Adding a module to existing multi-module system

Real Example - A customer with an existing software system, 2 existing modules, is adding a third module which has not been released yet and thus revenue cannot be recognized yet. Issue - How should deal be structured so that the existing, reliable revenue stream can be recognized and the new module's revenue is deferred? Resolution - This can be done as long as the new module is not intertwined into the functionality of the older system. For example, if the system fundamentally changes with the new module, such as upgrading from Windows 95 to Windows 2000, then the new module is not truly separate. However if the new module is like adding Excel to a system that has Word and Outlook, then revenue for the incumbent modules can continue to be recognized. Other indicators that the new module is separate from the current system and modules include:

1. If the new module's contract is separate and does not tie into the original deal.
2. If the new module's contract does not change the terms, or fee of the original deal.
3. If the module's sale is not linked to the renewal of the existing deal.
4. The customer is currently happy with their current system and paying their bills.
5. The customer would continue paying their bills should the new module's roll out be problematic.

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.

Determing VSOE of Fair Value for PCS

We believe there are two acceptable methods for determining VSOE of fair value for PCS:

1. Bell-Shaped-Curve Approach. Under the method, VSOE of fair value is determined by evaluating the price paid for PCS sold independently of other elements (e.g., PCS renewals). In evaluating whether prices paid by customers are within an acceptable range, for each group of PCS renewal arrangements in recent periods the vendor must compile and evaluate information about the PCS renewal amounts charged. To conclude that VSOE of fair value exists for a range of prices, those prices must be sufficiently clustered within an appropirate range. For example, we believe that a range of prices which approaches 80% of a group of similar arrangements during recent periods falling within 15% (either above or below) of the median price of the range may constitute a range that is sufficiently clustered to permit a conclusion that VSOE of fair value exists for that group of similar arrangements. 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 a PCS element is within this range for a particular group of similar arrangements. All relevant facts and circumstances must be considered in making this determination. When VSOE of fair value for PCS is determined by an evaluation of a reasonable range of prices and the stated contractual PCS renewal price in an arrangement falls outside that range, we believe the revenue allocated to PCS for that individual arrangement can be based on either (1) the midpoint of the range, or (2) the outer limit of the range nearest the stated price. This allocation of revenue for the arrangements whose pricing falls outside the range is an accounting policy election that should be applied consistently across all of the vendor's PCS arrangements and disclosed, if the impact of the policy is material to the vendor's results. When allocating revenue to outlier arrangements, an entity should also consider the guidance in 97-2, which indicates that amounts otherwise allocated to delivered elements would not meet the criterion of collectibility if the portion of the fee allocable to delivered elements is subject to forfeiture, refund, or other concession if any of the undelivered elements are not delivered. If payment for a delivered element is not due until a future element is not delivered, the payment for the delivered element would not meet the collectibility criterion in 97-2.
2. Stated Renewal Approach. Under the method, the vendor looks to the renewal rate stated in the specific customer contract as the basis for determining VSOE of fair value for the PCS arrangement. Under this approach, the renewal rate must be substantive. The stated renewal approach is based on the guidance in paragraph 57 of 97-2, which states that "the fair value of the PCS should be determined by reference to the price the customer will be required to pay when it is sold separately (that is, the renewal rate)". To be considered substantive, the PCS renewal rate cannot be significantly below the software vendor's normal pricing practice. Judgement is necessary to evaluate whether or not the stated contractual renewal dollar amount is substantive. Under the stated renewal approach, we believe in some situations a vendor can establish VSOE of fair value for PCS before a customer has actually purchased PCS in a separate renewal transaction. When the vendor uses the stated renewal approach and the renewal rate is determined to be nonsubstantive, VSOE of fair value does not exist for the transaction and, if PCS is the only undelivered element, the entire arrangement fee would be recognized ratably over the PCS period. In some cases, a customer may have the right to cancel a bundled PCS arrangement at any time during the initial term and obtain a refund for the pro-rata portion of the stated PCS fee. Such cancellation and refund provisions applicable to the initial bundled PCS term are not equivalent to stated renewal options and would not represent VSOE of fair value for the PCS.

