Technology Spotlight A Few Bytes Away From Downloading the Converged Revenue Recognition Standard! The Bottom Line Issue 2, February 2012 In This Issue: • Background • Key Accounting Issues • Challenges for Technology Companies • Thinking Ahead • Appendix — Key Differences Between ASC 985-605 and the FASB’s and IASB’s Revised ED • On November 14, 2011, the FASB and IASB (the “boards”) jointly issued their revised exposure draft (ED) Revenue From Contracts With Customers. The revised ED proposes a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and would supersede most current revenue recognition guidance. In addition, on January 4, 2012, the FASB issued a companion proposed ASU for public comment that would codify the revised ED’s amendments. • The revised ED would supersede ASC 985-605 1 (formerly SOP 97-2 2 ) in its entirety. The elimination of the requirement for vendor-specific objective evidence (VSOE) of fair value may significantly modify the timing of revenue recognition for software entities. • Warranties that provide a service in addition to simple assurance that a product complies with agreed-upon specifications must be treated as separate performance obligations, thereby potentially delaying the recognition of a portion of revenue until the obligations are satisfied. • Under the revised ED, the determination of whether virtual goods and services are transferred at a point in time or over a period of time may significantly affect revenue recognition. • Comments on the revised ED and the FASB companion proposed ASU are due by March 13, 2012. A final revenue recognition standard is not expected to be issued until later in 2012 and would not be effective earlier than for annual periods beginning on or after January 1, 2015. The proposed revenue model requires management to use greater judgment in recognizing revenue and related costs and may change the timing of revenue recognition from current practice. 1 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.” 2 AICPA Statement of Position 97-2, Software Revenue Recognition.
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Technology SpotlightA Few Bytes Away From Downloading the Converged Revenue Recognition Standard!
The Bottom Line
Issue 2, February 2012
In This Issue:• Background• KeyAccountingIssues• ChallengesforTechnology
Companies• ThinkingAhead• Appendix—KeyDifferences
BetweenASC985-605andtheFASB’sandIASB’sRevisedED
• OnNovember14,2011,theFASBandIASB(the“boards”)jointlyissuedtheirrevisedexposuredraft(ED)RevenueFromContractsWithCustomers.TherevisedEDproposesasinglecomprehensivemodelforentitiestouseinaccountingforrevenuearisingfromcontractswithcustomersandwouldsupersedemostcurrentrevenuerecognitionguidance.Inaddition,onJanuary4,2012,theFASBissuedacompanionproposedASUforpubliccommentthatwouldcodifytherevisedED’samendments.
• TherevisedEDwouldsupersedeASC985-6051(formerlySOP97-22)initsentirety.Theeliminationoftherequirementforvendor-specificobjectiveevidence(VSOE)offairvaluemaysignificantlymodifythetimingofrevenuerecognitionforsoftwareentities.
• Warrantiesthatprovideaserviceinadditiontosimpleassurancethataproductcomplieswithagreed-uponspecificationsmustbetreatedasseparateperformanceobligations,therebypotentiallydelayingtherecognitionofaportionofrevenueuntiltheobligationsaresatisfied.
• UndertherevisedED,thedeterminationofwhethervirtualgoodsandservicesaretransferredatapointintimeoroveraperiodoftimemaysignificantlyaffectrevenuerecognition.
• CommentsontherevisedEDandtheFASBcompanionproposedASUareduebyMarch13,2012.Afinalrevenuerecognitionstandardisnotexpectedtobeissueduntillaterin2012andwouldnotbeeffectiveearlierthanforannualperiodsbeginningonorafterJanuary1,2015.
The proposed revenue model requires management to use greater judgment in recognizing revenue and related costs and may change the timing of revenue recognition from current practice.
1 FortitlesofFASBAccountingStandardsCodification(ASC)references,seeDeloitte’s“TitlesofTopicsandSubtopicsinthe
FASBAccountingStandardsCodification.”2 AICPAStatementofPosition97-2,SoftwareRevenueRecognition.
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ThisTechnologySpotlighthighlightstheframeworkoftheproposedrevenuerecognitionmodelandthepotentialimplicationsfortechnologycompanies.
BackgroundTherevisedEDstatesthatthegoaloftheboards’revenuerecognitionproject,whichbeganin2002,isto“clarifytheprinciplesforrecognizingrevenueandtodevelopacommonrevenuestandardforU.S.GAAPandIFRSs.”Afterreceivingnearly1,000commentlettersandredeliberatingalmosteveryaspectoftheirJune2010ED,theboardsmodifiedtheproposedguidanceanddevelopedtherevisedED(changesfromtheJune2010EDarediscussedindetailinDeloitte’sNovember15,2011,HeadsUp).TherevisedEDretainedtheoverallmodelthatwasoriginallyproposed,whichoutlinedfivesequentialstepstorecognizingrevenue:
1. “Identifythecontractwithacustomer.”
2. “Identifytheseparateperformanceobligationsinthecontract.”
3. “Determinethetransactionprice.”
4. “Allocatethetransactionpricetotheseparateperformanceobligationsinthecontract.”
5. “Recognizerevenuewhen(oras)theentitysatisfiesaperformanceobligation.”
TherevisedEDstatesthatthecoreprincipleforrevenuerecognitionisthatan“entityshallrecognizerevenuetodepictthetransferofpromisedgoodsorservicestocustomersinanamountthatreflectstheconsiderationtowhichtheentityexpectstobeentitledinexchangeforthosegoodsorservices.”Althoughtheboardsdidnotmodifythefivestepstoapplyingthisprinciple,theydidchangehoweachstepisappliedaswellasotheraspectsoftheproposedmodel.Forinstance,theproposalwouldrequirecapitalizationofcertaincostsofobtainingandfulfillingacontractandwouldmodifythecriteriaforrecognizinglossesoncertainonerousperformanceobligations.
Comparedwithcurrentrevenuerecognitionguidance,therevisedEDrequiressignificantlyexpandeddisclosuresaboutrevenuerecognition,includingbothquantitativeandqualitativeinformationabout(1)theamount,timing,anduncertaintyofrevenue(andrelatedcashflows)fromcontractswithcustomers;(2)thejudgment,andchangesinjudgment,exercisedinapplyingtheproposal’sprovisions;and(3)assetsrecognizedfromcoststoobtainorfulfillacontractwithacustomer.
Key Accounting IssuesTherevisedEDclarifiestherevenuerecognitionprinciplesandincludesadditionalguidanceoncertainrevenuetransactions.Althoughtheeffectoftheproposalsonsomeentitiesisexpectedtobelimited,hardwareandsoftwareentitiesoperatinginthetechnologyindustrymayfacesignificantaccountingandoperationalchallengesasaresultoftherevisedED,anumberofwhicharediscussedbelow.
SoftwareTherevisedEDeliminatesindustry-specificsoftwareguidance,requiringthatentitiesinallindustries,includingthesoftwareindustry,applya“one-size-fits-all”model.UndertherevisedED,goodsandservicesinasoftwarecontractaretreatedasseparateperformanceobligationsiftheyaredeemed“distinct.”TherevisedEDcontainscriteriafordeterminingwhethergoodsorservicesrepresentdistinctperformanceobligationsthatshouldbeaccountedforseparately.Revenueisallocatedtoeachseparateperformanceobligationonthebasisofitsrelativestand-alonesellingprice.Ifthestand-alonesellingpriceofaperformanceobligationisnotobservable,theentitymustuseoneofthemethods
The proposed model requires technology entities to reassess their accounting for various software and hardware products and services and determine whether accounting changes are necessary.
Beyond the Bottom Line
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describedintherevisedEDtoestimateit.Revenueisthenrecognizedforeachseparateperformanceobligationastheobligationissatisfied(eitherovertimeoratapointintime),uptotheamounttowhichanentityisreasonablyassuredtobeentitled.
Softwarecompaniesmaybemostsignificantlyaffectedby(1)theeliminationoftherequirementthatVSOEoffairvaluemustexistforanentitytoseparateelementsinasoftwarearrangementand(2)thechangeinscopeoftheapplicationoftheresidualmethodforallocatingtheconsiderationtoeachelement.Theparagraphsbelowdiscusstheseitemsandafewotherdifferences.AlsoseetheappendixforadetailedcomparisonbetweenASC985-605(formerlySOP97-2)andtherevisedED.
Elimination of VSOE RequirementCurrently,ASC985-605providesindustry-specificguidanceonaccountingformultiple-elementsoftwarearrangements.Underthecurrentguidance,toseparateasoftwarearrangementthatincludesmultipleelements,avendormustestablishVSOEoffairvalue,whichASC985-605-25-6definesas:
a. Thepricechargedwhenthesameelementissoldseparately
b. Foranelementnotyetbeingsoldseparately,thepriceestablishedbymanagementhavingtherelevantauthority;itmustbeprobablethattheprice,onceestablished,willnotchangebeforetheseparateintroductionoftheelementintothemarketplace.
Theseparate-salecriterionforestablishingfairvalueismorerestrictivethanthatinanyexistingliteraturethatappliestomultiple-elementarrangements.WhetherVSOEoffairvaluecanbeestablishedforanelementmaydramaticallyaffecthowrevenueisrecognizedinamultiple-elementarrangement.Further,variationsinpricingfromcustomertocustomer,theuniqueandcustomer-specificnatureofmanysoftwareelements,andthelackofhistoricalsalesinformationfornewsoftwareproductscanoftenmakeitdifficultorimpossibletoestablishVSOEoffairvalue.
BecausetherevisedEDiseliminatingtheVSOErequirement,revenuerecognitioninsoftwarecontractswillnolongerbelimitedifVSOEoffairvalueisnotestablishedforcertaingoodsorservicesinacontract.However,whileentitieswillnolongerberequiredtoestablishandmaintainprocessesfordevelopingVSOEoffairvalueforgoodsorservicessoldinsoftwaretransactions,therevisedEDwillstillrequireentitiestodevelopsimilarprocessesfordeterminingthestand-alonesellingpriceofeachperformanceobligation.
EliminationoftheVSOErequirementmayhaveasignificantimpactonsoftwaretransactionsthatincludetechnology“roadmaps.”Mostsoftwarecompaniesdeveloproadmapstoarticulatebothshort-termandlong-termgoalsforthefuturedevelopmentofsoftwaresoldtoacustomer.Roadmapscanincludespecificupgradesorenhancementstothefunctionalityofsoftwaretobedeliveredataspecifictimeinthefuture.Becausesuchupgradesorenhancementstypicallyhavenotbeendevelopedorsoldseparatelyatcontractinception,VSOEoffairvalueoftendoesnotexistforsuchelements.Asdescribedabove,undercurrentguidance,ifaroadmapimpliesorexplicitlypromisesthedeliveryofspecifiedupgradesandVSOEoffairvaluedoesnotexistfortheupgraderights,revenuerelatedtootherelementsinthearrangementoftenmustbedeferreduntiltheupgradesaredeliveredorVSOEoffairvalueisestablished.Thislimitstheabilityofsoftwarecompaniestoincludedesiredcontentintheirproductroadmaps.ByreplacingtheseparationrequirementforVSOEoffairvaluewiththeconcept“distinct”goodsorservicesandrequiringallocationofrevenuetoseparateperformanceobligationsonthebasisofanestimateofstand-alonesellingprices,therevisedEDgivessoftwarecompaniesmoreflexibilitytoincludespecifiedupgraderightsintheirproductroadmaps.Inotherwords,revenuerecognitionincertainsoftwarearrangementsmaybeacceleratedasaresultoftherevisedED.
The elimination of VSOE and the allocation of revenue to each performance obligation on the basis of stand-alone selling prices may significantly change revenue recognition patterns in software arrangements.
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Residual Allocation TechniquesMultiple-elementsoftwarearrangementsthatarenotwithinthescopeofASC985-605(e.g.,certaintypesofhostedsoftwareanddataarrangements)aretypicallyaccountedforunderASC605-25,whichdiscusseshowanentityshouldallocatethearrangementconsiderationtoseparateunitsofaccounting.Entitiesarerequired,attheinceptionofanarrangement,toestablishthe“sellingprice”foralldeliverablesthatqualifyforseparation.Themannerinwhich“sellingprice”isestablishedisbasedonahierarchyofevidencethatentitiesmustconsider;totalarrangementconsiderationisallocatedonthebasisofthedeliverables’relativesellingprices.The“residualmethod,”asdescribedinASC985-605,iscurrentlyprohibitedformultiple-elementarrangementsthatarewithinthescopeofASC605-25.
Intheabsenceofobservableseparatesales,therevisedEDrequiresentitiestouseestimatestodeterminethestand-alonesellingpriceofaseparateperformanceobligation.AlthoughtherevisedEDincludesthreeexamplesofsuitableestimationmethods,itdoesnotprescribeone.Instead,anentitywouldusejudgmentindetermininganestimationmethodthatmaximizestheuseofobservableinputs.TherevisedEDspecifiesthatwhenthestand-alonesellingpriceofaperformanceobligationishighlyvariableoruncertain,theapplicationofaresidualtechniquemaybeusedasanestimationmethod,regardlessofthetypeofgoodorservicebeingsold.
