Delivery & Performance

a. Bill & Hold arrangements Company A receives purchase orders for products it manufactures. At the end of its fiscal quarters, customers may not yet be ready to take delivery of the products for various reasons. Question: May Company A recognize revenue for the sale of its products once it has completed manufacturing if it segregates the inventory of the products in its own warehouse from its own products? May Company A recognize revenue for the sale if it ships the products to a third-party warehouse but (1) Company A retains title to the product and (2) payment by the customer is dependent upon ultimate delivery to a customer-specified site? Response: Generally, no. The staff believes that delivery generally is not considered to have occurred unless the customer has taken title and assumed the risks and rewards of ownership of the products specified in the customer's purchase order or sales agreement. The Commission has set forth criteria to be met in order to recognize revenue when delivery has not occurred. These include:

1. The risks of ownership must have passed to the buyer.
2. The customer must have made a fixed commitment to purchase the goods, preferably in written documentation.
3. The buyer, not the seller, must request that the transaction be on a bill and hold basis. The buyer must have a substantial business purpose for ordering the goods on a bill and hold basis.
4. There must be a fixed schedule for delivery of the goods.
5. The seller must not have retained any specific performance obligations such that the earning process is not complete.
6. The ordered goods must have been segregated from the seller's inventory and not be subject to being used to fill other orders.
7. The equipment (product) must be complete and ready for shipment.

The Commission has also noted that in applying the above criteria to a purported bill and hold sale, the individuals responsible for the preparation and filing of financial statements also should consider the following factors:

1. The date by which the seller expects payment, and whether the seller has modified its normal billing and credit terms for the buyer.
2. The seller's past experiences with and pattern of bill and hold transactions.
3. Whether the buyer has the expected risk of loss in the event of a decline in the market value of goods.
4. Whether the seller's custodial risks are insurable and insured.
5. Whether extended procedures are necessary in order to assure that there are no exceptions to the buyer's commitment to accept and pay for the goods sold (i.e., that the business reasons for the bill and hold have not introduced a contingency to the buyer's commitment).

b. Customer Acceptance

After delivery of a product or performance of a service, if uncertainty exists about customer acceptance, revenue should not be recognized until acceptance occurs. Customer acceptance provisisions may be included in a contract to (1) test the delivered product, (2) require the seller to perform additional services subsequent to delivery of an initial product or performance of an initial service (e.g., a seller is required to install or activate delivered equipment, or (3) identify other work ncecessary to be done before accepting the product.

Question: Do circumstances exist in which formal customer sign-off (that a contractual customer acceptance provision is met) is unnecessary to meet the requirements to recognize revenue?

Response: Yes. Formal customer sign-off is not always necessary to recognize revenue provided that the seller objectively demonstrates that the criteria specified in the acceptance provisions are satisified. Customer acceptance provisions generally allow the customer to cancel the arrangement when a seller delivers a product that the customer has not yet agreed to purchase or delivers a product that does not meet the specifications of the customer's order. In those cases, revenue should not be recognized because a sale has not occurred. In applying this concept, the staff observes that customer acceptance provisisons normally take one of four general forms. These forms, and how the staff generally assesses whether customer acceptance provisions should result in revenue deferral, are described below:

• Acceptance provisions in arrangements that purport to be for trial or evaluation purposes.
• Acceptance provisions that grant a right of return or exchange on the basis of subjective matters.
• Accceptance provisions based on seller-specified objective criteria. An example of such provisions is one that gives the cusotmer a right of return or replacement if the delivered product is defective or fails to meet the vendor's published specifications for the product.
• Acceptance provisions based on customer-specified objective criteria. These provisions are referred to in this document as "customer-specific acceptance provisions" against which substantial completion and contract fulfillment must be evaluated. While formal customer sign off provides the best evidence that these acceptance criteria have been met, revenue recognition also would be appropriate, presuming all other reevenue recognition criteria have been met, if the seller reliably demonstrates that the delivered products or services meet all of the specified criteria prior to customer acceptance.

Question - Consider an arrangement that caclls for the transfer of title to equipment upon delivery to a customer's site. However, customer-specific acceptance provisions permit the customer to return the equipment unless the equipment satisfies certain performance tests. The arrangement calls for the vendor to perform the installation. Must revenue allocated to the equipment always be deferred utnil installation and on-site testing are successfully compelted?

Response: No. The staff would not object to revenue recognition for the equipment upon delivery (presuming all other revneue recognition criteria have been met for the equipment) if the seller demonstrates that, at the time of delivery, the eqiopment already meets all of the criteria and specifications in the customer-specific acceptance provisions. This may be demonstrated if conditions under which the customer intends to operate the equipment are replicated in pre-shipment testing.

c. Inconsequential or perfunctory performance obligations

Question: Does the failure to complete all activities related to a unit of accounting preclude recognition of revenue for that unit of accounting?

Response: No. When applying the substantially complete notion, the staff believes that only inconsequential or perfunctory actions may remain incomplete such that the failure to complete the actions would not result in the customer receiving a refund or rejecting the delivered products or services performed to date.

