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Anyone have experience with hardware that has software rev rec issues?

My company is developing some hardware (can't disclose right now) that is connected online and will receive continuous software updates. I'm being told that we will have to recognize revenue ratably over the expected life of the hardware. Does anyone have experience dealing with this? What are the main considerations for my rev rec and how should I steer this conversation with our auditor?

Answers

Topic Expert
John Kogan
Title: CEO/CFO
Company: Proformative, Inc.
(CEO/CFO, Proformative, Inc.) |

Jeff, I was at a company that sold hardware w/ continual software updates via the net. Absolutely no getting away from SOP 97-2 treatment in that instance assuming the software updates are more than just bug fixes. If it's bug fixes you are providing then you can argue that there are no new features or functionality being delivered and there is a reasonable expectation that the sale is complete when the hardware is delivered. Is that what's going on or is it more about delivering new features, etc. to the customer?

Jeff Taylor
Title: CFO
Company: Communications Co.
(CFO, Communications Co.) |

New features, functions, the whole 9 yards. I already went through that much with the auditor. It's pretty clear we're stuck with this.

Topic Expert
John Kogan
Title: CEO/CFO
Company: Proformative, Inc.
(CEO/CFO, Proformative, Inc.) |

So basically what you have is a multi-element sale with undetermined future deliverables. There is a promise of sorts between your company and your customer that they will get more, but you don't know what and you don't know when. There are a few points of attack that I recall (although it's been a while, so I may be rusty).

You could charge for software upgrades. I know most companies don't want to do this, and Apple pretty famously got burned for charging for a firmware update for some version of the ipod b/c without that they would have had to unwind all of their prior ipod rev rec. Since then they have gone to 2 year straight line (I believe, you can look at their annual report b/c they disclose their policy). So Apple decided to bail on the whole charging thing and just take the deferred revenue over 2 years, but you don't have to. If you charge for software upgrades (there's also a whole upgrade vs. update debate) you can recognize your hardware revenue in the standard fashion and you have a separate software sale when you sell the upgrade. This also presumes that your hardware works as advertised when it ships. If not, you've got other issues.

The other alternative that I recall (please chime in anyone) is amortizing the revenue over a reasonable period of time. "Reasonable", as we know, that's a very loaded word in the GAAP world. For us (and our auditors) it meant over the reasonable expected life of the product. We based our argument for two years on a)the expected life of the physical hardware, b)the expected life from the customer's perspective and the idea that they would want to upgrade to a newer, higher-performing generation of product after two years, and c)user churn - the idea that some customers would buy the hardware, use it for a few weeks or months and then basically turn it off.

As a comp we had the very public Apple decision to amortize over 2 years. Our product was not a music player, but had enough similar aspects that our auditors bought the combined argument. History will tell whether that all holds up and I am sure they will be looking to test all of our assumptions come years 2 and 3.

Mark Stokes
Title: CFO
Company: Private
(CFO, Private) |

Here's a good article on 97-2 which hits some of the issues you are probably seeing. http://www.thefreelibrary.com/Software+revenue+recognition+on+the+rise:+technology+boom+expands...-a0173554521

Kim Lowney
Title:
Company:
(, ) |

There is a new EITF out there that could impact your revenue recognition. See EITF June minutes. The EITF just had another meeting in September. I didn't see the minutes yet but I may be worth will to take a look at to see if impacts you. They are leaning more towards IFRS and the EITF does impact 97-2.

Jeff Taylor
Title: CFO
Company: Communications Co.
(CFO, Communications Co.) |

That is very good to know. I will keep an eye out.

Topic Expert
Sunil Thukral
Title: Controller/Technical Accounting Advisory..
Company: Consultant
(Controller/Technical Accounting Advisory/ SEC Reporting, Consultant) |

Hi Jeff.....I am posting the link to the two new documents that were added to the US GAAP codification.

Update No. 2009-14—Software (Topic 985): Certain Revenue Arrangements That Include Software Elements—a consensus of the FASB Emerging Issues Task Force

Update No. 2009-13—Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force

The above are available at http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498

These ASU were issued to codify the EITF decisions. If you need any additional help do let me know.

Robert Holland
Title:
Company:
(, ) |

Jeff
I have a very fundamenatl Revenue Recognition "recipe" or derived right from GAAP. Since you have a direct need for proper accounting treatment and discussion with the auditors.

There are actually three principles of Accounting that need to be addressed, and I believe John (above touched on them.)
You have the Revenue recognition principle that states that revenue is recognized when earnings process is comple or substantially complete. You have the matching principle that states that all costs and expenses should be allocated to their respected revenue source. You also have the Conservatism principle that state losses are recognized as soon as they are predictable or made certain.

By the way you have the IRS position which is different yet as to realized revenue verses Recognized revenue. However these are always M-1 adjustments and tend to reverse itself over time.

I believe if you want a simple answer to a complex principle then you attempt to speak with your accounting firm along these issues of public practice and policy.

I hope this helps.

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