Revenue Recognition Regulations Webinar, Primer, & Best Practices
The landscape of revenue recognition for many firms has changed, such as the result of the new EITF 08-01 and EITF 09-03 rules. It is critical that corporate finance and accounting professionals understand how to maximize the efficiency of their overall revenue recognition processes, implement practices to reduce
This Revenue Recognition Regulations Webinar video is from the Proformative webinar "Revenue Recognition Primer, Regulatory Update and Best Practices" held on September 16, 2011. The webinar features presentations from Timothy Perotti, Partner, Frank, Rimerman + Co. LLP and Eileen Tobias, Senior Director of
Revenue Recognition Regulations Webinar
When John contacted me and said "Hey, I'd like you to spend a little bit of time on software revenue recognition, the new multiple element rules, and maybe touch on what's coming down the pipe from a revenue recognition perspective, and, oh, by the way, we want you to do it in 20 minutes," I said, "Yeah, that's not a problem."
I always appreciate too the way the Proformative runs these seminars too, keeping people on, on task and on time. With that, to the extent that anyone wants to dig a little deeper through the Q&A session at the end, or if you want to follow up after this webinar with me, my contact information is listed through Proformative as well. So thank you very much.
Let's see here. As we move down the points of discussion, what I wanted to do was to spend just a few minutes touching on the general revenue recognition and software revenue recognition rules, then move into the new multiple element arrangement rule. So this is the, originally issued as
the pipe, just because that is in exposure draft, which provides exposure draft to come shortly.
Just again, a touchpoint here on the general revenue recognition criteria. So as, again, as it relates to -- any sort of arrangement must have persuasive evidence of arrangement. So that's typically a contract, purchase order, something along those lines. Delivery has to have occurred, fees, big store determinable, and collectability assured, so we assume you're going to be paid for your services or delivery of goods.
And then, as we move on to the software piece, a lot of the emphasis of SOP 97-2 when it was introduced had to do with the concept of multiple element arrangements. And so to the extent that you've got the concept of bender-specific objective evidence, that was first broached in SOP 97-2 and further clarified in EITF 00-21. And we'll touch on some of the new references, if you will, of post-codification here in a little bit.
So as we move from the software revenue recognition guide -- and so essentially, the literature as it relates now on the top of 985, originally in 97-, SOP 97-2, applies to licensing, leasing or marketing of computer software. So essentially, it applies when the software is essential to the functionality or not incidental to the product or service being delivered.
So these are the wonderful examples that we were walked through when we were first getting an understanding of the software revenue recognition rules, the examples being an automobile or a large test system that includes software but the cost of putting the software in or the functionality of a customer's perspective is incidental to the product they're buying. So in those situations, the software revenue recognition guidelines did not apply. So again, we're looking at situations where the software is essential to the functionality.
Sp again, one of the key concepts coming out of SOP 97-2 dealt mostly with how to handle multiple element arrangements. So as you see on the screen here, we've got just some typical examples of the elements that are usually found within software arrangements.
So if you look partway down the screen, the most common example would be a company that licenses software also has a degree of PCS, be it the delivery of any upgrades or enhancements when available. So again, these are unspecified upgrades or enhancement when they become available in theconcept of
But I think the key concept again is looking for this idea of vendor-specific objective evidence, the concept of fair value as it relates to any elements that are not delivered at the outset of the arrangement, be it an enterprise license that's delivered and then you have the follow-on professional services and any PCS, so being able to identify fair value for those undelivered elements at the inception of those agreements. And if you can't, then you need to defer the entire agreement over the period of time.
So, for example, if you have VSOE on your PCS but not on your professional services, then you need to defer the license over that professional services period. If you have VSOE on both PCS and professional services, then you can recognize your license up front and then recognize both the professional services and the PCS arrangement according to their terms as those services are provided.
So what I wanted to do here was to spend a couple minutes on what I call the common questions or common issues that come up within our
I think to the extent that anyone wants to have a discussion or has some questions on the specific parts of 97-2, again, we can do that in the Q&A, but at the same time I know a lot of the general rules have been hit in great detail, so we're spending a little bit more time walking through just some real-world examples, if you will, the first being the situation where software is sold with hosting services. So there, you go through a couple different decision points, if you will.
So the first is does the software revenue recognition guidance even apply. So this is the idea -- and I'll speak in pre-codification references, if you will. So is software SOP 97-2 going to apply, or EITS 00-3, which is their subscription account?
So as you're taking a look at the hosting arrangement, the extent that the customer can go ahead and take the software in-house as the literature defined, without incurring significant penalty, is further defined to be incurring a large amount of cost to go ahead and install and run that software in-house. So to the extent that they have the ability to do that without incurring a significant penalty, then the software revenue recognition rules would apply. So 97-2 rules do apply.
To the extent that they can't and the software needs to be hosted on the vendor's system and there's not an ability for the customer to take it in-house, then former EITS 00-3, essentially subscription accounting, applies.
Editor's Note: Take a look at the Proformative library of recorded
So then when you look at it a bit further to the extent you're under the 97-2 rules, if you have VSOE, so if you have fair value on your hosting services, you're able to recognize the license piece up front. And if you don't have VSOE on your hosting services, then you have to recognize the licensing and hosting together over the term of the arrangement.
Where this gets a little different is if you're outside of the software revenue recognition guide and still under the old subscription accounting, 003, and to the extent that the concept of VSOE isn't going to come into play. So essentially, the entire deal has to be recognized, the license and the hosting piece over the subscription period. So again, that's a little nuance in VSOE as it applies to 97-2 as opposed to the old subscription accounting.
The next item here on the screen is the specified versus unspecified updates and enhancements and the impact on revenue recognition. So the idea there is, to the extent of the inception of an agreement, you have a specified deliverable. So you've agreed in that arrangement to either deliver the next version that's not available at this point or a number of user likenesses or something along those lines. That becomes a separate element to your arrangement.
And as it's not delivered at the outset when you deliver the license, you need to have VSOE or fair value on that element. To the extent you do not, then you have to defer that license and defer that arrangement until you can go ahead and either obtain VSOE on those specified deliverables or until you go ahead and deliver them.
And what's more common is to have unspecified updates and enhancements, which are part of your closed-contract customer support or your PCS arrangement, the idea being there that the arrangement with the customer, to the extent that you come up with something in updates or enhancements or otherwise, that those will be delivered as part of the PCS arrangement.
In those situations, those unspecified at the onset of the arrangement are part of the PCS agreement. So to the extent you have VSOE on the PCS arrangement, then that plays in, as we talked about a little earlier, in terms of being able to carve out and recognize the license piece a bit earlier.
The last point I had on here has to do with the vendor-specific objective evidence of PCS and professional services and how that impacts your revenue recognition. So again, the methods to testing from an internal perspective are your bell-shaped curve and your stated renewal rate, the idea being in the bell-shaped curve analysis that you have the situation where customers are renewing their PCS on an annual basis. And to the extent you aggregate those renewals, which are standalone sales of PCS, if you can get a clustering..."
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