For example, the staff also consideres the following factors which are not all-inclusive, to be indicators that a remaining performance obnligation is substantive rather than inconsequential or perfunctory:

• The seller does not have a demonstrated history of completing the remaining tasks in a timely manner and reliably estimating their costs.
• The cost or time to perform the remaining obligations for similar contracts historically has variedsignficantly from one instance to another.
• The skills or equipment required to complete the remaining activity are specialized or are not readily available in themarketplace.
• The cost of completing the obligation, or the fair value of that obligation, is more than insignificant in relation to such items as the contract fee, gross profit, and operating income allocable to the unit of accounting.
• The period before the remaining obligation will be extinguished is lengthy. Registrants should consider whether reasonably possible variations in the period to complete performace affect the certainty that the remaining obligation will be completed successfully and on budget.
• The timing of payment of a portion of the sales price is coincident with completing performance of the remaining activity.

Question: Consider a unit of accounting that incfludes both equipment and installation because the two deliverables do not meet the separation criteria under EITF Issue 00-21. In this situation, must all revenue be deferred util installation is performed?

Response: Yes, if installation si essential to the functionality of the equipment. Examples of indicators that installation is essential to the functionality of equipment include:

• The installation involves significant changes to the features or capabilities of the equipment or building complex interfaces or connections.
• The installation services are unavailable from other vendors.

Conversely, examples of indicators that installation is not essential to the functionality of the equipment include:

• The equipment is a standard product.
• Insatllation does not significantly alter the equipment's capabilities.
• Other companies are available to perform the installation.

Persuasive evidence of an arrangement

Question: Company A has product available to ship to customers prior to the end of its current fiscal quarter. Customer Beta places an order for the product, and Company A delivers the product prior to the end of its current fiscal quarter. Company A's normal and customary business practice for this class of customer is to enter into a written sales agreement that requires the signatures of the authorized representatives of the company and its customer to be binding. Company A prepares a written sales agreement, and its authorized representative signs the agreement before the end of the quarter. However, Customer Beta does not sign the agreement because Customer Beta is awaiting the requisite approval by its legal department. Customer Beta's purchasing department has orally agreed to the sale and stated that it is highly likely that the contract will be approved the first week of Company A's next fiscal quarter. May Company A recognize the revenue in its current fiscal quarter for the sale of the product to Customer Beta. Answer: No. Generally the staff believes that, in view of Company A's business practice of requiring a written sales agreement for this class of customer, persuasive evidence of an arrangement would require a final agreement that has been executed by the properly authorized personnel of the customer. Question: Company Z enters into an arrangement with Customer A to delivery Company Z's product to Customer A on a consignment basis. Pursuant to the terms of the of the arrangement , Customer A is a consignee, and title to the products does not pass from Company Z to Customer A until Customer A consumes the products in its operations. Company Z delivers product to Customer A under the terms of their arrangement. May Company Z recognize revenue upon delivery of its product to Customer A? Answer: No. Products delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue recognition until a sale occurs. The staff believes that revenue recognition is not appropriate because the seller retains the risks and rewards of ownership of the product and title usually does not pass to the consignee. Such arrangements require a careful analysis of the facts and circumstances of the transaction, as well as an understanding of the rights and obligations of the parties, and the seller's customary business practices in such arrangements. The staff believes that the presence of one or more of the following characteristics in a transaction precludes revenue recognition even if title to the product has passed to the buyer. 1. The buyer has the right to return the product and:

• the buyer does not pay the seller at the time of sale, and the buyer is not obligated to pay the seller at a specified date or dates.
• the buyer does not pay the seller at the time of sale but rather is obligated to pay at a specified date or dates and the buyer's obligation to pay is contractually or implicitly executed until the buyer resells the product or subsequently consumes or uses the product.
• the buyer's obligation to the seller would be changed (e.g., the seller would forgive the obligation or grant a refund) in the event of theft or physical destruction or damage of the product.
• the buyer acquiring the product for resale does not have economic substance apart from that provided by the seller.
• the seller has significant obligations for future performance to directly bring about resale of the product by the buyer.

2. The seller is required to repurchase the product (or a substantially identical product or processed goods of which the product is a component) at specified prices that are not subject to change except for fluctuations due to finance and holding costs, and the amount to be paid by the seller will be adjusted, as necessary, to cover substantially all fluctuations in costs incurred by the buyer in purchasing and holding the product (including interest). The staff believes that indicators of the latter condition include:

• the seller provides interest-free or significantly below market financing to the buyer beyond the seller's customary sales terms and until the products are resold.
• the seller pays interest costs on behalf of the buyer under a third party financing arrangement.
• the seller has a practice of refunding (or intends to refund) a portion of the original sales price representative of interest expense for the period from when the buyer paid the seller until the buyer resells the product.

3. The transaction possesses the characteristics set forth in EITF Issue 9501 and does not qualify for sales-type lease accounting

4. The product is delivered for demonstration purposes.

If the title to the goods has passed but the substance of the arrangement is not a sale, the consigned inventory should be reported separately from other inventory in the consignor's financial statement as "inventory consigned to others" or another appropriate caption.

Revenue Recognition - Basics

Revenue recognition is realized or realizable and earned when all of the following criteria are met:

• Persuasive evidence of an arrangement exists.
• Delivery has occurred or services have been rendered.
• The seller's price to the buyer is fixed or determinable.
• Collectibility is reasonably assured.