UndertherevisedED,anentityispermittedtoapplyaresidualallocationtechniqueinthecircumstancesdescribedaboveregardlessofwhethertheentityobtainsVSOEoffairvalueforallotherperformanceobligationsinthearrangement(asrequiredforarrangementsthatarecurrentlywithinthescopeofASC985-605).Thus,anentitymightnolongerneedtoperformorjustifycomplexestimationtechniquestodeterminetheestimateofstand-alonesellingpriceforhighlyuniquegoodsorservicesinmultiple-deliverablearrangements(forarrangementscurrentlywithinthescopeofASC605-25).Lastly,entitiesmaybeallowedgreaterflexibilityinallocatingrevenuetoperformanceobligations,dependingonthefactsandcircumstances.
Overall,entitiesthatcurrentlyfinditchallengingtomeettherequirementforVSOEoffairvaluewillmostlikelyhaveincreasedflexibilitytouseestimatestodemonstratestand-alonesellingpricesandwillthusbelesslikelytodeferrevenuewhenVSOEoffairvaluedoesnotexist.
Online Gaming / New Media
Sale of Virtual GoodsTraditionally,onlinegamingandnewmediacompanieshavechargedcustomersamonthlysubscriptionfeeorafeeforpremiumservicestogainaccesstoonlinecontentforaspecifiedperiod.Recently,the“free-to-play”businessmodelhasbecomemorepopularintheonlineindustry.Underthefree-to-playmodel,customersaregivenaccesstoonlinecontentfornochargebuthavetheoptiontopurchasevirtualgoods.Virtualgoodsareintangibleobjectspurchasedforuseinonlineplatforms(e.g.,virtualpets,avatars).
TherevisedEDspecifiesthatrevenueshouldberecognizedwhentheentitysatisfiesaperformanceobligationbytransferringagoodorservicetoacustomerandtheentityisreasonablyassuredtobeentitledtosuchrevenue.Agoodorserviceisdeemedtobetransferredwhenthecustomerobtainscontrolofthatgoodorservice,whichmaybeovertime(whencertaincriteriaaremet)oratapointintime.
The use of the residual technique may be permitted when the stand-alone selling price of a performance obligation is highly variably or uncertain.
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Acustomergenerallycanexpectapurchasedvirtualgoodtobeavailableforuseatanytime.However,somecontractsspecifythemannerinwhichthecustomermayconsumethegood.Incertainsituations,controlofthevirtualgoodmaybetransferredtothecustomerinitsentiretyatthepointofsalesothatthecustomermayuseorconsumethevirtualgoodwithoutanyfurtherobligationonthepartofthesellertoprovideaccesstoit.Inthiscase,therevisedEDwouldmostlikelyrequirefullrevenuerecognitionforthesaleofthegoodatthepointofsaleiftheentityisreasonablyassuredtobeentitledtosuchrevenue.Incontrast,incertaincircumstances,acustomercouldberequiredtouseaseller’sonlineplatformorothermechanism,inwhichcasethesellerwouldbeobligatedtoprovidefurtherservicessothatthecustomercanuseorconsumethevirtualgood.Inthiscase,therevisedEDwouldmostlikelyrequirerevenuerecognitionasaccesstothevirtualgoodisprovidedanditsbenefitsareconsumedbythecustomer.
Giventhenumberofuniquearrangementsinthisindustry,onlinegamingandnewmediacompanieswillneedtoconsiderwhethertheircurrentrevenuerecognitionpracticesregardingthesaleofvirtualgoodsremainconsistentwiththerevisedED.
BreakageTherevisedED’sguidanceonbreakagemayaffecttheaccountingforrevenuerelatedtomicro-transactionsinthenewmediaandgamingindustries.“Micro-transactions”occurwhencustomerspurchasevirtualcurrencytoplaygames,purchasevirtualgoods,orpayforupgrades.“Breakage”referstotheamountofvirtualcurrencypurchasedbyacustomerthatwillneverbespent(i.e.,thevirtualcurrencyisneverredeemed).Incurrentpractice,amountsrelatedtobreakageoftenremainclassifiedasdeferredrevenueonthebalancesheetuntilitbecomeslikelythatthevirtualcurrencywillnotberedeemed.
TherevisedEDcontainsspecificimplementationguidanceonaccountingforacustomer’sunexercisedrights(i.e.,breakage).UndertherevisedED,whenanentityisreasonablyassuredofthebreakageamount,suchrevenueisrecognizedinproportiontothepatternofrightsexercisedbythecustomer.Iftheentityisnotreasonablyassuredofthebreakageamount,suchrevenuewouldbedeferreduntilthelikelihoodthatthecustomerwillredeemthevirtualcurrencyisremote.
TherevisedEDcouldmodifyrevenuerecognitionrelatedtobreakageformicro-transactions.Inparticular,therevenuerecognitionrelatedtomicro-transactionsmaybeaccelerated,providedthatentitieshavesufficienthistoricalinformationtoestimatethetimingandamountofbreakagesothattheycandeterminethattheyarereasonablyassuredofthebreakageamount.
HardwareCurrently,ASC605-20-25-1through25-6(formerlyFASBTechnicalBulletin90-13)provideguidanceonaccountingforanextendedwarrantythatispricedandsoldseparatelyfromthepurchasedproduct.Underthisguidance,theinvoicedamountthatispaidbyacustomerforaseparatelypricedwarrantyormaintenancecontractshouldberecognizedasrevenueonastraight-linebasisorinproportiontothecostsexpectedtobeincurredinperformingservicesoverthecontractterm.
UndertherevisedED,warrantieswouldbeaccountedforasfollows:
• Ifacustomerhastheoptiontopurchaseawarrantyseparatelyfromtheentity,theentitywouldaccountforthewarrantyasaseparateperformanceobligationandallocateaportionoftheoverallconsiderationtothewarrantyservice.
Entities that sell virtual goods and services may need to reconsider whether control of such goods or services is transferred at the point of sale or over a period of time.
3 FASBTechnicalBulletinNo.90-1,AccountingforSeparatelyPricedExtendedWarrantyandProductMaintenanceContracts.
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• Ifacustomerdoesnothavetheoptiontopurchasethewarrantyseparatelyfromtheentity,theentitywoulduseacostaccrualmodeltoaccountforthewarranty,unlessthewarrantyprovidesaservicetothecustomerinadditiontoassurancethattheproductcomplieswithagreed-uponspecifications(inwhichcasetheentitywouldaccountfortheserviceasaseparateperformanceobligationandrevenuewouldbedeferred).
Hardwareentitiestypicallyprovidearangeofwarrantiesonsalesofproductstocustomers.UndertherevisedED,theaccountingformostwarranties(i.e.,generalwarrantiesthatareincludedaspartofthepurchaseofaparticularproductandthatassurethatthegoodorservicecomplieswithagreed-uponspecifications)underacostaccrualmodelwillnotchange.However,hardwareentitiesmaywishtoreassessalltheirwarrantiestoensurethattherearenoinstancesinwhichwarrantiesprovideanyservicesbeyondassuringthattheproductcomplieswithagreed-uponspecifications.
Hardwareentitieswillneedtoevaluatetheiraccountingforwarrantiesthatprovidemorethanassurancethataproductcomplieswiththeagreed-uponspecificationstodeterminewhetheraseparateperformanceobligationisembeddedinthewarranty.Insuchcircumstances,hardwareentitieswillneedtogatherthenecessaryinformationtoallocateaportionofthetransactionpricetotheseparateperformanceobligation,whichwillaffectthemannerinwhichrevenueisrecorded.Hardwareentitiesmayneedtofurtheranalyzewarrantiesofferingmultipleservices(oradditionalproducts)toidentifyeachseparateperformanceobligationinthearrangement.Therefore,hardwareentitiesshouldthoroughlyanalyzeallwarrantiesthatarenotseparatelypricedtodeterminewhethertheyshouldbeaccountedforunderthecostaccrualmethodorwhethertheyshouldbetreatedasseparateperformanceobligationsundertherevisedED.
Select Issues That Are Likely to Affect All Technology Companies
Contract CostsTherevisedEDrequirescapitalizationofcertaincostsassociatedwithobtainingacontractifthosecostsareincrementalandrecoverable.TherevisedEDalsorequirescapitalizationofcertaincostsoffulfillingacontractifallofthefollowingcriteriaaremetandthecostsarenotcoveredbyotherstandards:
1. “Thecostsrelatedirectlytoacontract(oraspecificanticipatedcontract).”
2. “Thecostsgenerateorenhanceresourcesoftheentitythatwillbeusedinsatisfyingperformanceobligationsinthefuture.”
3. “Thecostsareexpectedtoberecovered.”
Amortizationofcapitalizedcostswouldoccurinamannerconsistentwiththepatternoftransferofthegoodsorservicestowhichtheassetrelatesand,incertaincircumstances,mayextendbeyondtheoriginalcontracttermwiththecustomer(e.g.,whenfutureanticipatedcontractsorexpectedrenewalperiodsexist).Asapracticalexpedient,qualifyingcoststoobtainacontractcanbeexpensedasincurredwhentheamortizationperiodisoneyearorless.Allcapitalized-costassetswillbesubjecttoimpairmenttestingifanyindicatorsofimpairmentexist.
Dependingonhowanentitycurrentlyaccountsforrevenue-relatedcosts,theproposedguidancemayresultinsignificantchangesinpracticeandpotentiallyrequiretechnologyentitiestocapitalizecoststhattheymayhavepreviouslyexpensed.Entitiesmaywanttocloselyevaluatetheimpactofsuchguidanceontheircurrentaccountingpoliciesandconsidertheneedtodeterminetheiraccountingpolicyrelatedtocontractcostsforshort-termcontractswithadurationofoneyearorless.
Warranties that provide services beyond simple assurance that a product complies with agreed-upon specifications may give rise to additional performance obligations that may alter existing revenue recognition patterns.
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The revised ED requires significantly more disclosures, including the judgments used in applying the guidance.
Presentation and DisclosuresTherevisedEDwouldrequiresignificantlymoreextensivedisclosuresthancurrentrevenuestandards,includingquantitativeandqualitativeinformationaboutcontractsandthesignificantjudgmentsusedinapplyingtheguidancetothosecontracts.Entitiesshouldconsiderhowdetailedtheirdisclosuresneedtobetomeettherequirementsandhowmuchemphasistoplaceoneachdisclosurerequirement.Therequireddisclosureswouldinclude:
• Adisaggregationofreportedrevenueinthe“primarycategoriesthatdepicthowthenature,amount,timing,anduncertaintyofrevenueandcashflowsareaffectedbyeconomicfactors.”
• Areconciliationofthebeginningandendingbalanceofcontractassetsandliabilities.
• Certaininformationaboutperformanceobligations(e.g.,typesofgoodsorservices,significantpaymentterms,typicaltimingofsatisfyingobligations,andotherprovisions).
• Informationaboutonerousobligations(extentandamountofsuchobligations,thereasonstheybecameonerous,theexpectedtimingtosatisfytheliability,andreconciliationofonerousbalances).
• Adescriptionofthesignificantjudgments,andchangesinthosejudgments,thataffecttheamountandtimingofrevenuerecognition.
• Informationaboutthemethods,inputs,andassumptionsusedtodeterminethetransactionpriceandallocateamountstoperformanceobligations.
• Informationaboutassetsrecognizedfromcoststoobtainorfulfillacontract,includingareconciliationofthebeginningandendingassets(bymaincategoryofasset).
OtherTherevisedEDprovidesguidanceonmanyothertopicsthatwerenothighlightedabove,includinglicensesandrightstouse,rightsofreturn,principal-versus-agentconsiderations,bill-and-holdarrangements,collectibility,onerouscontracts,andcustomeracceptance.Technologycompaniesshouldcarefullyanalyzesuchguidance,sinceitmaydifferfromcurrentpractice.Notethatsomeofthesetopicsarediscussedinrelationtosoftwarearrangementsintheattachedappendix.
Challenges for Technology Companies
Increased Use of JudgmentManagementwillneedtoexercisesignificantjudgmentinapplyingcertainoftherevisedED’srequirements,includingthoserelatedtotheidentificationofperformanceobligationsandallocationofrevenuetoeachperformanceobligation.ItisimportantforentitiestoconsiderhowtherevisedEDspecificallyappliestothemsothattheycanprepareforanychangesinrevenuerecognitionpatterns.
Retrospective Application TherevisedEDproposesretrospectiveapplication,withcertainoptionalpracticalexpedientsavailabletoentitiesattheirdiscretion.ThisaspectoftheproposalmayrequiretechnologyentitiestogatherdataandassesscontractsthatcommencedseveralyearsbeforetherevisedED’seffectivedate.Entitiesalsowillmostlikelyberequiredtoperformdualtrackingofrevenuebalancesduringthisretrospectiveperiod,giventhepotentialdifficultyassociatedwithretroactivelyrecalculatingrevenuebalancesatthetimethenewstandardbecomeseffective.
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Entities will need to reevaluate existing systems, processes, and controls to ensure that they are able to produce the required information under the revised guidance.
Impact on ContractsManyorganizationshaveseveralbusinesscontractsthatarelinkedtofinancialperformanceorrevenuerecognitionspecifically,suchassalescompensationstructureagreements.Ifrevenuerecognitionchangesundertherevisedguidance,itemssuchascompensationplansmayalsoneedtobeevaluatedandadjustedaccordingly.
