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AICPA
AICPA
Costs of Start-Up Activities and
Modification of SOP 97-2
Edward E. Nusbaum and Judith Weiss
A
Edward E. Nusbaum, CPA, is the
Managing Partner of Grant
Thornton LLP's Philadelphia office.
In this role he is responsible for
leading and managing the
assurance, tax, and consulting
practices for Philadelphia, one of the
national firm's larger offices. He was
previously Grant Thornton's
National Director of Assurance
Services based in New York, and is
now chairman of Grant Thornton
International's Audit Policy
Committee and chairman of the
firm's Strategic Initiatives Objectives
Committee. He is also a member of
the FASB Emerging Issues Task
Force and has been chairman of a
couple of the task force's working
groups. He has an M.S. in Management from Purdue University and a
B.S. in Business Administration,
Summa Cum Laude, from Ohio
State University. He is a recipient of
the Elijah Watts Sells Award, has
written articles for a variety of
publications including The Journal
of Corporate Accounting &
Finance, and is a frequent speaker
at seminars and conferences. Judith
Weiss, formerly a senior manager in
the National Accounting and
Auditing Department of Grant
Thornton, is now a freelance writer
on matters related to accounting
and auditing.
t the end of July, the Accounting Standards Executive Committee (AcSEC)
issued an Exposure Draft (ED) of a Proposed Statement of Position (SOP),
Modification of the Limitations on Evidence of Fair Value in Software Arrangements,
which would amend SOP 97-2, Software Revenue Recognition. Early in 1998,
AcSEC learned that under certain circumstances, a provision in SOP 97-2 related
to the requirement for vendor-specific objective evidence of the fair value of
separate elements of a multiple element software arrangement (to which contract
accounting does not apply) may result in excessively conservative revenue
recognition practices. This led AcSEC to issue SOP 98-4, Deferral of the Effective
Date of a Provision of SOP 97-2, Software Revenue Recognition, which deferred the
effective date of that requirement for one year and promised definitive guidance
before the end of 1998. This ED proposes such guidance.
Multiple-software elements are defined in paragraph 9 of SOP 97-2 as
“software arrangements [that] may provide licenses for multiple software
deliverables (for example, software products, upgrades/enhancements, PCS
[postcontract customer support] or services.” Such contracts usually require a
vendor to deliver the software product currently and to deliver additional elements
in the future, for example, PCS, or upgrades or enhancements, which also may be
referred to as “when-and-if available” deliverables, because delivery occurs only
if the upgrades or enhancements become available while the arrangement is in
effect.
The basic revenue recognition principle in SOP 97-2 as well as in SOP 91-1,
which was superseded by SOP 97-2, is that revenue should be recognized only
when an element has been delivered. In its discussions of SOP 97-2, AcSEC
considered whether arrangements that also include additional deliverables should
be accounted for as multiple-element arrangements. They concluded that because
customers attribute a value to other deliverables that may be included in the
arrangement at no additional cost, such as upgrades or enhancements delivered
on a “when-and-if available” basis or free PCS, arrangements that include such
deliverables are multiple element arrangements. Under SOP 91-1, revenue on all
deliverables included in an arrangement was recognized on delivery of a software
product, unless the remaining vendor obligations were significant.
The Journal of Corporate Accounting and Finance/Autumn 1998
CCC 1044-8136/98/1001171-04
© 1998 John Wiley & Sons, Inc.
171
Edward E. Nusbaum and Judith Weiss
The determination of whether vendor obligations are significant or
insignificant was not applied consistently in practice. Therefore, AcSEC decided
in its deliberations on SOP 97-2 that software vendors should account for all
obligations under an arrangement and that revenue should be allocated to its
various elements based on vendor-specific objective evidence of the fair value of
each element. Prices used by other vendors for similar products cannot be used
under SOP 97-2, because companies have different pricing structures. If a
vendor cannot determine the fair value of a separate element of a multiple
element arrangement, revenue must be deferred until one of the following
conditions has been met, whichever occurs first: (a) there is sufficient vendorspecific evidence of the fair value of the separate elements, or (b) all elements of
the arrangement have been delivered. There are some exceptions to that rule,
however, depending on the undelivered element. Revenue should be recognized
ratably on undelivered PCS or on an arrangement that is in substance a
subscription, and the entire fee for services should be recognized over the period
during which they are performed. Other allocation methods apply to
arrangements in which revenue is based on a fixed fee per license for the software
sold to a customer.
