Revenue Arrangements with Multiple Deliverables (EITF 00-21)

Issue #1 - Many companies offer multiple solutions to their customer's needs. Those solutions may involve the delivery or performance of multiple products, services, or rights to use assets, and performance may occur at different points in time or over different periods of time. In some cases, the arrangements include initial installation, initiation, or activation services and involve consideration in the form of a fixed fee or a fixed fee coupled with a continuing payment stream. The continuing payment stream generally corresponds to the continuing performance, and the amount of the payment may be fixed, variable based on future performance, or a combination of fixed and variable payment amounts. Issue #2 - This issue addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. This issue also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. Issue #3 - This issue does not address when the criteria for revenue recognition are met or provide guidance on the appropriate revenue recognition convention for a given unit of accounting. For example, this Issue does not address when revenue attributable to a unit of accounting should be recognized based on proportional performance. Issue #4 - This issue applies to all deliverables (that is, products, services, or rights to use assets) within contractually binding arrangements (whether written, oral, or implied, and hereinafter referred to as "arrangements") in all industries under which a vendor will perform multiple revenue-generating activities except the following: A. The following describes the three categories into which that higher-level literature falls and the application of this Issue or the higher-level literature in determining separate units of accounting and allocating arrangement consideration: If higher-level literature provides guidance regarding the determination of separate units of accounting and how to allocate arrangement consideration to those separate units of accounting and how to allocate arrangement consideration to those separate units of accounting, the arrangement or the deliverable(s) in the arrangement that is within the scope of that higher-level literature should be accounted for in accordance with the relevant provisions of that literature rather than the guidance in this Issue. If higher-level literature provides guidance requiring separation of deliverables within the scope of higher-level literature from deliverables not within the scope of higher-level literature, but does not specify how to allocate arrangement consideration to each separate unit of accounting, such allocation should be performed on a relative fair value basis using the entity's best estimate of the fair value of the deliverable(s) within the scope of higher-level literature and the deliverable(s) not within the scope of higher-level literature. If higher-level literature provides no guidance regarding the separation of the deliverables within the scope of higher-level literature from those deliverables that are not or the allocation of arrangement consideration to deliverables within the scope of the higher-level literature and to those that are not, then the guidance in this Issue should be followed for purposes of such separation and allocation. B. Arrangements that include vendor offers to a customer for either (1) free or discounted products or services that will be delivered at a future date; or (2) a rebate or refund, are excluded from the scope of this Issue. The Issues are: Issue #1 - How to determine whether an arrangement with multiple deliverables consists of more than one unit of accounting Issue #2 - If an arrangement consists of more than one unit of accounting, how the arrangement consideration should be allocated among the separate units of accounting. Issue #3 - What effect, if any, certain customer rights due to vendor nonperformance have on the measurement of arrangement consideration and/or the allocation of consideration to the delivered units of accounting. Issue #4 - How to account for direct costs incurred related to an arrangement that (a) are not associated with a specific deliverable or (b) are associated with a specific deliverable but that deliverable is required to be combined with another deliverable (or other deliverables). Issue 5A - The impact, if any, of a customer's ability to cancel a contract and incur a cancellation penalty on the measurement of arrangement consideration. Issue 5B - The impact, if any, of consideration that varies as a result of future customer action on the measurement and/or allocation of arrangement consideration. Issue 5C - The impact, if any, of consideration that varies as a result of future vendor actions on the measurement and/or allocation of arrangement consideration. Issue 6 - The impact of a vendor's intent not to enforce its contractual rights in the event of customer cancellation on the measurement and/or allocation of arrangement consideration. EITF Discussion: Principals Revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement meet the criteria. Arrangement consideration should be allotted among the separate units of accounting based on their relative fair values. Applicable revenue recognition criteria should be considered separately for separate units of accounting. EITF Discussion: Guidance Units of Accounting (Issue 1) A vendor should evaluate all deliverables in an arrangement to determine whether they represent separate units of accounting. That evaluation must be performed at the inception of the arrangement and as each item in the arrangement is delivered. In an arrangement with multiple deliverables, the delivered item(s) should be considered a separate unit of accounting if all of the following criteria are met: The delivered item(s) has value to the customer on a standalone basis. There is objective and reliable evidence of the fair value of the undelivered item(s) If the arrangement concludes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probably and substantially in the control of the vendor. The arrangement consideration allocable to a delivered item(s) that does not qualify as a separate unit of accounting within the arrangement should be combined with the amount allocable to the other applicable undelivered item(s) within the arrangement. The appropriate recognition of revenue should then be determined for those combined deliverables as a single unit of accounting. Measurement and Allocation of Arrangement Consideration (Issues 2, 3, 5A, 5B, 5C and 6) The amount of total arrangement consideration must be fixed or determinable other than with respect to the impact of (a) any refund rights or other concessions (hereinafter collectively referred to as "refund rights") to which the customer may be entitled or (b) performance bonuses to which the vendor may be entitled. (paragraph 12) If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration should be allocated to the separate units of accounting based on their relative fair values, except as specified in paragraph 13. However, there may be cases in which there is objective and reliable evidence of the fair value(s) of the undelivered item(s) in an arrangement but no such evidence for the delivered item(s). In those cases the residual method should be used to allocate the arrangement consideration. Under the residual method, the amount of consideration allocated to the delivered item(s) equals the total arrangement consideration less the aggregate fair value of the undelivered item(s). The "reverse" residual method (that is, using a residual method to determine the fair value of an undelivered item) is not an acceptable method of allocating arrangement consideration to the separate units of accounting, except as described in paragraph 13. (paragraph 13) To the extent that any separate unit of accounting in the arrangement (including a delivered item) is required under GAAP to be recorded at fair value (and marked to market each reporting period thereafter), the amount allocated to that unit of accounting should be its fair value. Under those circumstances, the remainder of arrangement consideration should be allocated to the other units of accounting in accordance with the requirements in paragraph 12. (paragraph 14) The amount allocable to a delivered item(s) is limited to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions (the noncontingent amount). That is, the amount allocable to the delivered item(s) is the lesser of the amount otherwise allocable in accordance with paragraph 12 and 13, or the noncontingent amount. (paragraph 16) Contractually stated prices for individual products and/or services in an arrangement with multiple deliverables should not be presumed to be representative of fair value. The best evidence of fair value is the price of a deliverable when it is regularly sold on a standalone basis.

