Specified Upgrade Rights & Specified Additional Software Product

If a vendor agrees to deliver specified additional software products in the future, the revenue attributable to the additional software products would be accounted for a separate element of the arrangement, even if the rights to the additional software products were included in the terms of a PCS agreement. Additional Software Deliverables and Rights to Exchange or Return Software

• As part of a multiple-element arrangement, a vendor may agree to deliver software currently and to deliver additional software in the future. The additional deliverables may include upgrades/enhancements or additional software products. Additionally, a vendor may provide the customer with the right to exchange or return software, including the right to transfer software from one hardware platform or operating system to one or more other platforms or operating system (a platform-transfer right)
• Upgrades/enhancements. As part of a multiple-element arrangement, a vendor may agree to deliver software currently and provide the customer with an upgrade right for a specified upgrade/enhancement. The upgrade right may be evidenced by a specific agreement, commitment, or the vendor's established practice. (Rights to receive unspecified upgrades/enhancements on a when-and-if-available basis are PCS, as it has been redefined in this SOP.)

Specified Upgrade Right Versus Specified Additional Software Product - specified upgrade rights differs from the amount of revenue allocated to a specified additional software product. Determining if a software deliverable is an upgrade/enhancement or a product, the vendor should consider carefully the specific facts and circumstances on a case-by-case basis. Factors to consider would include the following:

1. The significance of the differences in the features and functionality of the new deliverable from the vendor's existing products.
2. Replacement of existing products - if the new deliverable is intended to substantially replace the vendor's existing products.
3. The extent of development activities - if the new deliverable required a significant development effort, that may indicate that the deliverable is a product rather than an upgrade/enhancement.
4. The relationship of the price of the new deliverable to the pricing for the vendor's existing products, including price discounts to existing customers - if the new deliverable is priced at an amount that is significantly higher than the price of the vendor's existing products, or if the existing users of the vendor's products are offered no discount or only an indicate that the deliverable is a product rather than an upgrade/enhancement.
5. The manner in which the new deliverable is marketing.
6. The product's name.

Rights to Specified Additional Undelivered Software Products - 97-2 distinguishes between the right to receive specified additional software products and the right to receive unspecified additional software products. A right to receive specified additional software products is accounted for as a separate element, which a right to receive unspecified additional software products is accounted for as a subscription. The SOP provides the following guidance:

• Additional Software Prodcuts. As part of a multiple-element arrangement, a vendor may agree to deliver software currently and deliver specified additional software products in the future. The rights to these additional products may be included either in the terms of a PCS arrangement or in a separate agreement. Even if the rights to the additional software products are included in a PCS arrangement, the revenue allocable to the additional software products should be accounted for separately from the PCS arrangement as an element of a multiple-element arrangement.

More-Than-Insignificant Discount and Software Revenue Recognition

A more-than-insignificant discount with respect to future purchases that is provided in a software arrangement is a discount that is: (1) incremental to the range of discounts reflected in the pricing of the other elements of the arrangement, (2) incremental to the range of discounts typically given in comparable transactions, and (3) significant. Other factors to consider in determining whether a discount is significant enough to conclude that an additional element is being offered in the arrangement would include the following:

1. Is the discounted product currently being sold in the marketplace, or is it a product under development that will be sold in the future? If the discounted product currently is sold in the marketplace at its normal, undiscounted selling price or is under development, that may indicate that the discounted product is a negotiated element of the current arrangement rather than a marketing strategy designed by the vendor (i.e., the vendor is giving up current value as opposed to eliminating slow-moving or obsolete inventory).
2. Do a large percentage of customers exercise the right to receive the additional product? If a significant percentage of customers exercise the right to receive the additional product, or historically, a significant percentage of customers have exercised the right to receive additional products in similar arrangements, that may indicate that the discounted product is a negotiated element of the current arrangement and, thus, should be considered an additional element of the arrangement.
3. Is the discount a function of the volume of purchases from the vendor? If the discount offered on a product is a funtion of the volume of purchases from the vendor, that may indicate that the arrangement is a marketing strategy similar to a rebate arrangement and, thus, the discounted product would not be considered an additional element of the arrangement. The discount offered is consistent with the discount that was likely to have been affered had the customer purchased the product in a single order.

Accounting for significant incremental discounts - If a software arrangement includes a right to a significant incremental discount on a customer's future purchase of a product(s) or service(s), a proportionate amount of that significant incremental discount should be applied to each element covered by the arrangement based on each element's fair value (VSOE) without regard to the significant incremental discount.

If (a) future product(s) or service(s) to which the discount is to be applied is not specified in the arrangement (for example, a customer is allowed a discount on any future purchases), or (b) the fair value of the future purchases cannot be determined but the maximum amount of the incremental discount on the future purchases is quantifiable, that quantifiable amount should be allocated to the elements of the arrangement and the future purchases assuming that the customer will purchase the minimum amount necessary to utilize the maximum discount.

