Revenue Recognition Checklist - Delivery

Delivery via download? Is evidence on file of date of transfer? If not, then delivery deemed not to have occurred. Are access codes required? Is there evidence on file that they have been provided before then end of the accounting period? If not, then revenue deferred. Physical delivery? Is there evidence on file of the date of shipment? If not, then revenue deferred. Does the invoice state "FOB Shipping Point"? If not, then revenue deferred if shipped at month end. Are there undelivered elements? If yes, then revenue deferred in total if these elements are critical.

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.

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.

PCS Term Commences at Date Subsequent to Delivery of Software

A software arrangement may stipulate that the term of the PCS arrangement commences at a date later than delivery of the software. For example, the PCS term may not begin until installation of the software is complete or until a general warranty period has expired. Upon commencement of the contractual PCS term, generally the customer is entitled to receive upgrades/enhancements that were released by the vendor, if any, during the period between delivery and commencement of the contractual PCS term. In those situations, 97-2 specifies that an implied PCS arrangement exists that commences upon product delivery.

If the criteria for recognition of PCS revenue upon delivery of the software contained in 97-2 are not met, the vendor would allocate a portion of the fee to the implied PCS arrangement (i.e., the period from delivery of the software to the commencement of the contractual PCS term) based on VSOE of fair value of the elements. VSOE of fair value for the implied PCS arrangement may be derived, on a pro rata bases, from the VSOE of fair value of the contractual PCS arrangement.

Example - ABC Corp. enters into an arrangement with Customer to deliver Product A and to provide PCS for a period of one year for a nonrefundable fee of $100,000. However, the one-year PCS term commences upon expiration of a general warranty period which ends six months after delivery of Product A. Upon commencement of the PCS arrangement, Customer is entitled to receive any upgrades/enhancements released by ABC during the general warranty period. The VSOE of fair value for annual PCS for Product A is $20,000. Because Product A is never sold without PCS, VSOE of fair value does not exist for Product A.

The arrangement fee would be allocated to the elements using the residual method as follows:

VSOE of fair value for 12-month PCS - $20,000
Implied PCS Period - 6 months
VSOE of fair value for 18-months PCS ($20,000 x 18/12 months) - $30,000

The total arrangement consideration would be allocated to Product A and PCS as follows:

Total arrangement fee	$100,000
PCS	$(30,000)
Residual, allocated to Product A	$70,000

Assuming that all the other revenue recognition criteria of 97-2 are met, the revenue allocated to Product A would be recognized upon delivery of the software. The revenue allocated to PCS would be recognized ratably over the 18-month PCS period (i.e., the 6-month implied PCS period plus the 12-month contractual PCS period).

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.

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.