Terminations

When a customer terminates their contract, revenue may be recognized if the customer is the one opting out, requesting to terminate and no longer using the system (all in writing). However if the customer is requesting a termination to a contract so that it is not automatically renewed, revenue should be taken over the remaining term.

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.

Authorized users

Real example - Preliminary contract included language that authorized users (customer's potential customers) of a subscription service by inclusion of a list of "potential affiliates" that would be reviewed annually. Each affiliate would have their own license fee, but the total in this deal was based on a total number of affiliates multiplied by the license fee. Issue - by including a list of users, revenue would only be able to be recognized when all those users were 'live' on the system. Resolution - language was re-written to define contract based on the main client, thus recognizing revenue when that particular client was 'live' but also included that subsequent affiliates would be added by addendum or statement of work, and bound by the terms of this deal. In other words, each affiliate that was added would have the same terms (the contract would not have to be re-written each time, and revenue could be recognized for each affiliate as each went live.

Concessions

Any change to an arrangement that reduces the total revenue to be recognized, extends the payment terms, increases the customer's rights, or increases the seller's obligations consitutes a concession. Examples:

• extending payment due dates in arrangement
• decreasing total payments due
• accepting returns beyond terms
• discounted or free PCS
• discounted or free upgrades.

Refunds

Revenue allocated to an element is not considered collectible and is subject to forfeiture, refund or other concessions. Therefore management must intend not to accept returns or grant concessions. If a vendor has a historical pattern of making refunds or granting concessions on delivered elements not required under the original provisions of its arrangements due to non-delivery of the elements, no other lvidence is persuasive enough to reach a conclusion that revenue in current arrangements with similar elements is not subject to forteiture.

Acceptance

License revenue should not be recognized if uncertanty exists about customer acceptance. Often the case when a customer acceptance clause is based on customer or arrangement specific criteria that cannot be evaluated until the software is installed and operating in the customer's environment.

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.