Example #1 - ABC Corp. uses the bell-shaped-curve approach to establishing VSOE of fair value for its PCS arrangements. It has two classes of customers.

For the first class of customers, the median CPS renewal price for one year of PCS is $20,000. Therefore, a substantial portion of the renewal price should fall within a range of $17,000 to $23,000 (($20,000 - [$20,000 x 15%]) to ($20,000 + [$20,000 x 15%])). ABC finds that during recent periods, 84% of the renewal prices fell within this range and concludes that VSOE of fair value exists for PCS with respect to the first class of customers.

For the second class of customers, the median PCS renewal price for one year of PCS is $15,000. Therefore, a substantial portion of the renewal prices should fall within a range of $12,750 to $17,250 (($15,000 - [$15,000 x 15%]) to ($15,000 + [$15,000 x 15%])). ABC finds that during recent periods, 60% of the renewal prices fell within this range and concludes that VSOE of fair value does not exist for PCS with respect to the first class of customers.

Example #2 - Assume the same information from Example #1. Also assume that ABC Corp.'s policy is to use the median of the VSOE-of-fair-value range for an element when allocating consideration in arrangements when the contractual price for an element does not fall within the VSOE-of-fair-value range for the element. ABC sells software and one year of PCS for a nonrefundable fee of $125,000 to Customer. The contract indicates that the license fee is $110,000 and the one-year PCS arrangement is $15,000. ABC determines that Customer is in the first class of customer described in Example #1, so PCS prices that are between $17,000 and $23,000 would represent VSOE of fair value. ABC does not have VSOE of fair value for the software and uses the residual method.

ABC would allocate $20,00 of the arrangement consideration to PCS based on its VSOE of fair value (median of the range, in accordance with ABC's policy) and the residual ($105,000) to the software. Assuming all other criteria of 97-2 are met, the revenue allocated to the software would be recognized upon delivery, and the revenue allocated to the PCS would be recognized ratably over the on-year PCS period.

Example #3 - ABC Corp. is a start-up enterprise that licensed its data storage software (Product A) to Customer together with one year of PCS for a nonrefundable fee of $100,000. The license agreement specifies that the customer is entitled to renew PCS in the second year of $18,000.

Based on the guidance of paragraph 57 of 97-2, the renewal rate specified in the contract is sufficient to establish VSOE of fair value of PCS for this start-up enterprise (provided that the renewal amount is deemed substantive). Under the stated renewal approach, ABC can establish VSOE of fair value of PCS before a customer has actually purchased PCS in a separate renewal transaction if the renewal rate is substantive.

Example #4 - ABC Corp. licenses its customer relationship management software (Product B) to Customer together with one year of PCS for a nonrefundable fee of $1,000,000. The license agreement states that the overall arrangement fee consists of $800,000 for a perpetual license to use Product B and $200,000 for one year of PCS. The license agreement specifies that the customer is entitled to renew PCS in the second year at ABC's then-current list price for annual PCS. ABC's licensing arrangements generally contain a substantive PCS renewal option for specified amounts, so ABC uses the stated renewal approach to establish VSOE of fair value for PCS.

The arrangement contains no stated renewal amount; it merely specifies that ABC can renew PCS in the second year at the then-current list price, which the customer would be entitled to do regardless of whether the contract includes that provision. Even though the PCS renewal amount in year two is within ABC's control, that amount is not yet known to either the vendor or the customer. Accordingly, the PCS renewal provision in this arrangement would not establish VSOE of fair value for the PCS under the stated renewal approach. Assuming PCS is the only undelivered element and all other renewal approach. Assuming PCS is the only undelivered element and all other revenue recognition criteria of 97-2 are met, the entire $1,000,000 arrangement fee would be recognized ratably over the one-year contractual PCS period.

In some licensing arrangements with bundled PCS for the first year, PCS can be renewed in the second year for the PCS amount stated in the contract for the first year plus an amount not to exceed a specified percentage increase. Such arrangements contain a range of possible renewal amounts that are potentially subject to negotiation between the software vendor and the customer. If the vendor is able to demonstrate that the range of possible renewal amounts is sufficiently narrow to establish VSOE of fair value, the vendor should consider all relevant evidence (e.g., pricing patterns established in prior PCS renewal transactions) in determining which amount within that range of possible renewal amounts needs to be sufficiently narrow in order for VSOE of fair value to exist for PCS under the stated renewal approach.

