Technicalline Bb1643 Technology 5december2008

No.
2008-15 5 December 2008
Technical Line
Technical guidance on standards and practice issues
Revenue recognition in technology companies

The convergence of two standards
Contents Introduction .................................................... 1 Overview of US GAAP requirements for technology companies................................ 2 Overview of IFRS requirements for technology companies................................ 2 Similarities and differences between US GAAP and IFRS ..................................... 3 EITF Issue No. 08-1......................................... 4 The joint revenue recognition project .............. 5 A brief word of caution .................................... 6 Evidence of an arrangement............................ 7 Evaluating separate contracts as a single arrangement .............................................. 8 Accounting for multiple-element arrangements........................................... 11 Reseller Arrangements ................................. 16
Introduction
As the adoption of International Financial Reporting Standards (IFRS) becomes more likely in the United States, many technology companies are beginning to think about what their initial financial statements will look like when they convert from US GAAP to IFRS. Chief among the concerns for such companies is how their revenue recognition policies may change on conversion. In this publication, we take a look at a number of revenue recognition issues that are of particular interest for technology companies, and provide an overview of how US GAAP and IFRS are comparable for those issues, as well as discuss where they diverge. This publication focuses on four revenue recognition topics that commonly affect technology companies:

Establishing evidence of an arrangement Evaluating separate contracts as a single arrangement Accounting for multiple element arrangements Accounting for arrangements with resellers
For each topic, we summarize the guidance of both US GAAP and IFRS, and provide commentary on the implications of IFRS adoption for US technology companies. Although technology companies are rightly interested in how their revenue recognition policies might be affected by the conversion to IFRS, it is likely that by the time most US technology companies will be able to report using IFRS (based on the dates proposed by the SEC in its proposed Roadmap for US registrants conversion to IFRS), both current US GAAP and IFRS revenue recognition standards will have been replaced by a converged revenue recognition standard resulting from the currently ongoing joint revenue recognition project of the FASB and IASB (the Boards). Accordingly, this publication also discusses our current understanding of the Boards project and how the accounting for the four issues discussed above may be affected by a converged standard.
Overview of US GAAP requirements for technology companies

Under US GAAP, technology companies generally account for revenue-producing arrangements with customers in one or both of the following ways:
Arrangements to sell software, or hardware with embedded software that is deemed to be more than incidental to the hardware, are accounted for using the provisions of AICPA Statement of Position 97-2, Software Revenue Recognition (SOP 97-2). SOP 97-2, as interpreted by numerous Technical Practice Aids issued by the AICPA, provides guidance relating to the accounting for licensing, selling, leasing, or otherwise marketing computer software, including how to account for multiple-element arrangements involving the sale of software and related services. Arrangements not subject to the scope of SOP 97-2 are generally accounted for based on the provisions of Staff Accounting Bulletin No. 104, Revenue Recognition (Topic 13). Topic 13 provides general revenue recognition guidance to transactions that are not within the scope of specific authoritative revenue recognition literature such as SOP 97-2. Topic 13 is principally based on interpretations of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (CON 5), which establishes the basic principal that revenue should not be recognized until the earnings process is substantially complete, or when it has been earned and is realized or is realizable, and practices followed by the SECs Division of Corporate Finance and Office of the Chief Accountant. The concepts and theory in Topic 13 are consistent with those in CON 5 and other more recently issued revenue recognition pronouncements, such as SOP 97-2. Technology companies engaging in multiple-element arrangements with customers that are not subject to SOP 97-2 generally apply the provisions of Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (Issue 00-21), which provides guidance as to when multiple deliverables included in a single arrangement may be accounted for as separate units of accounting. Additionally, technology companies may apply the provisions of a number of other US GAAP revenue recognition pronouncements depending on the types of transactions they enter into with customers. For example, many technology companies offer their customers the option to buy separately priced extended warranty and/or product maintenance contracts concurrently with the sale of hardware. Such arrangements are generally subject to the scope of FASB Technical Bulletin No. 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts (FTB 90-1).
Both SOP 97-2 and Topic 13 provide that revenue may be recognized for a unit of accounting (either an arrangement as a whole or deliverables included in a multiple-element arrangement that may be separately accounted for pursuant to the provisions of either SOP 97-2, EITF 00-21, or other literature as appropriate) when all of the following criteria are met:

Persuasive evidence of an arrangement exists; Delivery has occurred or services have been rendered; The sellers price to the buyer is fixed or determinable; and Collectibility is reasonably assured.
These criteria are applicable regardless of whether the arrangement involves the delivery of goods or services.
Overview of IFRS requirements for technology companies

For companies reporting under IFRS, International Accounting Standards No. 18, Revenue (IAS 18), is the primary source of authoritative guidance on revenue recognition. IAS 18 defines revenue as the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, such that, like US GAAP, revenue recognition is tied to the completion of the earnings process and the realization of assets from such completion. IAS 18 provides the following five criteria that must be satisfied in order to recognize revenue from the sale of goods:
The entity has transferred to the buyer the significant risks and rewards of ownership of the goods The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold The amount of revenue can be measured reliably It is probable that the economic benefits associated with the transaction will flow to the entity The costs incurred or to be incurred in respect of the transaction can be measured reliably
Unlike US GAAP, IFRS has different criteria relating to when revenue should be recognized for service contracts. IAS 18 requires that when the outcome of a transaction involving the rendering of services can be estimated reliably, revenue is recognized by reference to the stage of completion of the transaction at the balance sheet date (in other words, using the percentage-ofcompletion method). In applying the percentage-of-completion method, the requirements of International Accounting Standards
Technical Line No. 2008-15, 5 December 2008
No. 11, Construction Contracts, are generally applicable to the recognition of revenue and the associated expenses for a transaction involving the rendering of services. According to IAS 18, the outcome of a transaction can be estimated reliably when all the following conditions are satisfied:

accounting results between them are often the same or similar. Readers of this publication should not lose sight of the fact that the two sets of standards are generally more alike than different for most commonly encountered transactions, with IFRS being largely, but not entirely, grounded in the same basic principles as US GAAP. Despite the similarities, differences in revenue recognition may exist as a result of differing levels of specificity between the two sets of standards. US GAAP is comprised of a number of revenue recognition standards, which generally contain more application and interpretive guidance than IFRS. This guidance can be prescriptive and may be limited to specific industry transactions. Conversely, a single standard (IAS 18) exists under IFRS which contains general principles and illustrative examples of specific transactions. As a general rule, IFRS standards are broader than their US counterparts, with limited interpretive guidance. The IASB has generally avoided issuing interpretations of its own standards, preferring to instead leave implementation of the principles embodied in its standards to preparers and auditors, and its official interpretive body, the International Financial Reporting Interpretations Committee (IFRIC), a body whose role in international standard setting is comparable to the EITFs role in US GAAP. While US standards certainly contain underlying principles, the strong regulatory and legal environment in US markets has resulted in a more prescriptive approach with far more bright lines, comprehensive implementation guidance, and industry interpretations. Therefore, while some might read the broader IFRS standards to require an approach similar to that contained in a more detailed US counterpart, others might not. IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors (IAS 8), states that when IFRS lacks guidance that specifically applies to a transaction, management shall use its judgment in developing and applying an accounting policy that results in information that, among other things, reflects the economic substance of transactions, other events and conditions, and not merely the legal form. In developing such policies, management may also consider the most recent pronouncements of other standardsetting bodies that use a similar conceptual framework to develop accounting standards . . . to the extent that these do not conflict with the requirements of IFRS standards or its conceptual framework. We have observed that many technology companies reporting under IFRS are looking to US GAAP for interpretative guidance around revenue recognition, based on the provisions of IAS 8. For example, although SOP 97-2 has no direct bearing on companies reporting under IFRS, many software companies use the hierarchy in IAS 8 to adopt the US requirements in the absence of an IFRS pronouncement of comparable detail (particularly if they are a US registrant). This is driven by the lack of implementation guidance under IFRS, as well as
The amount of revenue can be measured reliably It is probable that the economic benefits associated with the transaction will flow to the entity The stage of completion of the transaction at the balance sheet date can be measured reliably The costs incurred for the transaction and the costs to complete the transaction can be measured reliably
IAS 18 states that the recognition criteria of the standard are usually applied separately to each transaction. However, it goes on to say that, in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. This means that transactions have to be analyzed in accordance with their economic substance in order to determine whether they should be combined or segmented for revenue recognition purposes. For example, when the selling price of a hardware product includes an identifiable amount for subsequent services, an amount must be deferred and recognized as revenue over the period during which the service is performed. Conversely, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole. Each of these concepts is discussed in greater detail later in this publication.
Similarities and differences between US GAAP and IFRS