Software Hosting Arrangements

In certain arrangements, rather than selling a software license and related services to the customer, the vendor will make the functionalities of the software available to the customer through a hosting arrangement. In such arrangements, the vendor will run the software application on either its own or a third-party's hardware. Customers can access the software through the Internet or a dedicated transmission line.

In these situations , there is a question whether the arrangement is an arrangement to sell software and services within the scope of SOP 97-2 or whether the hosting arrangement is a service arrangement in its entirety. EITF 00-3 addresses the question of whether SOP 9-2 applies to arrangements that require the vendor to host the software. In EITF 00-3, the EITF concluded that:

... a software element covered by SOP 97-2 is only present in a hosting arrangement if the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and it is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software. Therefore, SOP 97-2 only applies to hosting arrangements in which the customer has such an option. Arrangements that do not give the customer such an option are service contracts and are outside the scope of SOP 97-2. The Task Force observed that hosting arrangements that are service arrangements may include multiple elements that affect how revenue should be attributed.

Based on the consensus in EITF 00-3, a hosting arrangement contains software that is within the scope of SOP 9-2 if both of the following conditions are met:

• The customer has the contractual right to take possession of the software at any time during the hosting period without incurring a significant penalty, and
• It is feasible for the customer to run the software either on its own hardware or on a third-party's hardware.

A significant penalty as used in EITF 00-3 embodies two distinct concepts: (1) the ability to take delivery of the software without incurring significant costs (i.e., a financial penalty), and (2) the ability to use the software separately without a significant reduction in its utility or value (i.e., a functional penalty). For example, a significant penalty would exist, and the arrangement would not be within the scope of SOP 97-2 in the following scenarios:

• The customer would have to pay a significant additional amount to the vendor in order to take possession of the software, or
• The software that the customer would receive under the arrangement has significantly less functionality than the software available under the hosting arrangement.