Systems, Processes and ControlsTherevisedEDproposesseveralnewpracticesanddisclosurerequirementsunderwhichtechnologyentitieswillhavetogatherandtrackinformationthattheymaynothavepreviouslymonitored.Thesystemsandprocessesassociatedwithsuchinformationmayneedtobemodifiedtosupportthecaptureofadditionaldataelementsthatmaynotcurrentlybesupportedbylegacysystems(e.g.,dataelementsneededtodetermineandallocatethetransactionpricebetweenseparateperformanceobligationsorelementsrelatedtocontractcoststhatmustbecapitalizedundertherevisedED).
Regardingtransactionprices,entitiesmayneedtodevelopanewmethodofestablishingastand-alonesellingpriceforeachperformanceobligation,takingintoaccount(1)variableconsideration,(2)thetimevalueofmoney,(3)noncashconsideration,and(4)considerationpayabletoacustomer.BecauseanentityhasnotpreviouslyconsideredmanyofthesefactorsinestablishingVSOEorestimatedsellingpricesunderthecurrentguidance,theentitywillneedtoupdateitscurrentpoliciesandprocedurestoestablishguidanceondeterminingtransactionprices.
Inaddition,toensuretheeffectivenessofinternalcontrolsoverfinancialreporting,managementwillneedtoassesswhetheradditionalcontrolsneedtobeimplemented.Technologyentitiesmayneedtobeginaggregatingessentialdatafromnewandexistingcontracts,sincemanyoftheirexistingcontractsmaybesubjecttotheproposedrulesgiventherequirementtoapplytherevisedEDretrospectively.
Income TaxesTaxdepartmentsneedtoassesschangesinbookrevenuerecognitionmethodstoprepareforthetaxeffects.Federalincometaxlawcontainsspecificrulesoncertaintypesofrevenue,suchasincomefromlong-termcontractsandadvancepaymentsforgoodsandservices.Thoserulesoftenoverlapwithataxpayer’sfinancialreportingpolicies,inwhichcasethetaxpayeroftenapplies,asitstaxmethod,therevenuerecognitionmethoditusesinmaintainingitsbooksandrecords.BecausetheproposedguidancemaychangetheamountandtimingofrevenuerecognitionforentitiesthatmaintaintheirbooksandrecordsunderU.S.GAAPorIFRSs,theaccountingproposedintherevisedEDmayhavecashtaximplicationsorgiverisetonewbook-taxdifferencesthatwillneedtobecaptured,calculated,andtrackedthroughtaxaccountingprocessesandsystems.
Ifachangeinataxaccountingmethodisadvantageousorexpedient,includingcircumstancesinwhichthebookmethodhashistoricallybeenused,thetaxpayerwillmostlikelyberequiredtoobtainapprovalfromthetaxauthorities.SimilarimplicationsmayariseinforeignjurisdictionsthatmaintainstatutoryaccountingrecordsunderU.S.GAAPorIFRSs.
Thinking AheadCommentsontherevisedEDandtheFASBcompanionproposedASUareduebyMarch13,2012.Afinalstandardisnotexpectedtobeissueduntillaterin2012andwouldbeeffectivenoearlierthanforannualperiodsbeginningonorafterJanuary1,2015(withaminimumofaone-yeardeferralfornonpublicentitiesapplyingU.S.GAAP).TechnologyentitiesshouldtakeadvantageofthistimetocarefullyexaminetherevisedED,providefeedbackontheproposedmodel,andbeginassessingtheimpactitmayhaveontheircurrentaccountingpolicies,procedures,systems,andprocesses.
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Appendix — Key Differences Between ASC 985-605 and the FASB’s and IASB’s Revised ED ThetablebelowsummarizeskeydifferencesbetweenASC985-605andtheFASB’sandIASB’srevisedED.ItdoesnotaddressallpossiblefactpatternsandshouldbereadinconjunctionwithASC985-605,withtherevisedED,andwithotherrelevantguidance.ASC985-605statesthatifanarrangementcontainssoftwareaswellasservicesthatinvolvesignificantproduction,modification,orcustomizationofthesoftware,theservicescannotberecognizedseparatelyfromthesoftwareandthearrangementisthereforewithinthescopeofASC605-35.TherevisedEDwouldcompletelysupersedeASC985-605andASC605-35,amongmostothercurrentrevenuerecognitionguidanceinU.S.GAAP.ThetablefocusessolelyonthepotentialimpactstocontractscurrentlywithinthescopeofASC985-605anddoesnotaddressthepotentialchangestocontractswithinthescopeofASC605-35.AlthoughtherevisedEDalsoaddressesothertopicsthatarenotinASC985-605,suchasonerouscontracts,coststoobtainorfulfillacontract,financialstatementpresentation,anddisclosures,thetabledoesnotassessthepotentialimpactofthosetopics.
Thelinksbelowcanbeusedtojumptogroupsoftopicsinthetable,whichconsistsofthefiveprimarystepsforrevenuerecognitionundertherevisedED(aswellasitsscope):
• Scope.
• Step1:IdentifytheContractWithaCustomer.
• Step2:IdentifytheSeparatePerformanceObligationsintheContract.
• Step3:DeterminetheTransactionPrice.
• Step4:AllocatingtheTransactionPricetotheSeparatePerformanceObligationsintheContract.
• Step5:RecognizeRevenueWhen(oras)theEntitySatisfiesaPerformanceObligation.
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ASC 985-605 Revised ED Likely Impact4
SCOPE
Scope Thisguidancegenerallyappliestothefollowingtransactionsandactivities:
• “Licensing,selling,leasing,orotherwisemarketingcomputersoftware.”
• “Thesoftwareandsoftware-relatedelementsofarrangementsthatincludesoftwarethatismore-than-incidentaltotheproductsorservicesinthearrangementasawhole.”
• “More-than-insignificantdiscountsonfuturepurchasesthatareofferedbyavendorinasoftwarearrangement.”
• “Arrangementstodeliversoftwareorasoftwaresystem,eitheraloneortogetherwithotherproductsorservicesthatrequiresignificantproduction,modification,orcustomizationofsoftware.”(ASC985-605-15-3)
ASC985-605includesvariousscopeexceptions,whicharedescribedinfurtherdetailinthesectionsbelow.
Thisguidanceappliestoallcontractswithcustomersforthetransferofgoodsorservices.Certaincontracts,suchasleasecontracts,insurancecontracts,guarantees,nonmonetaryexchanges,andcertainothercontractualrightsandobligations(i.e.,mostASCfinancialinstrumentstopics)areoutsidethescopeoftherevisedED.(9)5
“Acontractwithacustomermaybepartiallywithinthescopeof[therevisedED]andpartiallywithinthescopeofother[ASCtopics].”Ifothertopicsspecifyhowtoseparateorinitiallymeasureanypartsofthecontract,anentityfirstappliesthoseseparationormeasurementrequirements.Iftheothertopicsdonotspecifyhowtoseparateorinitiallymeasureanypartsofthecontract,theentityappliestherevisedEDtoseparateorinitiallymeasurethosepartsofthecontract.(11)
ContractspreviouslyaccountedforunderASC985-605arewithinthescopeoftherevisedED.Entitieswillnolongerhavetoevaluatewhetheranarrangementiswithinthescopeofmultiplerevenuestandards(e.g.,ASC985-605,ASC605-35,andASC605-25).Theywilluseasingle,comprehensivemodeltoaccountforallarrangementswithinthescopeoftherevisedED,andthepriorguidancewillbesuperseded.
NonsoftwareDeliverablesinaSoftwareArrangement
ASC985-605doesnotprovideguidanceonseparatingnonsoftware-relateddeliverablesthatarewithinthescopeofotherliteraturefromsoftwareandsoftware-relateddeliverables.Therefore,entitiesgenerallyfirstapplytheseparationandallocationguidanceinASC605-25toanarrangementthatcontainsbothsoftwareandnonsoftwaredeliverables.
TheseparationofacontractintoseparateperformanceobligationsandtheallocationofthetransactionpriceareaddressedbytherevisedED.SeeSteps2and4ofthefive-stepmodel,below.
ContractspreviouslyaccountedforunderASC985-605arewithinthescopeoftherevisedED.Entitieswillnolongerhavetoevaluatewhetheranarrangementiswithinthescopeofmultiplerevenuestandards(e.g.,ASC985-605,ASC605-35,andASC605-25).Theywilluseasingle,comprehensivemodeltoaccountforallarrangementswithinthescopeoftherevisedED,andthepriorguidancewillbesuperseded.
4 LikelyimpactisbasedontherevisedEDascurrentlywrittenandfortypicalcontractterms.Itissubjecttointerpretationandmaynotapplytoallfactsandcircumstances.5 ReferencesaretoparagraphsoftherevisedED.
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ASC 985-605 Revised ED Likely Impact
SoftwareComponentsExcludedFromtheScopeofASC985-605
Whenanarrangementcontainsbothnonsoftwarecomponentsoftangibleproductsandsoftwarecomponents,thenonsoftwarecomponentsareexcludedfromthescopeofASC985-605.Ifitisdeterminedthatthesoftwarecomponentsandtangibleproductsfunctiontogethertodeliverthetangibleproducts’essentialfunctionality,theessentialsoftwareandanyundeliveredelementsrelatedtothatessentialsoftwareareexcludedfromthescopeofASC985-605.(ASC985-605-15-4)
Allpromisedgoodsorservicesinacontractwithacustomer(e.g.,softwarecomponents,nonsoftwarecomponents,andtangibleproducts)thatdonotmeetanyofthescopeexceptions,arewithinthescopeoftherevisedED.
ContractspreviouslyaccountedforunderASC985-605arewithinthescopeoftherevisedED.Entitieswillnolongerhavetoevaluatewhetheranarrangementiswithinthescopeofmultiplerevenuestandards(e.g.,ASC985-605,ASC605-35,andASC605-25).Theywilluseasingle,comprehensivemodeltoaccountforallarrangementswithinthescopeoftherevisedED,andthepriorguidancewillbesuperseded.
ArrangementsIncludingLeasedSoftwareandTangibleProducts
UnderASC985-605,inarrangementsinvolvingaleaseofsoftwareandhardware(e.g.,property,plant,orequipment),revenueattributabletothehardwareisaccountedforinaccordancewithASC840,whilerevenueattributabletothesoftware,includingPCS,isaccountedforinaccordancewithASC985-605(providedthatthesoftwareismorethanincidentaltothearrangementbutnotessentialtothefunctionalityofthecombinedproduct).Ifthesoftwarefunctionstogetherwiththeleasedequipmenttodelivertheproduct’sessentialfunctionality,thehardware,software,andsoftware-relatedelementsareoutsidethescopeofASC985-605andsubjecttootherapplicableaccountingguidance(e.g.,ASC840,ASC605-25,orSABTopic13).
AcontractwithacustomermaybepartiallywithinthescopeoftherevisedEDandpartiallywithinthescopeofotherASCtopics.Ifothertopicsspecifyhowtoseparateorinitiallymeasureanypartsofthecontract,anentityfirstappliesthoseseparationormeasurementrequirements.Iftheothertopicsdonotspecifyhowtoseparateorinitiallymeasureanypartsofthecontract,theentityappliestherevisedEDtoseparateorinitiallymeasurethosepartsofthecontract.(11)
TheFASBandIASBarealsointheprocessofacompleteoverhaulofleaseaccounting.Ascurrentlyproposed,thetentativeleaseguidanceprovidesindicatorsforentitiestouseindeterminingwhetheranassetusedbyasupplierinthedeliveryofaserviceisseparablefromthearrangementasawhole(e.g.,whethertheassetissoldorleasedseparatelybythesupplierandwhetherthecustomercanusetheassetonitsownortogetherwithotherresourcesavailabletothecustomer).Insituationsinwhichasupplierdirectshowanassetisusedtoperformservicesforacustomer,thecustomerandsuppliermustassesswhethertheuseoftheassetisseparablefromtheservicesprovidedtothecustomer(e.g.,computerandserverequipmentwithoutsourcedinformationtechnologyservicesoracargoshipwithtimecharterservices).Iftheassetisseparable,thearrangementcouldcontainaleaseiftheassetiswithinthescopeofthetentativeleaseaccountingguidance(andthusisoutsidethescopeoftheproposedrevenueguidance).However,iftheuseofanassetisaninseparablepartoftheservicesrequestedbythecustomer,theentirearrangementwouldbewithinthescopeoftheproposedrevenueguidance.
ContractspreviouslyaccountedforunderASC985-605arewithinthescopeoftherevisedED.Entitieswillnolongerhavetoevaluatewhetheranarrangementiswithinthescopeofandcomplywithmultiplerevenuestandards(e.g.,ASC985-605,ASC605-35,andASC605-25).However,entitieswillstillberequiredtoseparateandallocatecontractconsiderationforgoodsandservicesthatarewithinthescopeofotherstandards.
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ASC 985-605 Revised ED Likely Impact
HostingArrangements
AsoftwareelementinahostingarrangementisonlywithinthescopeofASC985-605ifthe“customerhasthecontractualrighttotakepossessionofthesoftwareatanytimeduringthehostingperiodwithoutsignificantpenalty[andit]isfeasibleforthecustomertoeitherrunthesoftwareonitsownhardwareorcontractwithanotherparty...tohostthesoftware.”Ifthearrangementdoesnotmeetthesetwocriteria,itwouldbeaccountedforasaservicecontractandwouldbeoutsidethescopeofASC985-605.(ASC985-605-55-121)
Dependingonthesubstanceofahostingarrangement,acustomermayobtaincontrolofthesoftwareitself,simplyhavetherighttouseitovertime,oracombinationofboth.(SeeStep4belowforadiscussionofthefactorsthatindicatewhethercontroltransfersoveraperiodoftimeoratapointintime.)Inotherinstances,thetangibleproductsusedtoprovidethehostingmightbewithinthescopeofthetentativeleaseaccountingguidance(seeArrangementsIncludingLeasedSoftwareandTangibleProductsabove).
