Subscription accounting

Ok, now for some boring accounting stuff. Red Hat (RHAT) recently restated its financials. Its auditor, PWC, suggested that it change its revenue recognition policy. According to a CBS Marketwatch article:

Under the accounting method used in the past, the company would recognize a full month’s revenue from a subscription agreement, even if a deal was sealed in the middle of the month, for example.

The effect of the accounting change is to defer a portion of the revenue that had previously been recorded during the month that the subscription started to the end of the contract.

So what it comes down to is a timing issue. In the example above, a full month of revenue gets recognized even only if the customer signed in the middle of the month. I don’t really think that this in and of itself caused such a huge selloff in the company. One could argue that the company is overvalued at a $2.8 billion market cap and a 20.5 TTM revenue multiple.

Anyway, I checked around with my portfolio companies which sell hosted software and it seems that we are taking a conservative approach by recognizing a set up fee in the month that we sign a deal and do the work and then begin recognizing the subscription revenue the following month. Anyway, while a boring and mundane issue, I believe this will impact a number of other companies in terms of revenue recognition. My general rule of thumb is to always have portfolio companies prepare for success – this also includes making sure our accounting is conservative and inline with best practices.

Published by Ed Sim

founder boldstart ventures, over 20 years experience seeding and leading first rounds in enterprise startups, @boldstartvc, Saas 2.0, googlization of IT, security, smart data; cherish family time + enjoy lacrosse + hockey