Splitting "i" from the Phone – New Rules on Revenue Recognition for Tech Companies

 

The next time you buy an Apple iPhone or Palm Pre, your $200 will appear much sooner in Apple Inc. or Palm, Inc.’s revenue line and give the manufacturer a stronger boost on its current period earnings.

An accounting rule change approved unanimously by the Financial Accounting Standards Board (FASB) on September 23, 2009 will allow companies to recognize revenues sooner on complicated products that bundle hardware, software and services. With technological advances in recent years, the old rule on software revenue recognition (SOP 97-2) was capturing many products that are 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 up-front cash receipts by the distributor and the receipt of the device and software by the ultimate user. The inconsistency between accounting rules and the economics of the arrangement frustrated technology companies for years.

The new rule modifies the scope of SOP 97-2 by excluding any tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from software revenue recognition. Thus, companies will be able to unbundle the software and hardware components, and book more of the revenue when the product is sold. Among the technology companies that submitted comment letters to the FASB that supported the rule changes were Apple, Palm, Cisco Systems Inc., Dell Inc., International Business Machines Corp., Xerox Corp. and Hewlett-Packard Co.

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 approved new guidance that will allow the use of "best estimate of selling price" as an alternative to third-party evidence (TPE – previously referred to as vendor specific objective evidence, VSOE, or vendor objective evidence, VOE). Indeed, companies can no longer use the residual method when allocating the consideration to different deliverables.

The challenge is certainly more than just learning the new acronyms. Companies will need to embrace system or process changes when developing, documenting, and supporting management’s best estimates of selling price. Nevertheless, the new model should result in a better reflection of the economics of the transaction and therefore more transparency in accounting and financial reporting.

The above new accounting rules take effect for fiscal years beginning on or after June 15, 2010, but earlier application is permitted as of the beginning of a company’s fiscal year provided the company has not previously issued financial statements for any period within that year.

For more details on the accounting rules and assessment of entity-specific revenue recognition policy, please contact your Eisner engagement partner.

 

^{1 EITF 09-3, Applicability of SOP 97-2 to Certain Arrangements that Include Software Elements 2 SOP 97-2, AICPA Statement of Position 97-2, Software Revenue Recognition (ASC Topic 985-605) 3 EITF 08-1, Revenue Recognition with Multiple Deliverables}