to a service provided over time. Often, as part of the conversion, the customer receives a ‘credit’ towards the purchase of the SaaS equal to the ‘unused’ portion of the licence term.

On 1 January 20X0, entity A enters into a three-year non-cancellable contract with its customer, for a total up-front fee of C3 million, to provide a non-exclusive on-premises data analytics software licence for 100 users. The on-premises software utilises the customer’s data stored on the cloud to provide data analysis services. The on-premises software can also utilise data stored on the customer’s premises or data stored by other vendors.

On 1 January 20X1, entity A renegotiates the contract with the customer to convert all 100 user rights of the licence to a SaaS arrangement for the remaining two-year term. The SaaS has the same functionality as the licensed software, but it would be hosted by entity A. The customer is required to forfeit the on-premises software licence. The conversion of the licence to a SaaS arrangement is irrevocable. As per the modified terms, the customer is required to pay an incremental fee of C2,000 per user licence, which is adjusted for the credit of the pro-rata portion of the ‘unused’ term-based licence.

SSPs of entity A’s individual performance obligations are as follows:

How should the renegotiation of the arrangement be accounted for?

The contract has been modified, so entity A applies the modification guidance in paragraphs 18-21 of IFRS

15. In this case, the modification in the contract adds a distinct service (that is, the SaaS service), but not at its SSP. Therefore the contract modification is accounted for as a termination of the existing contract and the creation of a new contract in accordance with paragraph 21(a) of IFRS 15. The ‘credit’ received on the cancellation of the on-premises licence is accounted for as an incentive to the customer to purchase the SaaS (that is, a discount on the SaaS purchase).

Accordingly, entity A will recognise the following:

Another option is to account for the ‘credit’ received on cancellation of the on-premises licence as a refund for the return of the licence in accordance with right-of-return guidance (that is, as variable consideration). This reflects that the customer is returning the original good/service that was provided (that is, possession or control of the on-premises software licence). Under this option, the credit is reflected as a refund and reversed against revenue.

The customer then utilises the credit, together with the incremental cash paid, as consideration for the SaaS that is provided over the remaining term.

Accordingly, entity A will recognise the following:

Entities should apply judgement when determining which approach is more appropriate, based on the facts and circumstances. For example, the latter approach would not be appropriate if either (a) the software vendor does not enforce the revocation of the on-premises licence, or (b) the cancellation of the licence does not have substance. The latter approach might also be difficult to apply in cases where the SSP of the SaaS is not readily observable

Software vendors should consider whether there is an explicit right or an implicit right to convert the software licence, based on past business practices. Where this right exists at contract inception, the entity would need to account ¹ for it as either a material right or a right of return, based on the facts and circumstance.