Example - A software vendor sells Product A for $40 along with a right to a discount (the "coupon") of 50% off list price on any future purchases of its other software products, Products B through Z, with a maximum cumulative discount of $100. VSOE of fair value for Product A is $40 and VSOE of fair value for Products B through Z ranges from $20 to $100. The 50% discount is a significant incremental discount that would not normally be given in comparable transactions.

The vendor should assume that the maximum discount will be utilized. Therefore, the vendor would allocate the $100 discount across Product A and the assumed additional product to be purchased. The overall discount is 41.67% ($100/$240). Therefore, upon the delivery of Product A, the vendor would recognize $23.33 of revenue and defer $16.67. If the customer uses the discount by purchasing additional products with fair value totaling $200, the vendor would recognize $116.67 in revenue upon delivery of those products ($100 in cash received plus the $16.67 previously deferred). If the discount expires unused, the $16.67 in deferred revenue would be recognized at that time.

VSOE for a Group of Elements

A vendor may not sell separately all of the individual elements included in a multiple-element arrangement. However, the vendor may sell separately two or more of the software products included in the multiple-element arrangement. We believe that a software vendor can establish VSOE of fair value for a group of software products for purposes of allocating revenue to elements included ina multiple-element arrangement. Upon allocation of revenue to a group of software products, the revenue recognition provisions of SOP 97-2 should be applied as if the group were a single element (e.g., the delivery criterion cannot be met until all specified software products in the group have been delivered). Also, the vendor may use the residual method for purposes of allocating the arrangement consideration if VSOE of fair value exists for all of the undelivered elements.

Elements Sold at Varying Discounts

For element sold at varying discounts there is no specific amount that represents VSOE of fair value. We believe that an acceptable interpretation would be for a vendor to evaluate whether each element has VSOE of fair value by applying the following three-step approach:

1. Stratify the vendor's sales transactions into meaningful groups based on type of customer, volume of sales to customer (e.g., licensing arrangements > $X), geography, distribution channel, or other relevant groupings.
2. For each stratum, compile information about the amount charged in recent transactions when the element was sold separately. This information would reflect all separate sales of the element within the stratum during recent periods. In some cases, a software vendor may apply a random sampling approach to compile this information (i.e., when the number of specific sales within a stratum is substantial). We believe this approach is acceptable provided that the sampling methodology is statistically valid and representative of the population of the stratum as a whole.
3. For each stratum, analyze the information obtained in step 2 to determine whether the results fall within a reasonable range of prices that would represent VSOE of fair value. For example, we believe that a range of prices of the separate sales of an element within a stratum for which the lowest and highest price within the range are not more than 15% from the median price in the range and that range includes an amount approaching 80% of the sales transaction for that stratum, may be reasonable range of prices to represent that VSOE of fair value for the element exists for transactions within that stratum. However, it should be noted that this range does not constitute a safe harbor and there could be situations where it would be appropriate to conclude that VSOE of fair value does not exist, even though the pricing of separate sales of an element is within this range for tranactions within a particular stratum. All relevant facts and circumstances must be considered in making this determination.

Example #1 - ABC Corp sells Product A separately to its customers, but the price varies for different customers. ABC has determined that all customers that have purchased Product A constitute a single stratum. ABC has gathered the following information related to the separate sales of Product A.

Median sales price	$100,000
15% above median price	$115,000
15% below median price	$85,000
% of sales falling within $85k to $115k	84%

ABC has determined that VSOE of fair value exists for Product A.

Example #2 - ABC Corp sells Product A separately to its customers, but the price varies for different customers. ABC has determined that alll customers that have purchased Product A constitute a signle stratum. ABC has gathered the following information related to the separate sales of Product A.

Median sales price	$100,000
15% above median price	$115,000
15% below median price	$85,000
% of sales falling within $85k to $115k	60%

ABC has determined that VSOE of fair value does not exists for Product A.

Example #3 - ABC Corp, a software vendor, separately sells Product A, Product B, Product C at various amounts and frequently bundles two or more of the products together in one arrangement. ABC has historical evidence to demonstrate that substantially all of the separate sales of the products to this class of customer fall within the following acceptable ranges: Product A, $425,000 to $575,000; Product B, $5595,000 to $805,000; and Product C, $510,000 to $690,000. ABC considers any price stated in a multiple element arrangement which falls within the acceptable ranges for Products A, B, and C, respectively, to represent VSOE of fair value for each product.

ABC enters into an arrangement with Customer 1 to deliver Products A and B for a nonrefundable fee of $1,200,000, due at inception. The prices stated in the arrangement for Products A and B are $450,000 and $750,000 respectively. Because the prices stated in the arrangement for Products A and B fall within the acceptable range of prices for the two products, ABC considers the stated prices to be VSOE of fair value of the products for this transaction (however, the terms stated in the contract would not establish VSOE of fair value when evaluating another contract since the elements ar enot being sold separately in this arrangement). Accordingly, assuming that all other revenue recognition criteria have been met, ABC should recognize revenue of $450,000 upon the delivery of Product A, and $750,000 upon the delivery of Product B.

