IFRS 15 adopted, software, cloud, computing, policies and judgements, cumulative adjustment approach , effect on current period

SAP SE – Half year report – 30 June 2018

Industry: software

(3) Summary of Significant Accounting Policies (extract)

(3a) New Accounting Standards Adopted in the Current Period (extract)

As of January 1, 2018, SAP changed several of its accounting policies to adopt IFRS 15 ‘Revenue from Contracts with Customers’ and IFRS 9 ‘Financial Instruments’.

IFRS 15 ‘Revenue from Contracts with Customers’

Classes of Revenue

We derive our revenue from fees charged to our customers for (a) the use of our hosted cloud offerings, (b) licenses to our on-premise software products, and (c) standardized and premium support services, consulting, customer-specific software development agreements, training, and other services.

Cloud and software revenue, as presented in our Consolidated Income Statements, is the sum of our cloud subscriptions and support revenue, our software licenses revenue, and our software support revenue.

  • Revenue from cloud subscriptions and support represents fees earned from providing customers with any of the following:
    • Software as a Service (SaaS), that is, a right to use software functionality (including standard functionalities and customer-specific developed cloud applications and extensions) in a cloud-based infrastructure hosted by SAP or third parties engaged by SAP, where the customer does not have the right to terminate the hosting contract and take possession of the software to either run it on the customer’s own IT infrastructure or to engage a third-party provider unrelated to SAP for hosting and managing the software; the item also includes transaction and agent fees for transactions that customers of our network-business execute on our cloud-based transaction platforms
    • Platform as a Service (PaaS), that is, access to a cloud-based infrastructure to develop, run, and manage applications
    • Infrastructure as a Service (IaaS), that is, hosting and related application management services for software hosted by SAP or third parties engaged by SAP, where the customer has the right to take possession of the software
    • Additional premium cloud subscription support beyond the regular support that is embedded in the basic cloud subscription fees.
  • Software licenses revenue represents fees earned from the sale or license of software to customers for use on the customer’s premises, in other words, where the customer has the right to take possession of the software for installation on the customer’s premises or on hardware of third-party hosting providers unrelated to SAP (on-premise software). Software licenses revenue includes revenue from both the sale of our standard software products and customer-specific on-premise-software development agreements.
  • Software support revenue represents fees earned from providing customers with standardized support services which comprise unspecified future software updates, upgrades, and enhancements as well as technical product support services for on-premise software products.

Services revenue primarily represents fees earned from professional consulting services, premium support services, training services, messaging services, and payment services in connection with our travel and expense management offerings.

Policies and Judgment

Identification of Contract

We frequently enter into multiple contracts with the same customer that we treat, for accounting purposes, as one contract if the contracts are entered into at or near the same time and are economically interrelated. We do not combine contracts with closing days more than three months apart because we do not consider them being entered into near the same time. Judgment is required in evaluating whether two or more contracts are interrelated, which includes considerations as to whether they were negotiated as a package with a single commercial objective, whether the amount of consideration on one contract is dependent on the performance of the other contract, or if some or all goods in the contracts are a single performance obligation.

New arrangements with existing customers can be either a new contract or the modification of prior contracts with the customer. Our respective judgment in making this determination considers whether there is a connection between the new arrangement and the pre-existing contracts, whether the goods and services under the new arrangement are highly interrelated with the goods and services sold under prior contracts, and how the goods and services under the new arrangement are priced. In determining whether a change in transaction price represents a contract modification or a change in variable consideration, we examine whether the change in price results from changing the contract or from applying unchanged existing contract provisions.

Identification of Performance Obligations

Our customer contracts often include various products and services. Typically, the products and services outlined in the “Classes of Revenue” section qualify as separate performance obligations and the portion of the contractual fee allocated to them is recognized separately. Judgement is required, however, in determining whether a good or service is considered a separate performance obligation. In particular for our professional services and implementation activities, judgement is required to evaluate if such services significantly integrate, customize, or modify the on-premise software or cloud service to which they relate. In this context we consider the nature of the services and their volume relative to the volume of the on-premise software or cloud service to which they relate. In general, the implementation services for our cloud services go beyond pure setup activities and qualify as separate performance obligations. Similarly, our on-premise implementation services and our custom development services typically qualify as separate performance obligations. Non-distinct goods and services are combined into one distinct bundle of goods and services (combined performance obligation).

