Internet Accounting Issues

Internet Accounting
Issues
A Summary
May 2001
Table of Contents
Overview *
Transition *
Advertising Barter Transactions *
Gross Versus Net Revenue Recorded in Transactions *
Shipping and Handling Fees and Costs *
Sales Incentives *
Consideration From a Vendor to a Reseller *
Service Outages *
Website Development Costs *
Computer Files That are Essentially Films, Music, or Other Content *
Arrangements with Up-Front Payments *
Customer Origination and Acquisition Costs *
Amortization Periods of Intangible Assets *
Exchange of Equity Instruments for Goods or Services *
Revenue Arrangements With Multiple Deliverables *
"Points" and Other Time/Volume-Based Offers *
Software that Resides on the Vendors or a Third-Partys Server *
Revenue Recognition for Auction Sites *

Access and Maintenance of Websites *
Advertising Arrangements with Guaranteed Minimums *
Segment Information *
Disclosures About Revenues *
Overview
The rapid growth in the number of companies that provide
infrastructure to and goods and services on the Internet ("Internet
companies") during 1997-1999 spurred an increase in related
accounting issues. While many of these issues are the same as
those that companies in the non-cyber world face, Internet
companies are forced to address them more frequently. And because
measuring revenue growth is considered by some to be a significant
bellwether of progress for these companies, proper accounting for
that revenue growth is an important concern. The majority of issues
considered to be "Internet accounting issues" are those related to
revenue recognition and income statement classification.
The importance of the accounting issues first brought to light by
Internet companies has not gone unnoticed by accounting standardsetter organizations. In October 1999, the SEC staff sent a letter to
the FASBs Emerging Issues Task Force (EITF) describing various
Internet accounting issues, many of which have been added to the
EITFs agenda at the SECs request. Conclusions reached by the EITF
on these issues apply to not just Internet companies but to all
companies.
Several important revenue recognition issues, including some of
those raised in the SEC staffs letter to the EITF, were addressed by
Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in
Financial Statements, which was issued in December 1999. In
October 2000, the SEC staff issued a Frequently Asked Questions
(FAQ) document on SAB 101. For further information, refer to our
Summary of Staff Accounting Bulletin No. 101, Revenue Recognition
in Financial Statements (Updated for Frequently Asked Questions)
(SCORE Retrieval File No. BB4154).
This Summary primarily addresses those issues that have either

already been addressed or that are currently under consideration by
the EITF and describes our approach for many of them. Transition for
EITF consensuses is generally prospective, however, for some
issues, such as "gross versus net" revenue presentation,
reclassification of prior period income statements is required. This
Summary also highlights, where applicable, issues addressed in SAB
101 and the SEC staffs current views on various issues that it
expressed in its letter to the EITF or in other documents such as
speeches. We will be updating this Summary (which reflects
developments through the April 18-19, 2001 EITF meeting) as
definitive guidance on those issues is discussed and others arise.
The following categories more fully describe the four basic types of
Internet companies described in this Summary.
Internet Service Providers (ISPs) - These are most often
telephone and, more recently, cable TV companies that charge a
monthly fee for providing access (often unlimited) to the Internet, as
opposed to individual call-up charges. The largest such company is
AOL Time Warner, which is also one of the largest content providers
and Internet portal companies. Its monthly subscriber revenues are
derived from both Internet service and content.
Internet Portal Companies (IPCs) - These companies generally
provide extensive content on their websites, often with no
subscription fee, and either provide their own search engine and/or
access to other widely-used search engines. Their revenues usually
are derived from individual contractual arrangements with
advertisers or other content providers in which guarantees are made
as to the number of "hits" on the website or the advertisers banner,
or a button is placed on the IPCs website in varying degrees of
prominence. These buttons and banners generally allow "clickthrough" to the advertisers or providers website. Examples of IPCs
are Yahoo!, Excite, and Lycos.
Internet Commerce Companies (ICCs) - These are defined
narrowly as companies that conduct business only through the
Internet, such as product sales (e.g., Amazon.com) or service
providers. Others, such as eBay, facilitate transactions between
others and collect a fee per transaction. Virtually all companies now
have websites; however, in an effort to maintain good relations with

retailers and other distributors, many do not yet sell over the
Internet. They maintain a site for information and promotional
purposes only and provide a list of distributors. Others use the
Internet as an alternate sales channel. Other e-commerce
companies are business-to-business (B2B) companies that supplant
the traditional materials procurement process with Internet-enabled
processes.
Other Internet-Related Companies - These companies, although
tied to or dependent on the Internet for business, do not do anything
out of the ordinary, but because of the fast changing dynamics of
this emerging industry, may engage in unusual terms or conditions
in their contracts. Examples of companies that are Internet-related
are Cisco Systems, JDS Uniphase, Oracle, and Lucent Technologies.
They produce products tied to and dependent on the growth of the
Internet, but generally are not visible to the consumer. They provide
the hardware and software infrastructure of the Internet.
Transition
The EITF is expected to address most of the issues discussed in this
Summary and consensuses have already been reached on many of
them. Generally, the EITF is silent as to transition which allows
companies to adopt consensuses prospectively (i.e., for transactions
that occur after the consensus is reached) or as a cumulative catchup adjustment in accordance with APB Opinion No. 20, Accounting
Changes. However, if transition is specified in the consensus, that
transition should be followed. For accounting changes that impact
net income, where the EITF is silent on transition, we recommend
that companies consider electing to make the change by a
cumulative catch-up adjustment. The benefit of this treatment, for
example, is where adopting an EITF consensus would result in
delayed revenue recognition because revenue recognized prior to
the accounting change gets "recycled" into revenue after the
change and thus would not adversely impact the trend in earnings.
For accounting changes that affect income statement presentation,
the EITF generally requires retroactive reclassification.
Advertising Barter Transactions
An advertising barter arrangement exists when two companies enter

into a non-cash transaction to exchange advertising with each other.
These arrangements are often referred to as banner for banner,
button for button, click-through for click-through, reciprocal
advertising, or co-marketing arrangements. A typical transaction
might arise when Company A advertises on Company Bs website
and Company B advertises on Company As website. The
advertisements may be in the form of an image appearing on the
website describing the other website, or products and/or services
offered on the website (banner for banner), or a link to the other
website (click-through for click-through). Some entities record an
equal amount of revenue (for the web space they own and "sell")
and expense (for the web space they "purchase" from the other
entity). Typically, this has no effect on income (although it could, if
different periods are involved) but may have a significant impact on
revenue and perhaps, the stock price.
The issue is whether barter transactions that involve a nonmonetary
exchange of advertising should result in recorded revenues and
expenses, and if so, whether those revenues and expenses should
be recognized at the more readily determinable fair value of the
advertising surrendered or received in the exchange.
At the January 1920, 2000 meeting, the EITF reached a consensus
that revenue and expense should be recognized at fair value from
an advertising barter transaction only if the fair value of the
advertising surrendered in the transaction is determinable based on
the entity's own historical practice of receiving cash for similar
advertising from buyers unrelated to the counterparty in the barter
transaction. An exchange between the parties to a barter
transaction of offsetting monetary consideration, such as a swap of
checks for equal amounts, does not evidence the fair value of the
transaction. If the fair value of the advertising surrendered in the
barter transaction is not determinable within the limits of this Issue,
the barter transaction should be recorded based on the carrying
amount of the advertising surrendered, which likely will be zero.
The population of prior cash transactions that should be analyzed to
determine fair value should not exceed six months prior to the date
of the barter transaction. If economic circumstances have changed
such that the prior six months cash transactions are not
representative of current fair value for the advertising surrendered,

then a shorter, more representational period should be used. In
addition, it is inappropriate to consider cash transactions
subsequent to the barter transaction to determine fair value.
For advertising surrendered for cash to be considered "similar" to
the advertising being surrendered in the barter transaction, the
advertising surrendered must have been in the same media and
within the same advertising vehicle (e.g., same publication, same
website, or same broadcast channel) as the advertising in the barter
transaction. In addition, the characteristics of the advertising
surrendered for cash must be reasonably similar to that being
surrendered in the barter transaction with respect to:
a. Circulation, exposure, or saturation within an intended
market;
b. Timing (time of day, day of week, daily, weekly, 24
hours a day/7 days a week, and season of the year);
c. Prominence (page on website, section of periodical,
location on page, and size of advertisement);
d. Demographics of readers, viewers, or customers, and
e. Duration (length of time advertising will be displayed).
Additionally, in determining whether a cash transaction is similar,
the quantity or volume (e.g., the number of impressions) of
advertising surrendered in a qualifying past cash transaction can
only evidence the fair value of an equivalent quantity or volume of
advertising surrendered in subsequent barter transactions (i.e., a
cash transaction for 1,000 impressions can be used to support a
barter transaction up to 1,000 impressions). Consider the following
example:
Example 1:
An Internet company has one cash transaction for 1,000
advertising impressions at $1.00 per impression or $1,000. This
company shortly thereafter enters into a barter advertising
arrangement for 2,000 similar impressions for which the
company believes that fair value of the transaction is $1.00 per

impression or $2,000. The revenue (and advertising expense)
on the barter transaction is limited to $1,000 because the
quantity of the cash transaction is only 1,000 impressions. On
the other hand, had the company entered into a barter
advertising transaction for 500 similar impressions, revenue on
the barter transaction would be $500.
When a cash transaction has been used to support an equivalent
quantity and dollar amount of barter revenue that transaction
cannot serve as evidence of fair value for any other barter
transaction (i.e., barter revenue would not be more than equal to a
companys total revenue from cash transactions). To illustrate, using
the facts in the above example:
Example 2:
An Internet company enters into two barter transactions. The
first barter transaction is for 500 impressions at $1.00 per
impression and the company used the only similar cash
transaction of 1,000 impressions to support the fair value of
the barter. The company enters into another barter advertising
arrangement for 1,200 impressions. The revenue on the
second barter transaction is limited to $500 because that is the
remaining amount of the quantity (500 impressions) of the
prior similar cash transaction that is not older than six months
from the date of the second barter transaction. On a
cumulative basis the company would record $1,000 in
advertising revenue, $1,000 in barter revenue and $1,000 in
barter advertising expense. The value of the remaining 700
impressions on the second transaction is not recognized nor
would it be recognized at a later date if additional similar cash
transactions occur in the future.
Pursuant to the consensus, companies should disclose the amount
of revenue and expense recognized from advertising barter
transactions for each income statement period presented. In
addition, if an entity engages in advertising barter transactions for
which the fair value is not determinable within the limits of this EITF
Issue, information regarding the volume and type of advertising
surrendered and received (such as the number of equivalent pages,
the number of minutes, or the overall percentage of advertising

volume) should be disclosed for each income statement period
presented. An example disclosure for Example 2 above follows:
The Company recorded barter revenue and expense of $1,000
during the year ended December 31, 200X. In 200X, the
Company also entered into barter transactions that did not
result in revenue recognition, because fair value was not
determinable under the criteria established by the EITF, for 700
advertising impressions on its auction website, representing
41% of its total volume of advertising impressions.
Gross Versus Net Revenue Recorded in Transactions
Internet companies often must address the issue of whether to
record revenue at the gross amount billed or the net amount
received. Many Internet companies do not stock inventory and may
employ independent warehouses or fulfillment houses to drop-ship
merchandise to customers on their behalf. These companies also
may offer services that will be provided by an independent service
provider. However, this issue is not limited to Internet companies.
For example, travel agents, magazine subscription brokers, and
retailers that sell goods through catalogs or that sell goods on
consignment may face similar issues. How companies recognize
revenue for the goods and services they offer is an important issue
because many investors appear to value Internet companies based
on a multiple of gross revenues rather than a multiple of gross profit
or earnings. While net income does not differ based on whether a
company reports revenue on a gross basis or a net basis, some
believe that the financial statement presentation could affect the
companys stock price.
The issue is whether an Internet company should recognize revenue
in the amount of the gross amount billed to the customer because it
has earned revenue from the sale of the goods or services; or
whether the company should recognize revenue based on the net
amount retained (the amount paid by the customer less the amount
paid to the supplier) because, in substance, it has earned a
commission from the supplier of the goods or services on the sale.
At the July 1920, 2000 meeting, the EITF reached a consensus on