Example #4 - Assume the same facts as Exampel #3. ABC Corp enters into an arrangement with Customer 2 to deliver Products A, B and C for a nonrefundable fee of $1,700,000, due at inception. The prices stated in the arrangement for Products A, B and C are $450,000, $500,000 and $750,000, respecitvely. The price stated in the arrangement for Product A falls within its acceptable range of prices; however, the prices stated for Products B and C do not fall within their acceptable range of prices. For multiple-element outlier arrangements where the stated price for an element is outside the acceeptable VSOE-of-fair-value range, ABC's policy is to establish VSOE of fair value equal to the midpoint of the range. Therefore ABC would allocate the arrangement fee to the elements as follows:

Product	Fair Value	%	Revenue
A	$ 450,000	26%	$ 442,000
B	$ 700,000	40%	$ 680,000
C	$ 600,000	34%	$ 578,000
	$1,750,000	100%	$1,700,000

The prices stated in the arrangement for Product A falls within the acceptable range of prices , so that stated amount ($450,000) represents VSOE of fair value. However, the prices stated in the arrangement for Product B and Product C do not fall within their acceptable range of prices, so the midpoint price in each of their ranges ($700,000 and $600,000, respectively) is considered to be VSOE of fair value based on ABC's accounting policy for such outlier arrangements. Assuming that all other revenue recognition criteria have been met, the revenue allocable to Products A, B and C ($442,000, $680,000, and $578,000, respectively) would be recognized upon delivery of each product. However, this allocation of revenue maqy be subject to limitations (i.e., if a portion of the fee allocable to a delivered element is subject to forgeiture, refund, or other concession if any of the other elements are not delivered), depending on the terms of the arrangement and the order of delivery.

Example #5 - ABC Corp, a software vendor, separately sells Product B and Product C at various amounts and frequently bundles the two products together in one arrangement. ABC has historical evidence to demonstrate that substantially all of the separate sales of Product B and C to this class of customer fall within the following acceptable ranges: Product B, $595,000 to $805,000, and Product C, $510,000 to $690,000. ABC considers any price stated in a multiple-element arrangement that falls within the acceptable ranges for Product B and C, repectively, to represent VSOE of fair value for each product. ABC does not separately sell Product A and, as a result, does not have VSOE of fair value for that element. For multiple-element outlier arrangements where the stated price for an element is outside the acceptable VSOE-of-fair-value range, ABC's policy is to establish VSOE of fair value equal to the midpoint of the range.

ABC enters into an arrangement with Customer 3 to deliver Products A, B, and C for a nonrefundable fee of $1,700,000, due at inception. The prices stated in the arrangement for Products A, B, and C are $450,000, $750,000, and $500,000, respectively. Products A and B are delivered to Customer 3 prior to ABC's year-end and product C is delivered subsequent to year-end.

Because ABC has VSOE of fair value for the undelivered element (Product C), but does not have VSOE of fair value for all the delivered elements (there is no VSOE of fair value for Product A), revenue should be recognized using hte residual mthod. ABC should defer revenue for Product C based on VSOE of fair value. In this example, the $500,000 stated price does not fall within the range of prices that represents VSOE of fair value. Because VSOE of fair value for Product C is a reasonable range of prices, the midpoint price of the range ($600,000) is considered to be VSOE of fair value based on ABC's accounting policy for such outlier arrangements. Accordingly, residual arrangement considerations of $1,100,000 ($1,700,000 less $600,000) should be ascribed to the delivered elements (Products A and C) and recognized upon delivery assuming all other revenue recognition criteria are met.

Element #6 - ABC Corp, a software vendor, separately sells Products B and C at various amounts and frequently bundles the two products together in one arrangement. ABC has historical evidence to demonstrate that substantially all of the separate sales of Product B and C to this class of customer fall within the following acceptable ranges: Product B, $595,000 to $805,000, and Product C, $510,000 to $690,000. ABC considers any price stated in a multiple-element arrangement that falls within the acceptable ranges for Product B and C, respectively, to represent VSOE of fair value for each product. ABC does not separately sell Product A and, as a result, does not have VSOE of fair value for the product. For multiple-element outlier arrangements where the stated price for an element is outside the acceptable VSOE-of-fair-value range, ABC's policy is to establish VSOE of fair value equal to the outer limit of the range nearest to the stated price.

ABC enters into an arrangement with Customer 4 to deliver Products A, B, and C for a nonrefundable fee of $1,700,000, due at inception. The prices stated in the arrangement for Products A, B, and C are $450,000, $750,000, and $500,000, respectively. Products A and B are delivered to Customer 4 prior to ABC's eyear-end and Product C is delivered subsequent to year-end.

Because ABC has VSOE of fair value for the undelivered element (Product C), but does not have VSOE of fair value for all the delivered elements (there is no VSOE of fair value for Product A), revenue should be recognized using the residual method. ABC should defer revenue for Product C based on VSOE of fair value. In this example, the $500,000 stated prices does not fall within the range of prices that represents VSOE of fair value. Because VSOE of fair value for Product C is a reasonable range of prices, the outer limit of the range nearest to the stated price ($510,000) is considered to be VSOE of fair value based on ABC's accounting policy for such outlier arrangements. Accordinly, residual arrangement consideration of $1,190,000 ($1,700,000 less $510,000) should be ascribed to the delivered elements (Products A and C) and recognized upon delivery assuming all other revenue recognition criteria are met.