Example #5 - ABC Corp. licenses its networking software (Product A) to Customer together with one year of PCS for a nonrefundable fee of $1,000,000. The license agreement states that the overall arrangement fee consists of $800,000 for a perpetual license to use Product A for $200,000 for one year of PCS. The license agreement specifies that the customer is entitled to renew PCS in the second year for the year-one PCS fee stated in the contract plus an increase of no more than 12%. ABC uses the stated renewal approach to establish VSOE of fair value for PCS.

In the example, the ultimate amount the customer will be required to pay for PCS in year two is unknown because the renewal price can range between the amount stated in the contract for year one ($200,000, if there is no increase), up to a maximum increase of 12% ($224,000). ABC concludes that this range is not sufficiently narrow to establish VSOE of fair value for the PCS under the stated renewal approach. Assuming PCS is the only undelivered element and all other revenue recognition criteria of 97-2 are met, the entire $1,000,000 arrangement fee would be recognized ratably over the one-year PCS period.

Example #6 - ABC Corp. licenses its networking software (Product A) to Customer together with one year of PCS for a nonrefundable fee of $1,000,000. The license agreement states that the overall arrangement fee consists of $800,000 for a perpetual license to use Product A and $200,000 for one year of PCS. The license agreement specifies that the customer is entitled to renew PCS in the second year for the year-one PCS fee stated in the contract plus an increase of no more than 3%. ABC uses the stated renewal approach to establish VSOE of fair value for PCS.

In this example, the ultimate amount the customer will be required to pay for PCS in year two is unknown because the renwal price can range between the amount stated in the contract for year one ($200,000, if there is no increase), up to a maximum increase of 3% ($206,000). ABC concludes that this range is sufficiently narrow to establish VSOE of fair value for the PCS under the stated renewal approach. ABC should allocate a portion of the arrangement fee to the PCS element based on its VSOE of fair value (i.e., an amount between $200,000 and $206,000, depending on the specific facts and circumstances) and would be recognized over the one-year PCS period. The residual portion of the overall arrangement fee would be allocated to the software license.

PCS - A Seperate Element

If a multiple-element software arrangement includes explicit or implicit rights to PCS, PCS is a separate element of the arrangement. (97-2 Paragraph 57) If a multiple-element software arrangement includes explicit or implicit rights to PCS, the total fees from the arrangement should be allocated amount the elements based on vendor-specific objective evidence of fair value. The fair value of the PCS should be determined by reference to the price the customer will be required to pay when it is sold separately (that is, the renewal rate). The portion of the fee allocated to PCS should be recognized as revenue ratably over the term of the PCS arrangement, because the CPS services are assumed to be provided ratably. However, revenue should be recognized over the period of the PCS arrangement in proportion to the amounts expected to be charged to expense for the PCS services rendered during the period if -

• Sufficient vendor-specific historical evidence exists demonstrating that costs to provide PCS, are incurred on other than a straight -line basis. In making this determination, the vendor should take into consideration allocated portions of cost accounted for as research and development (R&D) costs and the amortization of costs related to the upgrade/enhancement capitalized in conformity with FASB Statement No. 86, Accounting for Costs of Computer Software to Be Sold, Leased or Otherwise Marketed. Such costs should be considered as part of the costs to provide PCS.
• The vendor believes that it is probable that the costs incurred in performing under the current arrangement will follow a similar pattern.

(SOP 97-2, Paragraph 58) If sufficient vendor specific objective evidence does not exist to allocate the fee to the separate elements and the only undelivered element is PCS, the entire arrangement fee should be recognized ratably over (a) the contractual PCS period (for those arrangements with explicit rights to PCS) or (b) the period during which PCS is expected to be provided (for those arrangements with implicit rights to PCS). Allocation of Revenue-to and Recognition-of Revenue for PCS Example - ABC Corp. enters into an arrangement with Customer to deliver Product A, which is currently available, and Product B, when available, and to provide PCS for a one-year period. ABC does not separately sell PCS and, thus, does not have sufficient VSOE of fair value to allocate revenue to the elements. Product A is delivered upon consummation of the arrangement and Product B is delivered three months later. ABC would defer the arrangement fee until Product B is delivered. Assuming all other revenue recognition criteria in 97-2 are met, upon delivery of Product B the PCS would be the only undelivered element and the entire fee would be recognized ratably over the remaining term of the PCS agreement.