Issue 99-19, Reporting Revenue as a Principal versus Net as an
Agent, which supplements SAB 101. Issue 99-19 indicates that
whether a company should recognize revenue gross or net is a
matter of judgment that depends on the relevant facts and
circumstances and that the following factors or indicators should be
considered in the evaluation. None of the indicators should be
considered presumptive or determinative; however, the relative
strength of each indicator should be considered.
Indicators of Gross Revenue Reporting
1. The company is the primary obligor in the arrangement
2. The company has general inventory risk (before customer
order is placed or upon customer return)
3. The company has latitude in establishing price
4. The company changes the product or performs part of the
service
5. The company has discretion in supplier selection
6. The company is involved in the determination of product or
service specifications
7. The company has physical loss inventory risk (after customer
order or during shipping)
8. The company has credit risk.
Indicators of Net Revenue Reporting
1. The supplier (not the company) is the primary obligor in the
arrangement
2. The amount the company earns is fixed
3. The supplier (and not the company) has credit risk.
The minutes and the EITF Abstracts for Issue 99-19 include a
detailed explanation of each indicator and provide several examples
that illustrate the application of those indicators that should be
considered when determining whether revenue should be recorded
gross or net. Accordingly, reference should be made to the
consensuses in evaluating a specific situation.
The SEC Observer reminded registrants that Regulation S-X, Rule 503(b)(1), requires separate presentation in the income statement of
revenues from the sale of products and revenues from the provision
of services. Because commissions and fees earned from activities
reported net are service revenues, this may often have the effect of
requiring separate presentation of revenues reported gross and
revenues reported net (i.e., gross revenue (product sales) and net
revenue (distributor sales) should be separate line items).
Voluntary disclosure of gross transaction volume for those revenues
reported net may be useful to users of financial statements. If
appropriate, such disclosure is permitted under the consensus either
parenthetically on the face of the income statement or in the notes
to the financial statements. However, if gross amounts are disclosed
on the face of the income statement, they should not be
characterized as revenues (a description such as "gross billings"
may be appropriate), nor should they be reported in a column that
sums to net income or loss.
SEC registrants should apply the consensus in Issue 99-19 no later
than the required implementation date for SAB 101, which, as
amended by SAB 101B, is the fourth quarter of a registrant's fiscal
year beginning after December 15, 1999. Nonregistrants should
apply the consensus no later than in annual financial statements for
the fiscal year beginning after December 15, 1999. Upon application
of the consensus, comparative financial statements for prior periods
should be reclassified to comply with the classification guidelines of
this Issue. If it is impracticable to reclassify prior-period financial
statements, disclosure should be made of both the reasons why
reclassification was not made and the effect of the reclassification
on the current period.
The SEC Observer noted that in Topic D-85, the SEC staff indicated
that registrants should retroactively apply the guidance in SAB 101
regarding income statement classification to all periods presented in

their next financial statements (whether interim or annual) filed with
the SEC after January 20, 2000, if that information is available. The
SEC Observer indicated that that same guidance applies to any
income statement reclassifications required by Issue 99-19. The SEC
Observer also noted that companies registering shares in an initial
public offering are expected to comply with SAB 101 at the time
they file their initial registration statement with the SEC.
Shipping and Handling Fees and Costs
Shipping and handling costs are incurred by most Internet product
sellers; however, diversity in practice exists regarding the income
statement classification of amounts charged to customers for
shipping and handling, as well as for costs incurred related to
shipping and handling. Many sellers charge customers for shipping
and handling in amounts that exceed the related costs incurred.
Some display the charges to customers as revenues and the costs
as expenses, while others net the costs and revenues.
The components of shipping and handling costs, and the
determination of the amounts billed to customers for shipping and
handling, may differ from company to company. Some companies
define shipping and handling costs as only those costs incurred for a
third-party shipper to transport products to the customer. Other
companies include as shipping and handling costs a portion of
internal costs (e.g., salaries and overhead related to the activities to
prepare goods for shipment). In addition, some companies charge
customers only for amounts that are a direct reimbursement for
shipping and, if discernible, direct incremental handling costs;
however, many other companies charge customers for shipping and
handling in amounts that are not a direct pass-through of costs.
At the July 1920, 2000 meeting, the EITF reached a consensus on
Issue 00-10, Accounting for Shipping and Handling Fees and Costs.
The consensus states that all amounts billed to a customer in a sale
transaction related to shipping and handling, if any, represent
revenues earned for the goods provided and should be classified as
revenue (even if the amounts billed are a direct pass-through of
costs when the seller is acting as an agent for its customers).
However, Issue 00-10 only applies to shipping and handling fees and
costs by companies that record revenue based on the gross amount

billed to customers under Issue 99-19.
At the September 2021, 2000 meeting, the EITF continued its
discussion of the classification of shipping and handling costs. The
EITF reached a consensus that the classification of shipping and
handling costs is an accounting policy decision that should be
disclosed pursuant to APB Opinion No. 22, Disclosures of Accounting
Policies. A company may adopt a policy of including shipping and
handling costs in cost of sales (the classification preferred by the
SEC staff). However, if shipping costs or handling costs are
significant and are not included in cost of sales (i.e., if those costs
are accounted for together or separately on other income statement
line items), a company should disclose both the amount(s) of such
costs and the line item(s) on the income statement that include
them.
The EITF observed that there would be some diversity in the types of
costs companies include in "shipping and handling," but decided not
to provide additional guidance. In addition, the EITF reached a
consensus that it is not appropriate to net shipping and handling
costs against revenues because doing so would be inconsistent with
its consensus that all amounts billed to customers related to
shipping and handling should be classified as revenue.
SEC registrants should apply the consensus in Issue 00-10 no later
than the required implementation date for SAB 101, which, as
amended by SAB 101B, is the fourth quarter of a registrant's fiscal
year beginning after December 15, 1999. Nonregistrants should
apply the consensus no later than in annual financial statements for
the fiscal year beginning after December 15, 1999. Upon application
of the consensus, comparative financial statements for prior periods
should be reclassified to comply with the classification guidelines of
this Issue. If it is impracticable to reclassify prior-period financial
statements, disclosure should be made of both the reasons why
reclassification was not made and the effect of the reclassification
on the current period.
The SEC Observer noted that in Topic D-85, the SEC staff indicated
that registrants should retroactively apply the guidance in SAB 101
regarding income statement classification to all periods presented in
their next financial statements (whether interim or annual) filed with

the SEC after January 20, 2000, if that information is available. The
SEC Observer indicated that that same guidance applies to
reclassifications of shipping and handling revenues required by Issue
00-10.
Sales Incentives
Many Internet companies offer sales incentives including discounts,
coupons, rebates, and free products or services, such as in certain
introductory offers. Some believe these arrangements should be
accounted for as a sale at full price, with the recognition of
marketing expense for the amount of the discount while others
believe the discount should be reflected as a reduction of the sales
price. At the May 17-18, 2000 meeting, the EITF reached a
consensus on EITF Issue 00-14, Accounting for Certain Sales
Incentives. Issue 00-14 addresses the recognition, measurement,
and income statement classification for sales incentives offered
voluntarily by a vendor without charge to customers that can be
used in, or that are exercisable by a customer as a result of, a single
exchange transaction and includes the following:
offers that can be used by a customer to receive a reduction in
the price of a product or service at the point of sale (e.g., a
coupon);
offers that entitle a customer to receive a reduction in the price
of a product or service by submitting a form or claim for a
refund or rebate of a specified amount of the purchase price
charged to the customer at the point of sale (e.g., a rebate);
offers by a vendor for a free product or service when the
customer purchases another specified item if the free product
or service is delivered to the customer at the point of sale of
the specified item (e.g., a free airline ticket); and
sales incentives offered by manufacturers to customers of
retailers or other distributors (e.g., a manufacturers coupon).
However, Issue 00-14 does not address the following types of sales
incentives:
coupons, rebates, and other forms of rights for free or

significantly discounted products or services received by a
customer in a prior exchange transaction that were accounted
for by the vendor as a separate element in that prior exchange
(these types of sales incentives are within the scope of EITF
Issue 00-21);
offers for free or significantly discounted products or services
that become exercisable by the customer as a result of a single
exchange transaction but will be delivered by the vendor at a
future date (e.g., six months of free Internet service offered by
an ISP);
offers of free or discounted products or services that are
exercisable after a customer has transacted a specified
cumulative level of purchases (these types of sales incentives
are within the scope of EITF Issue 00-22);
incentives offered by a company as consideration for goods or
services received by the company offering the incentive (e.g.,
employee discounts); and
incentives in the form of options or warrants to purchase stock
or the issuance of shares of stock of the vendor.
The EITF reached a consensus that, for the types of sale incentives
included within the scope of this Issue, the "cost" of a sales
incentive that will not result in a loss on the sale of a product or
service, should be recognized at the latter of the following:
a. The date at which the related revenue is recorded by the
vendor
b. The date at which the sales incentive is offered (which would
be the case when the sales incentive offer is made after the
vendor has recognized revenue; for example, when a
manufacturer issues coupons offering discounts on a product
that it already has sold to retailers).
For sales incentives resulting in the right to a refund or rebate (e.g.,
purchase of software for $200 would entitle the customer to a $50
rebate if the customer mails in the rebate form), the EITF reached a
consensus that a vendor should recognize a liability (or "deferred
revenue") for those sales incentives at the latter of (a) or (b) above
based on the estimated amount of refunds or rebates that will be
claimed by customers. If the amount of future rebates or refunds
cannot be reasonably and reliably estimated, a liability (or "deferred
revenue") should be recognized for the maximumpotential amount
of the refund or rebate (i.e., the liability should be recognized
for all customers buying the product subject to the rebate). The
ability to make a reasonable and reliable estimate of the amount of
future rebates or refunds depends on many factors and
circumstances that will vary from case to case. The EITF reached a
consensus that the following factors may impair a vendor's ability to
make a reasonable and reliable estimate:
a. Relatively long periods in which a particular rebate or refund
may be claimed
b. The absence of historical experience with similar types of
sales incentive programs with similar products or the inability
to apply such experience because of changing circumstances
c. The absence of a large volume of relatively homogeneous
transactions.
With regard to the income statement classification of sales
incentives, the EITF reached a consensus that, when recognized,
a cash sales incentive should be classified as a reduction of revenue.
(A cash sales incentive includes virtually all sales incentives
designed to effectively reduce the sales price to the customer
including coupons and rebates.) However, a non-cash sales
incentive (e.g., a gift certificate for a free weekend at a hotel that
will be honored by a another, unrelated entity) should be recognized
as an expense and not as a reduction of revenue. The EITF did not
address the classification of that expense, but the SEC staff has
indicated that they believe that the cost of a non-cash sales
incentive should be classified as cost of goods sold.
For sales incentives that will result in a loss on the sale of a product
or service, the EITF reached a consensus that a vendor should not
recognize a liability for the sales incentive prior to the date at which
the related revenue is recognized by the vendor. However, the EITF

observed that the offer of a sales incentive that will result in a loss
on the sale of a product may indicate an impairment of existing
inventory.
The following example illustrates the application of Issue 00-14:
In an attempt to expand its subscriber base, Internet Service
Provider offers a $400 rebate to purchasers of new computers
who contract for three years of Internet service. The cost of the
rebate is borne by both Internet Service Provider and PC
Retailer. PC Retailer provides advertising and marketing for the
arrangement. The arrangement includes a cancellation fee to
the ISP equal to a pro rata portion of the rebate based on the
length of time the customer used the service.
In this case, the cost of the rebate should be recorded as a
reduction of revenue for both Internet Service Provider and PC
Retailer based on the relative amounts of the cost borne by
each. PC Retailer would record its cost of the rebate at the
point of sale and Internet Service Provider likely would defer its
cost of the rebate and amortize it as a reduction of revenue
over the term of the service arrangement with the customer (in
this case, three years).
If the ISP had offered a free computer (a non-cash sales
incentive) to customers who contract for Internet service, the
cost of the computer would be deferred and amortized to cost
of sales over the term of the service arrangement with the
customer.
At the April 18-19, 2001 meeting, the EITF agreed to change the
transition date for Issue 00-14. Companies should now apply the
guidance in Issue 00-14 no later than in annual or interim financial
statements for periods beginning after December 15, 2001. Earlier
adoption is encouraged. Upon application of the consensus, financial
statements for prior periods presented for comparative purposes
should be reclassified accordingly. If it is impracticable to reclassify
prior-period financial statements, disclosure should be made of the
reasons why reclassification was not made and the effect of the
reclassification on the current period.
Financial statements for prior periods presented for comparative

purposes should be reclassified to comply with the income
statement display requirements. If it is impracticable to reclassify
reclassification on the current period. See Issue 00-14 for additional
transition guidance with regard to accounting changes that will
result in a change in net income.
For companies that would have been required to adopt Issue 00-14
under the original transition guidance, the SEC Observer stated that
following disclosures should be made in financial statements filed
with the SEC prior to adoption:
a. All disclosures required by SAB 74 (Topic 11M), including the
anticipated effects of any reclassifications of prior period
financial statements presented. If application of the
consensuses will require a reduction of previously reported
revenue, an explicit statement to that effect should be included
in the SAB 74 disclosures.
b. If incentives subject to the guidance in this Issue have not
been classified in the income statement consistent with the
consensus, disclosure of the amounts of such incentives for the
current period and, if practicable, all other periods presented,
and the line item in the statement of operations on which they
are classified.
c. If a registrant's historical accounting policy for the recognition
of incentives (i.e., when incentives are recognized and in what
amount) subject to this Issue is different from that provided for
by the consensus, disclosure of the recognition policy followed,
and a rollforward of the deferred revenue balance, if any,
related to sales incentives for all fiscal periods of fiscal years
beginning after December 15, 1999.
Consideration From a Vendor to a Reseller
Since the EITF reached a consensus on Issue 00-14, numerous
questions have been raised regarding the accounting and income
statement classification of costs, other than those directly addressed
in Issue 00-14, that a vendor incurs (typically a manufacturer) to or

on behalf of a reseller (typically a retailer) in connection with the
reseller's purchase or promotion of the vendor's products. These
types of arrangements are the subject of Issue 00-25, Vendor
Income Statement Characterization of Consideration Paid to a
Reseller of the Vendors Products.
Examples of such arrangements include (a) "slotting fees," in which
a vendor pays a fee to a retailer to obtain space for the vendor's
products on the retailer's store shelves, (b) cooperative advertising
arrangements, in which a vendor agrees to reimburse a retailer for a
portion of costs incurred by the retailer to advertise the vendor's
products, and (c) "buydowns," in which a vendor agrees to
reimburse a retailer up to a specified amount for shortfalls in the
sales price received by the retailer for the vendor's products over a
specified period of time.
The basic issue is whether such payments should be classified as an
expense (like the cost of other marketing programs) or as a
reduction of revenue. In addition, practice is mixed as to whether
certain payments should be deferred and amortized over the period
of benefit (if any) or expensed as incurred. Issue 00-25 does not
address whether up-front nonrefundable consideration from a
vendor to a reseller for "shelf space" results in an asset or an
expense for the vendor. Accordingly, this Issue does not address
how to measure or when to recognize the payments, only the
appropriate classification of the payments in the vendors income
statement.
After discussing Issue 00-25 at several meetings, the EITF finally
reached a consensus at the April 18-19, 2001 meeting. Under the
consensus, consideration from a vendor to a reseller of the vendor's
products is presumed to be a reduction of the selling prices of the
vendor's products and, therefore, should be characterized as a
reduction of revenue when recognized in the vendor's income
statement. That presumption is overcome and the consideration
should be characterized as a cost incurred if, and to the extent that,
a benefit is or will be received from the recipient of the
consideration that meets both of the following conditions:
a. The vendor receives, or will receive, an identifiable