Establishing VSOE

SOP 97-2 specifies that revenue from an arrangement involving multiple elements should be allocated to the various elements based on VSOE of fair values. SOP 97-2 specifies that VSOE of fair value is limited to (i) the price charged by the vendor when the same element is sold seperately or (ii) if the element is not yet being sold separately, the price for each element established by the vendor's management having the relevant authority to establish such a price. If a vendor's management establishes a price for an element that is not yet being sold separately, the vendor should expect that the element will be sold separately (i.e., the price established for an element that the vendor does not have the ability and current intent to sell separately would not constitute VSOE of fair value for the element). Furthermore, if a vendor establishes a price for an element that is not yet being sold separately, it must be probably that the established price will not change before the element is introduced into the marketplace. The guidance for establishing VSOE of fair value of an element would apply to (1) an element that is currently under development that hs not been introduced into the marketplace, and (2) an element that has been introduced into the marketplace but historically has not been sold separately (i.e., the element has been sold only as an element of a multiple-element arrangement). Common Methods to Determine VSOE

Element	Sources of VSOE of Fair Value
PCS - Perpetual License	Price when sold separately. Contractual renewal rates.
PCS - Time-based license	Price when sold separately. Contractual renewal rates.
Services	Hourly rates in separate sales.
Specified upgrades	Upgrade fees to installed base. Price to be charged when upgrade is available - provided that the vendor has a sufficient history of subsequently selling at established price.
Additional software products	Price when sold separately. Price to be charged when product is available - provided that the vendor has a sufficient history of subsequently selling at established price.

Additionally, AcSEC believes that separate prices stated in a contract cannot be presumed to represent fair value and, accordingly, should not be used as the basis for allocating revenue to the elements of an arrangement. The same limitation would apply to a price list published by a vendor. That is, a published price list, in and of itself, would not qualify as VSOE of fair value unless the vendor has an established history of selling products at list price. Thus, VSOE of fair value should be based on the actual amount charged to specific groups of customers when an element is sold separately (i.e., net of any discount from the published price list).

Risidual Method of Allocating Consideration in the Arrangement

Recognition of revenue using the residual method when (1) there is VSOE of the fair values of all undelivered elements in a multiple-element arrangement that is not accounted for using long-term contract accounting, (2) VSOE of fair value does not exist for one or more of the delivered elements in an arrangement, and (3) all revenue recognition criteria in SOP 9-2 other than the requirement for VSOE of fair value of each delivered element of the arrangement are satisfied. Under the residual method the arrangement fee is recognized as follows: (1) the total fair value of the undelivered elements, as indicated by VSOE of fair value, is deferred and subsequently recognized in accordance with the relevant section of SOP 97-2, and (2) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. As a result, under the residual method, any discount on the overall arrangement is allocated entirely to the delivered elements. Example: ABC Corp enters into an arrangement to deliver Software Products 1 and 2, PCS, training services, and installation services, which are not essential to the functionality of the software, for a total arrangement consideration of $1,000,000 to Customer. ABC has VSOE of fair value for PCS ($200,000), Training ($50,000) and Installations ($350,000) but does not have VSOE of fair value for Software Products 1 and 2.

Arrangement Consideration	$ 1,000,000
PCS	$ (200,000)
Training	$ ( 50,000)
Insatllation	$ (350,000)
Software Products 1 and 2	$ 400,000

ABC would recognize $400,000 as license revenue upon delivery of Software Products 1 and 2, assuming all revenue recognition criteria in SOP 97-2 have been met. The amounts allocated to PCS, training services, and installation services would be deferred and recognized over the stated PCS term, as the training is performed, and as the installation services are performed, respectively, provided that the service elements otherwise qualify for separate accounting under 97-2. Application of the Residual Method in an Extended Payment Term Arrangement To recognize revenue under the residual method for allocating arrangement consideration to the software license and PCS when the vendor concludes that the fee is not fixed or determinable:

1. Recognize revenue under the arrangement equal to the lesser of: (a) the cumulative amount recognizable under the residual method (as if the arrangement fee were fixed or determinable), or (b) the cumulative amount due and payable (including previous cash collections).
2. Recognize no revenue for the delivered elements until the cumulaitve amount due and payable (including cash collections) exceeds the VSOE of fair value of all undelivered elements.
3. Recognize no revenue for the delivered elements until the cumulative amount due and payable (including previous cash collections) exceeds the remaining amount deferred for the undelivered elements through the next payment due date (i.e., the revenue deferral is adjusted at each reporting period based on the cumulative amount due an dpayable versus the required remaining deferral under the residual method).

