Definition: Upgrade Rights

The right to receive one or more specific upgrades/enhancements that are to be sold separately. The upgrade right may be evidenced by a specific agreement, commitment, or the vendor's established practice.

Postcontract Customer Support (PCS)

PCS includes the right to receive services (typically telephone support and maintenance) or unspecified upgrades and enhancements, or both, offered to users or resellers, after the software license period begins, or after another point in time as provided for by the PCS arrangement. PCS does not include (i) installation or other services directly related to the initial license of the software, (ii) specified upgrade rights even if a customer would otherwise be entitled to the upgrade right as a subscriber to PCS, or (iii) rights to additional specified or unspecified software products.

• A vendor may develop historical patterns of regularly providing all customers or certain kinds of customers with the services or unspecified upgrades/enhancements normally associated with PCS, or may anticipate doing so, even though there is no written or contractual obligation or the stipulated PCS term commences at some date after delivery. In those situations, an implied PCS arrangement exists that commences upon product delivery. For purposes of applying the guidance in this SOP, PCS includes a vendor's expected performance based on such patterns, even if performance is entirely at the vendor's discretion and not pursuant to a formal agreement.

Under 97-2, a specified upgrade right constitutes a separate element of the arrangement whereas an unspecified upgrade right is part of PCS. Distinguishing between a specified and unspecified upgrade right requires an evaluation of all the relevent facts and circumstances to determine whether the vendor has made a commitment to provide specific funtionalities to the customer at some point in the future (regardless of whether or not the future date is specified). For example, some vendors of payroll software state in their license or PCS agreement that they will update the software as necessary for changes in payroll tax laws. Additionally, other software vendors commit to maintain compliance with a specified platform as part of their license of PCS agreements. In these instances, changes in payroll tax laws and changes to a specified platform are outside the control of both the vendor an customer and may be infrequent or nonexistent during the PCS term, so the upgrade rights are implicitly offered on a when-and-if-available basis. Accordingly, we believe that such a commitments to update software for changes in regulations or to maintain compliance with platform would be considered an unspecified upgrade right and would be deemed part of PCS.

Example - ABC Corp. is a provider of clinical software used by physician practices. ABC and its customers are subject to the requirements of the Health Insurance Portability and Accountability Act of 1996 (HIPPA), existing HIPPA standards are subject to change and new HIPPA standards may be released in the future.

Changes in HIPPA regulations are outside the control of ABC, and may be infrequent or nonexistent during the term of the PCS arrangement, so the updates are considered to be offered on a when-and-if-available basis. Also, the development effort for such updates would typically not be significant in comparison to the original development effort for the software, and updates for changes in HIPAA regulations would otherwise need to be made for ABC to continue its product offering in the marketplace. As such, the commitment to keep the software compliant with HIPAA regulations would be deemed to be an unspecified upgrade right (i.e., part of the PCS arrangement).

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.

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