benefit (goods or services) in return for the consideration. In
order to meet this condition, the identified benefit must be
sufficiently separable from the recipient's purchase of the
vendor's products such that the vendor could have entered
into an exchange transaction with a party other than a
purchaser of its products in order to receive that benefit.
b. The vendor can reasonably estimate the fair value of
the benefit identified under condition (a). If the amount of
consideration paid by the vendor exceeds the estimated
fair value of the benefit received, that excess amount
should be characterized as a reduction of revenue when
recognized in the vendor's income statement
The EITF observed that the separability aspect of condition (a) will
generally require slotting fees and similar product development or
placement fees to be characterized as a reduction of revenue.
Buydowns could never meet the separability aspect of condition (a)
and therefore should always be characterized as a reduction of
revenue.
Under Issue 00-25, if amounts are required to be characterized as a
reduction of revenue, a presumption exists that no portion of those
amounts should be recharacterized as an expense. However, if a
vendor can demonstrate that characterization of those amounts as a
reduction of revenue results in negative revenue for a specific
customer on a cumulative basis (i.e., since the inception of the
customer relationship), then the amount of the cumulative shortfall
may be recharacterized as an expense.
See Issue 00-25 for additional details and an exhibit that includes 13
examples of applying the consensus to programs such as pricing
adjustments to major customers, advertising allowances,
cooperative advertising, nonrefundable slotting fees, and
reimbursement of promotion-related payroll costs.
The consensus on Issue 00-25 should be applied no later than in
annual or interim financial statements for periods beginning after
December 15, 2001. Earlier adoption is encouraged. Financial
statements for prior periods presented for comparative purposes
should be reclassified to comply with the income statement display

requirements under the consensus. If it is impracticable to reclassify
reclassification on the current period.
Service Outages
Many Internet companies have experienced service outages. These
services outages may result in costs such as refunds to
customers/members, costs to correct the problem that caused the
outage, and damage claims. The issues are when should these costs
be recognized and whether the refunds that are not required but are
given as a gesture of goodwill should be classified as a reduction of
revenues or as marketing expense. In its October 1999 letter to the
EITF, the SEC staff indicated that it believes that the facts and
circumstances surrounding these situations are likely to be very
diverse, making the development of general guidance difficult and
that the EITF should not give this issue high priority. We believe that
each situation needs to be analyzed separately to determine the
appropriate accounting; if the cost to repair the website is similar to
a warranty cost, then warranty accounting is appropriate, however,
if it represents rebates to customers it generally should be
recognized as a reduction of revenue. Sometimes, Internet retail
companies ("e-tailers") also experience problems with website
orders. In certain of these instances, e-tailers may issue a refund on
the customers purchases or issue a credit voucher entitling the
customer to free merchandise in the future. The cost of any such
refunds or credit vouchers generally would be characterized in the
income statement as a reduction of revenue consistent with Issue
00-14.
Website Development Costs
Many companies incurs substantial costs to develop websites. These
costs include costs to develop the software to run the website, to
populate the website with content, and to purchase hardware. The
types of companies that are developing websites are very diverse
and include Internet service companies, portal companies, retail
companies (solely Internet ("click"), part Internet and part traditional
("click and mortar"), and traditional retail stores ("brick and
mortar")), manufacturers, distributors, financial services, and other

service companies. The websites are being used to promote a
business and/or entire industries, to sell products and/or services, to
provide customer service, and to provide information to the public or
to employees. The issues are whether such costs should be
capitalized and if so, what guidance should be followed.
At the March 16, 2000 meeting, the EITF reached a consensus on
Issue 00-2, Accounting for Web Site Development Costs. The
consensus is described below:
Costs Incurred in the Planning Stage
The EITF reached a consensus that, regardless of whether the
website planning activities specifically relate to software, all costs
incurred in the planning stage should be expensed as incurred.
Costs Incurred in the Website Application and Infrastructure
Development Stage
SOP 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, provides guidance for
distinguishing between internal-use software and software to be
sold, leased, or otherwise marketed. A key aspect of the definition of
internal-use software is that it excludes software for which a plan
exists or for which a plan is being developed to market the software
externally. The EITF reached a consensus that all costs relating to
software used to operate a website should be accounted for under
SOP 98-1 unless a plan exists or is being developed to market the
software externally, in which case the costs relating to the software
should be accounted for under FASB Statement No. 86, Accounting
for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed. Costs incurred for website hosting, which involve the
payment of a specified periodic fee to an Internet service provider in
return for hosting the website on its server(s) connected to the
Internet, generally would be expensed over the period of benefit.
The website application and infrastructure development stage
involves acquiring or developing hardware and software to operate
the website. The cost of hardware is outside the scope of this Issue.
We believe that such costs should be capitalized as a fixed asset.
Further, we believe that any costs that are considered process

reengineering costs should be expensed as incurred pursuant to
EITF Issue 97-13, Accounting for Costs Incurred in Connection with a
Consulting Contract or an Internal Project That Combines Business
Process Reengineering and Information Technology Transformation.
Costs Incurred to Develop Graphics
Under Issue 00-2, graphics include the overall design of the website
(use of borders, background and text colors, fonts, frames, buttons,
and so forth) that affect the "look and feel" of the website and
generally remain consistent regardless of changes made to the
content. The EITF reached a consensus that graphics are a
component of software and that the costs of developing initial
graphics should be accounted for under SOP 98-1 for internal-use
software, and under Statement 86 for software marketed externally.
Modifications to graphics after a website is launched should be
evaluated to determine whether the modifications represent
maintenance or enhancements of the website. The accounting for
maintenance and enhancements is discussed below.
Costs Incurred in the Operating Stage
Costs incurred during the operating stage include training,
administration, maintenance, and other costs to operate an existing
website. The EITF reached a consensus that the costs of operating a
website should not be accounted for differently from the costs of
other operations; that is, those costs should be expensed as
incurred. However, costs incurred in the operation stage that involve
providing additional functions or features to the website should be
accounted for as, in effect, new software. That is, costs of upgrades
and enhancements that add functionality should be expensed or
capitalized based on the general model of SOP 98-1 (which requires
certain costs relating to upgrades and enhancements to be
capitalized if it is probable that they will result in added
functionality) or, for software that is marketed, Statement 86 (which
applies its software capitalization model to "product enhancements,"
which include improvements that extend the life or significantly
improve the marketability of a product). The EITF observed that the
determination of whether a change to website software results in (a)
an upgrade or enhancement, if internal-use software, or (b) a
product enhancement, if externally-marketed software, is a matter

of judgment based on the specific facts and circumstances. The EITF
also observed that SOP 98-1 indicates that entities that cannot
separate internal costs on a reasonably cost-effective basis between
maintenance and relatively minor upgrades and enhancements
must expense such costs as incurred.
Income Statement Classification
In a speech at the December 2000 AICPA Conference on Current SEC
Developments, the SEC staff noted that the costs of designing,
updating, and maintaining websites generally should not be
included in an income statement caption entitled "Product
Development Costs" unless such costs are incurred in the
development of products that the reporting company intends to sell
(typically it is not the website itself that is the product to be sold). A
more appropriate income statement caption for these costs, if they
are to be reported as a separate line item, would be simply "Website
Development Costs."
The EITF also provided practical guidance in the form of an exhibit
that illustrates the application of the consensuses to specific website
development costs. That exhibit is summarized below.
Website Development Activity
Accounting Required by Issue

00-2
Planning Stage
Develop a business, project plan, or
both. This may include identification
of specific goals for the website (e.g.,
to provide information, supplant
manual processes, conduct ecommerce, and so forth), a
competitive analysis, identification of
the target audience, creation of time
and cost budgets, and estimates of
the risks and benefits.
Expense as incurred.
Determine the functionalities (e.g.,

order placement, order and shipment
tracking, search engine, e-mail, chat
rooms, and so forth) of the website.
Identify necessary hardware (e.g.,

the server) and web applications.
Web applications are the software
needed for the website's
functionalities. Examples of web
applications are search engines,
interfaces with inventory or other
back-end systems, as well as
systems for registration and
authentication of users, commerce,
content management, usage
analysis, and so forth.
Determine that the technology

necessary to achieve the desired
functionalities exists. Factors might
include, for example, target audience
numbers, user traffic patterns,
response time expectations, and
security requirements.
Explore alternatives for achieving

functionalities (e.g., internal versus
external resources, customdeveloped versus licensed software,
company-owned versus third-partyhosted applications and servers).
Conceptually formulate and/or

identify graphics and content (refer
to Graphics and Content
Development Stages for further
discussion).
Invite vendors to demonstrate how
their web applications, hardware, or

service will help achieve the
website's functionalities.
Selection of external vendors or
consultants.
Identify internal resources for work

on the website design and
development.
Identify software tools and packages

required for development purposes.
Address legal considerations such as

privacy, copyright, trademark, and
compliance.
Website Application and

Infrastructure Development
Stage
The discussion of website

application and infrastructure
development assumes that any
software is developed for the
entity's internal needs and no plan
exists or is being developed to
market the software externally.
Software for which a plan exists or
is being developed to market the
software externally is subject to
Statement 86, and costs
associated with the development
of that software should be
expensed until technological
feasibility is established.
Acquire or develop the software tools

required for the development work
(e.g., HTML editor, software to
convert existing data to HTML form,
graphics software, multimedia
software, and so forth).
Costs incurred to purchase

software tools, or costs incurred
during the application
development stage for internally
developed tools, generally should
be capitalized unless they are
used in research and development

and (1) do not have any
alternative future uses or (2) are
internally developed and
represent a pilot project or are
being used in a specific research
and development project.
Obtain and register an Internet
domain name.
Generally, capitalize under APB

17.
Acquire or develop software

necessary for general website
operations, including server
operating system software, Internet
server software, web browser
software, and Internet protocol
software.
Generally, capitalize under SOP

98-1.
Develop or acquire and customize

code for web applications (e.g.,
catalog software, search engines,
order processing systems, sales tax
calculation software, payment
systems, shipment tracking
applications or interfaces, e-mail
software, and related security
features).

98-1.
Develop or acquire and customize

database software and software to
integrate distributed applications
(e.g., corporate databases,
accounting systems) into web
applications.

98-1.
Develop HTML websites or develop

templates and write code to
automatically create HTML pages.

98-1.
Purchase the web and application

server(s), Internet connection
(bandwidth), routers, staging servers
(where preliminary changes to the
website are made in a test
environment), and production servers
(accessible to customers using the
website). Alternatively, these
services may be provided by a third
party via a hosting arrangement.
Acquisitions of servers and related

hardware infrastructure are
outside the scope of this Issue.
Payments for hosting
arrangements should be expensed
over the period of benefit.
Install developed applications on the

web server(s).

98-1.
Initial creation of hypertext links to

other websites or to destinations
within the website. Depending on the
site, links may be extensive or
minimal.

98-1.
Test the website applications (e.g.,

stress testing).

98-1.
Graphics and Content

Development Stages
Create initial graphics for the
website. Graphics include the design
or layout of each page (i.e., the
graphical user interface), color,
images, and the overall "look and
feel" and "usability" of the website.
Creation of graphics may involve
coding of software, either directly or
through the use of graphic software
tools. The amount of coding depends
on the complexity of the graphics.
Initial graphics are part of the

software and generally should be
capitalized under SOP 98-1.
Create content or populate

databases. Content may be created
To be addressed in EITF Issue 0020 (see discussion below).
or acquired to populate databases or

websites. Content may be acquired
from unrelated parties or may be
internally developed.
Enter initial content into the website.
Content is text or graphical
information (exclusive of initial
graphics described above) on the
website which may include
information on the entity, products
offered, information sources that the
user subscribes to, and so forth.
Content may originate from
databases that must be converted to
HTML pages or databases that are
linked to HTML pages through
integration software. Content also
may be coded directly into websites.
SOP 98-1 specifies that "data

conversion costs" should be
expensed as incurred. Similarly,
costs to input content into a
website generally should be
expensed as incurred. Software
used to integrate a database with
a website generally should be
capitalized under SOP 98-1.
Operating Stage
Train employees involved in support
of the website.
Generally, expense as incurred

under SOP 98-1.
Register the website with Internet

search engines.
Expense as incurred. These

expenditures represent
advertising costs and are
expensed as incurred under SOP
93-7.
Perform user administration

activities.

under SOP 98-1.
Update site graphics (for updates of

graphics related to major
enhancements, see below).

under SOP 98-1.
Perform regular backups.
under SOP 98-1.