Hostingarrangements,whetherhistoricallyaccountedforunderASC985-605orasaservicecontract,willbewithinthescopeoftherevisedED.Entitieswillhavetocloselyevaluatethesubstanceofthecontracttodeterminewhethertheentityis(1)performingaserviceforwhichcontrolistransferringovertimeor(2)insubstance,licensingsoftwareforwhichcontrolistransferredatapointintimeandprovidingaseparatehostingservice(whichmaybethecasewhenthecriteriainASC985-605-55-121aremet).WhileanentitywillmostlikelyconsiderfactorssimilartothescopingrulesinASC985-605todeterminethesubstanceofthearrangementandappropriateaccountinginaccordancewiththerevisedED,thesecriteriaarenotspecificallyincludedintherevisedEDandthusnotnecessarilydeterminativeoftheaccountingconclusion.Further,entitiesshouldcloselyevaluatethecontractualtermsofthehardwareasitmaymeetthedefinitionofalease.Ifitdoes,thecontractwouldneedtobeseparatedandinitiallymeasuredasdescribedinArrangementsIncludingLeasedSoftwareandTangibleProductsabove.
SoftwareRequiringSignificantProduction,Modification,orCustomization
Certainsoftwaresalesinvolvesignificantproduction,modification,orcustomizationofsoftware.AsstatedinASC985-605-25-88,thisarrangementisaccountedforunderASC605-35byusingtherelevantguidanceinASC985-605-25-88through25-107.
ContractscurrentlyaccountedforunderASC605-35arewithinthescopeoftherevisedED.
ContractspreviouslyaccountedforunderASC985-605orASC605-35arewithinthescopeoftherevisedED.Entitieswillnolongerhavetoevaluatewhetheranarrangementisinthescopeofmultiplerevenuestandards(e.g.,ASC985-605,ASC605-35,andASC605-25).Theywilluseasingle,comprehensivemodeltoaccountforallarrangementswithinthescopeoftherevisedED,andthepriorguidancewillbesuperseded.
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ASC 985-605 Revised ED Likely Impact
STEP 1: IDENTIFY THE CONTRACT WITH A CUSTOMER
PersuasiveEvidenceofanArrangementExists
Practicevarieswithrespecttotheuseofwrittencontracts.Althoughanumberofsectorsoftheindustryrelyuponsignedcontractstodocumentarrangements,othersectorsoftheindustrythatlicensesoftware(notablythepackagedsoftwaresector)donot.
Ifthevendoroperatesinamannerthatdoesnotrelyonsignedcontractstodocumenttheelementsandobligationsofanarrangement,thevendorshouldhaveotherformsofevidencetodocumentthetransaction(e.g.,apurchaseorderfromathirdpartyoronlineauthorization).Ifthevendor’scustomarybusinesspracticeistousewrittencontracts,evidenceofthearrangementisprovidedonlywithacontractsignedbybothparties.
TherevisedEDdefinesacontractasanagreementbetweentwoormorepartiesthatcreatesenforceablerightsandobligations.Contractscanbewritten,oral,orimpliedbytheentity’scustomarybusinesspractices.(13)
Undertheproposedrevenuerequirements,acontractexistsonlyif:
• “Thecontracthascommercialsubstance.”
• “Thepartiestothecontracthaveapprovedthecontract”andarecommittedtosatisfying“theirrespectiveobligations.”
• “Theentitycanidentifyeachparty’srightsregardingthegoodsorservicestobetransferred.”
• “Theentitycanidentifythepaymenttermsforthegoodsorservicestobetransferred.”(14)
Inaddition,acontractdoesnotexistifeachparty“hastheunilateralenforceablerighttoterminateawhollyunperformedcontractwithoutcompensatingtheotherparty(parties).”(15)
ThedefinitionofacontractundertheproposedguidancediffersfromthedefinitionofpersuasiveevidenceofanarrangementunderASC985-605.Dependingonanentity’shistoricalpractice,thesedifferencesmayresultinaccountingchanges.
Inaddition,therequirementinASC985-605that“collectibilityisprobable”forrevenuetoberecognizedisnotanexplicitcriterionintherevisedED.However,intheBasisforConclusionsoftherevisedED,theboardsindicatedthatareasonableexpectationofcollectibilitywouldbenecessaryforacontracttohavecommercialsubstance.Therefore,whenanentitydoesnothaveareasonableexpectationofcollectibility,acontractmaynotexistundertherevisedED(andthus,revenuecannotberecognized).Somemayinterpretthecurrentrequirement(i.e.,thatcollectibilityisprobable)asadifferentthresholdthanthatintherevisedED(i.e.,thatthecontracthascommercialsubstanceandthereforeanentityhasareasonableexpectationofcollectibility).
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ASC 985-605 Revised ED Likely Impact
CombinationofContracts
“Softwarevendorsmayexecutemorethanonecontractoragreementwithasinglecustomer.However,agroupofcontractsoragreementsmaybesocloselyrelatedthattheyare,ineffect,partsofasinglearrangementandshouldbeviewedasonemultiple-elementarrangement[inthedeterminationof]theappropriateamountofrevenuetoberecognizedinaccordancewith[ASC985-605].Theformofanarrangementisnotnecessarilytheonlyindicatorofthesubstanceofanarrangement.Theexistenceofanyofthefollowingfactors(whicharenotall-inclusive)mayindicatethatagroupofcontractsshouldbeaccountedforasasinglemultiple-elementarrangement:”
• “[N]egotiatedorexecutedwithinashorttimeframeofeachother.”
• Elementsincontracts“arecloselyinterrelatedorinterdependentintermsofdesign,technology,orfunction.”
• Thefeeforone“issubjecttorefund,forfeiture,orotherconcessionifanothercontractisnot[satisfied].”
• Oneormoreelementsinonecontract“areessentialtothefunctionality”ofanothercontract.
• Paymenttermsinonecontract“coincidewithperformancecriteriaofanothercontract.”
• Negotiated“jointlywithtwoormoreparties”todoasingleproject.(ASC985-605-55-4)
Anentitycombinestwoormorecontractsandaccountsforthemasasinglecontractiftheyareenteredintoatornearthesametimewiththesamecustomer(orrelatedparties)ifoneormoreofthefollowingcriteriaaremet:
• “Thecontractsarenegotiatedasapackagewithasinglecommercialobjective.”
• “Theamountofconsideration...inonecontractdependsonthepriceorperformanceoftheothercontract.”
• Thegoodsandservices(orsomegoodsorservices)promisedinthecontractsmeetthecriteriatobeaccountedforasasingleperformanceobligation.(17)
OtherthantheconceptintherevisedEDofpotentiallybeingrequiredtocombinecontractsnotonlywiththecustomerbutalsowithpartiesrelatedtothecustomer,theoverallprinciplesoncombiningcontractsappeartobesimilarandarenotlikelytoresultinasignificantchangetocurrentpractice.
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ASC 985-605 Revised ED Likely Impact
ModificationstoaSoftwareLicenseandSideAgreements
Otherthanrequiringthevendortoconsidertheimplicationsofconcessions,ASC985-605doesnotspecificallydiscussmodificationstosoftwarearrangements.Ifamodificationtoasoftwarearrangementisconsideredaconcession,thevendormayneedtoevaluatewhethertheoriginalfeewasfixedordeterminableandconsidertheimpactontheaccountingforfuturearrangements.Generally,previouslyrecognizedrevenueisnotaffectedandthevendordeterminestheimpactofamodificationprospectivelyonthebasisofthefactsandcircumstancesofthemodification.
Sideagreementsshouldbeevaluatedonacase-by-casebasistodeterminewhetherandhowtheyaffectthetermsofthearrangementandtherebyrevenuerecognition.Apracticeofenteringintosideagreementsraisesquestionsaboutwhatconstitutespersuasiveevidenceofanarrangementandwhen,infact,anarrangementhasbeenconsummated.
“Acontractmodificationexistswhenthepartiestoacontractapproveachangeinthescopeorpriceofacontract(orboth).”(18)IfthemodificationmeetsthecontractcriteriaundertherevisedED(discussedinPersuasiveEvidenceofanArrangementExistsabove),theaccountingtreatmentdependsonthenatureofthemodification.However,ifthepartieshaveapprovedachangeinthescopebutnottheprice,anentitywouldonlyaccountforthemodificationwhentheentityhasanexpectationthatthepriceofthemodificationwillbeapproved.
Acontractmodificationwouldbeaccountedforasaseparatecontractonlyifthemodificationresultsin(1)aseparateperformanceobligationand(2)additionalconsiderationthatreflectstheentity’sstand-alonesellingpriceofthatseparateperformanceobligation(whenappropriateadjustmentsforthecontract’sparticularcircumstancesaretakenintoaccount).Otherwise,anentitywouldevaluatethemodifiedcontractandallocatetheremainingtransactionpricetotheremainingperformanceobligations(prospectively)andupdateitsmeasureofprogresstowardcompletionforperformanceobligationsthataresatisfiedovertime(whichcouldresultinacumulativecatch-up).However,ifthemodificationtothecontractisonlyachangeinthetransactionprice,themodifiedtransactionpricewouldbereallocatedtoallperformanceobligationsinthecontract(seeStep4below).(19–22,78)
Althoughthereisnoexplicitguidance,entitieswithinthescopeofASC985-605generallyaccountforcontractmodificationsandsideagreementsprospectively.SincetherevisedEDspecificallyaddressesaccountingforcontractmodifications,itshouldimprovedisciplineandconsistencyinaccountingforcontractmodifications.TherevisedEDmayresultinacumulative-effectadjustmentwhenthemodificationisonlytothetransactionprice(becausethemodifiedtransactionpriceisreallocatedtotheseparateperformanceobligationsasifitexistedatcontractinception,potentiallyaffectingtheamountofrevenuepreviouslyrecognizedforsatisfiedperformanceobligations).
TherevisedEDdoesnotspecificallyaddresssideagreements,andentitieswillneedtoevaluatethemonacase-by-casebasistodeterminewhetherthey(1)representtermsintheoriginalcontract(andmeetthecontractcriteriaundertheproposedguidance,discussedabove)or(2)representacontractmodification(andshouldbeaccountedforunderthecontractmodificationguidancedescribedabove).
Ifasideagreementrepresentstermsthatexistedintheoriginalcontractandwerenotincludedintheoriginalaccountingforthatcontract,theentityshoulddeterminewhethertheadjustmentsfortheimpactofthesideagreementresultinanerrorunderASC250.
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ASC 985-605 Revised ED Likely Impact
STEP 2: IDENTIFY THE SEPARATE PERFORMANCE OBLIGATIONS IN THE CONTRACT
Multiple-ElementArrangements
Softwarearrangementscommonlycomprisemultipleelementsordeliverables(i.e.,softwareandanycombinationofPCS,specifiedorunspecifiedsoftwareproductsorupgrades,additionallicenses,services,orothernonsoftwaredeliverables).Avendorshouldseparateamultiple-elementarrangementtoaccountforeachcomponentindividually(inaccordancewiththespecificguidanceprovidedinASC985-605).
Anentityidentifies“whichgoodsorservices(orwhichbundlesofgoodsorservices)aredistinct”andthereforeaccountedforasseparateperformanceobligations.(23)
TherevisedEDdefinesaperformanceobligationas“apromiseinacontractwithacustomertotransferagoodorservicetothecustomer.”Thisobligationmaybeexplicitinthecontractorimplied.(24)
TherevisedEDlistswhatmaybeconsideredagoodorserviceinacontract.(26).Entitiesevaluatethegoodsorservicestodeterminetheappropriateaccountingunits(i.e.,separateperformanceobligations).
SeeSeparatingtheArrangementbelowforadditionaldiscussionofhowtodeterminetheaccountingunitsinacontract.
Thepromisedgoodsorservicesinacontractaresimilartothecurrentconceptsofa“deliverable”or“element.”Onceanentitydeterminesthegoodsorservices(explicitorimplied)inthecontract,itthenmustseparatethosegoodsorservicesintoseparateunitsofaccounting.BecausetherevisedEDislessrestrictiveinthisarea,manyarrangementswillhavemoreunitsofaccountingthanunderASC985-605.ThiscouldresultinlessdeferralofrevenueinsituationsinwhichVSOEoffairvaluedoesnotexistforanundeliveredelementthatcouldmeettheseparationcriteriaundertherevisedED.ThismayrequireentitiestocloselyevaluatethegoodsorservicesdeliveredearlierinanarrangementthatmaynothavepreviouslybeengivenasmuchscrutinybecauserevenuewasbeingdeferredbecauseofanundeliveredelementnothavingVSOEoffairvalue(e.g.,PCS).
SeparatingtheArrangement
“Ifanarrangementincludesmultipleelements,thefee[is]allocatedtothevariouselements[VSOE]offairvalue,regardlessofanyseparatepricesstatedinthecontractforeachelement.[VSOE]offairvalueislimitedtothefollowing:”
• “Thepricechargedwhenthesameelementissoldseparately.”
