The next time you buy a smart phone or PDA, your $200 may appear much sooner in the seller’s revenue and give them a stronger boost in their current period earnings.
Scope Clarification for Software Revenue
An accounting rule change, Accounting Standards Update (ASU) 2009-14, Certain Revenue Arrangements that Include Software Elements (previously exposed as EITF Issue No. 09-3), issued by the Financial Accounting Standards Board (FASB) on October 7, 2009, will likely allow companies to recognize revenues sooner on products that bundle hardware, software and services. With the technological advances which have been made in recent years, the rules on software revenue recognition (Accounting Standards Codification (ASC) Topic 985, Software, incorporating previous guidance under SOP No. 97-2) were capturing many products that were not traditional software products, such as smart phones and other software-enabled devices. This often resulted in a deferral of revenue recognition for these products, despite the upfront cash receipts by the company and the receipt of the device and included software by the customer. The inconsistency between accounting rules and the economics of the arrangement has frustrated technology companies for years.
ASU 2009-14 modifies ASC Topic 985 by excluding from its scope (1) non-software components of tangible products and (2) any tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from software revenue recognition rules. Thus, companies will be able to unbundle and recognize the revenue separately for the software and non-software components (see the following discussion on ASU 2009-13.) The guidance also provides a list of factors that a vendor should consider in determining whether a tangible product is delivered with software components and non-software components that function together to deliver the tangible product’s essential functionality.
Arrangements with Multiple Deliverables
A related significant change in revenue recognition will affect companies that provide multiple products or services (“deliverables”) to their customers in a single arrangement. The FASB issued new guidance in ASU 2009-13, Multiple-Deliverable Revenue Arrangements (previously exposed as EITF Issue No. 08-1), that will allow companies to allocate consideration in multiple-deliverable arrangements by allowing the use of a “best estimate of selling price” in addition to third-party evidence (TPE) (previously referred to as vendor-specific objective evidence VSOE or vendor objective evidence VOE). Because companies will now be required to identify all the deliverables in an arrangement and all deliverables will be separate units of accounting, the residual method of allocating consideration for multiple-deliverable arrangements is no longer permitted under ASU 2009-13.
The challenge is certainly more than just learning the new acronyms. Companies will need to embrace system and process changes when developing, documenting, and supporting management’s best estimate of selling price. The new guidance also includes new and significant ongoing disclosure requirements. Companies with multiple-deliverable arrangements are required to provide both qualitative and quantitative information necessary for a user of the financial statements to understand the revenue arrangements, the significant judgments made, and changes in those judgments that may significantly affect the timing or amount of revenue recognition.
Effective Date and Transition
The above new accounting rules are effective prospectively for arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Specific transition disclosures for multiple-deliverable revenue arrangements are required in the initial year of adoption. Companies that elect to apply the software revenue recognition guidance prospectively should also provide the transition disclosures required by the new guidance on multiple-deliverables.
Early adoption is permitted. If a company elects early application in an interim period other than the beginning of its fiscal year, it should apply the guidance on multiple-deliverables retrospectively for all prior reporting periods of that fiscal year. However, if applicable, the guidance on software revenue recognition must be adopted in the same period that the guidance on multiple-deliverables is adopted.
Alternatively, companies may elect to apply the new guidance retrospectively pursuant to ASC Topic 250, Accounting Changes and Error Corrections (previously known as FASB Statement No. 154,) and provide the applicable disclosures required by ASC Topic 250.