Example - ABC enters into an arrangement to license customer relationship management software on a perpetual basis and to provide two years of PCS for a fee of $1,150,000. VSOE of fair value for the two years of bundled PCS is $300,000 ($150,000 per year), based on the amounts charged in PCS renewal transactions. The arrangement fee is due as follows: $500,000 at delivery and $650,000 in 13 months. As a result of the extended payment terms, ABC concludes that the arrangement fee is not fixed or determinable.

• Method 1 - ABC would recognize $500,000 of licenseing revenue upon delivery because that amount is the lower of (i) the amount due of $500,000, or (ii) revenue that would have been recognized if payments were fixed or determinable of $850,000 ($1,150,000 arrangement fee "minus" $300,000 VSOE of the value of two years PCS). ABC would recognize no further revenue until the next installment becomes due. When the final installment becomes due, ABC would defer $137,500 ($300,000 x 11/24 months), based on the VSOE of fair value for the remaining PCS obligations and recognize revenue of $512,500 ($350,000 licensing + $162,500 PCS) under the residual method. The $137,500 of deferred PCS revenue would be recognized ratably over the remaining period of the bundled PCS (11 months).
• Method 2 - ABC would recognize $200,000 of licensing revenue upon delivery and defer $300,000 based on VSOE of fair value for the two years of bundled PCS. The remaining $650,000 of licensing revenue would be recognized when due (in 13 months) and the $300,000 of deferred PCS revenue would be recognized ratably over the two-year bundled PCS period.
• Method 3 - ABC would recognize $337,5090 of licensing revenu upon delivery and defer $162,500 ($300,000 x 13/24 months) based on VSOE of fair value for the PCS that will be provided through the next payment due date (in 13 months). The $162,500 of deferred PCS revenue would be recognized ratably over the period until the next payment due date (13 months). When the final installment becomes due, ABC would defer $137,500 ($300,000 x 11/24 months), based on the VSOE of fair value for the remaining PCS obligation and recognize licensing revenue of $512,500 under the residual method. The $137,500 of deferred PCS revenue would be recognized ratably over the remaining period of bundled PCS (11 months).

Lack of VSOE

If sufficient vendor specific objective evidence does not exist for the allocation of revenue to the various elements of the arrangement, all revenue from the arrangement should be deferred until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist or (b) all elements of the arrangement have been delivered. Exceptions:

• If the only undelivered element is PCS<>
• If the only undelivered element is services that do not involve significant production, modification or customization of software (for example, training or installation), the entire fee should be recognized over the period during which the services are expected to be performed.
• If the arrangement is in substance a subscription, the entire fee should be recognized ratably.
• There may be instances in which there is VSOE of the fair value of all undelivered elements in an arrangement but VSOE of fair value does not exist for one or more of the delivered elements in the arrangement. Ins uch instances, the fee should be recognized using the residual method, provdied that (a) all other appplicable revenue recognition criteria in this SOP are met and (b) the fair value of all the undelivered elements is less than the arrangement fee. Under the residual method, the arrangement fee is recognized as follows: (a) total fair value of the undelivered elements, as indicated by VSOE, is deferred and (b) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to delivered elements.

Separation and Allocation Criteria of SOP 97-2

When an arrangement includes multiple elements within the scope of 97-2, the SOP requires that vendor-specific objective evidence (VSOE), of fair value be available for the elements in order to seprate the arrangement and to account for each element of the arrangement separately. Vendor Specific Objective Evidence (VSOE) of fair value is limited to the following:

• The price charged when the same element is sold seperately.
• For an element not yet being sold separately, the price established by management having the relevant authority; it must be probably that the price, once established, will not change before the iintroduction of the element into the marketplace.

SOP 97-2 specifies that the fee from a multiple-element arrangement should be allocated to the elements based on VSOE of fair value of the elements.

Upgrade Rights - Allocation of Revenue

AcSEC concluded that, in allocating revenue to an ugrade right, the upgrade price should be used to determine the amount of the license fee to be deferred due to the difficulty in determining which version of the software induced the customer to enter into the arrangement. If sufficient vendor-specific objective evidence does not exist for the allocation of the fee to the upgrade right, revenue from the arrangement should be deferred until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist, or (b) all elements of the arrangement have been delivered.

Example: ABC Corp enters into a perpetual licensing arrangement with Customer to delivery Software, version 2.0 of Product A, and to provide PCS for a one-year period for a nonrefundable fee of $100,000. Because Customer is aware that ABC has plans to release Version 2.1 of Product A, ABC has promised that Customer will receive Version 2.1 when it is released at no additional charge.

VSOE of fair values for the elements of the arrangement are as follows: Product A, Version 2.0 - $80,000, upgrade to Version 2.1 (for existing users of 2.0) - $30,000; and one year of PCS - $12,000. ABC is unable to estimate the percentage of customers that are expected to exercise the upgrade right, so ABC would assume that 100% of customers will exercise the right.