• “Foranelementnotyetbeingsoldseparately,thepriceestablishedbymanagementhavingtherelevantauthority;itmustbeprobablethattheprice,onceestablished,willnotchangebeforetheseparateintroductionoftheelementintothemarketplace.”(ASC985-605-25-6)
Anentityaccountsforapromisetotransfermorethanonegoodorserviceasaseparateperformanceobligationifitisdistinct.Agoodorserviceis“distinct”iftheentityregularlysellsitseparatelyorthe“customercanbenefitfromthegoodorserviceeitheronitsownortogetherwithotherresourcesthatarereadilyavailable.”(27)
Further,theboardsdecidedthatanentitywouldaccountforabundleofgoodsorservicesasasingleperformanceobligationifthegoodsorservicesare(1)“highlyinterrelated”andtheentityprovides“asignificantserviceofintegrating”themintoacombineditemoritemsand(2)significantlymodifiedorcustomizedtofulfillthecontract.(28)
“Asapracticalexpedient,[when]twoormoredistinctgoodsorservices...havethesamepatternoftransfertothecustomer,”anentitymaycombinethemintooneseparateperformanceobligation.(30)
TherevisedEDreplacesthespecificrulesunderASC985-605withaprinciplethatislikelytoincreasethenumberofaccountingunitsbecauseofthelessrestrictiverequirementsintherevisedEDtoseparateperformanceobligations.Forexample,thefactthatVSOEoffairvaluedoesnotexistforanundeliveredelementwillnotdictatewhethergoodsorservicesinacontractcanbeseparated.The“distinct”criteriaprovidedintherevisedEDaregenerallyviewedasbeingconsistentwiththestand-alonevalueconceptinASC605-25.
UndertherevisedED,anentitymayneedtousesignificantjudgmentwhendeterminingwhetherthegoodsorservicesare“highlyinterrelated”and“significantlymodifiedorcustomized.”TheproposedASUincludesexamplestoillustratethisguidance;however,furtherclarificationmaybeneededtoensureconsistentapplication.
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ASC 985-605 Revised ED Likely Impact
AdditionalProducts Aspartofabundledarrangement,avendormayagreeto“deliverspecifiedadditionalsoftwareproductsinthefuture.”Sometimes,avendorofferstherightstotheseadditionalproductsaspartofPCS.Generally,evenwhentheadditionalproductsareincludedinPCS,theadditionalsoftwareproductisaseparateelementinthecontract.
ASC985-605requiresvendorstodistinguishbetweenspecifiedandunspecifiedadditionalproducts.Thisdeterminationisimportantbecauserightstospecifiedproducts,includingthoseofferedonawhen-and-if-availablebasis,mustbetreatedasseparateelementsofthesoftwarearrangement.Conversely,therighttounspecifiedadditionalproductsisaccountedforasasubscription.(ASC985-605-25-47through25-59)
Specifiedandunspecifiedadditionalproductsmaymeetthecriteriafortreatmentasseparateperformanceobligations(seeSeparatingtheArrangementabove).Inaddition,iftheseextraproductsareprovidedasanoptiontothecustomerfreeofchargeoratadiscount,theoptionrepresentsaseparateperformanceobligationifitgivesthecustomeramaterialrightthatitwouldnothavereceivedwithoutenteringintothatcontract.(IG20–IG24)
Specifiedadditionalproduct—ThetimingandmeasurementofrevenuerecognitionmaybeacceleratedundertherevisedED.ThereisnolongerarequirementtodeferallrevenuerecognitionunlessoruntilVSOEoffairvalueisestablishedforthespecifiedadditionalproduct,oruntilallelementsinthearrangementhavebeendelivered.Ifanentitydeterminesthataspecifiedadditionalproductmeetsthecriteriatobeaccountedforasaseparateperformanceobligation,theentitywouldallocateaportionoftheconsiderationtothatobligationonthebasisofitsrelativestand-alonesellingprice(seeStep4below)andrecognizerevenueupontransferofcontrolorthelapseofarighttofuturewhen-and-if-availableproducts(seeStep5below).
Unspecifiedadditionalproduct—TherevisedEDmaychangethetimingandmeasurementofrevenuerecognition(i.e.,thebundleofallsoftware-relatedrevenuemayberecognizedinapatternotherthanratableoverthetermoreconomiclifeasasubscription).Anentitywouldneedtoevaluatethefactsandcircumstancesoftheunspecifiedadditionalproductanddeterminewhethertheunspecifiedadditionalproductsmeetthecriteriatobeaccountedforasaseparateperformanceobligation.
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ASC 985-605 Revised ED Likely Impact
UpgradeRights ASC985-605requiresvendorstodistinguishbetweenspecifiedupgrades/enhancementsandunspecifiedupgrades/enhancements.Thisdeterminationisimportantbecauserightstospecifiedupgrades/enhancements,includingthoseofferedonawhen-and-if-availablebasis,mustbetreatedasseparateelementsofthesoftwarearrangementtowhichrevenuemustbeallocated.Conversely,rightstounspecifiedupgrades/enhancementsonawhen-and-if-availablebasisareconsideredtobePCS.
ASC985-605doesnotdefine“specified.”However,anupgradeorproductisgenerallyconsideredtobe“specified”ifitisdescribedinenoughdetailforboththevendorandthecustomertodeterminewhetherthevendor’sobligationtodelivertheupgradeorproducthasbeenextinguished.Thedescriptioncanrangefromadetailedreportontheupgradeorproduct’sfeaturesandfunctionality(suchasaproduct“roadmap”)toamerestatementofitsnameorversionnumber.
Finally,nodiscountinabundledarrangementisallocabletospecifiedupgraderights.(ASC985-605-25-44through25-46)
Specifiedandunspecifiedupgraderightsrepresentgoodsorservicesinthecontractthatwouldbeanalyzedtodeterminewhethertheymeetthecriteriatobetreatedasseparateperformanceobligations(seeSeparatingtheArrangementabove).Inaddition,iftheseupgraderightsareprovidedasanoptiontothecustomerfreeofchargeoratadiscount,theoptionrepresentsaseparateperformanceobligationifitprovidesthecustomeramaterialrightthatitwouldnothavereceivedwithoutenteringintothatcontract.(IG20–IG24)
Specifiedupgraderight—Whiletheremaybeexceptionsduetoindividualfactsandcircumstances,aspecifiedupgraderightwouldgenerallymeettheseparationcriteriabecausethecustomerwouldbelikelytoreceivebenefitfromtheupgradewithotherresourcesreadilyavailabletothecustomer(i.e.,thesoftwareobtainedinthepriorpurchase).TherevisedEDdoesnotcontainarulethatadiscountisnotabletobeallocatedtoaspecifiedupgraderight.(SeeStep4belowforadditionaldiscussionofallocatingthetransactionprice.)Controlwouldgenerallytransferatthepointintimethatthecustomerreceivesthespecifiedupgrade.(SeeStep5belowforadditionaldiscussionofwhencontroltransferstothecustomer.)
Unspecifiedupgraderight—Unspecifiedupgradesarelikelytobeaccountedforastheyareundercurrentpractice.Generally,customerspayaperiodicfeefortherighttounspecifiedwhen-and-if-availableupgradesandwouldmostlikelymeetthecriteriathatcontroltransfersovertime.(SeeStep5below.)
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ASC 985-605 Revised ED Likely Impact
PostcontractCustomerSupport
PCSrevenueisgenerallyrecognizedinthesamepattern(i.e.,ratablyoverthePCSperiod)regardlessofwhetheritissoldseparatelyoraspartofanoverallarrangement.IfhistoricalevidencesuggeststhatcoststoprovidePCSareincurredonotherthanastraight-linebasis,thenrevenueshouldberecognizedinproportiontotheamountsexpectedtobechargedtoexpenseforthePCSservices.
BecausePCSisgenerallynotconsideredessentialtothefunctionalityofotherdeliverablesinanarrangement,itisusuallyviewedasaseparateelement.Aswithothersoftwareelements,aportionofthearrangementfeemustbeallocatedtoPCSonthebasisofVSOEoffairvalue(andrecognizedoverthePCSperiodinaccordancewithASC985-605).IfVSOEoffairvaluecannotbeestablishedandthePCSistheonlyremainingundeliveredelement,theentirearrangementfeemustberecognizedratablyoverthestatedPCSperiod(ifexplicitlystatedinthecontract)ortheperiodoverwhichPCSservicesareexpectedtobeprovided(ifimplicitrightstoPCSexist).
VSOEoffairvalueforPCSisgenerallyevidencedbythepricethecustomerwillberequiredtopaywhenitissoldseparately(i.e.,therenewalrate).
PCSwouldgenerallybeaccountedforasaseparateperformanceobligation.Itwouldmostlikelybedistinctfromtheothergoodsorservicesinthecontractsinceitiseithersoldseparately(asevidencedthroughsubsequentrenewals)orthecustomercanbenefitfromthesoftwarewithoutthePCS.
SeeRecognitionofPCSRevenueUponDeliveryoftheRelatedSoftwareinStep5belowforadditionaldiscussionoftherevisedEDforrevenuerecognitionforPCS.
BecausetherevisedEDislessrestrictiveinseparatingandallocatingcontractconsideration,therearelikelytobefewerinstancesinwhichallrevenueisrequiredtobedeferredforabundleofgoodsorservicestoberecognizedratablyoverthePCSperiod.
SeeRecognitionofPCSRevenueUponDeliveryoftheRelatedSoftwareinStep5belowforadditionaldiscussionoflikelyimpacttorevenuerecognitionforPCS.
Warranty-RelatedServices
Warrantiesthatprotectcustomersfromdefectivesoftwareandthatareroutine,short-term,andrelativelyminor,arenotconsideredPCSandshouldbeaccountedforinaccordancewithASC450.(ASC985-605-25-37)
However,PCSmayincludecertainwarranty-typeservicessuchasthecorrectionoferrors(e.g.,bugfixes).(ASC985-605-55-77)
“Ifacustomerhastheoptiontopurchaseawarrantyseparately”fromtheentity,theentityshouldaccountforthe“warrantyasaseparateperformanceobligationbecausetheentity[isprovidingaservice]inadditiontotheproduct.”Therefore,theentitywouldallocaterevenuetothewarrantyservice.(IG11)
“Ifacustomerdoesnothavetheoptiontopurchaseawarrantyseparately[fromtheentity,]theentityshouldaccountforthewarrantyinaccordancewith[ASC460-10]”(costaccrualmodel)unlessthewarrantyprovidesaservicetothecustomer“inadditiontotheassurancethattheproductcomplieswith[thecontract’s]agreed-uponspecifications”(inwhichcasetheentitywouldaccountforthewarrantyserviceasaseparateperformanceobligation).(IG12andIG14)
TherevisedEDforseparatelypricedwarrantyoptionsorwarrantiesbeyondassuringanentity’spastperformancemayresultintheallocationanddeferralofcontractconsiderationincertaincircumstancesratherthanaccrualofcosts(asmaybethecaseundercurrentGAAP).MostlikelythiswillhavealimitedimpactontypicalsoftwarearrangementssinceaseparatelypricedwarrantyunderexistingguidanceisoftenviewedasPCS.
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ASC 985-605 Revised ED Likely Impact
PostdeliveryTelephoneSupport
ASC985-605requiresthatpostdeliverytelephonesupportthatisofferedoravailabletocustomersatnoadditionalchargebeaccountedforasPCS.Generally,thearrangementconsiderationallocatedtothetelephonesupportwouldhavetoberecognizedasrevenueovertheperiodduringwhichthetelephonesupportisexpectedtobeprovidedunlesstheASC985-605-25-71conditionsaremet,inwhichcasetherevenueallocabletotelephonesupportmayberecognizedtogetherwiththeinitiallicensingfeeondeliveryofthesoftware(substantiallyalltelephonesupportservicesareperformedwithinoneyearofthedateofsoftwaredelivery).
Postdeliverytelephonesupportismostlikelyaserviceinthecontractandanentitymustevaluateiftheservicerepresentsaseparateperformanceobligation.Ifitdoesnotmeettheseparationcriteria,theserviceshouldbecombinedwithanothergoodorserviceuntilthatbundleisdistinct.(27)
TherevisedEDdoesnotexplicitlyincludetheexceptionsthatwouldallowforpostdeliverytelephonesupporttoberecognizedupondeliveryofthesoftwarelicense.Rather,anentitywouldhavetoconcludethattheservicestobeprovidedarenotmaterialinaccordancewithASC105toconcludethattheseservicesdonotrequireallocationanddeferralofaportionoftheconsiderationinthearrangement.ASC105statesthattheguidanceintheASCdoesnotneedtobeappliedtoimmaterialitems.(BC66)
IndemnificationClauses
Thestandardsoftwarelicenseagreementofasoftwarevendoroftenincludesaclausethatprovidesforindemnificationforliabilitiesanddamagesarisingfromanyclaimsofpatent,copyright,trademark,ortradesecretinfringementbythesoftwarevendor’ssoftware.Thistypeofindemnificationisnotanelementthatcanbeseparatedfromthesoftware;rather,itisaninherentcomponentofthesoftwarelicenseitselfandissimilartoastandardwarranty.