Revenue recognition under both US GAAP and IFRS is tied to the completion of the earnings process and the realization of assets from such completion. Under both sets of standards, revenue is not recognized until it is both realized (or realizable) and earned. Ultimately, both sets of standards base revenue recognition on the transfer of risks and both attempt to determine when the earnings process is complete, and both sets of standards contain revenue recognition criteria that, while not identical, are similar. For example, one IFRS recognition criterion is that the amount of revenue can be measured reliably. US GAAP similarly requires that the consideration to be received from the buyer is fixed or determinable. While the US and international standards contain differences, the general revenue recognition principles and the underlying conceptual framework of the standards are similar, such that
the desire for consistency within the industry since a significant number of industry leaders and peer companies are based in the US and report using US GAAP. However, while the US GAAP revenue recognition pronouncements can provide useful guidance to technology companies reporting under IFRS, the IAS 8 hierarchy does not require companies to refer to US GAAP. Nor does it mean that US GAAP Sale of goods
technology companies reporting under IFRS can only look to US GAAP for interpretative guidance or that the accounting for all revenue transactions under IFRS should be the same as under US GAAP. The following is a comparison of the US GAAP and IFRS revenue recognition requirements. IFRS Revenue is recognized pursuant to IAS 18 when risks and rewards of ownership have been transferred, the buyer has control of the goods, revenues can be measured reliably, and it is probable that the economic benefits will flow to the company. Revenue may be recognized in accordance with longterm contract accounting, including considering the stage of completion, whenever revenues and costs can be measured reliably, and it is probable that economic benefits will flow to the company.
Technology companies either apply SOP 97-2 or Topic 13, each of which requires that delivery has occurred (the risks and rewards of ownership have been transferred), there is persuasive evidence of the sale, the fee is fixed or determinable, and collectibility is reasonably assured. Service contracts entered into by technology companies are generally subject to the same general revenue recognition criteria of SOP 97-2 or Topic 13 as are arrangements for the sale of goods. Application of long-term contract accounting (SOP 81-1 Accounting for Performance of Construction-Type and Certain Production-Type Contracts) is generally not permitted for services not related to construction or certain construction-related design services. Specific criteria are required in order for each element to be a separate unit of accounting, including the criteria that delivered elements must have standalone value (for arrangements subject to the scope of EITF 00-21) and evidence of fair value exists for undelivered elements.
Rendering of services
Multiple elements
IAS 18 requires recognition of revenue on an element of a transaction if that element has commercial substance on its own; otherwise the separate elements must be linked and accounted for as a single transaction. IAS 18 does not provide specific criteria for making that determination.
EITF Issue No. 08-1

During its 13 November 2008 meeting, the EITF reached a consensus-for-exposure on Issue No. 08-1, Revenue Arrangements with Multiple Deliverables (Issue 08-1). The Task Force consensusfor-exposure, if affirmed, will replace Issue 00-21 with Issue 08-1. Issue 08-1 will require an entity to estimate the separate selling price of an undelivered element of a multiple-element arrangement and allocate arrangement consideration using the residual method when the entity does not have VSOE or acceptable third-party evidence of the selling price of the undelivered element. An entity could only use its estimated selling price after it determined neither VSOE nor third-party evidence of selling price exist. Issue 08-1 will replace the current references to fair value within Issue 00-21 with the term selling price. In agreeing to this change, the EITF noted that the current fair value terminology in Issue 00-21 is not intended to represent a fair value measurement subject to
FASB Statement No. 157, Fair Value Measurements, and that such a change will avoid confusion. The EITF also noted that this revision to refer to selling price instead of fair value is not intended to result in a change in practice. When estimating the separate selling price of an undelivered element included in a multiple-element arrangement, the vendor's estimate of selling price shall be consistent with the objective of determining VSOE of the selling price for the element; that is, it should be the entitys best estimate of the price at which it would transact to sell the undelivered element on a standalone basis. The entity must consider market conditions as well as entity-specific factors when estimating this selling price. The Task Force also concluded that if a vendor determines the selling price of the undelivered element in an arrangement using its best estimate, the amount of arrangement consideration allocated to a delivered element using the residual method will be limited to VSOE or
acceptable third-party evidence of the selling price of that delivered element, if such amount is known to the vendor. We believe that this cap on the amount that may be allocated to a delivered element will not be used often. Rather, we believe vendors will reevaluate their estimated selling price of an undelivered element if their initial estimate indicates that the amount of arrangement consideration to be allocated to a delivered element is greater than VSOE or thirdparty evidence of the selling price of that element. The existing requirement that deliverables included in multipleelement arrangements within the scope of Issue 00-21 be accounted for as separate units of accounting only if VSOE or acceptable thirdparty evidence of fair value of at least the undelivered elements of the arrangement exists (among other criteria) is largely consistent with the provisions of SOP 97-2. However, the decision to revise the fair value threshold of Issue 00-21 will create divergence between the two models, and has the potential to place additional stress on to the determination of whether items including embedded software are or are not within the scope of SOP 97-2. Accordingly, the EITF was asked whether the scope of Issue 08-1 should be expanded to address the fair value threshold of SOP 97-2. Although the Task Force concluded that the scope of Issue 08-1 should not be expanded to include arrangements within the scope of SOP 97-2, it did decide that a separate, follow-on project should be started immediately to reconsider the scope, and potentially other areas, of SOP 97-2. Provided that the FASB Chairman agrees to add the project to the EITFs agenda, the FASB staff intends to present an issue summary for such a project to the Task Force at its March 2009 meeting. The EITFs goal for such a project is to reach a consensus relating to any changes in SOP 97-2 that would have the same effective date as Issue 08-1. Consistent transition dates will reduce the tension on the determination of whether or not a transaction is within the scope of SOP 97-2. We believe that this follow-on project to reconsider certain aspects of SOP 97-2 is an important undertaking, and may help to minimize what otherwise could be a significant practice issue. Although the follow-on project will address issues relating to the application of SOP 97-2, it is not anticipated that other pieces of revenue recognition literature will also be addressed. For example, it is not anticipated that the follow-on project will address the provisions of FTB 90-1. Although it will not result in full convergence, the changes to Issue 0021 contemplated by Issue 08-1 will more closely align US GAAP with the manner in which multiple-element arrangements are evaluated pursuant to IFRS. Although Issue 08-1 may more closely align US GAAP and IFRS for arrangements currently subject to the scope of Issue 00-21, absent a decision in the follow-on project to modify the fair value threshold of SOP 97-2 in a manner comparable to the
changes made to the fair value standards of Issue 00-21, comparable alignment will not occur for arrangements within the scope of SOP 972. The changes to Issue 00-21 contemplated by Issue 08-1 are also consistent with many of the tentative conclusions of the Boards in the joint revenue recognition project, as discussed below. The consensus-for-exposure, if affirmed, would be effective for the first annual reporting period beginning after December 15, 2009. The consensus would be applied prospectively to arrangements entered into or modified after the effective date. Early application would be permitted.
The joint revenue recognition project