Total arrangement fee			$ 100,000
Specific upgrade right			$ (30,000)
Remaining fee to allocate			$ 70,000
	Fair Value	Pct	Revenue
Version 2.0	$ 80,000	87%	$ 60,900
PCS	$ 12,000	13%	$ 9,100
Total	$ 92,000	100%	$70,000
Version 2.1 upgrade right			$30,000
Total Revenue			$100,000

Marketing and Promotional Activities

As part of a marketing promotion, a vendor may provide customers with the right to obtain additional software products at a discount from the normal selling price (e.g., the customer is offered small discounts on future purchases of software). Such activities are not included in the scope of SOP 97-2. If, however, the vendor provides the customers with more significant discounts, those discounts must be evaluated to determine whether they are significant incremental discounts that must be accounted for as additional elements of the arrangement.

Multi-Element Arrangements

Multi-element arrangement - occurs when a vendor agrees to provide more than one product or a combination of products and services to a customer in an arrangement. Multi-element arrangements may include additional software products, rights to purchase additional software products at a significant incremental discount, specified upgrades or enhancements, hardware, PCS or other services. Multiple-element arrangements must be evaluated for separation to determine whether there are multiple units of accounting within the multiple-element arrangement. Definition of "Arrangement" - A group of contracts or agreements may be so closely related that they are, in effect, parts of a single arrangement. The form of an arrangement is not necessarily the only indicator of the substance of an arrangement. The existence of any of the following facts (with are not all inclusive) may indicate that a group of contracts should be accounted for as a single arrangement:

• The contracts or agreements are negotiated or executed within a short time frame of each other.
• The different elements are closely interrelated or interdepent in terms of design, technology, or funtion.
• The fee for one or more contracts or agreements is subject to refund or forfeiture or other concession if another contract is not completed satisfactorily.
• One or more elements in one contract or agreement are essential to the funtionality of an element in another contract or agreement.
• Payment terms under one contract or agreement coincide with performance criteria of another contract or agreement.
• The negotiations are conducted jointly with two or more parties (for example, from different divisions of the same company) to do what in essence is a single project.

Evaluation of Whether a Fee is Fixed or Determinable

If a software vendor's participation in an end user customer's financing results in incremental risk that the software vendor will provide a refund or concession to either the end user customer or the financing party, there is presumption that the arrangement fee is not fixed or determinable. Any one of the following conditions or software vendor actions results in incremental risk and a presumption that the fee is not fixed or determinable:

1. Provisions that require the software vendor to indemnify the financing party above and beyond the standard indemnification provisions that are explicitly included in the software arrangement between the software vendor and the end user customer.
2. Provisions that require the software vendor to make representations to the financing party related to customer acceptance of the software that are above and beyond the written acceptance documentation, if any, that the software vendor has already received from the end user customer.
3. Provisions that obligate the software vendor to take action (such as to terminate the license agreement and/or any related services), on behalf of the financing party in the eveent that the end user customer defaults under the financing.
4. Provisions that prohibit or limit the ability of the software vendor to enter into another software arrangement with the customer for the same or similar product if the end user customer defaults under the financing.
5. Provisions that require the software vendor to guarantee, certify, or otherwise attest in any manner to the financing party that the customer meets the financing party's qualification criteria.
6. Software vendor has previously provided concessions to financing parties or to customers to facilitate or induce payment to financing parties.
7. Provisions that lead to the software vendor's guarantee of the customer's indebtedness to the financing party.

Evaluate fixed or determinable fees for resellers - because a reseller is not the ultimate user of software products, the following factors should be considered when evaluating whether the fee is fixed or determinable in arrangements with resellers:

1. Business practices, the resller's operating history, competitive pressurs, informal communications, or other factors indicate that payment is substantially contingent on the reseller's success in distributing individual units of the product.
2. Resellers are new, undercapitalized, or in financial difficulty and m ay not demonstrate an ability to honor a commitment to make fixed or determinable payments until they collect cash from their customers.
3. Uncertainties about the potential number of copies to be sold by the reseller may indicate that the amount of future returns cannot be reasonably estimated on delivery; examples of such factors include the newness of the product or marketing channel, competitive products, or dependence on the market potential of another product offered (or anticipated to be offered) by the reseller.
4. Distribution arrangements with resellers require the vendor to rebate or credit portion of the original fee if the vendor subsequently reduces its price for a product and the reseller still has rights with respect to the product (sometimes referred to as price protection).

Fixed or Determinable Fees and Collectibility

SOP 97-2 specifies that in order to recognize revenue for a software arrangement, a vendor's fee must be fixed or determinable, and collectible. A software licensing fee is not fixed or determinable if the amount is based on the number of units distributed or copied, or the expected number of users of the product. Factors that Affect the Determination of Whether a Fee is Fixed or Determinable and Collectible:

1. A number of arrangements that call for fixed or determinable payments, including minimum royalties or license fees from resellers, specify a payment period that is short in relation to the period during which the customer is expected to use or market the related products. Because a product's continuing value may be reduced to the subsequent introduction of enhanced products by the vendor or competitors, the possibility that the vendor still may provide a refund or concession to a creditworthy customer to liquidate outstanding amounts due under the terms of the initial transaction increases as payment terms become longer.
2. For the reason cited in #1, any extended payment terms in a software licensing arrangement may indicate that the fee is not fixed or determinable. Further, if payment of a significant portion of the software licensing fee is not due until after expiration of the license or more than 12 months after delivery, the licensing fee should be presumed not to be fixed or determinable. However, this presumption may be overcome by evidence that the vendor has a standard business practice of using long-term or installment contracts and a history of successfully collecting under the original payment terms without making concessions.
3. If it cannot be concluded that a fee is fixed or determinable at the outset of an arrangement, revenue should be recognized as payments from customers become due (assuming all other conditions for revenue recognition in this SOP have been satisfied).