“[A]nentity’spromisetoindemnifythecustomerforliabilitiesanddamagesarisingfromclaimsofpatent,copyright,trademark,orotherinfringementbytheentity’sproductsdoesnotgiverisetoaperformanceobligation.”TheentityaccountsforsuchobligationsinaccordancewiththeguidanceonlosscontingenciesinASC450-20.(IG15)
ItisnotlikelythatthiswillhaveasignificantimpactbecausetheprovisionsoftherevisedEDareconsistentwithcurrentpractice.
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STEP 3: DETERMINE THE TRANSACTION PRICE
Vendor’sFeeIsFixedorDeterminable—ExtendedPaymentTerms
UnderASC985-605,anarrangementfeemustbefixedordeterminablebeforerevenuecanberecognized.Ifavendorcannotconcludethatthefeeisfixedordeterminableattheoutsetofanarrangement,revenuewouldberecognizedaspaymentsfromthecustomerbecomedue(providedthatallotherrequirementsforrevenuerecognitionaremet).
Inarrangementswithextendedpaymentterms,itmaybelesslikelythatthevendorwillcollectthefullpaymentstipulatedinthepaymenttermsandthearrangementfeemaynotmeetthefixed-or-determinablecriterion.ASC985-605-25-34specifiesthatanarrangementfeeispresumednottobefixedordeterminable“ifpaymentofasignificantportionofthesoftwarelicensingfeeisnotdueuntilafterexpirationofthelicenseormorethan12monthsafterdelivery.”
Anentity’sobjectivewhendeterminingthetransactionpriceistoestimatethetotalamountofconsiderationtowhichtheentityexpectstobeentitledunderthecontract.Tomeetthatobjective,anentityshoulduseeitherofthefollowingmethodstoestimatethetransactionprice,dependingonwhichmethodbetterpredictstheamountofconsiderationtowhichtheentitywillbeentitled:
• Theexpectedvalue(i.e.,probability-weightedamount).
• Thesinglemostlikelyamount.(55)
Anentityshouldadjustthepromisedamountofconsiderationtoreflectthetimevalueofmoneyifthecontractincludesasignificantfinancingcomponent.TherevisedEDcontainsfactorsforentitiestoconsiderindeterminingwhethertheeffectoffinancingissignificanttothecontract.Asapracticalexpedient,anentityshouldnotassesswhetheracontracthasasignificantfinancingcomponentifthe“periodbetweenpaymentbythecustomer[and]thetransferofthepromisedgoodsorservicestothecustomer[is]oneyearorless.”(58–62)
TherevisedEDmayrepresentasignificantchangefromcurrentpracticeforextendedpaymentterms.Thatis,extendedpaymenttermsmay(1)beindicatorsofasignificantfinancingcomponenttothecontract,(2)affectthecalculationoftheexpectedvalueormostlikelyamount,or(3)changetheuncertaintyregardingcollectibility(discussedinthenextsection).
Thisstepintheproposedmodelsimplycalculatestheamountofrevenuethatisexpectedtobereceivedfromthecontract.Whilemuchoftheguidanceinthesubheadingsunderthisstepmayaffectthetransactionpricecalculation,thetopicsinthesesubheadingsmayalsoaffecttheamountthattheentityisreasonablyassuredtobeentitledtointhedeterminationoftheamountofrevenuetoberecognized(seeStep5below).
Vendor’sFeeIsFixedorDeterminableandCollectabilityIsProbable
UnderASC985-605,theevaluationofcollectibilityfocusesbothonwhetherthecustomerhastheintentandabilitytopay(i.e.,creditworthiness)andonwhetherthefeeisdeemedfixedordeterminable.
TherevisedEDdoesnotincludeaspecificrecognitionthresholdrequiringthatcollectibilitybeprobable.Rather,implicitinthe“commercialsubstance”criterionforwhenacontractexistsisanotionthatrequiresareasonableexpectationofcollectability.(BC168–BC170)
Initialandsubsequentadjustmentsforcollectibility(i.e.,acustomer’screditriskorbad-debtexpense)areshownasareductionofrevenueinaseparatelineitem(i.e.,contrarevenuebelowgrossrevenue)andaremeasuredinaccordancewithASC310(69).
Somecouldinterpretthethresholdsof“collectibilityisprobable”and“reasonableexpectationofcollectibility”asbeingdifferent.Incertaincircumstances,thisdifferencecouldaffectthetimingandmeasurementofrevenuerecognition.Thepresentationofcollectibilityadjustmentsinaseparatelineitemisachangefromthecurrentpresentationrequirements.SeeadditionaldiscussioninPersuasiveEvidenceofanArrangementExistsabove.
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Price-ProtectionClauses
Ifavendoroffersacustomeraprice-protectionclauseandcannotreasonablyestimatefuturepricechanges,orifthevendor’sabilitytomaintainitspriceisuncertain,thefeewouldnotbefixedanddeterminableandrevenueshouldbedeferreduntilthevendor’sliabilityundertheprice-protectionclausecanbereasonablyestimated(providedthatallotherrequirementsforrevenuerecognitionaremet).
Anentity’sobjectivewhendeterminingthetransactionpriceistoestimatethetotalamountofconsiderationtowhichtheentityexpectstobeentitledunderthecontract.Tomeetthatobjective,anentityshoulduseeitherofthefollowingmethodstoestimatethetransactionprice,dependingonwhichmethodbetterpredictstheamountofconsiderationtowhichtheentitywillbeentitled:
• Theexpectedvalue(i.e.,probability-weightedamount).
• Thesinglemostlikelyamount.(55)
Anentitymustrecognizerevenuefromsatisfyingaperformanceobligationintheamounttowhichtheentityisreasonablyassuredtobeentitled.(81)(SeeStep5belowforadditionaldiscussionofconstrainingrecognizedrevenuetotheamountthatisreasonablyassured.)
Futurepricechangeswouldbeincludedintheentity’sestimateofthetransactionprice.Thisestimatewouldbeupdatedineachreportingperiodandwouldaffecttheamountofrevenuerecognized.However,thecumulativeamountrecognizedwouldbelimitedtotheamountthatisreasonablyassured(seeStep5belowforadditionaldiscussion).Unlikecurrentpractice,whichcouldrequiredeferraloftheentireamount,therevisedEDmayonlyrequiredeferralforalesseramount(i.e.,theamountthatisnotreasonablyassured).
CustomerCancellationPrivilegesandForfeitureorRefundClauses
Arrangementswithcustomercancellationprivilegesdonotmeetthefixedordeterminablefeerecognitioncriteriauntilthecancellationprivilegeslapse.Whenthecancellationprivilegesexpireratablyoverthelicenseperiod,thefeesbecomedeterminableandrevenueisrecognizedratablyoverthelicenseperiodastheprivilegeslapse.(ASC985-605-25-37)
Noportionofthefee(includingamountsotherwiseallocatedtodeliveredelements)meetsthecollectibilitycriterioniftheportionofthefeeallocabletodeliveredelementsissubjecttoforfeiture,refund,orotherconcessionifanyoftheundeliveredelementsarenotdelivered.
Customercancellationprivilegesandforfeitureorrefundclausesareaccountedforasarightofreturn.
Whenarightofreturnexists,anentityrecognizes(1)revenueforgoodsorservicesthathavebeentransferredtothecustomerandwhosereturnisnotreasonablyassured,(2)arefundliability,and(3)(ifapplicable)anasset(includinganadjustmenttocostofsales)fortherighttorecoverreturnedgoods.Ifanentityisnotreasonablyassuredoftheamountthatwillberefunded,revenueshouldnotberecognizeduntilsuchanamountisreasonablyassured(whichmaynotbeuntiltherightofreturnexpires).(IG2–IG9)
UndertherevisedED,whenanentityisreasonablyassuredtobeentitledtoconsiderationbeforetheexpirationofthecancellation,forfeiture,orrefundperiod,revenuemayberecognizedearlierthanitisundercurrentpractice.Thatis,revenuefromcontractsthatanentitydoesnotexpecttobecanceledmayberecognizedwhentheperformanceobligationsaresatisfied.
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FiscalFundingClauses
Afiscalfundingclausewithacustomerotherthanagovernmentalunitthatisrequiredtoincludesuchaclausecreatesacontingencythatprecludesrevenuerecognitionuntiltherequirementsoftheclauseandallotherprovisionshavebeensatisfied.
Anentity’sobjectivewhendeterminingthetransactionpriceistoestimatethetotalamountofconsiderationtowhichtheentityexpectstobeentitledunderthecontract.Tomeetthatobjective,anentityshoulduseeitherofthefollowingmethodstoestimatethetransactionprice,dependingonwhichmethodbetterpredictstheamountofconsiderationtowhichtheentitywillbeentitled:
• Theexpectedvalue(i.e.,probability-weightedamount).
• Thesinglemostlikelyamount.(55)
Anentitymustrecognizerevenuefromsatisfyingaperformanceobligationintheamounttowhichtheentityisreasonablyassuredtobeentitled.(81)(SeeStep5belowforadditionaldiscussionofconstrainingrecognizedrevenuetotheamountthatisreasonablyassured.)
UndertherevisedED,whenanentityisreasonablyassuredtobeentitledtoconsiderationbeforetheresolutionofthecontingencycreatedbythefiscalfundingclause,revenuemayberecognizedearlierthanitisundercurrentpractice.Thatis,revenueintheamountthatanentityisreasonablyassuredwillnotbecanceledbythecustomerasaresultofthefiscalfundingclausemayberecognizedwhentheperformanceobligationsaresatisfied.
DeterminingtheamountthatisreasonablyassuredinaccordancewiththerevisedEDmayrequiresignificantjudgment.
Discounts Avendormayofferacustomerarighttoapricingdiscountonafuturepurchaseofaproductorservice.Ifthisdiscountismorethaninsignificant,therighttoitisconsideredanelementinthearrangement.(ASC985-605-15-3(d))
The“optiontoacquireadditionalgoodsorservicesatadiscount[representsa]performanceobligation[ifit]providesamaterialrighttothecustomer”thatwouldnototherwisehavebeenreceived.(IG20andIG21)
“Ifacustomerhastheoptiontoacquireanadditionalgoodorserviceataprice”thatiswithintherangeofpricestypicallychargedforthosegoodsorservices,“thatoptiondoesnotprovidethecustomerwithamaterialrighteveniftheoptioncanbeexercisedonlybecause[a]previouscontract”wasenteredinto.The“entityhasmerelymadeamarketingoffer.”(IG22)
TheguidanceinASC985-605andtherevisedEDappearsimilar;thus,itisnotlikelythattheproposedprovisionwillhaveasignificantimpact.
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Fixed-FeeArrangementsBasedonaPriceperCopy
Whenafixed-feearrangementdoesnotspecifythemaximumnumberofcopiesallowed,theallocationofthearrangementfeetotheproductsisnotpossiblebecauseitdependsonthenumberofcopiesultimatelymadeofeachproduct.Revenueisrecognizedascopiesaredelivered.However,allunrecognizedrevenueinthearrangementisrecognizedwhenthevendorisnotobligatedtodeliveradditionalproductsandeither(1)deliveryofallproductsiscompleteor(2)totalrevenueresultingfromthecopiesproducedequalsthearrangement’sfixedfee.
If“anentitygrantsacustomertheoptiontoacquireadditionalgoodsorservices,thatoptiongivesrisetoaseparateperformanceobligationinthecontractonlyiftheoptionprovidesamaterialrighttothecustomerthatitwouldnotreceivewithoutenteringintothatcontract....Iftheoptionprovidesamaterialright,...thecustomerineffectpaystheentityinadvanceforfuturegoodsorservicesandtheentityrecognizesrevenuewhenthosefuturegoodsorservicesaretransferredorwhentheoptionexpires.”(IG20andIG21)
Regardlessofwhetherthearrangementspecifiesthemaximumnumberofcopiesallowed,theentitywouldallocatethefixedconsiderationamongtheseparateperformanceobligations(i.e.,expectednumberofcopiestobetransferredtothecustomeroverthelifeofthearrangement)andwouldrecognizerevenuewheneachcopyistransferredinamannerthatbestdepictsthetransferofcontrol.However,theentitywouldneedtoreevaluateitsperformanceinrelationtothenumberofcopiesexpectedtobedeliveredwhenitismeasuringitsperformancetodateineachperiod.
Therighttoreproduceorobtaincopiesofsoftwareproductsataspecifiedpricepercopywouldbeconsideredacustomeroptionforadditionalgoodsorservices.
Iftheright/optiontoreproduceorobtaincopiesofsoftwareproductswouldprovidethecustomerwithamaterialrightthatthecustomerwouldnotreceivewithoutenteringintothearrangement,eachadditionalcopyofthesoftwarewouldbeconsideredaseparateperformanceobligation.
Regardlessofwhetherthearrangementspecifiesthemaximumnumberofcopiesallowed,theentitywouldallocatethefixedfeeortransactionpriceamongtheseparateperformanceobligations(i.e.,expectednumberofcopiestobetransferredtothecustomeroverthelifeofthecontract)andwouldrecognizerevenuewhencontrolforeachperformanceobligationistransferred.
Platform-TransferRights
Forendusers,dependingonthetermsofthearrangement,platform-transferrightsshouldbeclassifiedasareturn,asanexchange(ifitisforthesameproductanddoesnotincreasethenumberofcopiesorconcurrentusersunderthelicenseagreement),orasanadditionalsoftwareproduct(ifthetermsallowthecustomertocontinueusingapreviouslydeliveredsoftwareproductinadditiontothesoftwarerelatedtothenewplatform).