The provision that has created the controversy is the second sentence of
paragraph 10, which provides specific guidance on the method of determining
the fair value of a separate element. That is, vendor-specific objective evidence
of fair value is limited to the price of the same element if it is sold separately or
for an element that is not yet sold separately, it must be probable that an
established price will not change before the separate element is introduced into
the marketplace. Those who believe that revenue recognition under that provision
is too conservative assert that it is unfair to preclude revenue recognition on an
element of an arrangement, such as the software product, which has already been
delivered merely because an element of the arrangement is not sold separately
and therefore has no separate price. Proponents of this view argue that
“unbundling” should be permitted with revenue recognition on the delivered
elements of the arrangement if the fair value of the undelivered elements can be
determined based on other vendor-specific objective evidence.
The ED includes the following three examples that illustrate transactions for
which no revenue can be recognized under SOP 97-2:
•
•
172
A vendor nearly always sells its software with PCS or other elements, and
has vendor-specific evidence of the fair value of the total arrangement,
the PCS, or other elements. Some have interpreted the second sentence
of paragraph 10 to mean that in that situation there is no vendor-specific
objective evidence of the fair value of the software element because it is
not sold separately. Therefore, according to paragraph 12 of the SOP,
revenue on an arrangement that involves PCS would be recognized
ratably over the period PCS is performed even if the software had already
been delivered.
A vendor nearly always sells PCS or other elements only with software
and has vendor-specific evidence of the fair value of the software and the
total arrangement. Some have interpreted the second sentence of
paragraph 10 to mean that in that situation there is no vendor-specific
objective evidence of the fair value of the PCS element, because it is not
The Journal of Corporate Accounting and Finance/Autumn 1998
AICPA
•
sold separately and no price has been determined in anticipation of the
sale of PCS. Therefore, according to paragraph 12 of the SOP, revenue
on an arrangement that involves PCS would be recognized ratably over
the period PCS is performed even if the software had already been
delivered.
A multiple element arrangement includes a multi-year PCS commitment
even though such arrangements generally include PCS for only one year.
Some have interpreted the second sentence of paragraph 10 to mean that
in that situation there is no vendor-specific objective evidence of the fair
value of a multi-year PCS commitment, because the vendor usually sells
only one-year contracts for PCS. Therefore, according to paragraph 12
of the SOP, revenue on an arrangement that involves a multi-year PCS
commitment would be recognized ratably over the period PCS is
performed even if the software had already been delivered.
The ED modifies the revenue recognition guidance for separate elements of
a arrangement by deleting the second sentences of Paragraph 10, 37, 41, and 57
of SOP 97-2, thus eliminating the requirement that an element be sold separately
in the marketplace or that a separate price for an element not yet sold separately
be determined. The effect of this modification is that vendors will be permitted
to provide other vendor-specific objective evidence of the fair value of the
elements of arrangements. The following examples in the ED, which replace
certain examples in the application guidance in Appendix A of SOP 97-2,
illustrate the effect of the change in revenue recognition requirements proposed
in this ED for multi-element arrangements:
•
•
•
Management has not yet decided on the price at which an upgrade,
which is also included in an arrangement, will be sold to existing users.
As a result, there is no vendor-specific objective evidence of the upgrade’s
fair value; all revenue on the arrangement must be deferred until such
evidence is available.
A vendor sells software with implementation services, which are never
sold separately. Although the software is sold separately, it not sold
consistently at the same price, so it is impossible to infer the price of the
implementation services for which there is no vendor-specific objective
evidence of fair value. Revenue should be recognized on the arrangement
beginning on the date the software is delivered and continuing over the
period (90 days) the services are expected to be performed.
Software product A always is sold with free PCS for one year and nearly
always sells for a specific price ($1,000, for this example). The software
has no separate price. A one-year renewal of PCS costs $150. Even
though the vendor has no vendor-specific objective evidence of the
separate price of the software, the price of the total arrangement can be
allocated to the separate elements, because there is vendor-specific
objective evidence of the price of the multiple element arrangement,
which nearly always sells for $1,000 and of a one-year contract of PCS,
which always sells for $150. Consequently, the vendor can infer that
$850 should be recognized on delivery of the software with the remaining
$150 recognized over the one-year term of PCS. If the price of the
The Journal of Corporate Accounting and Finance/Autumn 1998
173
Edward E. Nusbaum and Judith Weiss
multiple element arrangement were not consistent then but were to
fluctuate from one customer to another, the vendor would not be able
to allocate the price of the arrangement and revenue would have to be
recognized over the period of PCS.
The proposed SOP would be effective for transactions entered into in fiscal
years that begin after December 15, 1998, but earlier adoption is permitted.
Entities that accounted for transactions based on the guidance in SOP 97-2 in a
period that ended on or before March 31, 1998, and did not change their
accounting for those transactions as a result of the issuance of SOP 98-4, may
restate when adopting the proposed SOP amounts reported for those transactions
in financial statements or information issued after SOP 97-2 was adopted but
before the date the proposed SOP becomes effective. ♦
174
The Journal of Corporate Accounting and Finance/Autumn 1998
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