Advanced Topics in Revenue Recognition

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Advanced Topics in Revenue Recognition

• What CEOs, CFOs, CAOs, Controllers and Legal
  Officers Should Know
• KPMG and MMM Revenue Recognition
• September 25, 2003

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Advanced Topics in Revenue Recognition

• Update on Accounting Guidelines
• September 25, 2003

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Accounting for Revenue Arrangements with Multiple
ElementsEITF 00-21 Scope

• Applies to all deliverables within contractually
  binding arrangements in all industries under
  which multiple revenue-generating activities will
  be performed except
• Deliverables that are within the scope of
  existing higher-level authoritative literature
• Arrangements within the scope of EITF No. Issue
  00-22
• Provides guidance on arrangements where some
  deliverables are in higher-level authoritative
  literature and some are not.

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EITF 00-21 Determining Scope
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EITF 00-21 continuedScope Interaction with
Higher-Level Literature (HLL)
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Three Principles of EITF 00-21

• Divide into separate accounting units if
  criteria met
• Allocate based on fair value
• Apply appropriate guidance for each accounting
  unit

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EITF 00-21 continued Transition - General

• Transition options are as follows
• Prospective adoption for all revenue arrangements
  entered into in fiscal periods beginning after
  June 15, 2003.
• Cumulative-effect adjustment in accordance with
  APB No. 20 as of the beginning of year (FAS 3 if
  in other than 1st quarter).
• Early application is permitted.
• SEC staff will amend SAB 101 and SAB 101 FAQ to
  conform to this consensus.

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SOP 97-2Software Revenue Recognition

• VSOE Continued Issues
• EITF 03-05 Applicability of SOP 97-2 to
  non-software deliverables containing more than
  incidental software
• TPAs
• Recently issued TPAs
• AICPA web site
• www.aicpa.org/members/div/acctstd/general/tpa4.htm
  
• KPMGs Software Revenue Recognition Manual

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Other Revenue Recognition Models

• SAB 101 Revenue Recognition
• Basic Criteria
• Persuasive evidence of an arrangement exists
• Delivery has occurred
• The vendors fee is fixed or determinable
• Collectibility is probable

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Fact Patterns

• Service Agreements
• Multiple Deliverables
• Distributors
• Warranties

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Fact Pattern 1

• Service Agreements

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Service Agreements

• TechCo licenses software product under perpetual
  license agreements.
• TechCo separately executes service agreement that
  includes maintenance, training and consulting.
• A free year of maintenance is included in the
  price, and is renewable at the then-current rates.

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Service Agreements Contd

• Consulting services provide installation and
  configuration at customer site.
• Training includes basic training within a few
  weeks of installation.
• Additional training and consulting services are
  available at rates stipulated in the service
  agreement.

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Service Agreements - Issues

• Residual method for software.
• VSOE of maintenance.
• Stated renewal vs. bell-shaped curve.
• Classes of customers.
• Documentation of VSOE.
• Carve-out for free maintenance.

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Service Agreements - Issues

• Allocation of fees for training services.
• Consulting services.
• Are they essential to the functionality of the
  software?
• Is the timing of any payments tied to completion
  of services?
• Verify rates for additional services are at fair
  market value.

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Service Agreements - Issues

• Not relevant for revenue recognition purposes
  that service agreement is separate from software
  license.
• Stand-alone sales provide VSOE of various
  elements.
• Services not always in SOP 97-2.

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Service Agreements - Issues

• Avoid improper revenue shifting for the
  one-time deal.
• Discounts on services will reduce revenue
  recognized for software components under the
  residual method.
• Avoid contract accounting?

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Fact Pattern 2

• Multiple Deliverables

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Multiple Deliverables

• TechCo licenses software and sells hardware
  product to Customer.
• Customer is not required to purchase the hardware
  in order to properly utilize the software.

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Multiple Deliverables - Issues

• How to analyze transaction under EITF 00-21.
• Other accounting guidance may apply to
  transaction.
• Sales that include software and hardware may
  allow hardware to be treated separately.