Therearenospecificrequirementsforplatform-transferrights.Anentityshouldcloselyevaluatethetermsofthecontractandshoulddeterminewhetherthetransferrightsrepresentareturn,anexchange,oranadditionalsoftwareproduct.SeeRightstoExchangeorReturnSoftwareProductsinStep5belowandAdditionalSoftwareProductinStep2aboveforguidanceoneachtypeofcontract.
SeediscussioninStep5on“RightstoExchangeorReturnSoftwareProducts”andStep2on“AdditionalSoftwareProduct”forguidanceoneachtypeofcontract.
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STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE SEPARATE PERFORMANCE OBLIGATIONS IN THE CONTRACT
AllocatingConsideration
Theallocationoftheconsiderationtoelementsinamultiple-elementsoftwarearrangementandthesubsequentrecognitionofsuchconsiderationdependonwhetherVSOEoffairvaluehasbeenestablished.
IfVSOEoffairvalueisestablishedforallundeliveredelements,theportionofthefeeallocatedtoanelement(onthebasisofVSOEoffairvalue)shouldberecognizedasrevenuewhentherecognitioncriteriaaremetforeachelement(unlessanundeliveredelementinanarrangementisconsideredessentialtothefunctionalityofadeliveredelement).
IfVSOEoffairvalueisnotestablished,allrevenuefromthearrangementmustbedeferreduntiltheearlierof(1)theestablishmentofVSOEoffairvalueor(2)thedeliveryofallelementsinthearrangement(withcertainexceptions,aslistedinASC985-605-25-10).TheexceptionsinASC985-605-25-10includetheuseofaresidualmethod.
Thetransactionpriceisallocatedonarelativestand-alonesellingpricebasis(stand-alonesellingpriceshouldbeestimatedifitisnotobservable).Suitableestimationmethodsincludeexpectedcostplusmargin,adjustedmarketassessment,andtheresidualapproach(incertainlimitedcircumstances).Theresidualapproachdoesnotspecificallyprecludetheuseofareverseresidualallocation(i.e.,useofaresidualmethodtoestimatethestand-alonesellingpriceforanundelivereditem).(70–73)
Whenspecificconditionsaremet,certaindiscountsoramountsthatarecontingentonafutureeventmaybeallocatedtooneormorespecificseparateperformanceobligations.(74–76)
Aftercontractinception,changesinthetransactionpricearegenerallyallocatedtoallperformanceobligations(onthebasisofinitialallocation).However,subsequentchangesinthetransactionpricethatarerelatedtoacontingentfutureeventmaybeallocatedtooneormorespecificperformanceobligations(whencertainconditionsaremet).(77–80)
AnentitymaybelessconstrainedbytherevisedED’sallocationrequirementsforrevenuerecognitionthanitisunderthecurrentrequirements.
TherevisedEDallowsentitiestouseestimates,intheabsenceofobservableprices,todeterminethestand-alonesellingprice.AlthoughtherevisedEDincludesthreeexamplesofsuitableestimationmethods,itdoesnotprescribeone.Therefore,anentitywouldbeallowedsomejudgmentindeterminingamethodofestimationaslongasitmaximizestheuseofobservableinputsandisappliedconsistentlytogoodsorservicesandcustomerswithsimilarcharacteristics.Asaresult,andbecauseofanentity’sabilitytouseareverseresidualmethod,revenuemaybeallocateddifferentlyundertherevisedEDthanitisunderASC985-605incertaincircumstances.
EntitiesthatcurrentlyfinditdifficulttoobtainVSOEoffairvaluewillbegivensignificantlymorejudgmenttouseestimatestodemonstratestand-alonesellingprices,increasingthelikelihoodthatrevenuewillberecognizedwheneachperformanceobligationissatisfied.
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STEP 5: RECOGNIZE REVENUE WHEN (OR AS) THE ENTITY SATISFIES A PERFORMANCE OBLIGATION
DeliveryHasOccurred
ThesecondcriterioninASC985-605-25-3forrevenuerecognitionisdelivery.Theprincipleofnotrecognizingrevenuebeforedeliveryappliesregardlessofwhetherthecustomerisauserorreseller.Exceptforarrangementsinwhichthefeeisafunctionofthenumberofcopies,deliveryisconsideredtohaveoccurreduponthetransferoftheproductmasteror,iftheproductmasterisnottobedelivered,uponthetransferofthefirstcopy.Forsoftwarethatisdeliveredelectronically,thedeliverycriterioninthatparagraphisconsideredtohavebeenmetwheneitherofthefollowinghasoccurred:
• Thecustomerhastakenpossessionofthesoftwareviaadownload(i.e.,whenthecustomertakespossessionoftheelectronicdataonitshardware).
• Thecustomerhasbeenprovidedwithaccesscodesthatallowthecustomertotakeimmediatepossessionofthesoftwareonitshardwarepursuanttoanagreementorpurchaseorderforthesoftware.
Anentitysatisfiesaperformanceobligationwhencontrolofthegoodorserviceunderlyingtheobligationhasbeentransferredtothecustomer.Controlofagoodorservicecanbetransferredtoacustomer,andhenceanentitycansatisfyaperformanceobligation,atapointintimeorovertime.
Anentitysatisfiesaperformanceobligationovertimeifeitherofthefollowingoccurs:
• “Theentity’sperformancecreatesorenhancesanasset...thatthecustomercontrolsastheassetiscreatedorenhanced.”
• “Theentity’sperformancedoesnotcreateanassetwithanalternativeusetotheentity”andatleastoneofthefollowingismet:
o “Thecustomersimultaneouslyreceivesandconsumesthebenefitsoftheentity’sperformanceas[it]performs.”
o “Anotherentitywouldnotneedtosubstantiallyreperformthework[performed]todateifthatotherentityweretofulfilltheremainingobligationtothecustomer.”
o “Theentityhasarighttopaymentforperformancecompletedtodateand[isexpected]tofulfillthecontract.”(35)
Revenueisrecognizedforseparateperformanceobligationsthataresatisfiedovertimebymeasuringtheentity’s“progresstowardcompletesatisfactionof[the]performanceobligation”inamannerthatbestdepictsthetransferofgoodsorservicestothecustomer.(38–40)TheproposedASUprovidesspecificguidanceontheuseandapplicationofanoutputmethodandaninputmethodformeasuringprogresstowardcompletion.(41–46)Theamountrecognizedislimitedtotheamounttowhichtheentityisreasonablyassuredtobeentitled.(81)
Thecriteriaforwhenacustomerobtainscontrolofagoodorserviceatapointintimearegenerallyconsistentwiththetypesofitemsconsideredintheassessmentofwhetherandwhendeliveryhasoccurred.
Undertheproposedmodel,serviceswillgenerallybeunbundledandrecognizedovertimeastheserviceobligationsaresatisfied(assumingthattheseparationcriteriainStep2aremet).
Seeadditionaldiscussionbelowforguidanceonaccountingforagoodorservicesatisfiedovertime.
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DeliveryHasOccurred(continued)
Ifaperformanceobligationdoesnotmeetthecriteriaforsatisfactionovertime,itissatisfiedatapointintime.TheproposedASUstatesthatindicatorsthatcontrolofanassethasbeentransferredtoacustomeratapointintimeinclude,butarenotlimitedto,thefollowing:
• “Theentityhasapresentrighttopayment.”
• “Thecustomerhaslegaltitle.”
• “Theentityhastransferredphysicalpossession.”
• “Thecustomerhasthesignificantrisksandrewardsofownership.”
• “Thecustomerhasacceptedtheasset.”(37)
CustomerAcceptance
Softwarearrangementsoftenincludespecificcustomeracceptanceprovisions;ASC985-605indicatesthatifthecustomer’sacceptanceofthesoftwareisuncertain,revenueshouldnotberecognizeduntilacceptanceoccurs.Further,ifpaymentforthesoftwareistiedtocustomeracceptance,theacceptanceprovisionwouldbepresumedsubstantive.Therefore,providedthatallotherrequirementsforrevenuerecognitionhavebeenmet,revenuerecognitionwouldbeprecludeduntilpaymentismadeordueunlessthatpresumptionisovercome.
Customeracceptanceisoneoftheindicatorsthatanentitymustconsiderindeterminingthepointintimeatwhichcontrolistransferredforagoodorserviceprovidedtoacustomer.(37e)Theeffectoftheacceptanceclausesondeterminingwhetheracustomerhasobtainedcontrolofapromisedgoodorservicedependsonwhetheranentitycanobjectivelydeterminethatagoodorservicehasbeentransferredtothecustomerinaccordancewiththeagreed-uponspecificationsinthecontract.“Ifanentitycanobjectivelydeterminethatcontrolofagoodorservicehasbeentransferredtothecustomerinaccordancewiththeagreed-uponspecifications,”thecustomeracceptanceprovisionswouldnotaffectthedeterminationofcontroltransfer.Ifanentitycannotobjectivelymakethisdetermination,itwouldnotbeabletoconcludethatithasobtainedcontroluntilitreceivesthecustomer’sacceptance.(IG55–IG58)
ItisnotlikelythattheseprovisionsoftherevisedEDwillhaveasignificantimpactsincetheyareconsistentwithcurrentpractice.However,therevisedEDdoesnotincludeapresumptionthatthecustomer’sacceptanceprovisionsaresubstantiveiftheyaretiedtopayment,whichcouldaffectthetimingofrevenuerecognition.
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KeysorAuthorizationCodes
Insoftwarearrangementsinvolvingtheuseofkeys,avendorisnotnecessarilyrequiredtodeliverakeytofulfillitsdeliveryresponsibility.Thesoftwarevendorrecognizesrevenueondeliveryofthesoftwareifallofthefollowingconditionsaremet(providedthatallotherrequirementsforrevenuerecognitioninASC985-605aremet):
• “Thecustomerhaslicensedthesoftwareandthevendorhasdeliveredaversionofthesoftwarethatisfullyfunctionalexceptforthepermanentkeyortheadditionalkeys(ifadditionalkeysareusedtocontrolthereproductionofthesoftware).”
• “Thecustomer’sobligationtopayforthesoftwareandthetermsofpayment,includingthetimingofpayment,arenotcontingentondeliveryofthepermanentkeyoradditionalkeys(ifadditionalkeysareusedtocontrolthereproductionofthesoftware).”
• “Thevendorwillenforceanddoesnothaveahistoryoffailingtoenforceitsrighttocollectpaymentunderthetermsoftheoriginalarrangement.”(ASC985-605-25-28)
Acustomerobtainscontrolofagoodorservicewhenthecustomerhastheabilitytodirecttheuseof,andreceivethebenefitfrom,thegoodorservice.Whenaperformanceobligationdoesnotmeetthecriteriatobesatisfiedovertime,itissatisfiedatapointintime.TheproposedASUstatesthatindicatorsthatcontrolofanassethasbeentransferredtoacustomeratapointintimeinclude,butarenotlimitedto,thefollowing:
• “Theentityhasapresentrighttopayment.”
• “Thecustomerhaslegaltitle.”
• “Theentityhastransferredphysicalpossession.”
• “Thecustomerhasthesignificantrisksandrewardsofownership.”
• “Thecustomerhasacceptedtheasset.”(37)
Inthesecircumstances,anentityneedstoevaluatewhetherthecustomerhastheabilitytodirecttheuseof,andreceivebenefitfrom,thegoodorserviceundertheproposedstandard.Ifthesoftwaredoesnotfunctionwithoutthekeysorcodes,thetreatmentwouldbesimilar.
Anentitywillalsoneedtoevaluatethespecificfactsandcircumstancesassociatedwiththeuseofkeysandhowtheyaffecttheevaluationofwhetherthecustomerhasobtainedcontrolofthegoodorservice.Forexample,ifthekeyisusedsolelytoprotectagainstthecustomer’sfailuretocomplywiththetermsofthecontract,controlmaystillhavebeentransferred;however,ifthekeyisusedtocontroltheuseforatrialperiodorfordemonstrationpurposes,thencontrolmaynothavebeentransferredtothecustomer.
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ResellerArrangementTerms
Forresellerarrangements,ifanyofthefollowingfactorsorconditionsexist,theyarealsoconsideredintheevaluationofwhethertherevenuerecognitioncriteriaforfixedordeterminablefeeandcollectibilityaremet:
• Businesspractices,thereseller’soperatinghistory,competitivepressures,informalcommunications,orotherfactorsindicatethatpaymentissubstantiallycontingentonthereseller’ssuccessindistributingindividualunitsoftheproduct.Contractualarrangementsunderwhichtheresellerisobligatedtopayonlyasandifsalesaremadetousersareaccountedforasconsignments.
• Resellersarenew,undercapitalized,orinfinancialdifficultyandmaynotdemonstrateanabilitytohonoracommitmenttomakefixedordeterminablepaymentsuntiltheycollectcashfromtheircustomers.
• Uncertaintiesaboutthepotentialnumberofcopiestobesoldbytheresellermayindicatethattheamountoffuturereturnscannotbereasonablyestimatedondelivery.Examplesofsuchfactorsincludethenewnessoftheproductormarketingchannel,competitiveproducts,ordependenceonthemarketpotentialofanotherproductoffered(oranticipatedtobeoffered)bythereseller.