If collectibility is considered reasonably assured at the outset of an arrangement and revenue is recognized, but events arise in subsequent periods such that the related account receivable is no longer deemed collectible due to the subsequent deterioration of the customer's credit worthiness, bad debt expense should be recorded rather than reversing the previously-recorded revenue. Extended Payment Terms (Pyment Due In One Year or Less) - The following factors should be considered in evaluating whether extended payment terms are fixed or determinable:

1. Susceptibility of software to technological obsolescense - If the software is susceptible to rapid technological obsolescence, it is more likely that a fee inolving extended payment terms is not fixed or determinable.
2. Costs to implement the software - If the customer will incur significant costs to implement the software or the software will be integrated into a large complex system with pervasive use of the software throughout the organization, it is more likely that a fee involving extended payment terms is fixed or determinable.

Overcoming the presumption of concessions in extended payment term arrangements - To have a "history of successfully collecting under the original payment terms without making concessions," a vendor woul dhave to have collected all payments as due under comparable arrangements without providing concessions. Examples of factors that should be assessed in evaluating a vendor's history include, but are not limited to, the following:

• Similarity of customers
• Similarity of products - types of products; stages of product life cycle; elements included in the arrangement
• Similarity of license economics - Length of payment terms; economics of li cense arrangement (the overall economics of the license arrangement should be reviewed to ensure that the vendor can conclude that the history developed under a previous arrangement is relevent, particularly if the primary products licensed are near the end of their lives and the customer would not be entitled to the updated version under a PCS arrangement).

Customer Financing with No Software Vendor Participation and Software Revenue Recognition:

How should a software vendor recognize revenue if it inters into an arrangement with an end user customer that contains customary (that is, non-extended) payment terms and the end user customer obtains, without the software vendor's participation, financing from a party unrelated to the software vendor?

Because the software arrangement's payment terms are not extended, and the software vendor does not participate in the end user cusotmer's financing, the software vendor should recognize revenue upon delivery of the software product, provided all other requirements or revenue recognition are met.

Effects of Prepayment on Software Revenue Recognition When Vendor Participates in Customer Financing?

If the the software vendor's participation in the customer's financing results in incremental risk that the software vendor will provide a refund or concession to either the end user customer or the financing party, the presumption is that the fee is not fixed or determinable.

Delivery

Delivery is considered to have occurred upon the transfer of the product master or, if the product master is not to be delivered, upon the transfer of the first copy.

Delivery of a software product that has not yet been through the vendor's normal quality assurance process

A customer may wish to license a newer version of a vendor's software product that has yet been made available for general release. In some cases, the vendor may deliver a limited-release (e.g. beta) version of a product that is in the latter stages of development to be used by the customer until development of the product is made available for general release. In such arrangements, there is typically an implied (or contractual) obligation for the vendor to deliver the final product when the quality assurance process is complete and the software is made available for general release. When such an implied or contractual obligation exists, the delivery criterion has not been met when the cusotmer receives the limited-release version of the product. As a result, revenue may not be recognized upon delivery of the limited-release version of the software product, even if the vendor has received payment, because the vendor has not yet delivered the final product that the customer ordered. Revenue should be recognized when final product is delivered, provided that all other revenue recognition criteria are met.

Delivery of multiuple copies vs delivery of multiple licenses:

• In delivery of multiple copies, duplication is incidental to the arrangement and the delivery criterion is met upon th edelivery of the first copy of product master.
• In delivery of multiple licenses, the licensing fee is a function of the number of copies delivered to, made by, or deployed by the user or reseller. Delivery occurs and revenue should be recognized as the copies ar emade by the user or sold by the reseller.

Site Licenses - SOP 97 defines a site license as a license that permits a customer to use either specified or unlimited number of copies of a software product either throughout the company or at a specified location. Therefore, duplication of the software is considered to be incidental to the arrangement and delivery is considered to have occurred upon delivery of the first copy or product master.

Evidence of an Arrangement

Practice varies with respect to the use of written contracts. Although a number of sectors of the industry rely upon signed contracts to document arrangements, other sectors of the industry that license software (noteably the packaged software sector) do not.

Evidence of arrangement for "different" class of customer

However, the vendor may enter into arrangements with certain customers whose business practices of providing evidence of an arrangement differ from the vendor's customary practice of utilizing written contracts (i.e., certain customers may license or lease software products only by purchase orders).