We expect the Boards to issue a preliminary views document related to their joint revenue recognition project later this year. This document is expected to discuss an asset and liability based revenue recognition model that companies will use to measure contractual rights and obligations arising at the inception of a contract with a customer and in subsequent periods. The Boards contemplated including two different approaches in the document but have decided to focus only on one, the customer consideration approach. Under the customer consideration approach, rights received by a company at the inception of an arrangement with a customer are initially measured at the contractual amount of consideration to be received from the customer (i.e., the sales price). This amount is then allocated to the contractual performance obligations based on the selling price of the underlying goods and services to be provided. The customer consideration approach is broadly similar to the current accounting for many multiple-element arrangements under US GAAP; however, as currently contemplated, this approach will require the use of estimated separate selling prices, determined using an entity-specific entry price1 hierarchy, for goods and services in multiple-element contracts if there are no observable selling prices for those goods and services. This would be a significant change to some current US GAAP practices, particularly EITF 00-21 and SOP 97-2. The preliminary views document is expected to address the following specific areas:
The perceived problems with the existing revenue recognition literature. An explanation of the focus on assets and liabilities for purposes of evaluating contractual arrangements and determining when revenue may be recognized. The rationale for proposing a single revenue recognition principle.
A price a vendor would transact at with a customer, as compared to a price the vendor would have to pay to transfer its performance obligations to a third party (i.e., an exit price).
Discussion of contractual rights and obligations, and changes thereto, and how those affect revenue recognition. The proposed customer consideration approach. The effect of the proposed model on current practice.
The Boards believe that the issuance of the preliminary views document will give them an opportunity to understand whether constituents think that the proposed requirement to use estimated separate selling prices to allocate arrangement consideration to deliverables included in multiple-element arrangements is workable or whether it needs to be constrained in any respect, as well as obtain feedback from constituents on other matters. Although the Boards plan to issue the preliminary views document later this year, they acknowledge that a number of significant topics will be excluded from it and remain to be addressed. The Boards intend to consider these topics during the period the preliminary views document is exposed for comment. These topics include:
The scope of any final revenue recognition standard. The Boards have not yet considered whether any industries or types of contracts would be exempted from this general standard. Discussions are expected to occur specifically with respect to insurance, leases (from the lessors perspective) and financial instrument contracts. The effect of contract cancellation and renewal provisions. When and how multiple contracts entered into (or contemplated) at the same time should be combined. The accounting for contract modifications and scope changes. Identification of performance obligations in a contract. What changes in a contract lead to revenue recognition, including what constitutes satisfaction of a performance obligation. The measurement of rights and obligations in a contract, including when such rights and obligations should be remeasured. The effect of contingent and uncertain consideration. Financial statement presentation and disclosure. Implementation guidance and illustrations. Effective date and transition guidance.
Although much of this publication discusses how technology companies revenue recognition policies might be affected by a conversion to IFRS as it is today, it is likely that by the time most US technology companies would be able to report using IFRS (based on the dates proposed by the SEC in its Roadmap for US registrants conversion to IFRS), both current US GAAP and IFRS revenue recognition standards will have been replaced by a final joint revenue recognition standard issued by the Boards. Accordingly, as we discuss in this publication those revenue recognition issues that are of particular concern to technology companies, we also discuss our current understanding of how those issues may be affected by any tentative conclusions reached by the Boards to date. However, while such discussions are based on our understanding of the Boards tentative conclusions to date, any final standard may ultimately reflect different conclusions. Additionally, as discussed above, certain significant issues remain to be addressed by the Boards. Accordingly, the manner in which any final joint revenue recognition standard affects the issues addressed in this publication ultimately may differ significantly from the discussions herein.
A brief word of caution

No publication that compares two broad sets of accounting standards can include all differences that may arise in accounting for the myriad business transactions that could possibly occur. The existence of any differences and their materiality to an entitys financial statements depends on a variety of specific factors including, among others:

The nature of the entity The types of products and services sold by an entity, and the types of arrangements utilized to sell those goods or services to customers An entitys interpretation of the more general IFRS principles Industry practices Accounting policy elections required under either US GAAP and IFRS
The Boards conclusion with respect to these matters will be included in an exposure draft that currently is expected to be exposed for comment in the latter part of 2009.
Before reaching any conclusion as to how your specific companys revenue recognition practices may be affected by a change to IFRS, you should read IAS 18 and any other applicable authoritative standard, consider your specific facts and circumstances and then consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice.
Evidence of an arrangement
One of the basic revenue recognition criteria of US GAAP is that persuasive evidence of the final form of an arrangement between a vendor and a customer must exist before revenue can be recognized. Although there is no corresponding explicit requirement Overview SOP 97-2 and Issue 00-21/Topic 13
within IFRS, it is implicit that the terms of an arrangement should be understood prior to revenue recognition by an IFRS reporter. However, what constitutes acceptable evidence of the terms of the arrangement can be different between US GAAP and IFRS.
IAS 18
EY Commentary
Revenue Recognition Project
Persuasive evidence of an arrangement must exist prior to revenue recognition Form of evidence is dependent on a vendors customary business practices
Persuasive evidence of an arrangement is not an explicit requirement for revenue recognition Implicit that the terms of the arrangement between the vendor and customer must be understood prior to revenue recognition
IFRS reporters may have a greater range of acceptable forms of evidence that permit revenue recognition than do US GAAP reporters The timing of revenue recognition may differ as an understanding of the terms of an arrangement may occur before persuasive evidence of an arrangement, as defined by US GAAP, exists
Model based on rights and performance obligations arising from contractual arrangements with customers Contractual arrangements preliminarily defined as an enforceable arrangement between a vendor and a customer Currently unclear as to when such enforceable agreements will be deemed to have arisen
US GAAP Arrangements within the scope of SOP 97-2 or Issue 00-21/Topic 13 One of the basic revenue recognition criteria of both SOP 97-2 and Topic 13 is that persuasive evidence of an arrangement must exist before revenue from an arrangement is recognized. If a vendors customary practice is to obtain signed contracts to evidence an arrangement, revenue recognition is precluded if a contract signed by both parties is not in hand at the end of an accounting period, even if the contract is executed soon thereafter and management believes that as of the end of the period execution of the contract is merely perfunctory. If a vendors customary business practices do not rely on signed contracts, persuasive evidence of an arrangement must still exist prior to revenue recognition. Many technology companies utilize master purchasing arrangements with their customers, and in such cases persuasive evidence of an arrangement generally takes the form of a binding purchase order submitted pursuant to the master purchasing arrangement. Other written forms of evidence also may constitute persuasive evidence of an arrangement. For example, electronic evidence (e.g., an on-line authorization) may provide persuasive evidence. Oral arrangements also may be acceptable in certain limited circumstances.
Regardless of the form of evidence, persuasive evidence of an arrangement should generally describe the following pertinent terms and conditions of the arrangement:
All the products and services included in the arrangement (i.e., the deliverables of the arrangement) Fees and the payment terms Delivery terms Rights of return, price protection, or cancellation provisions Warranties, rights, obligations and termination provisions Other pertinent contractual provisions
If an arrangement is not final (e.g., if it is subject to subsequent approval or execution of another agreement) revenue recognition is inappropriate until that subsequent approval or agreement is complete, regardless of whether management considers the ability to obtain the necessary approvals or signatures perfunctory. It is not uncommon for a vendor to use different forms of persuasive evidence of an arrangement for different segments of a business or classes of customers. Accordingly, the form of evidence used to demonstrate persuasive evidence of an arrangement may vary by type of product, class of customer or geography. The key in determining whether persuasive evidence of an arrangement exists is whether the evidence obtained is consistent with the vendors customary business practices for the type of transaction under evaluation.
IFRS Evidence of a final arrangement between a vendor and its customer is not an explicit revenue recognition criterion within IFRS. However, it is implicit that the terms of the arrangement must be understood to evaluate whether the explicit revenue recognition criteria of IAS 18 have been met. EY commentary Although IFRS reporters must have evidence of the terms of the arrangement with a customer prior to recognizing revenue for that arrangement, they have a greater range of acceptable forms of evidence of an arrangement than do US GAAP reporters. Although vendors should consider their customary business practices when determining whether sufficient evidence of an arrangement exists to evaluate whether the IAS 18 revenue recognition criteria have been met, there likely will be circumstances where the evidence supports revenue recognition at an earlier date under IFRS than US GAAP. Specifically, while US GAAP is relatively prescriptive in defining when a vendor has established persuasive evidence of an arrangement with a customer, IFRS reporters have a greater ability to conclude that the terms of an arrangement with a customer are understood even if the final arrangement has not been executed by both the customer and the vendor. For example, assume a vendor receives a contract prior to the end of a reporting period that includes all the relevant terms and conditions of the arrangement and that has been signed by the customer. The vendor has delivered all the products pursuant to the arrangement prior to the end of the reporting period but, due to administrative delays, it does not countersign the contract until the first day of the following reporting period. In this example, the vendor would be precluded from recognizing revenue pursuant to US GAAP until the following reporting period. However, an IFRS reporter may reasonably conclude that, since they had provided the final terms to the customer and received a signature prior to the period end, sufficient evidence existed as of the end of the reporting period to understand the terms of the arrangement with the customer. This issue is likely to be relatively more important to enterprise software companies, as such companies commonly enter into software licensing arrangements at the end of a reporting period that relate to software previously delivered to the customer (e.g., an arrangement may be entered into at a period end to license additional users of a previously delivered licensed product). It is less likely to be significant to technology companies that must ship hardware sold to customers at a period end, as the shipment of physical units would likely not occur absent a definitive contractual arrangement. Technology companies (particularly software companies) frequently negotiate key terms of arrangements with customers until the final
moments of the end of a reporting period, largely because the customer realizes that they have significant leverage on terms and that such leverage often increases up until the final moments. Such behavior may in fact have escalated as a result of the strictness of the US GAAP revenue recognition rules in this area. In such circumstances, the circumstances in which revenue can be recognized in a reporting period for a contract executed by a customer after the period has ended may be limited. The facts and circumstances, as well as a vendors revenue recognition policies, should be carefully evaluated when concluding whether sufficient evidence exists under IFRS to understand the pertinent terms of an arrangement between a vendor and customer. This may prove to be an area in which practice will evolve under IFRS such that more quarter-end documentation close-calls are evaluated from a substance perspective, particularly when hindsight demonstrates that contractual terms demonstrably agreed upon prior to the end of a reporting period did not change in the final executed form of arrangement. Revenue recognition project The Boards are developing an asset and liability based revenue recognition model focusing on recognizing the rights (to receive consideration) and obligations (to perform services or transfer assets) that arise from a companys contractual arrangement with a customer. While a contractual arrangement has been preliminarily defined as an enforceable arrangement between a vendor and a customer, it is currently unclear when such an arrangement will be deemed to have arisen between a vendor and a customer under this model.
Evaluating separate contracts as a single arrangement