Specified Upgrade Rights & Specified Additional Software Product

If a vendor agrees to deliver specified additional software products in the future, the revenue attributable to the additional software products would be accounted for a separate element of the arrangement, even if the rights to the additional software products were included in the terms of a PCS agreement. Additional Software Deliverables and Rights to Exchange or Return Software

• As part of a multiple-element arrangement, a vendor may agree to deliver software currently and to deliver additional software in the future. The additional deliverables may include upgrades/enhancements or additional software products. Additionally, a vendor may provide the customer with the right to exchange or return software, including the right to transfer software from one hardware platform or operating system to one or more other platforms or operating system (a platform-transfer right)
• Upgrades/enhancements. As part of a multiple-element arrangement, a vendor may agree to deliver software currently and provide the customer with an upgrade right for a specified upgrade/enhancement. The upgrade right may be evidenced by a specific agreement, commitment, or the vendor's established practice. (Rights to receive unspecified upgrades/enhancements on a when-and-if-available basis are PCS, as it has been redefined in this SOP.)

Specified Upgrade Right Versus Specified Additional Software Product - specified upgrade rights differs from the amount of revenue allocated to a specified additional software product. Determining if a software deliverable is an upgrade/enhancement or a product, the vendor should consider carefully the specific facts and circumstances on a case-by-case basis. Factors to consider would include the following:

1. The significance of the differences in the features and functionality of the new deliverable from the vendor's existing products.
2. Replacement of existing products - if the new deliverable is intended to substantially replace the vendor's existing products.
3. The extent of development activities - if the new deliverable required a significant development effort, that may indicate that the deliverable is a product rather than an upgrade/enhancement.
4. The relationship of the price of the new deliverable to the pricing for the vendor's existing products, including price discounts to existing customers - if the new deliverable is priced at an amount that is significantly higher than the price of the vendor's existing products, or if the existing users of the vendor's products are offered no discount or only an indicate that the deliverable is a product rather than an upgrade/enhancement.
5. The manner in which the new deliverable is marketing.
6. The product's name.

Rights to Specified Additional Undelivered Software Products - 97-2 distinguishes between the right to receive specified additional software products and the right to receive unspecified additional software products. A right to receive specified additional software products is accounted for as a separate element, which a right to receive unspecified additional software products is accounted for as a subscription. The SOP provides the following guidance:

• Additional Software Prodcuts. As part of a multiple-element arrangement, a vendor may agree to deliver software currently and deliver specified additional software products in the future. The rights to these additional products may be included either in the terms of a PCS arrangement or in a separate agreement. Even if the rights to the additional software products are included in a PCS arrangement, the revenue allocable to the additional software products should be accounted for separately from the PCS arrangement as an element of a multiple-element arrangement.

VSOE for a Group of Elements

A vendor may not sell separately all of the individual elements included in a multiple-element arrangement. However, the vendor may sell separately two or more of the software products included in the multiple-element arrangement. We believe that a software vendor can establish VSOE of fair value for a group of software products for purposes of allocating revenue to elements included ina multiple-element arrangement. Upon allocation of revenue to a group of software products, the revenue recognition provisions of SOP 97-2 should be applied as if the group were a single element (e.g., the delivery criterion cannot be met until all specified software products in the group have been delivered). Also, the vendor may use the residual method for purposes of allocating the arrangement consideration if VSOE of fair value exists for all of the undelivered elements.

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.

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).

