Mind the GAAP! Cloud accounting is all about matching revenue and costs to consumption…well, except for professional services!

Cloud computing is fairly different from traditional enterprise software and, unfortunately, the accounting here confirms the rule. After seeing our portfolio wrestling with GAAP accounting practices and seeing public companies like Taleo restating their financials because of their alleged aggressive stance on revenue recognition, we thought this issue earned the right to be included in the “10 Laws.” If you are a Cloud Computing CEO or CFO – even if you do not take the London tube every morning – we recommend that you “Mind the GAAP”! Before digging into some of these issues, we need to highlight that this paragraph is just scratching the surface and is not meant to replace the counsel of a certified professional.

Typically, Cloud Computing revenue is composed of two elements: subscription services and professional services, including implementation and training. Let’s tackle first the subscription revenue. In the old days of Enterprise software, the license revenue could be recognized when the CD was shipped, as software was comparable to a product – like any box you can buy at Fry’s. This was easy and intuitive as the revenue recognition was generally aligned with the cash collection. For a recurring revenue model however, the world is more complex. Even if the cash is collected upfront, the revenue needs to be recognized ratably over the lifetime of the contract. In addition, the revenue recognition cannot start before the service goes live, to ensure that revenue will match consumption. So, if you sell a product today, bill the customer upfront for one year with net 45 days, but need 60 days to implement the service and go live, you will have collected one year of cash, but won’t be able to recognize any of it before the 61st day. This explains why the GAAP revenue lags the CMRR as we have discussed earlier in law #2.

Now, let’s look at the professional services side. Initially, some companies, using the rules of Enterprise software, opted to recognize professional services as they were delivered. For example, if a customer paid $100k of professional services to get the subscription service going over a period of two months, the company would recognize the $100k ratably over these two months. Unfortunately, things are not that simple and this is (partially) why Taleo had to restate its financials. According to G