We believe that a vendor may establish a different customary practice for evidencing an arrangement for specific customers, or for various classes of customers (e.g., by customer type, geographic regions, product types, or sales price ranges) if the vendor has historical evidence to demonstrate that customers have honored the terms of the type of documentation designated as customary practice for that customer or class of customer.

Establishing different customary practice to evidence an arrangement for new customers or classes of customers include:

1. Customer's policy for evidencing an arrangement - if the customer has an established policy with respect to evidencing an arrangement and that customer will not accept the vendor's customary practice of evidencing an arrangement, the customer's form of evidencing an arrangement generally would represent sufficient evidence of the arrangement in the first arrangement with the customer.
2. Reputation of the customer - If the customer has a history of honoring the terms of similar arrangements with other vendors, that may indicate that evidence of the arrangement exists in the first arrangement with that customer.
3. Nature of the arrangement - if the nature of the arrangement with the customer is routine and noncomplex (e.g., involves off-the-shelf software for which the vendor historically has not encountered problems or significant returns), that may indicate that evidence of the arrangement exists in the first arrangement with the customer.

Side agreements - Due to intense competition in the software industry, the sales and marketing staff of software vendors may be motivated to make commitments to customers (either verbally, written or electronically transmitted (e.g., email)) that are not part of the master arrangement with the customer. Software vendors should establish policies and procedures that prohibit such side agreements and require that any modifications to an original arrangement be reflected either in a new written contract, as a written amendment to the master contract, or in another form of written documentation that is customarily used by the vendor to evidence its arrangements.

Basic Revenue Recognition Pricipals

Software arrangements range from those that provide a license for a single software product to those that, in addition to the delivery of software or a software system, require significant production, modification or customization of software. If an arrangement to deliver software or a software system, either alone or together with other products or services, requires significant production, modification, or customization of software, the entire arrangement should be accounted for in conformity with Accounting Research Bulletin (ARB) No. 45, Long-Term Construction-Type Contracts, using the relevant guidance herein, and in SOP 81-1, Accounting for performance of Construction-Type and Certain Production-Type Contracts. Shorter version - Software arrangements may include:

• Just software
• Software, services & support
• lots of different combinations

If contact accounting does not apply, SOP 97-2 specifies four criteria that must be met prior to recognizing revenue for a single-element arrangement or for the individual elements within the scope of SOP 97-2 in a multiple-element arrangement.

1. Persuasive evidence of an arrangement exists.
2. Delivery has occurred.
3. Vendor's fee is fixed or determinable.
4. Collection is probably.

Is Software Incidental To Whole

SOP 97-2 does not apply to revenue earned on products that contain software that is incidental to the product as a whole. The following are indicators of whether software is incidental:

1. Whether the software is a significant focus of the marketing efforts or is sold seperately.
2. Whether the vendor is providing postcontract customer support - if upgrades and enhancements for the software component of the product periodically are provided to the existing users of the product, that may indicate that the software is not incidental to the product as a whole.
3. Whether the vendor incurs significant costs. If so, that may indicate that the software is not incidental to the product as a whole.

Additional indicators:

1. Does the right to u se the software remain solely with the vendor or is the right transferred to the customer as part of the product or service offering? If the customer is entitled to use the software after sale of the related product, that may indicate that the software is not incidental to the product as a whole.
2. Does the contractual terms of the arrangement require the customer to provide dedicated information technology support? If the customer must dedicate personnel to maintain and troubleshoot the embedded software, that may indicate that the software is not incidental to the product as a whole.
3. Can the software component of the product be substituted for other software provided by a competitor of the vendor? If the software component of the product is replaceable by software provided by a competitor of the vendor, that may indicate that the software is not incidental to the product as a whole.
4. Is the product sold or distributed along with other software products? If so, that may indicate that the software is not incidental to the product as a whole.

Overview of SOP 97-2

SOP 97-2 provides guidance on when revenue should be recognized and in what amounts for licensing, selling, leasing, or otherwise marketing computer software. It should be applied to those activities by all entities that earn such revenue. It does not apply, however, to revenue earned on products or services containing software that is incidental to the products or services as a whole.

General terms:

• Software - programs that control the funtioning of hardware and direct its operation.
• System software - software required to support production or execution of application programs but which is not specific to any particular application.
• Application software - programs that allow users to carry out certain activities.
• Enterprise resource planning (ERP) software - business management software system that provides different modules that integrate all facets of the business including the planning, manufacturing, sales, and marketing.
• Firmware - Software stores in read-only memory (ROM) or programmable ROM (PROM). Firmware is responsible for the behavior of a machine when it is first switched on.
• Hardware - the physical material parts of a computer or other system.
• Code - Instructions for a computer written in some programming language.
• Source code - Code written by a programmer in a formal programming language and readable by people but not computers. Source code must be converted to object code or machine language before a computer can read or execute the program.
• Object code - the machine code generated by a source code language processor such as an assembler or compiler. A file of object code may be immediately executable or it may require linking with other object code files.