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).