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Multiple Deliverables - Issues

• In contrast to SOP 97-2, more relaxed guidance
  for determining fair value.
• EITF 00-21 applies to various industries--not
  just software.

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Multiple Deliverables - Issues

• Presumption that extended payment terms can cause
  deferral of revenue recognition fees not fixed
  and determinable due to collection risks and
  obsolescence.
• Transactions that involve leasing or financing
  arrangements will require additional analysis.

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Fact Pattern 3

• Distributors

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Distributors

• Distributor will distribute TechCos software.
• TechCo software will be modified to work with
  Distributors technology.
• Distributor will sell the combined product to its
  Customers.
• No acceptance on TechCos product until Customer
  accepts Distributors product.

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Distributors - Issues

• No sale for reasons that have nothing to do
  with TechCo software.
• Effectively a conditional sale.
• TechCo wants revenue recognition Distributor may
  not care.
• Consider tying end user acceptance to X days from
  delivery, to production use, or to X days from
  production use.

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Distributors - Issues

• Acceptance by Distributor does not have to be
  tied to acceptance by Distributor customer.
• Allow re-licensing by Distributor to new customer
  if transaction between Distributor and customer
  not completed.

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Distributors - Issues

• For 6 months following the Effective Date,
  Distributor shall have the right to return a
  Product (Product Return Rights), in a
  cumulative amount not to exceed X for a credit
  against amounts owed by Distributor under the
  next Quarterly Report provided, however, such
  returns are only eligible for a credit if
  returned within 60 days of the original shipment.

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Distributors - Issues

• Licensee may not transfer licensed copies of
  Software from one End User to another except in
  connection with Licensee or a Distributor
  redistributing the Software to another End User
  in the event the Software is returned by an End
  User.

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Distributors - Issues

• Even if acceptance criteria is modified, TechCo
  may still have revenue recognition issues.
• Revenue recognition depends on payment
  obligations.
• Sell-in vs. sell-through policies.
• Thinly capitalized entities
• New relationships with distributors.
• Rebates.

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Fact Pattern 4

• Warranties

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Warranties

• TechCo offers a technology product to Customer.
• Customer wants significant warranties.
• TechCo also provides broad indemnification to
  Customer for third party claims.

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Warranties - Issues

• SOP 97-2warranties that are routine, short-term
  and relatively minor are accounted for under FASB
  No. 5.
• Revenue recognition may be deferred if it is more
  akin to acceptance.
• Warranty may be implied PCS, if PCS commences at
  conclusion of warranty.

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Warranties - Issues

• Need to identify warranties being granted in the
  marketplace.
• Carefully review specifications for open-ended
  requirements.
• Include disclaimers of implied warranties of
  merchantability, fitness for a particular
  purpose, etc.

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Warranties - Issues

• Need to include objective measurement for scope
  of warranty (e.g., software documentation).
• Who gets the warranty?
• Distributor or its customers?
• What is the warranty period?
• One-time warranty period from first shipment.
• New warranty period upon each shipment by
  Distributor to a customer.
• Are warranty periods consistent?

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Warranties - Issues

• Important to understand breach of warranty,
  remedies, and effect on other agreements.
• For warranty and indemnification obligations, may
  need to accrue liabilities under FIN 45.
• May have disclosure obligations under FIN 45.

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Implementing Revenue Recognition Policies

• Revenue Recognition Plan

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Revenue Recognition Policies

• Have A Written Plan for Revenue Recognition
  Policies.
• Determine Revenue Recognition Goals.
• Establish a Pricing Committee.
• Revise Form Agreements.
• Prepare Pre-Approved Optional Clauses.

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Revenue Recognition Policies Contd

• Adopt and Enforce a Contract Approval Process.
• Implement Educational Programs for the Sales
  Force.
• Maintain Specific Historical Information on
  Certain Areas.
• Establish Fair Value for All Elements.