When selling goods or services, we frequently grant customers options to acquire additional goods or services (for example, renewals of renewable offerings, or additional volumes of purchased software). We apply judgment in determining whether such options provide a material right to the customer that it would not receive without entering into that contract (material right options). In this judgment, we consider whether the options entitle the customer to a discount that exceeds the discount granted for the respective goods or services sold together with the option.

Determination of Transaction Price

We apply judgement in determining the amount to which we expect to be entitled in exchange for transferring promised goods or services to a customer. This includes estimates as to whether and to what extent subsequent concessions or payments may be granted to customers and whether the customer is expected to pay the contractual fees. In this judgment, we consider our history both with the respective customer and more broadly.

Our typical cloud services do not provide the customer with a software license because the customer does not have the right to terminate the hosting contract and take possession of the software. Consequently, cloud fees that are based on transaction volumes are considered in the transaction price based on estimates rather than being accounted for as sales-based license royalties.

Only very rarely do our contracts include significant financing components. We do not account for financing components if the period between when SAP transfers the promised goods or services to the customer and when the customer pays for those goods or services is one year or less.

Allocation of Transaction Price

We have established a hierarchy to identify the standalone selling prices (SSPs) that we use to allocate the transaction price of a customer contract to the performance obligations in the contract.

  • Where standalone selling prices for an offering are observable and reasonably consistent across customers (that is, not highly variable), our SSP estimates are derived from our respective pricing history. Typically, our standardized support offerings and our professional service offerings follow this approach.
  • Where sales prices for an offering are not directly observable or highly variable across customers, we use estimation techniques. For renewable offerings with highly variable pricing, these techniques consider the individual contract’s expected renewal price as far as this price is substantive. Typically, our cloud subscription offerings follow this approach. For non-renewable offerings, these estimations follow a cost-plus-margin approach.
  • For offerings that lack renewals and have highly variable pricing, we allocate the transaction price by applying a residual approach. We use this technique in particular for our standard on-premise software offerings.

Judgment is required when estimating SSPs. To judge whether the historical pricing of our goods and services is highly variable, we have established thresholds of pricing variability. In judging whether contractual renewal prices are substantive, we have established floor prices that we use as SSPs whenever the contractual renewal prices are below these floor prices. In judging whether contracts are expected to renew at their contractual renewal prices, we rely on our respective renewal history. The SSPs of material right options depend on the probability of option exercise. In estimating these probabilities, we apply judgment considering historical exercise patterns.

We review the stand-alone selling prices periodically or whenever facts and circumstances change to ensure the most objective input parameters available are used.

Recognition of Revenue

Cloud subscriptions and support revenue is recognized over time as the services are performed. Where our performance obligation is the grant of a right to continuously access and use a cloud offering for a certain term, revenue is recognized based on time elapsed and thus ratably over this term.

Software revenue is recognized at a point in time or over time depending on whether we deliver standard software or customer-specific software:

  • Licenses of our standard on-premise software products are typically delivered by providing the customer with access to download the software, and the license period starts upon such grant of access. We recognize revenue for such on premise licenses at the point in time when the customer has access to and thus control over the software. In judging that our on-premise software offerings grant the customers a right to use rather than a right to access our intellectual property, we have considered the usefulness of our software without subsequent updates.
  • Our customer-specific on-premise-software development agreements typically
    • Are for software developed for specific needs of individual customers and thus the developed software does not have an alternative use to us, and
    • Provide us with an enforceable right to payment for performance completed to date

For such development agreements, we recognize revenue over time as the software development progresses. Judgment is required in identifying an appropriate method to measure the progress towards complete satisfaction of such performance obligations. We typically measure progress of our development agreements based on the direct costs incurred to date in developing the software as a percentage of the total reasonably estimated direct costs to fully complete the development work. This method of measuring progress faithfully depicts the transfer of the development services to the customer, as substantially all of these costs are cost of the staff or third parties performing the development work. In estimating the total cost to fully complete the development work, we consider our history with similar projects.

Support revenue is typically recognized based on time elapsed and thus ratably over the term of the support arrangement. Under our standardized support services, our performance obligation is to stand ready to provide technical product support and unspecified updates, upgrades, and enhancements on a when-and-if-available basis. Our customers simultaneously receive and consume the benefits of these support services as we perform.

Service revenue is typically recognized over time. Where we stand ready to provide the service (such as access to learning content), we recognize revenue based on time elapsed and thus ratably over the service period. Consumption-based services (such as separately identifiable consulting services and premium support services, messaging services, and class room training services) are recognized over time when the services are utilized, typically based on a percentage of completion-based method or ratably. When using the percentage-of-completion method, we typically measure the progress towards complete satisfaction in the same way and with the same reasoning and judgment as we do for customer-specific on-premise-software development agreements. We apply judgment in determining whether a service qualifies as a stand-ready service or as a consumption-based service.

