Based on the June 6, 2012, OBA Session with the same title featuring keynote speakers Joyce Lam (Deloitte) and Wendy Gross (Osler).

A common and often misunderstood point of conflict in negotiating technology and software licensing agreements is revenue recognition. Often, commonly sought contractual protections for customers or licensees can lead to objections from suppliers or licensors based on their ability to recognize revenue from the transaction. At times there may be a real risk, but frequently misunderstandings about revenue recognition can cause a molehill of an issue to become a mountain of a roadblock to finalizing the deal.

This blog post summarises some of the key points arising out of the OBA Technology and E-Commerce session on revenue recognition in technology contracting and software licensing held on June 6, 2012. A recording of the session is available.

Principles of Revenue Recognition

The overriding principle in revenue recognition is that revenue is recognized when it is realized (or realizable) and when it is earned. What follows is a table prepared by Joyce Lam that identifies the high-level criteria used under US GAAP and IFRS to make this determination:

Click here to view table.

Key Observation for Technology Contracting and Software Licensing

The key observation about the principles of revenue recognition for purposes of negotiating technology and software licensing agreements is that absolute certainty is not required. Suppliers and licensors are able to recognize revenue based on their reasonable expectations. For example, where a customer or licensee requests warranty protections or a right to receive a refund in limited, defined circumstances (e.g., software fails to meet specified acceptance criteria) the supplier or licensor can use its reasonable expectation (e.g., based on its track record with the same or similar software) to recognize the bulk of the revenue.

Often times it is a lack of understanding regarding this point that causes revenue recognition to be a red herring in technology and software licensing negotiations. If a supplier doesn’t have a reasonable expectation that it can achieve a warranty obligation or meet specified acceptance criteria, negotiations should focus on the warranty obligation or acceptance criteria rather than on whether or not the supplier will be able to recognize revenue.

Revenue recognition can be a complex and difficult issue, but a little knowledge about how it works can help you avoid having it sidetrack or stall technology and software licensing negotiations.