If the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and it is feasible for the customer to run the software on either its own hardware or on a third-party's hardware, the provisions of SOP 97-2 ap[ply to the arrangement. In that case, the vendor must evaluate the elements of the arrangement to determine whether all or only some of the elements are within the scope of SOP 97-2. All of the revenue recognition requirements in SOP 97-2, including VSOE of fair value for all undelivered elements and the refund, or other concession, must be met in order to recognize revenue upon delivery for the portion of the fee allocated to the software element. The portion of the fee allocated to the hosting element should be recognized as the service is provided. Any non-software elements that are not within the scope of SOP 97-2, based on the provisions in EITF 03-5 (discussed in Paragraph 1.008-1.010), should be evaluated for separation under the provisions of EITF 00-21.

If the customer does not have the contractual right to take possession of the software at any time during the hosting period without significant penalty or it is not feasible for the customer to run the software on either its own hardware or on a third party's hardware, the provisions of SOP 97-2 do not apply to the arrangement. Hosting arrangements, and revenue recognition would be determined by other appropriate literature (e.g., SAB 104 and FASB Invitation to Comment, Accounting for Certain Service Transactions). Hosting arrangements that are service arrangements may contain multiple elements, so the guidance in EITF 00-21 must be applied to determine whether those elements should be treated as separate units of accounting.

Hosting arrangements including software and non-software deliverables

Based on the guidance of EITF 00-3, a hosting arrangement may include software and non-software deliverables (e.g., hosting services, hardware, PCS). If, based on EITF 00-3, a software element subject to the guidance in SOP 97-2 is present in the hosting arrangement, the vendor should then determine whether all or only some of the elements of the arrangement are within the scope of SOP 97-2. EITF 03-5 provides guidance on determining whether non-software deliverables are within the scope of SOP 97-2 (software-related deliverables) or not (non-software-related deliverables). EITF 03-5 specifies that if the software is essential to the functionality of the non-software deliverable, then the non-software deliverable is within the scope of SOP 97-2.

By applying the guidance of EITF 00-3 and EITF 03-5, the arrangement deliverables are segregated into the following categories: (1) software, (2) software-related, and (3) non-software related. The software and software-related deliverables are accounted for in accordance with SOP 97-2. The non-software-related deliverables however, are not within the scope of SOP 97-2. Accordingly, EITF 00-21 should be applied to determine whether the non-software-related deliverables constitute separate units of accounting for the software and software-related deliverables. A further complication exists in that the software-related deliverables may be services that require the application of contract accounting (e.g., services that are essential to the functionality of the software).

A software vendor that enters into a hosting arrangement should apply the following steps to determine the applicable literature for identifying the unit(s) of accounting and the revenue recognition method for the unit(s):

• Apply the criteria of EITF 00-3 to determine whether SOP 97-2 applies to the hosting arrangement. If not, the arrangement is a service contract. If the arrangement is a service contract containing multiple elements, apply EITF 00-21 to determine if the elements constitute separate units of accounting.
• If SOP 97-2 applies to the hosting arrangement, apply EITF 03-5 to determine which elements of the arrangement are software and software-related (i.e., within the scope of SOP 97-2) and which elements are non-software-related (i.e., non within the scope of SOP 97-2).
• Apply EITF 00-21 to determine whether non-software-related elements constitute separate units of accounting.
• If software-related deliverables including services, determine whether the services require application of contract accounting to the arrangement.
• If the arrangement is not subject to contract accounting, apply the criteria of SOP 97-2 to determine whether the software and software-related elements of the arrangement qualify for separation.
• If the arrangement is accounted for using contract accounting and includes software-related deliverables that are within the scope of SOP 97-2 (based on tahe guidance in EITF 03-5) but are not within the scope of SOP 81-1 (e.g., PCS), apply SOP 97-2 and its related interpretations to determine whether those deliverables can be separated from the contract accounting unit.
• If the arrangement is accounted for using contract accounting and includes non-software-related deliverables that are not within the scope of SOP 97-2 or SOP 81-1, apply EITF 00-21 to determine whether those non-SOP 81-1 deliverables can be separated from the contract accounting unit.

Example #1 - ABC Corp. enters into an arrangement with Customer to license software Product A and provide hosting service. There are no circumstances in which Customer is entitled to take possession of Product A. As a consequence, Customer would lose the right to use Product A in the event the hosting arrangement with ABC is not renewed.

Because Customer does not have the contractual right to take possession of the software at any time during the hosting period, the guidance in EITF 00-3 specifies that a software element covered by SOP 97-2 is not present. This conclusion is not impacted by the language or pricing of the contract, which states that a software license is an element of the arrangement.