Technology companies often have continuing relationships with their customers, and these business relationships can lead to numerous arrangements between the two parties. The substance of multiple contracts executed concurrently or in close proximity to one another may indicate that they are components of a single arrangement, and the timing of recognition and measurement of revenue for the deliverables included in such arrangements might differ if accounted for as a single arrangement instead of as multiple arrangements. US GAAP generally contains a presumption that contracts executed with the same customer concurrently or in close proximity to one another were negotiated in contemplation of each other and should be combined and evaluated as one multiple-element arrangement. IFRS combines two or more transactions together for purposes of evaluating them for revenue recognition when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole.
Overview SOP 97-2
Issue 00-21/Topic 13
IAS 18
EY Commentary
TPA 5100.39 provides a number of factors to be considered when evaluating whether a group of contracts or agreements may be so closely related that they are, in effect, parts of a single arrangement The substance and form of an arrangement are considered Determining when multiple contracts represent a single arrangement requires the use of judgment
Presumes that separate contracts entered into at or near the same time with the same entity or related parties should be evaluated as a single agreement Provisions of TPA 5100.39 commonly looked to in practice Determining when multiple contracts represent a single arrangement requires the use of judgment
Two or more transactions linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole should be recognized together Determining when multiple contracts represent a single arrangement requires the use of judgment
US GAAP and IFRS share similar principles that revenue arrangements should be evaluated based on their substance and not their form In many cases, conclusions under US GAAP and IFRS about combining separate contracts will be similar
The Boards intend to deliberate when and how multiple contracts entered into (or contemplated) at the same time should be combined
US GAAP Arrangements within the scope of SOP 97-2 Although SOP 97-2 does not address when multiple contracts should be combined and evaluated as a single arrangement, AICPA Technical Practice Aid (TPA) 5100.39, Software Revenue Recognition for Multiple-Element Arrangements (TPA 5100.39), provides relevant guidance. TPA 5100.39 states that a group of contracts or agreements may be so closely related that they are, in effect, parts of a single arrangement. Various factors must be considered to determine when contracts or agreements are so closely related, and the form of an arrangement is not necessarily the only indicator of the substance of an arrangement. TPA 5100.39 provides the following factors that may indicate separate contracts should be accounted for as a single arrangement:
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 (e.g., from different divisions of the same company) to do what in essence is a single project.
In addition to the factors outlined in TPA 5100.39, we believe that the following factors also should be considered:
If the separate contracts require delivery of the same product(s) or service(s), this is an indicator that the contracts should be evaluated as a single agreement If the separate contracts relate to the delivery of the same product(s) or service(s) to multiple customer locations, this is an indicator that the contracts should be evaluated as a single agreement If the contracts were negotiated in contemplation of one another, regardless of the time frame over which the contracts are signed, this is a strong indicator that the contracts should be evaluated as a single agreement If the contracts were awarded by the customer pursuant to separate bona-fide competitive bid processes, this is a strong indicator that the contracts should be accounted for as standalone agreements
The contracts or agreements are negotiated or executed within a short time frame of each other. The different elements are closely interrelated or interdependent in terms of design, technology, or function. 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 functionality of an element in another contract.
Whether it was likely that a follow-on contract to provide services relating to a previously delivered product would be executed. In such cases, the original contract and the subsequent contracts generally should be considered one arrangement. Factors that may indicate that execution of such a contract is likely include:
The vendor performs such services for a majority of the customers that purchase its products, and Pricing of the service contract is agreed to at the date the product was purchased.
The International Financial Reporting Interpretations Committee (IFRIC), a group whose role in IFRS standard setting is comparable to the EITFs role in US GAAP, has discussed indicators of when separate contracts should be linked and evaluated as one arrangement under IAS 18, but did not reach a consensus. Although the factors they discussed differed in certain respects from those described in TPA 5100.39, the concepts discussed were generally similar in that they attempted to identify when a series of contracts were so closely related that they should be evaluated as one overall arrangement for accounting purposes. As previously discussed, IAS 8 allows management to look to pronouncements of certain other standard-setting bodies to develop accounting policies when IFRS lacks guidance that specifically applies to a transaction. Accordingly, companies reporting under IFRS may develop a policy that incorporates the factors outlined in TPA 5100.39 for purposes of evaluating whether separate contracts entered into at or near the same time with the same entity or related parties were negotiated as a package and should be evaluated as a single agreement pursuant to IAS 18. EY Commentary Because US GAAP and IFRS share the principle that revenue arrangements should be accounted for based on the substance of the arrangement with the customer and not the form, we believe that, in many cases, similar conclusions will be reached under both bases of accounting when evaluating whether multiple contracts represent a single arrangement. Under both bases of accounting, all applicable facts and circumstances should be carefully evaluated when determining whether separate contracts should be combined. Revenue Recognition Project Although the Boards plan to issue a preliminary views document later this year for review and comment by constituents, they acknowledge that a number of significant topics will be excluded from it and remain to be addressed. The Boards intend to consider these topics during the period the preliminary views document is exposed for comment. One of the issues the Boards intend to address during this period is when and how multiple contracts entered into (or contemplated) at the same time should be combined for revenue recognition purposes.
While we do not believe that any single factor above is necessarily determinative, a presence of any one, or a combination, of these factors (other than competitive bid processes) may indicate that contracts entered into at or near the same time should be evaluated as a single arrangement with multiple deliverables. Conversely, the absence of all of the above factors (other than proximity of negotiation/execution and a competitive bid process) may overcome the presumption that separate contracts entered into at or near the same time are a single arrangement. All facts and circumstances applicable to an arrangement should be considered when making this determination. Arrangements within the scope of Issue 00-21/Topic 13 Paragraph 2 of Issue 00-21 contains a presumption that separate contracts entered into at or near the same time with the same entity or related parties were negotiated as a package and should be evaluated as a single agreement. However, it does not provide additional guidance as to what factors should be evaluated in determining whether that presumption can be rebutted. Accordingly, the guidance of TPA 5100.39 is generally applied in practice to determine whether contracts entered into concurrently or within close proximity should be evaluated separately or as one multipleelement arrangement. As is the case with arrangements subject to the scope of SOP 97-2, determining whether multiple contractual arrangements should be combined and evaluated as one multiple-element arrangement for purposes of applying the provisions of Issue 00-21 and Topic 13 requires the use of professional judgment and careful consideration of the applicable facts and circumstances. IFRS IAS 18 generally requires separate recognition of each transaction. However, it provides that if two or more transactions are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole, then the transactions should be recognized together. However, IAS 18 does not provide any further guidance for determining when transactions are linked.
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Accounting for multiple-element arrangements

Many technology companies provide multiple products and/or services (deliverables) to their customers as part of a single arrangement. For example, software vendors often provide postcontract customer support (PCS), training, installation and consulting in combination with a software license. Hardware vendors may sell extended maintenance contracts or other service elements in combination with their hardware. Further, technological advances can have profound effects on a vendors business and products. Customers demand not only a technologically current product when making an initial purchasing decision, but given the prohibitive costs to purchase, install, and maintain certain software applications and other technologically-enabled products, they also demand protection against obsolescence and the risk that purchased products will not Overview SOP 97-2
continue to meet their needs due to evolutions in software or other technological advances. Vendors offer this protection in the form of various rights for post-contract support, maintenance services, upgrades and additional products. The inclusion of services and rights such as those described above (or others) in an arrangement with a customer complicates revenue recognition for the arrangement under US GAAP and IFRS. Under both reporting regimes, a determination must be made as to whether the elements can be accounted for separately. If the elements can be accounted for separately, an evaluation must be made as to how the arrangement consideration should be allocated to the various elements. If the elements cannot be accounted for separately, a determination must be made as to how revenue should be recognized for the combined unit of accounting.
Issue 00-21/Topic 13
IAS 18
EY Commentary
Allocate fees based on VSOE of fair value Use residual method when VSOE exists for the undelivered elements, but not for the delivered elements If VSOE does not exist, generally defer revenue recognition until VSOE does exist, all elements are delivered or recognize revenue over the service period Contingent revenue deferred until contingency is resolved
Allocate fees based on reliable and objective evidence of fair value, unless higher-level literature provides otherwise Use residual method when reliable and objective evidence of fair value exists for the undelivered elements, but not for the delivered elements Contingent revenue deferred until contingency is resolved The EITF is currently deliberating potential revisions to the separation and allocation provisions of Issue 00-21
Allocate fees based on fair value to elements having commercial substance on their own No specific guidance on how to determine fair value or acceptable methods to allocate fees
IFRS reporters may utilize more sources of evidence to support fair value More likely under IFRS that deliverables included in multipleelement arrangements will be accounted for separately
Broadly similar to current practice under US GAAP and IFRS Contemplates separating deliverables and allocating consideration on relative fair value basis using an entity-specific entry-price hierarchy
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US GAAP Arrangements within the scope of SOP 97-2 Under SOP 97-2, if an arrangement includes multiple elements, the fee should be allocated to the various elements based on vendorspecific objective evidence (VSOE) of fair value, regardless of any separate prices stated within the contract for each element. VSOE of fair value is limited to the following:

The price charged when the same element is sold separately. For an element not yet being sold separately, the price established by management having the relevant authority. It must be probable that the price, once established, will not change before the introduction of the element into the marketplace
If VSOE of fair value does not exist for undelivered elements included in a multiple-element arrangement, all revenue from the arrangement should be deferred until the earlier of the point at which (a) sufficient VSOE of fair value does exist or (b) all elements of the arrangement have been delivered. However, if the only undelivered element is PCS or services that do not involve significant production, modification or customization of software, then the entire fee should be recognized ratably over the period during which the PCS is to be provided or the services are expected to be performed. As noted above, SOP 97-2 does not allow revenue recognition for delivered elements when VSOE of fair value does not exist for undelivered elements included in a multiple-element arrangement, even if VSOE of fair value exists for the delivered elements. Application of the reverse residual method, which allocates an amount of arrangement consideration to the delivered elements equal to their VSOE of fair value and an amount to the undelivered elements equal to the difference between the total arrangement consideration and the VSOE of fair value of the delivered elements, is not acceptable. Although this generally does not affect software vendors, because a software license is rarely sold at a consistent price such that VSOE can be established for delivered licenses, hardware vendors subject to SOP 97-2 can be affected by this provision, as they may sell hardware on a standalone basis at a consistent price. The bundling of such hardware with a service element that is not frequently sold separately, or is new, may require deferral of revenue for the hardware product because of the inability to apply a reverse residual method to these arrangements. SOP 97-2 also restricts the amount of arrangement consideration allocable to any delivered element to amounts that are not subject to forfeiture, refund or other concession if undelivered elements are not successfully delivered. Revenue recognition for any amounts that are subject to forfeiture, refund or other concession if undelivered elements are not successfully delivered (commonly termed contingent revenue) is deferred until the contingency is resolved. Arrangements within the scope of Issue 00-21/Topic 13 Elements included in a multiple-element arrangement under Issue 00-21 may be accounted for separately if the following criteria are met:
Although the concept of VSOE may appear to be quite simple, in practice, establishing VSOE of fair value can be difficult. To support an assertion that VSOE of the fair value of an item included in a multiple-element arrangement exists based on reference to the price of an item when sold separately, vendors generally perform an analysis to evaluate whether a substantial majority of recent standalone sales of the item are priced within a relatively narrow range. Many technology companies have expended significant time and effort developing processes and systems to analyze standalone sales transactions for purposes of demonstrating that VSOE of fair value exists for a product or service that is routinely sold within multiple-element arrangements. The allocation of arrangement consideration to multiple elements included in an arrangement differs based on whether the element is delivered or undelivered and whether VSOE exists for all elements or only some. In the rare circumstances where VSOE of fair value exists for all elements, the fee generally should be allocated to the various elements based on each elements VSOE of fair value (the relative fair value method of allocation). Any discount in the arrangement is allocated to all elements proportionately based on their relative fair values. In the more customary circumstance when VSOE of fair value exists for undelivered, but not delivered, elements, the arrangement consideration should be allocated to multiple elements included in an arrangement using the residual method of allocation, whereby the amount of arrangement consideration allocated to the undelivered elements is equal to the VSOE of fair value of those elements. The amount allocated to the delivered elements is equal to the difference between the total arrangement consideration and the fair value of the undelivered elements. The use of the residual method results in any discount included in the arrangement being allocated, in its entirety, to the delivered elements.
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).
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If a general right of return exists for the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the vendor.
A delivered item has standalone value to the customer when either (a) any vendor sells that item separately or (b) the customer could resell that item on a standalone basis. An observable secondary market for the resale of the delivered item is not required to conclude that the item has standalone value to the customer. When determining whether an item is sold separately by other vendors, the type and function of the original item should be considered. While competing products have different brand names or may be marketed as having unique qualities or features, if those products and/or services can be used in place of the product or service that was delivered by the vendor, the sold separately criterion generally is met. Like SOP 97-2, Issue 00-21 provides that contractually stated prices for items included in an arrangement with multiple deliverables should not be presumed to be representative of fair value. Rather, it provides the following hierarchy of evidence that should be considered when determining if objective and reliable evidence of the fair value of an undelivered item exists:
Although Issue 00-21 provides the general guidance discussed above with respect to determining whether elements included in multiple-element arrangements can be accounted for separately, it acknowledges that other, higher-level literature (e.g., a FASB Statement, Technical Bulletin or Interpretation) may provide differing separation and allocation guidance in certain circumstances. When higher-level literature provides guidance as to the separation of multiple deliverables in a multiple-element arrangement into separate units of accounting and provides guidance on how to allocate the arrangement consideration between the separate units of accounting, Issue 00-21 states that the provisions of the higher-level literature should be applied. Many technology companies offer their customers the option to buy separately priced extended warranty and/or product maintenance contracts in conjunction with the purchase of hardware. Such arrangements are generally subject to the scope of FASB Technical Bulletin No. 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts (FTB 90-1), which provides that the stated amount of an extended warranty and product maintenance contract should be separated from the associated products and recorded as deferred revenue to be recognized over the term of the service contract. Because FTB 90-1 is higher-level literature than Issue 00-21, companies that enter into arrangements subject to the scope of FTB 90-1 do not have to establish objective and reliable evidence of fair value. Rather, such companies may account for the service contract separately from the sale of the hardware based on the stated prices in the arrangement. As discussed previously, the EITF has reached a consensus-forexposure to amend the current separation provisions of Issue 00-21 to allow a vendor to estimate a separate selling price for an undelivered item or items when it does not have VSOE or third-party evidence of fair value, as currently required by Issue 00-21, for those undelivered item(s). A vendors ability to estimate selling price would be limited to the undelivered item(s) in an arrangement and could be used only when VSOE or third-party evidence of fair value is unavailable for the undelivered items. This amendment likely will reduce the number of situations in which elements included in a multiple-element arrangement cannot be separated and must be accounted for as a single unit of accounting. IFRS IAS 18 requires separate recognition of revenue for separately identifiable components of a single transaction in order to reflect the substance of the transaction. If an element has commercial substance on its own, revenue for it should be recognized separately from other elements.
The best evidence of fair value of an undelivered item is VSOE of fair value, as that concept is presented in SOP 97-2 and discussed above. When VSOE of fair value is not available to determine fair value, relevant third-party evidence of fair value may be acceptable. When comparing a vendors deliverable(s) to a third partys deliverable(s), the deliverables must be similar in that they are largely interchangeable and can be used in similar situations by similar customers.
Generally, the methods for allocating arrangement consideration to elements included in multiple-element arrangements that are determined to be separate units of accounting are similar to those used under SOP 97-2. When objective and reliable evidence of fair value exists for all elements, the fee should be allocated to the various elements using the relative fair value method. If reliable and objective evidence of fair value only exists for the undelivered items, the arrangement consideration should be allocated to the elements using the residual method, as described above. Issue 00-21 prohibits the use of the reverse residual method, except when a delivered item is required by other authoritative literature to be recorded at fair value and marked to market thereafter. Like SOP 97-2, Issue 00-21 also restricts the amount of arrangement consideration allocable to any delivered element to amounts that are not contingent on the successful delivery of undelivered elements of the arrangement.
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However, the standard does not explicitly address how arrangement consideration should be allocated to elements included in a multipleelement arrangement with a customer but separately accounted for based on their commercial substance. The appendix to IAS 18 does provide an example of a multiple-element arrangement containing products and services, stating that when the selling price of a product includes an identifiable amount for subsequent servicing (in the example in the appendix, the service contemplated is PCS provided in connection with a software licensing arrangement), an amount should be deferred and recognized as revenue over the period during which the service is performed. The amount deferred is that which will cover the expected costs of the services under the agreement, together with a reasonable profit on those services. Additionally, IFRIC 13, Customer Loyalty Programmes, discusses two allocation methods that are considered to be acceptable for allocating arrangement consideration when current sales of goods or services also result in customers earning award credits in a vendors customer loyalty program. Under the first method, the residual method, consideration allocated to an award credit is measured by reference to a reasonable estimate of that elements fair value (as observed or estimated). Alternatively, the arrangement consideration allocated to an element could be measured based on the fair value of the element relative to the fair value of all elements (the relative fair value method). IFRIC 12, Service Concession Arrangements, also includes a description of the use of the relative fair value method of allocating arrangement consideration to elements included in a multiple-element arrangement. Taken together, these references have been interpreted to mean that under IFRS, an element included in a multiple-element arrangement should be accounted for as a separate unit of accounting if it has commercial substance, and that arrangement consideration should be allocated to the elements included in a multiple-element arrangement based on a reasonable estimate of fair value (regardless of any separate prices stated within the contract for each element). The allocation may be performed using either the relative fair value method or the residual value method. IFRS does not explicitly address the reverse residual method, and its use also may be acceptable depending on specific facts and circumstances. Unlike US GAAP, IAS 18 does not prescribe how the fair value of an element should be determined, but it does define fair value as the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction. Accordingly, different approaches to determining a reasonable estimate of fair value are acceptable. We believe these approaches include, but are not necessarily limited to:
Prices charged by the vendor for a similar product or service Prices charged by competitors for similar products or services (relevant third-party evidence of fair value as defined by US GAAP) For software companies, contractually stated substantive PCS renewal rates The estimated costs of providing a product or rendering a service, plus a reasonable profit margin thereon (a cost-plus approach)