Revenue for combined performance obligations is recognized over the longest period of all promises in the combined performance obligation.

Judgement is also required to determine whether revenue is to be recognized at a point in time or over time. For performance obligations satisfied over time, we need to measure the progress using the method that best reflects SAP’s performance. When using cost incurred as a measure of progress for recognizing revenue over time, we apply judgement in estimating the total cost to satisfy the performance obligation.

All of the above mentioned judgments and estimates can significantly impact the timing and amount of revenue to be recognized.

Contract Balances

We recognize receivables for performance obligations satisfied over time gradually as the performance obligation is satisfied and in full once the invoice is due. Judgement is required in determining whether a right to consideration is unconditional and thus qualifies as a receivable. Contract liabilities primarily reflect invoices due or payments received in advance of revenue recognition. They are recognized as revenue upon transfer of control to the customers of the promised goods and services.

Typically, we invoice fees for on-premise standard software upon contract closure and software delivery. Periodic fixed fees for cloud subscription services, software support services, and other multi-period agreements are typically invoiced yearly or quarterly in advance. Such fee prepayments account for the majority of our contract liability balance. Fees based on actual transaction volumes for cloud subscriptions and fees charged for non-periodical services are invoiced as the services are delivered. While payment terms and conditions vary by contract type and region, our terms typically include a requirement of payment within 30 to 60 days.

Incremental Costs of Obtaining Customer Contracts

The assets we recognize for the incremental costs of obtaining a customer contract primarily consist of sales commissions earned by our sales force. Typically, we either do not pay sales commissions for customer contract renewals or such commissions are not commensurate with the commissions paid for new contracts. Consequently, we amortize sales commissions paid for new contracts on a straight-line basis over the expected contract life including probable contract renewals. Judgement is required in estimating the contract lives. In this judgement, we consider our respective renewal history adjusted for indications that the renewal history is not fully indicative for future renewals. The amortization periods range from two to eight years depending on the type of the offering. Amortization of capitalized costs of obtaining customer contracts is included in sales and marketing expense.

We expense incremental costs of obtaining a customer contract as incurred if we expect an amortization period of one year or less.

Costs to Fulfill Customer Contracts

Capitalized costs incurred to fulfill customer contracts mainly consist of direct costs for customer-specific cloud development contracts that are not in scope of other IFRSs. These costs are amortized after completion of the development on a straight-line basis over the expected life of the cloud subscription contract including expected renewals. Judgment is required in evaluating whether costs are direct or indirect and in estimating the contract lives. Based on our respective history, the amortization period is typically six years.

Amortization of capitalized costs to fulfill customer-specific developed cloud applications and extensions contracts is included in cost of cloud subscription and support.

Adoption of IFRS 15

Under the IFRS 15 adoption method chosen by SAP, prior years (including the prior-period numbers presented in the primary financial statements in this half-year report) are not restated to conform to the new policies.

The impact of the policy change1 in the first half of 2018 was as follows:

  • Software licenses and support revenues experienced a benefit of €23 million, with most of the difference resulting from exercises of customer software purchase options granted in prior years which result in software revenue.
  • Operating expenses benefitted, in cost of sales and marketing, in the amount of €83 million from higher capitalization of sales commissions net of higher amortization of amounts capitalized.
  • The abovementioned effects together with other insignificant effects resulted in a net positive impact on operating profit of approximately €98 million.
  • As at June 30, 2018, balance sheet items are affected by the application of IFRS 15 as compared to our pre-IFRS 15 accounting policies as follows:
    • Non-current and current other non-financial assets were higher by €203 million and €40 million, respectively (January 1, 2018: higher by €132 million and €26 million, respectively) due to the higher capitalization of sales commissions.
    • Trade and other receivables and contract liabilities were lower by €768 million and €684 million, respectively (January 1, 2018: higher by €560 million and €648 million, respectively), resulting from changes in the timing of and amounts recognized as contract balances.
    • Provisions were lower by €17 million (January 1, 2018: lower by €25 million), reflecting lower provisions for onerous customer contracts.
    • Intangible Assets were higher by €22 million (January 1, 2018: higher by €14 million), due to capitalization of costs for certain customer-specific on-premise software development arrangements.

Please also refer to Note (3e) of our Integrated Report 2017 for further qualitative explanations of the changes in accounting policies as a result of the adoption of IFRS 15.