Lack of VSOE

If sufficient vendor specific objective evidence does not exist for the allocation of revenue to the various elements of the arrangement, all revenue from the arrangement should be deferred until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist or (b) all elements of the arrangement have been delivered. Exceptions:

• If the only undelivered element is PCS<>
• If the only undelivered element is services that do not involve significant production, modification or customization of software (for example, training or installation), the entire fee should be recognized over the period during which the services are expected to be performed.
• If the arrangement is in substance a subscription, the entire fee should be recognized ratably.
• There may be instances in which there is VSOE of the fair value of all undelivered elements in an arrangement but VSOE of fair value does not exist for one or more of the delivered elements in the arrangement. Ins uch instances, the fee should be recognized using the residual method, provdied that (a) all other appplicable revenue recognition criteria in this SOP are met and (b) the fair value of all the undelivered elements is less than the arrangement fee. Under the residual method, the arrangement fee is recognized as follows: (a) total fair value of the undelivered elements, as indicated by VSOE, is deferred and (b) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to delivered elements.

Separation and Allocation Criteria of SOP 97-2

When an arrangement includes multiple elements within the scope of 97-2, the SOP requires that vendor-specific objective evidence (VSOE), of fair value be available for the elements in order to seprate the arrangement and to account for each element of the arrangement separately. Vendor Specific Objective Evidence (VSOE) of fair value is limited to the following:

• The price charged when the same element is sold seperately.
• For an element not yet being sold separately, the price established by management having the relevant authority; it must be probably that the price, once established, will not change before the iintroduction of the element into the marketplace.

SOP 97-2 specifies that the fee from a multiple-element arrangement should be allocated to the elements based on VSOE of fair value of the elements.

Upgrade Rights - Allocation of Revenue

AcSEC concluded that, in allocating revenue to an ugrade right, the upgrade price should be used to determine the amount of the license fee to be deferred due to the difficulty in determining which version of the software induced the customer to enter into the arrangement. If sufficient vendor-specific objective evidence does not exist for the allocation of the fee to the upgrade right, revenue from the arrangement should be deferred until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist, or (b) all elements of the arrangement have been delivered.

Example: ABC Corp enters into a perpetual licensing arrangement with Customer to delivery Software, version 2.0 of Product A, and to provide PCS for a one-year period for a nonrefundable fee of $100,000. Because Customer is aware that ABC has plans to release Version 2.1 of Product A, ABC has promised that Customer will receive Version 2.1 when it is released at no additional charge.

VSOE of fair values for the elements of the arrangement are as follows: Product A, Version 2.0 - $80,000, upgrade to Version 2.1 (for existing users of 2.0) - $30,000; and one year of PCS - $12,000. ABC is unable to estimate the percentage of customers that are expected to exercise the upgrade right, so ABC would assume that 100% of customers will exercise the right.

Total arrangement fee			$ 100,000
Specific upgrade right			$ (30,000)
Remaining fee to allocate			$ 70,000
	Fair Value	Pct	Revenue
Version 2.0	$ 80,000	87%	$ 60,900
PCS	$ 12,000	13%	$ 9,100
Total	$ 92,000	100%	$70,000
Version 2.1 upgrade right			$30,000
Total Revenue			$100,000

Multi-Element Arrangements

Multi-element arrangement - occurs when a vendor agrees to provide more than one product or a combination of products and services to a customer in an arrangement. Multi-element arrangements may include additional software products, rights to purchase additional software products at a significant incremental discount, specified upgrades or enhancements, hardware, PCS or other services. Multiple-element arrangements must be evaluated for separation to determine whether there are multiple units of accounting within the multiple-element arrangement. Definition of "Arrangement" - A group of contracts or agreements may be so closely related that they are, in effect, parts of a single arrangement. The form of an arrangement is not necessarily the only indicator of the substance of an arrangement. The existence of any of the following facts (with are not all inclusive) may indicate that a group of contracts should be accounted for as a single arrangement:

• The contracts or agreements are negotiated or executed within a short time frame of each other.
• The different elements are closely interrelated or interdepent in terms of design, technology, or funtion.
• The fee for one or more contracts or agreements is subject to refund or forfeiture or other concession if another contract is not completed satisfactorily.
• One or more elements in one contract or agreement are essential to the funtionality of an element in another contract or agreement.
• Payment terms under one contract or agreement coincide with performance criteria of another contract or agreement.
• The negotiations are conducted jointly with two or more parties (for example, from different divisions of the same company) to do what in essence is a single project.