Example #2 - ABC Corp. enters into an arrangement with Customer to license software Product A and provide hosting service. Customer has a contractual right to take possession of Product A at any time without significant penalty, and it is feasible for Customer to run the software on its own hardware.

Because Customer has a contractual right to take possession of Product A at any time without significant penalty and it is feasible for Customer to run the software on its own hardware, the guidance in EITF 00-3 specifies that a software element covered by SOP 97-2 is present.

Example #3 - ABC Corp. enters into an arrangement with Customer to license software Product A and provide hosting service. The contractual terms of the arrangement specify a fee of $200,000 for the first year, due at inception. Customer has a contractual right to take possession of Product A at any time without significant penalty, and it is feasible for Customer to run the software on its own hardware.

Because Customer has a contractual right to take possession of Product A at any time without significant penalty and it is feasible for Customer to run the software on its own hardware, the guidance in EITF 00-3 specifies that a software element covered by SOP 97-2 is present. Additionally, Product A is essential to the functionality of the hosting element in this example, so the hosting service represents a software-related element within the scope of SOP 97-2.

VSOE of fair value does not exist for Product A because it is never sold separately. The median price for hosting service based on renewal transactions with other customers is $220,000 per year. ABC concludes that a substantial portion of renewal prices for one year of hosting service fall within a range of $187,000 to $253,000. The contract does not separately state a price for the hosting element; however, the $220,000 median of renewal transactions with other customers, which are consistently prices within a sufficiently narrow range, constitutes VSOE of fair value for the hosting element of this arrangement.

VSOE of fair value exists for the undelivered element (the hosting service) but not for the delivered element (the software license) . However, the fair value of the undelivered hosting element ($220,000) exceeds the total arrangement consideration ($200,000), so the application of the residual method results in a single unit of accounting for the arrangement. The hosting service is the only undelivered element, so the entire fee should be recognized over the one year period in which the hosting service will be performed.

Example #4 - ABC Corp. enters into an arrangement with Customer to sell hardware, license software Product A, and provide hosting service. The contractual terms of the arrangement specifiy a fee of $1,500,000 for the first year, dur at inception, which the contract specifies relates to the hardware ($500,000), a software license ($800,000), and one year of hosting service ($200,000). The hosting service may be renewed in subsequent years for an amount to be negotiated between ABC and Customer. There are no circumstances in which Customer is entitled to take possession of Product A. As a consequence, Customer would lose the right o use Product A in the event the hosting arrangement with ABC is not renewed. Therefore, in accordance with EITF 00-3, the arrangement does not contain a software element within the scope of SOP 97-2. Objective evidence indicates that the fair value of the hosting service based on renewal transactions with other customers is $220,000 per year. Objective evidence indicates that the fair value of the hardware element is $660,000 based on the prices charged when competitors sell the same hardware. The hardware is delivered at inception of the hosting agreement and has continued functionality in the event the hosting arrangement is not renewed (i.e., the hardware has standalone value).

The arrangement in this example represents a contract to provide hosting service and deliver hardware such that neither element of the arrangement is not within the scope of SOP 97-2. Accordingly, the guidance in EITF 00-21 should be applied to determine whether the hosting service and hardware would be separate units of accounting for revenue recognition purposes. In this example, the delivered hardware element has standalone value, fair value evidence exists for the undelivered hosting element (in this example, fair value evidence also exists for the delivered hardware element), there are no general rights of return and there are no contingent revenue provisions. Accordingly, the elements should be treated as separate units of accounting for revenue recognition purposes based on guidance in EITF 00-21. Fair value evidence exists for each of the elements in the arrangement, so the arrangement fee would be allocated based on the relative fair value of the hardware and hosting elements as follows:

	Fair value		Allocation of Arrangement Fee
Hosting	$ 660,000	75%	$1,125,000
Hosting (one year)	$ 220,000	25%	$ 375,000
Total	$ 880,000		$1,500,000

Provided all the requirements for revenue recognition under SAB 104 and FASB Invitation to Comment, Accounting for Certain Service Transactions, are met for each element, the $1,125,000 of hardware revenue should be recognized upon delivery and the $375,000 of hosting revenue should be recognized over the one-year hosting period.