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.