• Distributionarrangementswithresellersrequirethevendortorebateorcreditaportionoftheoriginalfeeifthevendorsubsequentlyreducesitspriceforaproductandtheresellerstillhasrightswithrespecttothatproduct(sometimesreferredtoaspriceprotection).Ifavendorisunabletoreasonablyestimatefuturepricechangesinlightofcompetitiveconditions,orifthereissignificantuncertaintyregardingthevendor’sabilitytomaintainitsprice,thearrangementfeeisnotfixedordeterminable.Insuchcircumstances,revenuefromthearrangementisdeferreduntilthevendorisabletoreasonablyestimatetheeffectsoffuturepricechangesandtheotherconditionshavebeensatisfied.
“Whenanentitydeliversaproducttoanotherparty(suchasadealeroradistributor)forsaletoendcustomers,theentity[evaluates]whether[thedealerordistributor]hasobtainedcontroloftheproductatthatpointintime”inaccordancewithparagraph37.(IG49)
“Inventoryonconsignmenttypicallyiscontrolledbytheentityuntilaspecifiedeventoccurs,suchasthesaleoftheproducttoacustomerofthedealer,oruntilaspecifiedperiodexpires.Untilthatpoint,theentitytypicallyisabletorequirethereturnoftheproductsortotransferthemtoanotherdealer.Moreover,thedealertypicallydoesnothaveanunconditionalobligationtopayfortheproducts(althoughitmightberequiredtopayadeposit).Accordingly,inthosecircumstances,theentitywouldnotrecognizerevenueupondeliveryoftheproductstothedealer.”(IG50)
ThefactorsinASC985-605-25-36concernspecifictermsofthecontractthatwouldprecludeanentityfrombeingabletoassertthatitsfeeisfixedordeterminableandcollectibilityisprobableandthatitthuswouldpreventrevenuerecognition.UndertherevisedED,manyofthesefactorsandconditionswouldnotaffectthetimingorrevenuerecognitionbutwouldinsteadaffectthedeterminationofthetransactionprice(e.g.,priceprotectionclauses,extendedpaymentterms)orcollectibilityadjustments(reseller’sabilitytopay).
Asaresultofthesedifferences,thetimingandmeasurementofrevenuerecognitionundertherevisedEDmaybedifferentfromcurrentpractice.
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RightstoExchangeorReturnSoftwareProducts
Rightofexchange—Acustomer’srighttoexchangeistherighttoreplaceasoftwareproductforanothersoftwareproductthathasnomore-than-minimaldifferencesinprice,functionality,orfeatures.Forthetransactiontobeaccountedforasanexchange,thecustomershouldnothavetherighttocontinueusingtheoriginalproduct.
Inaccountingforarightofexchange,avendordoesnotreducerevenueforexpectedcustomerexchanges;however,theestimatedcostsofexecutingsuchexchangesshouldbeaccruedinaccordancewithASC450-20.
Rightofreturn—Acustomer’srighttoreturnistherighttoreturnasoftwareproductforarefund(ortoexchangeasoftwareproductforanotherproductthathasmore-than-minimaldifferencesinprice,functionality,orfeatures).Inaccountingforarightofreturn,avendormustbeabletoreasonablyestimateexpectedproductreturnswhenrecognizingrevenue.InamannerconsistentwithASC605-15-25-1through25-4,revenuerecognizedshouldbereducedtoreflecttheestimatedreturnsandtheestimatedcostsofexecutingsuchreturnsshouldbeaccruedinaccordancewithASC450.Ifthevendorisunabletoreasonablyestimatereturns,revenuemustbedeferreduntilareasonableestimatecanbemadeortherightofreturnhaslapsed.
Rightofexchange—“Exchangesbycustomersofoneproductforanotherofthesametype,quality,condition,andprice(forexample,onecolororsizeforanother)arenotconsideredreturns”undertheproposedrequirements.(IG8)
Rightofreturn—Anentityrecognizesthefollowingfortransferredproductswitharightofreturn:
• Revenueforproductstransferredthattheentityisreasonablyassuredwillnotbereturned.
• Arefundliability(amountofconsiderationexpectedtoberefunded).
• Anasset(andequaladjustmenttocostofsales)fortheentity’srighttorecoverthetransferredgoodsuponsettlingtherefundliability.(IG3)
Ifanentityisnotreasonablyassuredofthequantityofgoodstobereturned,theentitymustrecognizeanyconsiderationreceivedasarefundliability(andshouldnotrecognizerevenue).Insuchcases,theentityrecognizesrevenuewhenitdeterminesthatitisreasonablyassuredofthequantityofgoodsthatwillnotbereturned.(IG7)
Anentityupdatesthe“measurementoftherefundliabilityattheendofeachreportingperiodforchanges.”(IG6)
TheguidanceinASC985-605andtheproposedguidanceappeartobesimilar;thus,itisnotlikelythatthisprovisionwillhaveasignificantimpact.
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RecognitionofPCSRevenueUponDeliveryoftheRelatedSoftware
PCSrevenuemayberecognizedupondeliveryoftherelatedsoftwareproductifthefollowingcriteriaaremet:
• ThePCSfee“isincludedwiththeinitiallicensingfee.”
• ThePCSisincludedwiththeinitiallicensingfee“foroneyearorless.”
• The“estimatedcostofproviding[PCS]duringthearrangementisinsignificant.”
• “Unspecifiedupgradesorenhancementsofferedduring[thePCSarrangement]historicallyhavebeenandareexpectedtobe...minimalandinfrequent.”(ASC985-605-25-71)
Revenueshouldberecognizedforeachseparateperformanceobligationupontransfertothecustomer(whichmayoccuratapointintimeoroveraperiodoftime).Typically,PCStransferstothecustomerovertime(i.e.,overastatedPCSperiod).
Anentitysatisfiesaperformanceobligationovertimeifeitherofthefollowingoccurs:
• “Theentity’sperformancecreatesorenhancesanasset...thatthecustomercontrolsastheassetiscreatedorenhanced.”
• “Theentity’sperformancedoesnotcreateanassetwithanalternativeusetotheentity”andatleastoneofthefollowingcriteriaismet:
o “Thecustomersimultaneouslyreceivesandconsumesthebenefitsoftheentity’sperformanceas[it]performs.”
o “Anotherentitywouldnotneedtosubstantiallyreperformthework[performed]todateifthatotherentityweretofulfilltheremainingobligationtothecustomer.”
o “Theentityhasarighttopaymentforperformancecompletedtodateand[isexpected]tofulfillthecontract.”(35)
Revenueisrecognizedforseparateperformanceobligationsthataresatisfiedovertimebymeasuringtheentity’s“progresstowardcompletesatisfactionof[the]performanceobligation”inamannerthatbestdepictsthetransferofgoodsorservicestothecustomer.(38–40)TheproposedASUprovidesspecificguidanceontheuseandapplicationofanoutputmethodandaninputmethodformeasuringprogresstowardcompletion.(41–46)Theamountrecognizedislimitedtotheamounttowhichtheentityisreasonablyassuredtobeentitled.(81)
Revenueisallocatedtoeachseparateperformanceobligationonthebasisofitsrelativestand-alonesellingprice.ForPCS,thestand-alonesellingpricewouldgenerallybeestablishedby(1)separatesalesor(2)substantiverenewalrates.
TherevisedEDdoesnotincludeanexceptionthatallowsPCSrevenuerecognitionupondeliveryoftherelatedsoftware.SomeentitiesmayreachthesameaccountingconclusionwhentheydeterminethatthePCSfeeisnotmaterialinaccordancewithASC105(whichstatesthattheguidanceintheASCdoesnotneedtobeappliedtoimmaterialitems).However,anentitymaydeterminethatachangetocurrentaccountingiswarrantedonthebasisofitsevaluationofthethresholdinASC985-605regardingtheterms“insignificant”and“immaterial”inASC105.
32
ASC 985-605 Revised ED Likely Impact
DelayedStartforPCS ThePCStermofasoftwarearrangementmaynotbeginasofthedeliverydateofthesoftware(e.g.,PCSmaybeginafterinstallationortheexpirationofawarrantyperiod).Insuchsituations,(1)thePCSagreementtypicallyallowsthecustomertoreceiveanyupgradesorenhancementsreleasedbythevendorintheperiodbetweendeliveryofthelicenseandthebeginningofthePCSterm,and(2)thereisanimpliedPCSarrangementthatbeginsupondeliveryofthesoftware.
AportionofthefeeshouldbeallocatedtotheimpliedPCSarrangementonthebasisofVSOEoffairvaluefortheelementsinthearrangement.VSOEoffairvaluefortheimpliedPCSmaybederivedonaproratabasisfromtheVSOEoffairvalueofthecontractualPCSarrangement,particularlyPCSrenewalrates.
Goodsorservicesinacontractdonotneedtobeexplicitlystated;theymaybeimpliedonthebasisofanentity’scustomarybusinesspractices.(24)
IfacustomerisabletoreceiveupgradesorenhancementsreleasedbytheentityintheperiodbetweendeliveryofthelicenseandthebeginningofthecontractualPCSterm,animpliedPCSserviceobligationmostlikelyexists.AnentityshoulddeterminewhetherthePCSmeetsthecriteriaforaseparateperformanceobligationand,ifso,allocaterevenuetoitonthebasisofitsrelativestand-alonesellingprice.RevenueshouldberecognizedbyusingthemethodthatbestdepictsthetransferofthePCStothecustomer(totheextentthatitisreasonablyassured).
UnlikeASC985-605,theproposaldoesnotcontainprescriptiveguidance;however,theprinciplesintherevisedEDwouldmostlikelyresultinsimilaraccounting,soitisnotlikelythatthenewprovisionswillhaveasignificantimpact.
Services Certainarrangementsincludebothsoftwareandserviceelements(otherthanPCS-relatedservices).Theservicesmayincludetraining,installation,orconsulting.Consultingservicesoftenincludeimplementationsupport,softwaredesignordevelopment,orthecustomizationormodificationofthelicensedsoftware.
Ifanarrangementincludessuchservices,anentitydetermineswhethertheserviceelementcanbeaccountedforseparatelyastheservicesareperformed.ASC985-605-25-78discussesthecriteriathatanentitymustconsiderinmakingsuchadetermination.Ifthenatureoftheservicesissuchthattheserviceelementdoesnotqualifyforseparateaccountingasaservice,theentityappliescontractaccountingtoboththesoftwareandserviceelementsofthearrangement.ASC985-605-25-88through25-107addresstheapplicationofcontractaccountingtosoftwarearrangements.
Revenueshouldberecognizedforeachseparateperformanceobligationupontransfertothecustomer(whichmayoccuratapointintimeoroveraperiodoftime).
Anentitysatisfiesaperformanceobligationovertimeifeitherofthefollowingoccurs:
• “Theentity’sperformancecreatesorenhancesanasset...thatthecustomercontrolsastheassetiscreatedorenhanced.”
• “Theentity’sperformancedoesnotcreateanassetwithanalternativeusetotheentity”andatleastoneofthefollowingcriteriaismet:
o “Thecustomersimultaneouslyreceivesandconsumesthebenefitsoftheentity’sperformanceas[it]performs.”
o “Anotherentitywouldnotneedtosubstantiallyreperformthework[performed]todateifthatotherentityweretofulfilltheremainingobligationtothecustomer.”
o “Theentityhasarighttopaymentforperformancecompletedtodateand[isexpected]tofulfillthecontract.”(35)
TherevisedEDislessrestrictivethancurrentguidancebecauseitremovestherequirementthatVSOEoffairvaluemustexistbeforeagoodorserviceinamultiple-elementcontractmaybetreatedasaseparateunitofaccounting.UndertherevisedED,servicesthatpreviouslywerebundledmayqualifyforseparationandberecognizedastheserviceobligationsaresatisfied.TherevisedEDwilllikelyincreasethenumberofaccountingunits.
33
ASC 985-605 Revised ED Likely Impact
Services(continued) • Theservicesarenotessentialtothefunctionalityofanyotherelementofthetransaction.
• Theservicesaredescribedinthecontractsuchthatthetotalpriceofthearrangementwouldbeexpectedtovaryastheresultoftheinclusionorexclusionoftheservices.
IfanarrangementincludesservicesthatmeetthecriteriaofASC985-605-25-78forseparateaccounting,revenueisallocatedamongtheserviceandsoftwareelementsofthecontract.ThisallocationshouldbebasedonVSOEoffairvalues.(Fairvaluesarenotnecessarilythesameasanyseparatepricesstatedfortheseparateelementsofthearrangement.)Revenueallocatedtotheserviceelementisrecognizedastheservicesareperformedor,ifnopatternofperformanceisdiscernible,onastraight-linebasisovertheperiodduringwhichtheservicesareperformed.
Revenueisrecognizedforseparateperformanceobligationsthataresatisfiedovertimebymeasuringtheentity’s“progresstowardcompletesatisfactionof[the]performanceobligation”inamannerthatbestdepictsthetransferofgoodsorservicestothecustomer.(38–40)TheproposedASUprovidesspecificguidanceontheuseandapplicationofanoutputmethodandaninputmethodformeasuringprogresstowardcompletion.(41–46)Theamountrecognizedislimitedtotheamounttowhichtheentityisreasonablyassuredtobeentitled.(81)
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