Create new links.

under SOP 98-1.
Verify that links are functioning

properly and update existing links
(i.e., link management or
maintenance).

under SOP 98-1.
Add additional functionalities or

features.
Generally, capitalize if they meet

the definition of "upgrades and
enhancements" under SOP 98-1.
Perform routine security reviews of

the website and, if applicable, of the
third-party host.

under SOP 98-1.
Perform usage analysis.

under SOP 98-1.
Costs Incurred to Develop or Acquire Database Content

Database content refers to information included on the website,
which may be textual or graphical in nature (although the specific
graphics described above are excluded from content). For example,
articles, product photos, maps, and stock quotes and charts are all
forms of database content. Database content may reside in separate
databases that are integrated into (or accessed from) the website
with software, or it may be coded directly into the website.
Many Internet companies derive revenues from making database
content and other collections of information available to users.
Those collections of information may be made available
electronically or otherwise and they may be purchased from
unrelated parties or may be originated (created) internally.
Alternatively, some Internet companies provide free database
content access to users and derive revenues by selling either
advertising to be shown to, or demographic information on, the user

population. Practice is mixed as to how the costs of developing or
acquiring database content and other collections of information
should be accounted for. Some companies capitalize and amortize
such costs over the period of expected benefit whereas other
companies expense such costs as incurred. In addition, practice is
mixed as to the types of costs that qualify for capitalization (e.g., the
extent to which internal costs can be capitalized).
At the September 2021, 2000 meeting, the EITF briefly discussed
EITF Issue 00-20, Accounting for the Costs Incurred to Acquire or
Originate Information for Database Content and Other Collections of
Information, but was not asked to reach a consensus. The EITF
instructed the FASB staff to obtain more information on the types of
databases being used by companies as well as the methods that
companies are using to account for the costs to acquire or originate
the database content. Further discussion is expected at a future
meeting.
We believe that costs incurred internally to develop database
content generally should be expensed as incurred. However, it may
be appropriate to capitalize costs to acquire database content that is
expected to be used for a reasonable period of time (i.e., at least
one year). Additionally, we believe consideration should be given to
whether costs relating to websites that are constantly refined should
be expensed as incurred.
Computer Files That are Essentially Films, Music, or Other
Content
Vendors may sell software or the rights to use software that is
essentially a new medium to distribute music. The issue, raised in
the SEC staffs October 1999 letter to the EITF, is whether the
websites and files or information available on websites should be
considered software, and therefore, subject to the provisions of SOP
97-2, SOP 98-1, and/or Statement 86.
In EITF Issue 96-6, Accounting for the Film and Software Costs
Associated with Developing Entertainment and Educational Software
Products, the SEC staff expressed its view that the costs of software
products that include film elements should be accounted for under
the provisions of Statement 86. As such, revenue from the sale of

these products should be accounted for under the provisions of SOP
97-2. By analogy, the SEC staff believes that guidance should be
applied to software with other embedded elements, such as music.
However, Issue 96-6 did not discuss accounting for the costs of
computer files that are essentially films (e.g., .mpeg, RealVideo),
music (e.g., .mp3), or other content. In those cases it is unclear
whether a company purchasing the rights to distribute music in
the .mp3 format should account for those costs under FASB
Statement No. 50, Financial Reporting in the Record and Music
Industry, or Statement 86. Similarly, it is not clear whether the
revenue from the sales of .mp3 files falls under SOP 97-2.
The accounting for the costs of computer files that are essentially
films, music, or other content may be addressed in EITF Issue 0020, Accounting for Costs Incurred to Acquire or Originate
Information for Database Content and Other Collections of
Information. (See discussion of Issue 00-20 under "Website
Development Costs" above.)
Arrangements with Up-Front Payments
Many Internet companies enter into complex arrangements that
make it difficult to understand the underlying economics of the
transaction. At the inception of these arrangements, the purchaser
expects that the benefit (direct or indirect) it will receive over the
term of the contract will equal or exceed its costs over the term of
the contract. Internet companies typically enter into these contracts
to increase user traffic on websites.
One type of arrangement is that an Internet company makes an upfront payment for long-term contractual rights (e.g., Internet
distribution rights) that are intended to be exploited only through
Internet operations. The payment for the contractual rights meets
the definition of a long-term asset, but the measurement of the
probable economic benefits is difficult. Some companies have
asserted that these rights are immediately impaired under FASB
Statement No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, as their best
estimate of the expected cash flows would indicate the asset is not
recoverable. Certain other contracts may be partially executory in

nature and would not be covered by Statement 121.
Statement 121 requires a company to write down an asset to fair
value when an impairment exists. Determining whether an
impairment exists is based on the companys undiscounted
estimated future cash flows. One method commonly employed for
determining an assets fair value is to use the estimated discounted
future cash flows of the asset. Many Internet start-up companies
have limited cash flows or may not be able to identify the cash flows
related to the asset, and thus believe the ultimate (estimated future
discounted) cash flows will be less than the assets carrying amount.
However, the SEC staff has indicated that an up-front payment in
exchange for contractual rights represents the fair value of that
transaction and, accordingly, it would not be appropriate to record
an impairment charge at the outset of the arrangement (analogous
to accounting for goodwill in a purchase business combination). The
SEC staff believes an impairment should not be recorded unless it
can be shown that conditions have changed since the execution of
the contract and that change in condition has resulted in a change
in fair value that gives rise to an impairment.
Another type of transaction involves advertising arrangements
(sometimes with other Internet companies) in which one company
pays the other an up-front fee (or guarantees certain minimum
payments over the course of the contract) in exchange for certain
advertising services over a period of time. The payers in these
arrangements have at times recognized an immediate loss on
signing the contract, arguing that the expected benefits are less
than the up-front or guaranteed payments. The SEC staff has
indicated that it views these payments as being similar to payments
made for physical advertising space and that any up-front payment
should be treated as prepaid advertising costs that would
subsequently be expensed pursuant to SOP 93-7, Reporting on
Advertising Costs. The SEC staff discussed this issue at the
December 1998 AICPA Conference on Current SEC Developments.
The issue of when an acquirer or purchaser of rights under
executory contracts should recognize impairment is being addressed
by EITF Issue 99-14, Recognition by a Purchaser of Losses on Firmly
Committed Executory Contracts. The EITF Issue Summary for Issue
99-14 includes the following example (which will be discussed at a

future meeting) of how this issue relates to an Internet company.
Company C (purchaser), an ISP, enters into an arrangement
with an Internet access company, Company D. For a fixed upfront cash payment, Company C becomes a premier search
provider for search and navigation on Company D's network of
Internet products and services. Company C's objective in
entering into the agreement is to increase user traffic on its
system. Company D commits to list Company C as a premier
search provider on Company D's website, providing the user
with the ability to click through to Company C's website.
Company C, in turn, will be able to generate revenues through
the sale of advertising space on its website. This ability is
enhanced by the increased traffic resulting from the agreement
with Company D.
At the contract's inception, Company C estimates that the
incremental advertising revenues over the period of the
agreement are not sufficient to cover the total up-front cash
payment and the estimated direct selling and costs of sales.
However, Company C expects that the contract with Company
D will increase its market capitalization because the
incremental number of users of Company C's services enhance
Company C's prospects for reaching the critical mass of users
necessary for Company C to be profitable in the future.
Subsequent to the signing of the initial agreement, incremental
advertising revenues have not met Company C's initial
expectations, decreasing the value of the remaining
contractual right asset to Company C. Such circumstances
could result in Company C having to recognize an impairment
charge.
The EITF began its discussion of Issue 99-14 at the November 17-18,
1999 meeting. At that meeting, the EITF expressed a preference that
companies that enter into executory contracts should evaluate them
for impairment using a Statement 121 approach. (However, a
consensus or tentative conclusion was not reached.) The SEC staff
expressed significant concerns about this preference at the meeting
because it believes executory contracts, as long as the company has
not exited the activity, do not result in current losses so the
outcome of the deliberations is not currently predictable. Under

current practice, losses on executory contracts such as operating
leases generally are not recognized unless a sublease is entered into
(see FASB Technical Bulletin No. 79-15, Accounting for Loss on a
Sublease Not Involving the Disposal of a Segment) or the company
is exiting the activity (see EITF Issue 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)). We
believe this accounting is appropriate and should not be changed
unless a consensus is reached establishing a new requirement. If the
EITF decides an impairment loss could be recognized in certain
circumstances, it is likely it would provide guidance on when and
how to recognize it. Further discussion is expected at a future
meeting.
The EITF has also begun debating Issue 00-26, Recognition by a
Seller of Losses on Firmly Committed Executory Contracts, which
addresses loss recognition issues associated with accounting for
such arrangements from the sellers perspective. At the January 17
18, 2001 meeting, the EITF expressed support for developing criteria
under which a seller should recognize a loss under a firmly
committed executory contract that will be executed by the seller
and not otherwise terminated before full performance occurs and
that was initially entered into at fair value ("loss contracts").
However, certain EITF members suggested that any methodology
developed under this Issue should limit a loss contract liability to the
amount that would be paid to terminate, transfer, or otherwise
liquidate the contract.
The EITF recognized that due to the broad scope of this Issue, any
model developed could be inconsistent with other authoritative
guidance for specific transactions or industries and asked the FASB
staff to identify potential conflicts. Certain EITF members observed
that any model developed for this Issue should include a mechanism
that ensures that a loss is not recognized twice (i.e., through
recognition of a loss contract liability and an impairment of assets or
leases used to provide the goods or services under the contract).
Other EITF members suggested that any proposed methodology
should address when, and how, individual contracts should be
combined, as well as provide indicators of when a contract should
be reviewed for possible loss recognition. Further discussion is

expected at a future meeting.
Customer Origination and Acquisition Costs
Internet companies often make large investments in building a
customer or membership base. A few examples of this are:
Websites that give users rewards (points, products, discounts,
or services) in exchange for setting up an account with the
website or providing demographic or product preference
information;
Websites that make payments to business partners for
referring new customers or members; and
Internet companies that give users a PC and Internet service
for free if they are willing to spend a certain minimum amount
of time on the Internet each month and are willing to have
advertisements reside permanently on their computer.
In each of these cases, a question may arise as to whether the costs
represent customer origination or acquisition costs or costs of
building a membership listing that qualify for capitalization, by
analogy to FASB Statement No. 91, Accounting for Nonrefundable
Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases. In its October 1999 letter to the EITF,
the SEC staff indicated that it believes that most companies appear
to be expensing such costs as incurred; therefore, diversity in
practice, at least with respect to Internet companies, appears to be
limited.
Nonetheless, due to the magnitude and complexity of customer
acquisition activities in recent years, AcSEC has recently added this
issue its agenda with the goal of providing comprehensive guidance
for the accounting and disclosure for customer acquisition activities.
As a part of the project, AcSEC is expected to address key issues
such as:
How should customer acquisition costs be defined?
Should some or all customer acquisition costs be capitalized or

expensed as incurred?
Do customer acquisition costs meet the definition of an asset?
Should the recognition criteria distinguish between internal and
external costs?
If capitalized, how should the costs of these assets be
amortized?
How should recoverability of any capitalized amount be
assessed?
This project may also address direct-response advertising in SOP 937. In March 2001, the FASB considered a prospectus for the project
and expressed concerns about whether AcSEC should undertake the
project. Alternatives explored by the FASB included the FASB
undertaking the project, with the AICPA perhaps developing initial
background information that might assist the Board in its project, if
any. The FASB asked AcSEC to revise the prospectus to clarify the
scope of the project, define the potential asset, and indicate the
anticipated direction of the project. The FASB will reconsider the
prospectus after those revisions are made.
Amortization Periods of Intangible Assets
Determining an amortization period for websites, domain names,
and goodwill requires considerable judgment given the uncertainty
of the success of a company, as well as the volatility in the Internet
environment.
The SEC staff has taken the position that unrealistically long
amortization periods for intangibles and goodwill inflate earnings
and fail to accurately reflect the diminishing value of acquired
assets. The SEC staff expressed particular concern in situations
where a long amortization period is assigned to goodwill and
intangibles in an industry that has little earnings visibility and low
barriers to entry. The SEC staff will challenge an unrealistically short
amortization period. The SEC staff does not find arguments that
justify an amortization life solely on the basis of industry practice to
be persuasive. Further, the SEC staff may request that registrants

furnish evidence supporting the factors that are specific to that
business. Further, Therefore, we believe that it is important for
companies to consider all relevant information, such as the specific
nature of the asset and how it will use the asset in determining its
economic useful life. Some examples of specific application are
provided below:
Capitalized Website Costs
The amortization period for capitalized costs for development
of the websites should be based on the economic useful life of
the website which generally should be short, for example,
three to five years. The three to five years should be used only
as a general guide. The actual life should be determined based
on factors such as the stage of the company
(established/young) and the purpose of the website.
Additionally, there may be instances in which a company
develops a website for a third-party to be used for a specific
purpose and for a specified period of time (e.g., a website may
be developed to launch a new product; once the advertising of
this new product is completed the website will no longer exist).
In such instances, we believe that the amortization life should
be based on the specified period of time in the arrangement or
an estimate of the time in which the specific purpose will be
fulfilled.
Domain Names
The amortization period for the cost of domain names acquired
from a third party should be based on the estimated economic
useful life of the asset. When determining the estimated useful
life, the future revenue to be generated from the asset should
be considered. We have seen instances in which the
amortization period ranged from two to ten years, however,
the appropriate period must be determined based on the facts
and circumstances.
Goodwill
The goodwill amortization period should generally be short