EY commentary As IFRS does not provide guidance on when an element included in a multiple-element arrangement may be deemed to have commercial substance, such a determination will require the use of professional judgment. The guidance contained in Issue 00-21 on whether an element has standalone value may be helpful in making those judgments. As discussed above, because IFRS does not provide prescriptive or limiting guidance on how to determine the fair value of elements included in a multiple-element arrangement, it is more likely that elements may be accounted for separately under IFRS than for a comparable arrangement accounted for using US GAAP. However, technology companies should consider the following factors when contemplating the IFRS accounting for multiple element arrangements:
The ability to use a cost-plus approach to estimating fair value of elements is a significant difference from US GAAP (such an approach to estimating fair value is not permitted by either SOP 97-2 or Issue 00-21). While many technology companies may view this as a welcome change from the provisions of US GAAP, the use of such an approach may require companies to develop new policies, processes and controls relating to its use. Specifically, companies will have to address the following questions: (a) Does the definition of cost include only the direct costs of providing goods and services to customers (i.e., fulfillment costs), or does it include an allocation of indirect costs? If cost includes allocated indirect costs, which costs are allocable? How are such costs allocated? Do systems and processes exist to capture such costs on a routine basis? For PCS provided by software companies, should costs include only the direct support provided to licensees (i.e., bug fixes and phone support), or costs of developing new product features and functionality that are provided on a when-and-if available basis? Should costs include an allocation of certain of the costs to develop the previously licensed software that is being enhanced? When costs of developing new features and functionality are included in any cost estimates used as a basis of estimating the fair value of PCS, determining how to
The price charged when the same element is sold separately (VSOE of fair value as defined by US GAAP)
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estimate the costs of future enhancements and allocate such costs across multiple existing and new customers may prove challenging. (b) What is a reasonable profit margin? Is it based on company-specific margins, or should it reference marketplace assumptions? Should the margins used be consistent for arrangements with different, comparably situated customers, or can they vary from customer to customer? These determinations may be especially difficult for PCS and other post-contract support services that have very high margins. While some technology companies (particularly those that regularly price services or other elements of an arrangement on a cost-plus basis) may have already developed policies to address such questions and processes to capture the necessary data, others will need to address these issues as part of any transition to IFRS.
However, companies selling software may not be limited to VSOE of fair value evidence, as is currently the case under SOP 97-2. As discussed above, third-party evidence or cost plus a reasonable profit margin, among other evidence, are also acceptable methods of establishing a reasonable estimate of fair value under IFRS. If a company has such sources of fair value evidence available to it (or, potentially, other sources), but is unable to establish VSOE of fair value for an element as required by SOP 97-2, it may be inappropriate to defer revenue recognition due to a lack of VSOE of fair value in a manner similar to US GAAP.
Many software companies under IFRS may be encouraged by the fact that evidence of fair value is not limited to VSOE of fair value. The ability to look to competitors prices may be particularly helpful for services such as software customization, installation and training. However, it is likely that the ability to establish fair value of licensed software products and PCS by reference to third-party prices will be limited in practice because the proprietary nature of software companies intellectual property may make it difficult to identify sufficiently similar products in the marketplace. In fact, this issue is one of the reasons the AICPAs Accounting Standards Executive Committee (AcSEC) chose to limit acceptable fair value evidence to VSOE of fair value when deliberating the provisions of SOP 97-2. Additionally, it may be difficult to obtain sufficient visibility into the pricing practices of competitors to establish reasonable evidence of fair value. As mentioned above, many technology companies have invested significant time and effort into developing systems and processes to establish VSOE of fair value of elements commonly included in multiple-element arrangements. Although not required under IFRS, such companies may decide that they wish to adopt a policy to continue to use VSOE of fair value as fair value evidence. In fact, many of the initial technology companies reporting under IFRS appear to be using a VSOE of fair value evidence standard, based upon the accounting policies they have disclosed. We believe that VSOE of fair value evidence is generally acceptable as a value established through an analysis of separate, standalone sales transactions meets the definition of an exchange of assts in an arms length transaction between willing parties (the IFRS definition of fair value).
Technology companies that offer their customers the option to buy separately priced extended warranty and/or product maintenance contracts concurrently with the sale of hardware will not be able to account for the service contract solely based on its stated price. Rather, such companies must evaluate if the service contract has commercial substance, and, if so, arrangement consideration should be allocated to the hardware and service contract based on a reasonable estimate of fair value (regardless of any separate prices stated within the contract for each element). Because there are multiple acceptable means to establish a reasonable estimate of fair value under IFRS, detailed disclosure of the basis used is important and should be included in the notes to the financial statements.
Additionally, IFRS does not expressly limit the amount of arrangement consideration allocable to a delivered item to amounts that are not subject to forfeiture, refund or other concession if undelivered elements are not successfully delivered, as do SOP 97-2 and Issue 00-21. However, before recognizing such amounts as revenue, vendors must be able to demonstrate that it is probable that future economic benefits will flow to the organization (a basic revenue recognition criterion of IAS 18). As previously discussed, with the recent EITF consensus-forexposure on Issue 08-1 to amend the separation provisions of Issue 00-21, US GAAP for technology companies that are not subject to the scope of SOP 97-2 will become much more closely aligned with IFRS than is the case currently. However, absent a decision in the follow-on project to modify the fair value threshold of SOP 97-2 in a manner comparable to the changes made to the fair value standards of Issue 00-21, comparable alignment will not occur for arrangements within the scope of SOP 97-2. Revenue recognition project We understand that the approach proposed by the Boards will require arrangement consideration to be allocated to goods and services included in a multiple-element arrangement based on the estimated separate selling prices of the respective elements, in a manner similar to a relative fair value allocation. The proposed
15
approach will be more similar to current IFRS than US GAAP as it will not limit the determination of the selling price to VSOE or third-party evidence of fair value. Rather, if there is no observable selling prices for goods and services, the separate selling prices will be estimated. This proposed approach is broadly similar to current practice within both US GAAP and IFRS. However, we expect that for US GAAP reporters it will more frequently result in elements included in multiple-element arrangements being accounted for as separate units of accounting than under current GAAP. Whether and how contingent revenue provisions included in multiple-element arrangements will affect the allocation of arrangement consideration remains to be deliberated by the Boards.
significant source of recurring sales as resellers may represent the only distribution channel for a specific product or in a geographic region. Such companies may be willing to provide resellers with greater rights than those they would provide to end customers to maintain a mutually beneficial relationship and maximize future sales opportunities. Additionally, a company may provide concessions it is not otherwise contractually obligated to provide if a reseller is unable to sell delivered products to end customers. Because of these factors, there are particular revenue recognition considerations for transactions with resellers that must be evaluated under both IFRS and US GAAP. These considerations may preclude a vendor from recognizing revenue for sales to resellers until delivered products are ultimately sold to end customers, or until cash is remitted by the reseller.
Reseller Arrangements
Many technology companies utilize resellers in the distribution of their products. For many companies, these relationships may be a Overview SOP 97-2 and Issue 00-21/Topic 13
IAS 18
EY Commentary
A number of considerations must be assessed to determine whether delivery has occurred and whether fees are fixed or determinable and collectible at the time products are transferred to a reseller
Revenue recognized when risks and rewards of ownership have passed When the buyer is acting, in substance, as an agent, the sale is treated as a consignment sale
Both US GAAP and IFRS attempt to evaluate the business relationship to determine if revenue may be recognized on delivery of products to a reseller, or whether it should be deferred until sale to the end customer occur
Transactions with resellers not specifically addressed to date
US GAAP Arrangements within the scope of SOP 97-2 and Issue 00-21/Topic 13 Determining whether or not revenue may be recognized on the transfer of software licenses pursuant to an arrangement with a reseller generally is difficult under SOP 97-2. Because of factors such as those previously discussed, there is a greater inherent risk that fees are not fixed or determinable in an arrangement with a reseller because a vendor may not be able to: 1) reasonably estimate the effects of rights of return or other rights given to a reseller or 2) conclude that it will not grant a future concession. Additionally, other factors may indicate that the substance of the arrangement is more akin to a consignment and not a sale unless and until the reseller is able to sell delivered products to an end customer. In such cases, revenue should not be recognized until sufficient evidence has been obtained demonstrating that the products have been sold to the end customer (i.e., the vendor should recognize revenue on the sell-through method).
Paragraph 30 of SOP 97-2 explicitly identifies the following factors a vendor must consider when determining whether an arrangement fee with a reseller is fixed or determinable.
Business practices, the resellers operating history, competitive pressures, informal communications, or other factors that indicate payment is substantially contingent on the resellers success in distributing individual units of the product. Resellers that are new, undercapitalized, or in financial difficulty may not demonstrate an ability to honor a commitment to make fixed or determinable payments until they collect cash from their customers. Uncertainties about the potential number of copies to be sold by a reseller may indicate that the amount of future returns cannot be reasonably estimated on delivery; examples of such factors include the newness of the product or marketing channel, competitive products, or dependence on the market potential of another product offered (or anticipated to be offered) by the reseller.
16
Distribution arrangements with resellers that require the vendor to rebate or credit a portion of the original fee if the vendor subsequently reduces its price for a product and the reseller still has rights with respect to that product (sometimes referred to as price protection). If a vendor is unable to reasonably estimate future price changes in light of competitive conditions, or if significant uncertainties exist about the vendors ability to maintain its price, the arrangement fee is not fixed or determinable.
Considerations relating to the accounting for arrangements with resellers are not specifically addressed in either Issue 00-21 or Topic 13 as they are in SOP 97-2, other than to note that fees due pursuant to an arrangement to sell products to a reseller must be fixed or determinable and collectible prior to revenue recognition occurring. However, we believe that the considerations discussed above are equally applicable to transactions with resellers when the products sold are not subject to the scope of SOP 97-2. IFRS IAS 18 specifies that certain criteria should be satisfied before revenue is recognized from the sale of goods. These include:
We believe certain additional factors also should be considered when assessing whether revenue for sales to a reseller may be recognized when products are licensed to the reseller. These include:

Whether the arrangement contains extended payment terms Whether the payment terms coincide with the resellers sales to end users Whether collection of the fees associated with a reseller arrangement can be assessed as probable If the arrangement includes rights of return, exchange, or stock balancing rights, whether a reasonable estimate of future returns can be made pursuant to the provisions of FASB Statement No. 48, Revenue Recognition When Right of Return Exists, including an assessment as to whether uncertainties about the potential number of copies of licensed software that will be sold by the reseller indicate that the amount of future returns cannot be reasonably estimated Whether the reseller has been induced to buy more product than can be promptly resold Whether the arrangement includes either explicit or implicit commitments by the vendor to assist the reseller in selling the product to end users Whether a transaction is complex, involving both a reseller and an end user The resellers bargaining strength
The entity has transferred to the buyer the significant risks and rewards of ownership of the goods The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold It is probable that the economic benefits associated with the transaction will flow to the entity
These criteria are elaborated on in paragraphs 15 and 16 of IAS 18. Paragraph 15 states The assessment of when an entity has transferred the significant risks and rewards of ownership to the buyer requires an examination of the circumstances of the transaction and that in some cases the transfer of risks and rewards of ownership occurs at a different time from the transfer of legal title or the passing of possession. Paragraph 16 adds that If the entity retains significant risks of ownership, the transaction is not a sale and revenue is not recognized, noting that An entity may retain a significant risk of ownership in a number of ways. Although the body of IAS 18 does not specifically provide guidance specific to transactions with resellers beyond the excerpts cited in the preceding paragraph, the appendix states that revenue from sales to intermediate parties, such as distributors, dealers or others for resale is generally recognized when the risks and rewards of ownership have passed. However, when the buyer is acting, in substance, as an agent, the sale is treated as a consignment sale. Although this acknowledges that it may not be appropriate to recognize revenue on the delivery of products to a reseller, it does not provide factors that should be considered in determining if the substance of an arrangement with a reseller is in effect a consignment sale.
Each of the above factors is discussed in greater detail in our Financial Reporting Developments Book, Software Revenue Recognition, an Interpretation (as revised October 2008) (SCORE Retrieval No. BB1357). Unless a vendor can assess the risks associated with these factors, or other identified risks, as minimal, revenue generally should be recognized using the sell-through method.
17
EY Commentary Both US GAAP and IFRS attempt to determine if, in a transaction with a reseller:
Revenue Recognition Project To date, the Boards have not specifically discussed transactions with resellers, and it is unclear whether any specific guidance will be developed as a result of their continuing deliberations.
The vendor has transferred the risks and rewards of ownership of delivered goods to the reseller, Whether it is likely the vendor will be paid a reasonably estimable amount for the delivered goods absent resale, or Whether factors exist that indicate revenue should not be recognized for the transaction until the reseller sells the goods on to the end customer.
Although, as discussed above, SOP 97-2 provides certain limited guidance for transactions with resellers, neither US GAAP nor IFRS provide exhaustive guidance on how to make an assessment of whether revenue should be recognized when goods are transferred to a reseller (the sell-in method of revenue recognition) or on a sell-through basis. However, companies reporting on either basis of accounting should evaluate the specific facts and circumstances of their business relationships with resellers to determine when revenue should be recognized. When making such an evaluation, factors such as those previously discussed should be considered. Many technology companies reporting under US GAAP have concluded that revenue should be recognized on a sell-through basis for products shipped to resellers because of the nature of their business relationships and the associated rights and obligations of the parties. Absent any change in the business relationships with their resellers, it is likely that companies that have reached such a conclusion under US GAAP will generally reach a similar conclusion when reporting under IFRS.
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2008-15 5 December 2008

Revenue recognition in technology companies

Revenue recognition in technology companies

Overview of US GAAP requirements for technology companies

Overview of IFRS requirements for technology companies

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Similarities and differences between US GAAP and IFRS

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

EITF Issue No. 08-1

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

The joint revenue recognition project

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

A brief word of caution

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Revenue Recognition Project

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Evaluating separate contracts as a single arrangement

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Overview SOP 97-2

Revenue Recognition Project

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Accounting for multiple-element arrangements

Revenue Recognition Project

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Revenue Recognition Project

Transactions with resellers not specifically addressed to date

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Technical Line No. 2008-15, 5 December 2008

Revenue recognition in technology companies

Technical Line No. 2008-15, 5 December 2008

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Online digests and features.

financial reporting, internal controls and other issues.

Financial Reporting Developments In-depth

Accounting & Auditing Developments

International GAAP & GAAS Includes

comment letters, IASB meeting minutes)

Canada Includes the complete CICA Standards

when new material is posted and much more

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