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.

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.