given the low barriers to entry, the rapid level of change in the
industry, and the failure rate of start-up companies in this
arena. The SEC staffs general expectations are three to five
years. We believe that the goodwill life should not be shorter
than the life of the longest identified intangible asset, unless
such intangible assets represent an insignificant piece of the
total purchase price. (Companies should keep abreast of the
FASBs business combinations project which is expected to
result in a new non-amortization, impairment-only approach. A
final Statement is expected in July 2001.)
Subscriber Accounts
Internet companies (especially ISPs) frequently acquire groups
of subscriber accounts or customer lists in a business
combination. These accounts or lists typically are measured at
the present value of the estimated net cash flows from the
contracts (including expected renewals) and amortized over
the life expectancy of the subscriber base. Because of
customer attrition, the benefit of customer relationships within
a large group of subscriber accounts often tends to dissipate,
sometimes at a more rapid rate in the earlier periods following
the acquisition, such that the future cash flows directly
attributable to the acquired accounts declines on an
accelerated basis. In this circumstance, an accelerated method
of amortization, rather than the straight-line method, would be
a more appropriate method of amortizing such costs.
Other Intangible Assets
Other intangible assets may also be present and these would
have to be analyzed on a case by case basis. Generally, a
starting assumption of a three to five year amortization life
would be reasonable.
Exchange of Equity Instruments for Goods or Services
Many well-established companies are entering into transactions with
start-up Internet companies under which the established companies
provide services or a combination of cash and services in exchange
for an equity interest (common stock, preferred stock, warrants,

and/or stock options) in the start-up Internet companies. Often the
services provided include advertising, traditional print, radio and TV
ads or, alternatively, banners, buttons, or click-throughs on the
established companys website. These transactions involve both
mature public Internet companies, as well as other more traditional
media and entertainment companies.
While certain transactions that involve the exchange of equity
instruments for goods or services are straightforward, others are
more complex in that the exchange spans several periods and the
issuance of the equity instruments is contingent upon service or
delivery of goods that must be completed by the grantee (i.e., the
goods or services provider) in order to vest in the equity instrument.
Additionally, transactions are becoming common in practice where a
fully vested, nonforfeitable equity instrument issued to a grantee
contains terms that may vary based on the achievement of a
performance condition or certain market conditions. For example, a
fully vested stock option may be issued to a grantee that contains a
provision that the exercise price will be reduced if the grantee
completes a project by a specified date. In certain cases, the fair
value of the goods or services to be received may be more reliably
measurable than the fair value of the goods or services to be given
as consideration.
These issues impact both the issuer of the equity instrument
(typically the start-up Internet company) and the recipient of the
equity instrument (typically the established company). Therefore,
our discussion on the issue is divided into two sections: accounting
by the issuer (grantor) and accounting by the recipient (grantee).
Accounting by the Issuer
FASB Statement No. 123, Accounting for Stock Based
Compensation, and EITF Issue 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring,
or in Conjunction with Selling, Goods or Services, address
transactions where equity instruments are issued to nonemployees
in exchange for goods or services. In addition, the EITF has added
Issue 00-18, Accounting Recognition for Certain Transactions
involving Equity Instruments Granted to Other Than Employees, to
its agenda which addresses certain measurement date issues not

contemplated under Issue 96-18; however, no consensuses have
been reached to date.
Determining the Measurement Date
The first step in accounting for equity instruments issued to other
than employees is to determine whether the measurement date is
fixed or variable. Most Internet companies want to have a fixed
measurement date at the inception of the arrangement (before the
services are complete) so that periodic revaluations of the equity
instrument and associated expense volatility are not necessary.
Although Statement 123 establishes the measurement principles for
nonemployee transactions, Issue 96-18 addresses the date the
issuer should use to measure the fair value of the equity
instruments (the measurement date).
The measurement date for the equity instruments under Issue 96-18
is generally either the date of grant (i.e., a fixed award) or the
vesting date (i.e., a variable award where the charge goes up or
down as the price of the stock changes). For unvested options, in
order to fix the measurement date prior to vesting, a performance
commitment must exist. A performance commitment is a
commitment under which performance by the counterparty to earn
the equity instrument is probable because of a sufficiently large
disincentive ("penalty") for nonperformance. The penalty must be
large enough to require the counterparty to perform in accordance
with the agreement. In general, this penalty should be a specified
cash penalty; forfeiture of the equity instruments or the potential of
being sued are not sufficient disincentives.
In cases where warrants are granted to a customer as an
inducement to enter into a long-term (e.g., greater than, say, one
year) sales contract and the warrants vest as sales are made to the
customer, it is highly unlikely that a penalty could be large enough
to make performance probable because the customer may at some
point no longer need or be able to use the product. Furthermore, a
slow down in the economy or decrease in the issuers stock price
may affect the economics of the arrangement such that the
customer may ultimately believe it is more beneficial and
economical to cancel the transaction and pay the penalty.
Accordingly, the penalty typically is inadequate in this situation

because for a long-term sales contract it would not necessarily deter
the customer from nonperformance and the measurement date
would be variable.
At the July 19-20, 2000 meeting, the EITF began discussing Issue 0018, Accounting Recognition for Certain Transactions involving Equity
Instruments Granted to Other Than Employees, which includes the
following two issues related to the accounting by the issuer:
1. If fully vested, exercisable, nonforfeitable equity instruments
are issued at the date the issuer and recipient enter into an
agreement for goods or services (no specific performance is
required by the recipient to retain those equity instruments),
the period(s) and manner in which the issuer should recognize
the measured cost of the transaction; and
2. If fully vested, nonforfeitable equity instruments are granted
that are exercisable by the recipient only after a specified
period of time, and the terms of the agreement provide for
earlier exercisability if the recipient achieves specified
performance conditions, how the issuer should measure and
recognize the equity instruments at the arrangement date, and
thereafter, if the recipient achieves the performance condition
and exercisability is accelerated.
On the first issue, a majority of the EITF members agreed that by
eliminating any obligation on the part of the counterparty to earn
the equity instruments, a measurement date has been reached.
Further, the EITF expressed a view that the issuer should recognize
the equity instruments when they are issued (in most cases, when
the agreement is entered into). The EITF generally agreed that
whether the corresponding cost is an immediate expense or a
prepaid asset (or whether the asset should be classified as contraequity) depends on the facts and circumstances.
On the second issue, a majority of the EITF members agreed that
the issuer should measure the fair value of the equity instruments at
the date of grant and should recognize that measured cost under
the same guidance as under the first issue above. Under this view,
footnote 5 in Issue 96-18 would need to be amended to eliminate
the reference to immediate exercisability. A majority of the EITF

agreed that if, subsequent to the arrangement date, the recipient
performs as specified and exercisability is accelerated, the issuer
should measure and account for the increase in the fair value of the
equity instruments resulting from the acceleration of exercisability
using "modification accounting" (as described in paragraph 35 of
Statement 123). That is, the adjustment would be measured at the
date of the revision of the quantity or terms of the equity instrument
as the difference between (a) the then-current fair value of the
revised instruments utilizing the then-known quantity and terms and
(b) the then-current fair value of the old equity instruments
immediately before the adjustment.
However, the EITF did not reach a consensus on either of these
issues, and further discussion of Issue 00-18 is expected at a future
meeting.
Measuring the Fair Value of Equity Instruments
Once a measurement date is determined, the next step is to
measure the fair value of the equity instrument. Statement 123
requires all transactions (except those entered into with employees
that are covered by APB Opinion No. 25, Accounting for Stock Issued
to Employees) in which goods or services are received for the
issuance of equity instruments to be accounted for based on the fair
value of the goods or services received or the fair value of the
equity instruments issued, whichever is more reliably measurable.
Companies should assess whether the fair value of the goods or
services received is more reliably measurable than the fair value of
the equity instruments issued; however, in most cases, it typically
would be important to determine the fair value of the equity
instruments issued. Statement 123 defines fair value as follows:
The amount at which an asset could be bought or sold in a
current transaction between willing parties, that is, other than
in a forced or liquidation sale. Quoted market prices in active
markets are the best evidence of fair value and should be used
as the basis for the measurement, if available. If a quoted
market price is available, the fair value is the product of the
number of trading units times that market price. If a quoted
market price is not available, the estimate of fair value should

be based on the best information available in the
circumstances. The estimate of fair value should consider
prices for similar assets or similar liabilities and the results of
valuation techniques to the extent available in the
circumstances. Examples of valuation techniques include the
present value of estimated expected future cash flows using
discount rates commensurate with the risks involved, optionpricing models, matrix pricing, option-adjusted spread models,
and fundamental analysis.
When valuing stock awards granted to nonemployees, Statement
123s minimum value method (that excludes volatility) is not an
acceptable method. The following methods are ways to apply the
above methods for valuing equity instruments for which a public
market does not exist:
1. Obtaining a formal appraisal from an independent valuation
expert or investment banker.
In addition to the initial valuation, the issuer of the equity
instrument may require periodic revaluations in situations
where the measurement date, under Issue 96-18, is not fixed
(see discussion on measurement date under Issue 96-18 later
in the section).
Ideally, the valuation should be made contemporaneous with
the issuance of the equity instruments. In one fact pattern
discussed by the SEC staff at the December 2000 AICPA
Conference on Current SEC Developments, a company issuing
equity instruments obtained in July 2000 a valuation of October
1999 equity grants based on a multiple of the grantors
revenue for the 12 months prior to October 1999, while an
investment banker performed in April 2000 a separate
valuation, using a multiple of the grantors 2001 projected
revenues. The SEC staff did not believe a valuation, performed
9 months after the initial equity grants and based on
"inappropriate" revenue streams, provided persuasive
evidence of the equity grants fair value as of October 1999.
Other problems or concerns that the SEC staff has seen in

reviewing appraisals include:
Failures to properly select, define, or conform to the standard
of fair value appropriate to the valuation context.
Internal inconsistencies (e.g., increases in revenue growth
without including significant investments required to realize
the revenue growth) in the valuation.
Data problems in comparative valuations, including the use of
inappropriate public comparables and the failure to adjust
comparative company financial results for unusual or
nonrecurring items.
Failure to adjust or restate the historical financial information in
valuation models to eliminate the effects of unusual or
nonrecurring items.
Reliance on undocumented or unsubstantiated "rules of
thumb" (e.g., start-up companies that use a fixed percent of
the most recent third-party preferred stock share price as a
"rule of thumb" to value common stock). The SEC staff also
challenges the use of "rules of thumb" for discounts or
premiums associated with lack of marketability or minority
interests. The SEC staff does not believe that average
discounts represent specific facts and circumstances.
2. Applying valuation techniques such as a Black-Scholes
model for options and warrants.
To value options, a private company may use an estimation
model, such as Black-Scholes. Our valuation tool, EY/Options,
may be used to perform the calculation. The estimation models
require the input of several highly subjective variables. It may
be difficult for a start-up Internet company to obtain relevant
and sufficient history to determine these input factors and
obtain meaningful results. Expected volatility, which is a
measure of the amount by which a stock price is expected to
fluctuate, may be a particular challenge. Generally, expected
volatility is estimated based on historical volatility. However,
historical stock prices usually will not be available for a private

company, and some young public companies may have
insufficient trading history. In these situations, companies may
use the pattern and level of historical volatility of a comparable
public entity in the same industry. Statement 123 expressly
allows that practice. For example, a company with only a one
year trading history may grant an option with a five year life. In
order to more appropriately predict the expected volatility of
the stock, the company could consider the historical volatility
of a comparable company in the same industry for the first five
years the stock of that company was publicly traded. According
to the SEC staff, the use of overall volatility measures typically
would not be appropriate. For example, using the volatility of
the NASDAQ 100 index to value common stock warrants issued
by an Internet start-up company would not be appropriate
because the volatility of well-established NASDAQ companies
could not be expected to equal that of an Internet start-up
company. Due to the large effect on the option valuation from
even small changes to the subjective input assumptions, it is
important for companies to carefully choose the assumptions
used in the valuation to ensure that the results are meaningful.
3. Using comparable independent third-party transactions.
In some instances, other equity transactions of the company
with independent third-parties involving comparable
instruments may be referenced to determine the current value
of the equity granted. Recent cash transactions involving an
independent third-party provide objective evidence to
determine the value of an equity instrument. However, the
independent third-party transaction should be a stand-alone
equity transaction and not part of a multiple-deliverable
arrangement (see separate section on Revenue Arrangements
with Multiple Deliverables). Occasionally, the only significant
sales of company securities that might provide a relevant
common stock pricing reference are convertible preferred
shares. Careful consideration should be given to the respective
terms of the two securities, with the help of an independent
appraiser if possible, before using the convertible preferred
stock as a basis for estimating the value of the related
common stock. The rights for conversion, dividends, voting,
and liquidation preferences are among those that need to be

compared and analyzed. To the degree that the rights of the
common stock are substantively similar to those of the
convertible preferred stock, its value also should be similar.
Where significant differences in value are considered
appropriate, perhaps most often for liquidation preferences,
objective evidence should support this. In many cases, a
liquidation preference may have little or no value if a company
is in the process of registering its common stock and the
preferred stock is mandatorily converted to common stock on a
one-for-one basis at the IPO date.
4. Using the value of the goods or services.
Statement 123 asserts that the fair value of goods or services
received from suppliers other than employees frequently is
reliably measurable and therefore indicates the fair value of
the equity instruments issued. In some cases, the goods or
services received may be from well-established companies
(e.g., media companies) and therefore, the issuing company
may value the equity instruments issued based on the value of
the services received. However, this may be more reliably
measurable when the services provided represent more
traditional advertising such as radio or television broadcasts or
print media. This assumes the issuer would be able to obtain
this information. Further, assuming that both parties would
ideally use the same value, a question that arises in this
situation is whether the media company should use its full rate
card in determining the value of the services (and the equity
instrument) or whether a discount from the full rate should be
applied. Most traditional media companies have used the
lowest discounted rate (i.e., bottom of the rate card). The
rationale for the discount is that the advertising to be provided
by the media company may not be considered prime
advertising (i.e., it may be considered excess space). The best
evidence of fair value would be to base the value of the
services (advertising) on what the advertising objectively
would be sold for in a cash transaction.
While all of the above methods used to measure the fair value of
equity instruments are acceptable, the SEC staff indicated in a
speech at the December 2000 AICPA Conference on Current SEC

Developments that it believes a valuation, regardless of the method
used, generally should include the following, among other items:
Discussion of the companys performance, both historically and
prospectively. Any business valuation must begin with a
thorough understanding of the company including, but not
limited to, an understanding of the companys business, its
products and services, strategies, markets, management team,
and competitors.
Reconciliation of differences between the determination of the
equity instruments fair value and the IPO price. These
differences should also be documented and appropriately
supported. For example, if such differences are the result of
substantive changes in a companys underlying business and
future prospects such as the introduction of a new product or
the addition of a new customer, then that should be both
quantified and discussed in the valuation document.
Discussion of valuations of the company performed by
underwriters who have been approached with regards to an
initial public offering.
Reconciliation of differences between the companys valuation
of the equity instruments fair value and the counterpartys
valuation, if known. Grantors and grantees should not use
radically different valuations for the same equity instrument. In
a recent example, the SEC staff notes that a grantor valued an
equity instrument at approximately $60 million while the
grantee claimed that it was unable to determine the value and
recorded no value for the equity instrument. The SEC staff
believes that it is illogical for such diverse valuations to exist.
Balance Sheet Presentation
Questions often arise as to the appropriate balance sheet
presentation of arrangements where unvested, forfeitable equity
instruments are issued to a counterparty as consideration for future
services. Prior to an SEC staff announcement made at the July 1920, 2000 EITF meeting, practice was mixed as to whether such
transactions are recorded at the measurement date. Some

registrants made no entries until performance occurred, while others
recorded the fair value of the equity instruments as equity at the
measurement date and recorded the offset either as an asset or as a
reduction of stockholders' equity (contra-equity).
As announced in EITF Topic D-90, the SEC staff believes that if the
issuer receives a right to receive future services in exchange for
unvested, forfeitable equity instruments, those equity instruments
should be treated as unissued for accounting purposes until the
future services are received (i.e., the instruments are not
considered issued until they vest). Consequently, there would be no
recognition at the measurement date and no entry should be
recorded. The SEC staff will not enforce compliance with this
guidance for arrangements entered into before July 20, 2000.
Income Statement Classification
At the December 2000 AICPA Conference on Current SEC
Developments, the SEC staff discussed the appropriate income
statement classification of the cost of equity instruments issued to
non-employees. The SEC staff has consistently held that when
equity instruments are issued to customers or potential customers
in arrangements where the instrument will not vest or become
exercisable without purchases by the recipient, the related cost
must be reported as a sales discount in other words, as a reduction
of revenue.
Further, the SEC staff does not believe that undue emphasis should
be placed on non-cash sales discounts on the face of the income
statement. Unless cash-based sales discounts are otherwise
presented as a reconciling item between gross revenue and net
revenue, non-cash sales discounts generally should not be
presented as a separate line item reconciling gross to net revenue.
Similarly, when equity instruments are issued to suppliers or
potential suppliers, and the instruments will not vest or become
exercisable unless the recipient provides goods or services to the
issuer, the cost of the equity instrument should be reported as a
cost of the related goods or services. (The SEC staffs position is
consistent with Issue 96-18.)
In some circumstances, companies may wish to present separate

line items within the income statement for the apparent purpose of
emphasizing that a portion of the sales discounts or expenses did
not involve a cash outlay. However, in certain instances, the SEC
staff has objected to presentations and disclosures that put undue
emphasis on revenue, gross margin, or other income statement
measures before reductions for the costs of equity instruments
issued to customers or suppliers.
Some companies also have issued equity instruments in
arrangements that do not appear to require any performance from
the counterparty. Some have argued that the lack of such a
performance requirement indicates that the cost should be recorded
as a marketing or even a non-operating expense, as opposed to a
cost of sales or a reduction of revenue. However, the SEC staff is
extremely skeptical of transactions that do not appear to require any
performance from the potential customer or supplier in order for the
options to vest and/or become exercisable. In the absence of any
required future performance, the SEC staff presumes that the
issuance of such equity instruments relates to past transactions
between the entities and asks that the cost be classified accordingly
(generally as a reduction of revenue if the company has sold
products or services to the customer in the past).
In order to show that the issuance of equity in these situations
is not related to past transactions, the SEC staff believes there
should be evidence that the issuer has or will receive from the
counterparty a direct benefit in return for the equity instrument that
is separable from other business relationships between the issuer
and counterparty. Furthermore, the SEC staff considers whether
there is sufficient, objective, and reliable evidence that indicates
that the fair value of such a benefit is at least as great as the fair
value of the equity instruments.
In very rare and limited circumstances (e.g., when there was both no
performance commitment and no past relationship between the
companies) the SEC staff has accepted classification of the cost of
the equity instruments as a marketing expense if such classification
appeared reasonable, so long as detailed and transparent
disclosures of the transaction, including the lack of any required
performance and the fact that no consideration was received for the
instrument, are made.
In addition, whenever significant amounts of equity instruments
have been issued to business partners, the SEC staff believes that
MD&A should include sufficient discussion of the effects of these
non-cash transactions on the results of operations, why they are
used, and what effect their use has on the comparability of the
results of operations in the periods presented.
Accounting by the Recipient
The accounting for equity instruments received in exchange for
services is a multi-step process: determining the measurement date
to value the transaction, determining how to measure fair value,
determining when and at what amount to recognize revenue, and
determining how to account for subsequent changes in the value of
the equity instrument received (if the measurement date is not
fixed). The accounting for the equity instruments received is
governed by EITF Issue 00-8, Accounting by a Grantee for an Equity
Instrument to Be Received in Conjunction with Providing Goods or
Services. The accounting for the revenue recognition is governed
primarily by FASB Concepts Statement No. 5, Recognition and
Measurement in Financial Statements of Business Enterprises, and
SAB 101 (provided that the transaction is not specifically addressed
in other accounting literature) and the accounting for nonmonetary
transactions involving the receipt of equity instruments is governed
by APB Opinion No. 29, Accounting for Nonmonetary Transactions.
The consensus in Issue 00-8 was based on the consensus in Issue
96-18. The measurement requirements in each of the consensuses
essentially mirror one another; however, in some instances, the
guidance in Issue 96-18 is more developed than in Issue 00-8. In
those situations, the best starting point would be to analogize to
Issue 96-18. For example, Issue 00-8 does not address the timing of
revenue recognition whereas Issue 96-18 states that costs should be
recognized in the same manner as if it were a cash transaction.
FASB Concepts Statement 5 and SAB 101 describe the general rules
for revenue recognition in cash transactions.
Issue 00-8 applies to all grants and to modifications of existing

grants that occur after March 16, 2000. The notion "modifications of
existing grants" does not include changes to the quantity or terms of
an equity instrument that occur when any originally unknown
quantity or term becomes known pursuant to the terms of the
original instruments.
Consistent with Issue 96-18, Issue 00-8 states that the measurement
date is the earlier of the date on which the services are complete or
the date at which a commitment for performance by the
counterparty to earn the equity instruments is reached
(a performance commitment). If on the measurement date the
quantity or any of the terms of the equity instrument are dependent
on the achievement of a market condition, then the grantee should
measure revenue based on the fair value of the equity instruments
inclusive of the adjustment provisions. That fair value would be
calculated as the fair value of the equity instruments without regard
to the market condition plus the fair value of the commitment to
change the quantity or terms of the equity instruments if the market
condition is met. That is, the existence of a market condition that, if
achieved, results in an adjustment to an equity instrument generally
affects the value of the instrument. As noted in footnote 10 to
Statement 123, pricing models have been adapted to value many of
those path-dependent equity instruments.
Additionally, if on the measurement date the quantity or any of the
terms of the equity instruments are dependent on the achievement
of grantee performance conditions (beyond those conditions for
which a performance commitment exists), changes in the fair value
of the equity instrument that result from an adjustment to the
instrument upon the achievement of a performance condition should
be measured as additional revenue from the transaction using a
methodology consistent with Statement 123 "modification
accounting." Changes in the fair value of the equity instruments
after the measurement date unrelated to the achievement of
performance conditions should be accounted for in accordance with
any relevant literature on the accounting and reporting for
investments in equity instruments, such as APB 18 and Statement
115. In addition, consideration should be given to whether the
instrument meets the definition of a derivative under Statement
133.
The EITF also observed that in accordance with APB 29, companies
should disclose, in each period's financial statements, the amount of
gross operating revenue recognized as a result of nonmonetary
transactions addressed by Issue 00-8. Furthermore, the SEC
Observer reminded registrants of the requirement under Item 303(a)
(3)(ii) of Regulation S-K to disclose known trends or uncertainties
that have had or that a registrant reasonably expects to have a
materially favorable or unfavorable impact on revenues. In addition,
whenever significant amounts of equity instruments have been
received from business partners, the SEC staff believes that MD&A
should include sufficient discussion of the effects of these non-cash
transactions on the results of operations, why they are used, and
what effect their use has on the comparability of the results of
operations in the periods presented.
The following example illustrates the application of the
measurement date guidance in Issue 00-8 for a transaction in which
a performance commitment exists prior to the time that the
grantee's performance is complete and the terms of the equity
instrument are subject to adjustment after the measurement date
based on the achievement of specified performance conditions.
On 1/1/X2, Company grants Service Provider 100,000
options with a life of 2 years. The options vest if Service
Provider advertises products of Company on Service
Provider's website for 18 months ending 6/30/X3.
Company also agrees that if Service Provider provides 3
million "hits" or "click-throughs" during the first year of
the agreement, the life of the options will be extended
from 2 years to 5 years. If Service Provider fails to provide
the agreed upon minimum of 18 months of advertising
through 6/30/X3, Service Provider will pay Company
specified monetary damages that, in the circumstances,
constitute a "sufficiently large disincentive for
nonperformance."
Service Provider would measure the 100,000 stock
options for revenue recognition purposes on the
performance commitment date of 1/1/X2 using the 2-year
option life. Assume that at the measurement date
(1/1/X2) the fair value of the options is $400,000. On
12/1/X2, Service Provider has provided 3 million "hits" and

the life of the option is adjusted to 5 years. Service
Provider would measure additional revenue pursuant to
the achievement of the performance condition as the
difference between the fair value of the adjusted
instrument at 12/1/X2 (i.e., the option with the 5-year life
assumed to be $700,000) and the then fair value of the
old instrument at 12/1/X2 (i.e., the option with the 2-year
life, which is assumed to be $570,000). Accordingly,
additional revenue of $130,000 would be measured. The
remaining $170,000 increase in fair value of the
instrument should be accounted for in accordance with
the relevant literature on the accounting and reporting for
investments in equity instruments, such as APB 18,
Statement 115, and Statement 133.
In certain circumstances, it may be difficult to value an equity
instrument received from a privately-held company. However, that
does not relieve a company from the requirement of valuing the
transaction. In a speech at the December 1999 AICPA Conference on
Current SEC Developments, the SEC staff stated that it understands
that "some recipients of equity-based compensation, particularly
equity of private companies, may be ascribing little or no value to
such consideration, even though the fair value of the consideration
may be substantially higher." Generally, the SEC staff believes this
would not be acceptable. Refer to the section above on accounting
by the issuer for guidance on valuing equity instruments for which a
public market does not exist. Because the transaction will result in
revenue recognition by the grantee, particular care should be given
to ensure the value is reasonable.
At the July 19-20, 2000 meeting, the EITF began discussing Issue 0018 which, in addition to addressing several issues concerning the
accounting by the issuer, addresses the recipient's accounting for
the contingent right to receive an equity instrument when a
performance commitment by the recipient exists prior to the receipt
(vesting) of the equity instrument. A majority of the EITF members
agreed that the recipient should account for the arrangement as an
executory contract (i.e., generally no accounting before
performance) in the same manner as it would if the issuer had
agreed to pay cash (upon vesting) for the goods or services. Further
discussion of Issue 00-18 is expected at a future meeting.
Revenue Arrangements With Multiple Deliverables
The ease of an Internet companys ability to provide goods and
services at different points in time or over different periods of time
has resulted in many Internet companies entering into complex
purchase and sale arrangements. These arrangements may involve
the delivery of more than one product, the provision of multiple
services, or a combination of both. In other cases, these
arrangements may involve the right to use certain intangible assets
over a period of time (e.g., a license). Each revenue-generating
activity may be considered a separate "element" or "deliverable" if
certain conditions are met.
These arrangements may require payment as goods are delivered or
services are provided or they may involve either an up-front fee or
an up-front fee coupled with a continuing payment stream. A
continuing payment stream generally corresponds to the provision
of services or delivery of products over time or a license term. The
continuing payments may be fixed, variable based on future
performance, or a combination of fixed and variable.
Issue 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables, addresses how to account for multiple-deliverable
revenue arrangements and focuses on when a revenue arrangement
should be separated into different revenue-generating deliverables
or "units of accounting" and if so, how the arrangement
consideration should be allocated to the different deliverables or
units of accounting.
An example of a multiple-deliverable arrangement would be a
company that provides a service (e.g., Internet access) that requires
the use of specific equipment to obtain the service. The equipment
generally is sold to the customer and is bundled with the continuing
service for a stated period as part of one fixed-fee arrangement. The
issue is whether the equipment and the service can be accounted
for separately and if so, how the arrangement consideration would
be allocated to the two deliverables.
After discussing the Issue for several meetings, the EITF reached a
tentative conclusion on Issue 00-21 at the April 18-19, 2001 meeting
as part of a delicate compromise with the SEC staff. The EITF will
discuss this Issue at a future meeting.
Under the tentative conclusion, a revenue arrangement with
multiple deliverables should be divided into separate units of
accounting based on the deliverables in the arrangement if (1) there
is objective and reliable evidence of fair value to allocate the
arrangement consideration to the deliverables in the arrangement
and (2) the deliverable meets either of the following criteria, at the
inception of the arrangement:
a. The deliverable does not affect the quality of use or the value
to the customer of other deliverables in the arrangement that
could (given the characteristics of the deliverables or according
to the contractual terms of the arrangement) be delivered
before the deliverable being evaluated.
b. The deliverable could be purchased from another unrelated
vendor without diminishing the quality of use or the value to
the customer of the remaining deliverables in the
arrangement.
If neither criterion (a) nor criterion (b) is met, the
deliverable being evaluated would not qualify to be a
separate unit of accounting within the revenue
arrangement. Instead, that deliverable would be
combined with the other items within the arrangement
and the appropriate revenue recognition then would be
determined for those combined deliverables as a single
revenue accounting unit.
Regarding inconsequential and perfunctory deliverables (i.e., "small"
or "incidental" deliverables), the EITF tentatively concluded that
vendor may adopt a policy of excluding a deliverable from the
revenue accounting for an arrangement (and therefore account for
the item as an accrued cost) if it meets all of the following
conditions:
a. The deliverable does not affect the quality

of use or the value to the customer of
other deliverables in the arrangement or
could be purchased by the customer from
another unrelated vendor without
diminishing the quality of use or value of
the other deliverables in the
arrangement.
b. Any vendor obligation relating to
nonperformance (failure to provide the
deliverable being evaluated) would not
result in a refund, revenue reversal, or
concession.
c. The deliverable is inconsequential or
perfunctory. In order to consider the
deliverable inconsequential or
perfunctory, the vendor should have a
demonstrated history of providing the
deliverable in a timely manner and
reliably estimating the cost of providing
that deliverable.
The EITF also tentatively concluded that the presence of contractual
terms that provide the customer with return, refund, or concession
rights does not preclude a vendor from recognizing revenue on a
relative fair value basis for previously delivered items that have
been identified as separate units of accounting if the vendor is able
to make reasonable and reliable estimates of the likelihood of
completing performance under the arrangement and that
performance is probable. The consensus will provide several factors
that would indicate that a vendor is unable to make a reasonable
and reliable estimate of the amount of future refunds, concessions,
or returns resulting from the vendor's failure to complete
performance under the arrangement.
If a vendor is not able to make a reasonable and reliable estimate of
the likelihood of completing performance, as well as the related
forfeiture, refund or other concession, under the arrangement,
revenue should not be recognized for the portion of the allocated fee
that is subject to forfeiture, refund, or other concession. Revenue

that is initially not recognized would be recognized either when the
return, concession, or refund privilege has expired (for example,
upon delivery of the remaining items in an arrangement).
The final consensus is expected to include several disclosure
requirements.
Existing Guidance
Pending a final consensus on Issue 00-21, the FAQ document on SAB
101 issued in October 2000 indicates that companies should use a
"reasoned method of accounting" for multiple-deliverable
arrangements that is applied consistently and disclosed
appropriately. Question 4 of the FAQ document indicates that the
SEC staff has stated that it will not object to a method that includes
the following conditions:
1. To be considered a separate element, the product or service in
question represents a separate earnings process. The SEC staff
notes that determining whether an obligation represents a
separate element requires significant judgment. The SEC staff
also notes that the best indicator that a separate element
exists is that a vendor sells or could readily sell that element
unaccompanied by other elements.
2. Revenue is allocated among the elements based on the fair
value of the elements. The fair values used for the allocations
should be reliable, verifiable and objectively determinable. The
SEC staff does not believe that allocating revenue among the
elements based solely on cost plus a profit margin that is not
specific to the particular product or service is acceptable
because, in the absence of other evidence of fair value, there
is no objective means to verify what a profit margin should be
for the particular element(s). Additional guidance on allocating
among elements may be found in SOP 81-1, SOP 97-2, and SOP
98-9. If sufficient evidence of the fair values of the individual
elements does not exist, revenue would not be allocated
among them until that evidence exists. Instead, the revenue
would be recognized as earned using revenue recognition
principles applicable to the entire arrangement as if it were a

single element arrangement.
3. If an undelivered element is essential to the functionality of a
delivered element, no revenue allocated to the delivered
element is recognized until that undelivered element is
delivered.
If the above criteria are met, companies would essentially have a
"safe harbor" to allocate revenue to the different deliverables in a
multiple-deliverable arrangement. However, we understand that the
SEC staff would not necessarily object to allocating revenue even if
not all of the above guidelines were present provided that
companies arrive at well-reasoned basis of accounting. This would
have to be based on the specific facts and circumstances that
should be well-documented and companies should monitor EITF
activities on this issue.
In addition to the guidance in the FAQ document, we believe the
following should be helpful until the EITF reaches a final consensus
on Issue 00-21:
In order to separately account for each deliverable in a
multiple-deliverable arrangement, companies must first be
able to identify all of the deliverables in the arrangement. Next,
sufficient verifiable objective evidence of fair value must be
determinable such as by reference to history of other
comparable and relevant third-party cash transactions for each
deliverable in the arrangement. These third-party cash
transactions cannot be part of another multiple-deliverable
arrangement but must be a separate stand-alone transaction.
If sufficient verifiable objective evidence of fair value can be
determined, the total arrangement fee would be allocated to
the deliverables based on the relative fair value of each
deliverable. The lack of the ability to separate the deliverables
in the arrangement or a lack of sufficient evidence of fair value
would indicate that the arrangement fee should not be
allocated to the various deliverables but instead should be
recognized proportionately over the life of the arrangement or
deferred until all of the deliverables are delivered, as
appropriate.
In general, we believe that the standard for fair value in

allocating revenue in a multiple-deliverable arrangement
(other than software transactions) should be sufficient
objective verifiable evidence of fair value rather than the more
stringent standard of vendor-specific objective evidence
(VSOE) of fair value. We believe that sufficient verifiable
objective evidence of fair value may be determined by the
following (the items are listed in order of persuasiveness):
Separate cash transactions involving the same product or
service.
Standard pricing policy (e.g., rate cards and standard volume
discounts) that are consistently applied.
Comparable cash transactions.
Prices charged in the marketplace by other vendors for the
same product/service.
Pricing based on pass through cost from an independent
vendor.
As discussed above, the FAQ document indicates the SEC
staffs view that an allocation of the arrangement fee based
solely on cost plus "normal" profit margins or similar measures
is not acceptable because, in the absence of other evidence of
fair value, there are no objective means to verify if the profit
margin specific to the particular service or product
approximates the "normal" profit margin.
In addition, the FAQ document reminds companies that prices
listed in a multiple-deliverable arrangement with a customer
may not be representative of the fair value of those
deliverables because the prices of the different components of
the arrangement can be altered in negotiations and still result
in the same aggregate consideration.
Many multiple-deliverable arrangements involving service
transactions contain exclusivity clauses. An example of an
exclusivity clause is when a company will agree to run an
exclusive banner advertisement for one online company only

for a specified period of time. The nature of the exclusivity
clause is that it grants an exclusive right to another company
for a specific time period and therefore, the amount allocated
to the exclusivity clause based on objective evidence of fair
value would be recognized ratably over the exclusivity period
concurrent with the provision of services. In virtually all cases,
objective evidence of fair value for an exclusivity clause will
not be determinable because of the unique nature of the
service and because exclusivity is not sold separately.
Accordingly, it would not be possible to separate the service
and exclusivity elements of the arrangement, and therefore we
believe that the entire arrangement fee should be recognized
ratably over the longer of the exclusivity time frame or the
delivery/performance time frame of the service element in the
arrangement.
Multiple-deliverable arrangements may involve separate
contracts that are negotiated at the same time or at different
times but in contemplation of each other. These separate
transactions may be part of one negotiated transaction. In this
situation, all of the arrangements are linked and as such, the
analysis of determining how to recognize revenue should
consider all of the linked arrangements. It is difficult to set a
time frame in determining whether transactions are linked. An
indicator as to whether transactions are linked is whether they
are part of one overall negotiation. The closer in time that the
contracts are entered into would represent a stronger
indication that they are linked (and therefore should be
accounted for as a single arrangement).
Companies may enter into simultaneous transactions whereby
both companies exchange cash in equal or close to equal
amounts at the same or slightly different time. If reciprocal
cash flows occur in a transaction, this may be an indicator of a
nonmonetary transaction and that APB Opinion No.
29, Accounting for Nonmonetary Transactions, would apply.
In some instances, the amount of revenue to be received for
services to be provided cannot be separated from the costs
being paid for services received. Therefore, it may be more
appropriate to show the amounts received as a reduction or

offset to the amounts being paid and costs incurred rather than
as revenue. Determining whether and how revenue should be
recognized in multiple-deliverable arrangements will depend
on the specific facts and circumstances of each transaction
because of their complex nature.
"Points" and Other Time/Volume-Based Offers
Many Internet companies have developed business models that
involve building a membership list through the use of "points" and
other time/volume-based offers. The objective of such offers is to
build brand loyalty and increase sales volume. These offers typically
are structured so that a specified volume of transactions, or
membership over a specified time period, is required in order for a
customer or program member to earn sufficient award credits to
redeem an award. Each time a customer or program member
purchases a product or service, or performs an action specified as
part of the loyalty program requirements, he or she earns award
credits that, subject to specified minimum thresholds, may be
redeemed in the future for awards such as free, or deeply
discounted, products or services.
Issue 00-22, Accounting for "Points" and Certain Other Time-Based
or Volume-Based Sales Incentive Offers, and Offers for Free
Products or Services to Be Delivered in the Future, addresses
vendor-sponsored programs that offer awards consisting of the
vendor's products or services, broad-based programs operated by
program operators whose business consists solely of administering
the loyalty program, and combination programs operated by
vendors for their own customers as well as other participating
vendors and their customers.
The basic issue is whether a portion of revenue associated with the
product or service being sold should be deferred or if revenue could
be recognized in full at the time of sale with an accrual for the
incremental costs of the award.
Issue 00-22 is expected to provide guidance on how a vendor should
account for the following three types of offers to customers:
1. Free or discounted products or services delivered by the

vendor that are redeemable (become earned) only if the
customer completes a specified cumulative level of revenue
transactions or remains a customer for a specified time period
(e.g., accumulating "points" which can be redeemed for free
merchandise).
2. Free or discounted products or services from the vendor that is
redeemable by the customer at a future date without a further
exchange transaction with the vendor (e.g., purchasing
software and receiving a coupon for a year of free Internet
service).
3. Cash rebates or refunds if the customer completes a specified
cumulative level of revenue transactions or remains a
customer for a specified time period (e.g., a rebate of 1% of
on-line purchases over $1,000 per year).
Regarding the first two types of offers, some EITF members
expressed a preference for an accounting approach that would
allocate a portion of the revenue on the transaction to the product
or service that may be delivered in the future, while other EITF
members expressed a preference for an accounting approach that
would be based on the significance of the value of the award
products or services as compared to the value of the transactions
necessary to earn the awards. If the value of the award products or
services is insignificant in relation to the value of the transactions
necessary to earn the awards, a liability would be recorded for the
estimated cost of the award products or services.
At the January 1718, 2001 meeting, the EITF reached a consensus
(affirming a prior tentative conclusion) on accounting for the third
type of offer above. Under the consensus, a vendor should recognize
a cash rebate or refund obligation as a reduction of revenue based
on a systematic and rational allocation of the cost of the rebates or
refunds to each of the underlying revenue transactions that result in
progress by the customer toward earning the rebate or refund.
Measurement of the total cash rebate or refund obligation should be
based on the estimated number of customers that will ultimately
earn and claim rebates or refunds under the offer (that is,
"breakage" should be considered if it can be reasonably estimated).
However, if the amount of future cash rebates or refunds cannot be

reasonably estimated, a liability should be recognized for
the maximum potential amount of the refund or rebate. The ability
to make a reasonable estimate of the amount of future cash rebates
or refunds depends on many factors and circumstances that will
vary from case to case (see Issue 00-22 for factors that may impair
a vendors ability to make reasonable estimates).
In some cases, the relative size of the cash rebate or refund changes
based on the volume of purchases. For example, the rebate may be
10% of total consideration if more than 100 units are purchased but
may increase to 20% if more than 200 units are purchased. If the
volume of a customer's future purchases cannot be reasonably
estimated, the maximum potential cash rebate or refund factor
should be used to record a liability (20% in the example). In
contrast, if the volume of a customer's future purchases can be
reasonably estimated, the estimated amount of cash to be rebated
or refunded should be recognized as a liability.
The EITF also reached a consensus that changes in the estimated
amount of cash rebates or refunds and retroactive changes by a
vendor to a previous offer (an increase or a decrease in the rebate
amount that is applied retroactively) should be recognized using a
cumulative catch-up adjustment. That is, the vendor would adjust
the balance of its rebate obligation to the revised estimate
immediately. The vendor would then reduce revenue on future sales
based on the revised refund obligation rate as computed (see Issue
00-22 for an example).
The EITF consensus on cash rebates and refunds should be applied
no later than quarters ending after February 15, 2001. The effect of
application should be reported on a cumulative effect basis as a
reduction of revenue. Upon application of the consensus, rebate or
refund amounts reported as an expense in prior-period financial
statements presented for comparative purposes should be
reclassified to comply with the income statement display
requirements (i.e., presented as a reduction of revenue).
Also at the January 1718, 2001 meeting, the EITF discussed the
Working Group's observations and general direction with regard to
the accounting for "points" and other time/volume-based offers by
program operators but was not asked to reach a consensus. The

Working Group preliminarily believes that the sale of award credits
by a program operator to other vendors is a multiple-deliverable
revenue arrangement in which the deliverables consist of the award
product(s) or service(s) and certain other services provided by the
program operator to the sponsor. If the deliverables under the
arrangement cannot be identified or the fair value of the
deliverables other than the award product(s) or service(s) is not
determinable, Working Group members expressed a preference for
developing a revenue recognition approach with respect to these
loyalty program arrangements that is either similar to the residual
approach found in SOP 98-9 or based on the program operator's
proportionate performance under the arrangement.
The EITF also raised concerns about whether the deliverables
offered by a program operator are indeed separable and about the
timing of revenue recognition for credits that may not be redeemed.
Accordingly, the EITF requested that the FASB staff and the Working
Group consider those concerns as well as the interaction between
Issue 00-21 and Issue 00-22. Further discussion is expected at a
future meeting.
Software that Resides on the Vendors or a Third-Partys
Server
Some purchasers of software do not actually receive the software.
Rather, the software application resides on the vendor's or a thirdparty's server, and the customer accesses the software on an asneeded basis over the Internet. Thus, the customer is paying for two
elements (1) the right to use the software and (2) the storage of the
software on someone else's hardware (often referred to as hosting).
The question is whether that transaction is in the scope of SOP 97-2.
At the March 16, 2000 meeting, the EITF reached a consensus on
Issue 00-3, Application of AICPA Statement of Position 97-2, Software
Revenue Recognition, to Arrangements that Include the Right to Use
Software Stored on Another Entitys Hardware. The consensus states
that a software element covered by SOP 97-2 is only present in a
hosting arrangement if the customer has the contractual right to
take possession of the software at anytime during the hosting period
without significant penalty and it is feasible for the customer to
either run the software on its own hardware or contract with another
party unrelated to the vendor to host the software. Therefore, SOP
97-2 only applies to hosting arrangements in which the customer
has such an option. Arrangements that do not give the customer
such an option are service contracts and are outside the scope of
SOP 97-2. The EITF observed that hosting arrangements that are
service arrangements may include multiple elements that affect how
revenue should be attributed.
The EITF reached a consensus that for those hosting arrangements
in which the customer has the option, as described above, to take
possession of the software, delivery of the software occurs when the
customer has the ability to take immediate possession of the
software. The EITF observed that if the software element is within
the scope of SOP 97-2, all of the SOP's requirements for recognizing
revenue, including vendor-specific objective evidence (VSOE) of fair
value and the requirement that the fee allocated to the software
element not be subject to forfeiture, refund, or other concession
must be met in order to recognize revenue upon delivery for the
portion of the fee allocated to the software element. The portion of
the fee allocated to the hosting element should be recognized as the
service is provided. The EITF noted that hosting arrangements that
are within the scope of SOP 97-2 may also include other elements,
such as specified or unspecified upgrade rights, in addition to the
software product and the hosting service.
The EITF observed that if the vendor sells, leases, or licenses
software that is within the scope of SOP 97-2, then the development
costs of such software should be accounted for in accordance with
Statement 86. Conversely, if the vendor never sells, leases, or
licenses the software in an arrangement within the scope of SOP 972, then the software is utilized in providing services and the
development costs of the software should be accounted for in
accordance with SOP 98-1. However, if during such softwares
development or modification, the vendor develops a substantive
plan to sell, lease, or otherwise market the software externally, the
development costs of the software should be accounted for in
accordance with Statement 86.
Revenue Recognition for Auction Sites
It has become increasingly popular for Internet companies to

sponsor auction sites or to be in business for the sole purpose of
running an auction site. The Internet company (an auction house in
this case) is a facilitator in the transaction. The auction house does
not take title to the goods and does not assist in closing the
transaction. The auction house merely provides a website for people
to list their goods for auction. Internet auction houses usually charge
both up-front (listing) fees and back-end (transaction-based) fees.
To the extent that the front-end or back-end fees are not payment
for separate deliverables (i.e., the fee does not relate to a specific
product delivered or service performed that represents the
culmination of a separate earnings process), SAB 101 and the SAB
101 FAQ document provide guidance on when to recognize revenue.
Specifically, Questions 5, 6, and 7 of SAB 101, and Question 10 in
the SAB 101 FAQ document provide guidance on the issue of
revenue recognition in connection with front-end fees. Generally, we
believe that up-front listing fees should be recognized over the
listing period, which is the period of performance. We generally
believe that nonrefundable, back-end transaction fees should be
recognized when the underlying sale transaction occurs because
facilitation of that sale represents the earnings process. If the backend fee is refundable until some later event occurs (e.g., after the
underlying sale is completed), Question 7 of SAB 101 provides
relevant guidance. If the auction site has continuing involvement
with the transaction after initially facilitating the sale, then the
earnings process may not be complete and some or all of the fee
may need to be deferred, depending on the relevant facts and
circumstances.
Access and Maintenance of Websites
Internet companies may provide customers with services that
include access to a website, maintenance of a website, or
publication of certain information on a website for a period of time.
Certain Internet companies have argued that because the
incremental costs of maintaining the website and/or providing
access to it are minimal (or even zero), this ongoing requirement
should not preclude up-front revenue recognition. In accordance
with SAB 101, up-front fees like this (even if nonrefundable)
generally should be recognized over the performance period, which
would be the period over which the Internet company has agreed to
maintain the website or listing, as appropriate. The fee generally
should not be recognized up-front because the earnings process is
not yet complete because the company has a continuing
performance obligation under the terms of the arrangement. If the
fee relates to a separate deliverable, the accounting for that fee is
expected to be addressed in Issue 00-21.
Advertising Arrangements with Guaranteed Minimums
Many Internet companies enter into various types of advertising
arrangements (sometimes with other Internet companies) to provide
advertising services over a period of time. These arrangements
often include minimum guarantees on "hits," "viewings," or "clickthroughs." A typical example is where an Internet company
guarantees a certain number of impressions over a certain period of
time. The payment for the advertising may be made up-front or
based on a payment plan (usually separate from the "delivery"
progress of the impression). If the Internet company does not deliver
the required number of minimum impressions, the arrangement may
be extended to achieve the minimums and additional impressions
also may be delivered. Some Internet companies may not recognize
revenue until the guarantee is achieved while others may assess the
likelihood of achieving the guaranteed minimum and recognize
revenue ratably over the hosting period. Some situations may be
analogous to the contingent rent for lessors issue discussed in
Question 8 of SAB 101 (for example, if no amounts become due if a
guaranteed minimum number of hits or clickthroughs is not
achieved). Accordingly, revenue would not be recognized until the
guaranteed minimum is achieved. The terms of these arrangements
vary somewhat from contract to contract and therefore the facts and
circumstances of each arrangement need to be analyzed to assess
when revenue should be recognized.
Segment Information
One significant focus of SEC staff reviews during 2001 will be to
evaluate whether registrants have complied completely with all the
disclosure requirements of FASB Statement No. 131, Disclosures
about Segments of an Enterprise and Related Information.
Statement 131 defines an operating segment as a component of an
enterprise that engages in business activities from which it may

earn revenues and incur expenses, whose operating results are
regularly reviewed by the enterprise's chief operating decision
maker to make decisions about resources to be allocated to the
segment and assess its performance, and for which discrete
financial information is available. Segments may be aggregated in
the disclosure only to the limited extent permitted by Statement
131.
According to the SEC staffs October 1999 letter to the EITF, if the
chief operating decision maker reviews information about the
Internet portion of a company's business separate from other
operations, the Internet operations should be considered a separate
operating segment. On a few occasions, the SEC staff has requested
copies of all reports furnished to the chief operating decision maker
if the reported segments did not appear realistic for management's
assessment of a company's performance or conflicted with that
officer's public statements describing the company. The SEC staff
also has reviewed analysts' reports, interviews by management with
the press, and other public information to evaluate consistency with
segment disclosures in the financial statements. Where that
information revealed different or additional segments, the SEC has
required amendment of the companys filings to comply with
Statement 131.
Disclosures About Revenues
Most of the disclosure requirements in SAB 101 are applicable to
Internet companies. Specifically, SAB 101 requires that a registrant
always disclose its revenue recognition policy. Also, if a company
has a different policy for different types of revenue transactions
(e.g., barter transactions), the policy for each material types of
transaction should be disclosed. If a company has sales transactions
that include multiple deliverables, the revenue recognition policy for
each deliverable as well as the policy for determining and valuing
the deliverables should be disclosed. SAB 101 also points out that
Regulation S-X requires companies to disclose the various types of
revenue they generate (e.g., revenue from products versus services)
separately on the face of the income statement. In addition, SAB
101 indicates that the SEC staff believes that the costs relating to
each type of revenue also should be disclosed on the face of the
income statement. Other disclosure requirements of SAB 101

possibly could apply as well (refer to SAB 101 for further details).
The SEC staff believes all public companies should review the
completeness and accuracy of disclosures concerning their sources
of revenues, method of accounting for revenues, and material
considerations in evaluating the quality and uncertainties
surrounding their revenue generating activity. Disclosures should be
concise and to the point; more disclosure is not necessarily better.
Descriptive information about the effects of variations in revenue
generating activities and practices, or changes in the magnitude of
specific uncertainties, should be provided in MD&A. Accounting
policies, material assumptions and estimates, and significant
quantitative information about revenues should be included in notes
to the financial statements.
Based on the March 31, 2001 edition of Current Accounting and
Disclosure Issues issued by the Division of Corporation Finance,
specific disclosures the SEC staff expects to see include the
following:
Disaggregate product and service information
Report product and service revenues (and costs of revenues)
separately on the face of the income statement
Furnish separate revenues of each major product or service
within segment data
Describe the major revenue-generating products or services
clearly
For major contracts or groups of similar contracts, disclose
essential terms, including payment terms and unusual
provisions or conditions
Disclose when revenue is recognized (examples)
Upon delivery (indicate whether terms are customarily FOB
shipping point or FOB destination)
Upon completion of service

After commencement of service, ratably over service period
Upon satisfaction of a significant condition of sale - (identify
the condition)
Only after customer acceptance?
Only after testing?
Upon completion of all terms of contract
Over performance period based on progress toward completion
Upon delivery of separate elements in multi-element
arrangement
If revenue is recognized over the service period, based on
progress toward completion, or based on separate contract
elements or milestones, disclose how the period's revenue is
measured
Disclose how progress is measured (cost to cost, time and
materials, units of delivery, units of work performed)
Identify types of contract payment milestones, and explain how
they relate to substantive performance and revenue
recognition events
Disclose whether contracts with a single counterparty are
combined or bifurcated
Identify contract elements permitting separate revenue
recognition, and describe how they are distinguished
Explain how contract revenue is allocated among elements
Relative fair value or residual method?
Fair value based on vendor specific evidence or by other

means?
Disclose material assumptions, estimates and uncertainties
Disclose contingencies such as rights of return, conditions of
acceptance, warranties, price protection, etc.
Describe the accounting treatments for the contingencies
Describe significant assumptions, material changes, and
reasonably likely uncertainties
Special disclosures and conditions are specified by SAB 101 for
companies that recognize refundable revenues by analogy to
FASB Statement No. 48, Sales With the Right of Return.

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Internet Accounting Issues

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Internet Accounting

Revenue Recognition for Auction Sites *

This Summary primarily addresses those issues that have either

have websites; however, in an effort to maintain good relations with

An advertising barter arrangement exists when two companies enter

representative of current fair value for the advertising surrendered,

company believes that fair value of the transaction is $1.00 per

the number of minutes, or the overall percentage of advertising

At the July 1920, 2000 meeting, the EITF reached a consensus on

regarding income statement classification to all periods presented in

costs by companies that record revenue based on the gross amount

their next financial statements (whether interim or annual) filed with

coupons, rebates, and other forms of rights for free or

the related revenue is recognized by the vendor. However, the EITF

Financial statements for prior periods presented for comparative

in Issue 00-14, that a vendor incurs (typically a manufacturer) to or

a. The vendor receives, or will receive, an identifiable

should be reclassified to comply with the income statement display

mortar")), manufacturers, distributors, financial services, and other

Further, we believe that any costs that are considered process

product enhancement, if externally-marketed software, is a matter

Accounting Required by Issue

Determine the functionalities (e.g.,

Identify necessary hardware (e.g.,

Determine that the technology

Explore alternatives for achieving

Conceptually formulate and/or

Invite vendors to demonstrate how

their web applications, hardware, or

Identify internal resources for work

Identify software tools and packages

Address legal considerations such as

Website Application and

The discussion of website

Acquire or develop the software tools

Costs incurred to purchase

used in research and development

Generally, capitalize under APB

Acquire or develop software

Generally, capitalize under SOP

Develop or acquire and customize

Generally, capitalize under SOP

Develop or acquire and customize

Generally, capitalize under SOP

Develop HTML websites or develop

Generally, capitalize under SOP

Purchase the web and application

Acquisitions of servers and related

Install developed applications on the

Generally, capitalize under SOP

Initial creation of hypertext links to

Generally, capitalize under SOP

Test the website applications (e.g.,

Generally, capitalize under SOP

Graphics and Content

Initial graphics are part of the

Create content or populate

To be addressed in EITF Issue 0020 (see discussion below).

or acquired to populate databases or

SOP 98-1 specifies that "data

Generally, expense as incurred

Register the website with Internet

Expense as incurred. These

Perform user administration