Thanks to everyone who attended "EITF 08-1 and the Relative Selling Price Method for Multiple Element Arrangements," another very informative webcast presentation by Silicon Valley revenue recognition expert, Jeffrey Werner.  Tensoft was pleased to host this event, and is looking forward to Jeffrey's upcoming revenue recognition online classes that we'll hosting in November - check Tensoft's website next week for more information about that. 

Meanwhile, here are the answers to attendees' questions from last week's webcast:

Q: How does this apply to Web Based Application Services, if at all?

JW: If the web-based application service includes multiple elements, we would use ESP to allocate revenue to each stand alone element and then generally recognize revenue when that element is delivered. There may be other considerations such as the requirement to recognize set up fees over the longer of the contract period and the expected customer relationship period.

Q: If a company sells software using an on premise subscription model and SAAS-on demand, how can you justify using different revenue recognition models for which is essentially the same business model. The primary difference is on is a time based license that is on premise at the customer's location and the other is time based whereby the customer's software is located at a data center? This is more a request, but it would be helpful to see similar examples where the multiple elements include services, on demand services that include support. Is there anywhere I can obtain this info

JW: If the on-premise subscription model meets the requirements for software revenue (customer has the right and ability to take possession without significant cost) it would be recognized under software revenue recognition (residual method using VSOE).

The SaaS on demand sales would be allocated and recognized under EITF 08-1.

If a transaction had both on premise subscription and SaaS, the allocation would be done using EITF 08-1 and then on premise recognized using residual method and VSOE and the SaaS recognized as a service under 08-1.

Q: is EITF 03-5 no longer relevant?

JW: EITF 03-5 is superseded by EITFs 08-1 and 09-3.

Q: is ASU 2009-14 only used for tangible items w/ software?  What is used to determine how to account for a hosting engagement where software is sold? 

JW: If the hosting engagement meets the requirements for software revenue recognition because the customer has the right and ability to take possession and self-host without significant cost, then software revenue recognition would continue to be applied. If not, the multiple elements in the arrangement would be allocated revenue according to EITF 08-1.

Q: Would you use residual method for delivered software other than ESP?

JW: The residual method would only be used for the initial revenue allocation for software sales without other non-software elements. Software would use ESP and the relative selling price method for the allocation if the multiple element arrangement included non-software element.

Q: While I understand that contract terms and conditions affect the decision, I am wondering about his opinion on a particular transaction set.  If a company responds to an RFP which requires HW, SW & ongoing services (PCS & BPO, for example).

JW: This would appear to be a transaction that requires allocation of revenue to the separate elements using the relative selling price method. If some of the elements are determined to be software elements under the guidance of EITF 09-3, then the residual method would be applied to the allocated amount and VSOE would be required for any undelivered elements.

Q: Assume vendor responds to RFP requiring HW, SW and ongoing services (PCS & Business Process Outsourcing) and also assume that the vendor usually uses contract accounting & guidance of 97-2, an old fashion "Build & Run" scenario.  What's your opinion about using ASU 2009-14 to take the transaction outside of 97-2 guidance?

JW: If the hardware and software meet the requirements of EITF 09-3 to determine that the hardware and software work together to provide the functionality of the combined hardware and software product, then the transaction would be accounted for under EITF 08-1 for both the allocation and revenue recognition. If it is determined that there are both software and non-software elements, then revenue would be allocated using ESP and the relative selling price method and the software recognized under software revenue recognition and the non-software elements recognized under EITF 08-1.

Q: Does this mean that the software & PCS are taken outside of 97-2 with the hardware?

JW: It depends on whether the hardware and software meet the requirements of EITF 09-3 for treatment as non-software. If the hardware and software are always sold together and work together to provide the functionality, then the entire transaction would appear to be outside of software accounting. See Case A.

If the hardware is not always sold with the software, the determination might be that the hardware is a non-software element and the software is a software element. See Case B.

It would depend on the facts and circumstances.

Q: If your company has VSOE established for your product, can you choose to use BESP instead to avoid having to keep VSOE data and analysis?

JW: If a product currently has VSOE, the expectation is that the company would continue to use VSOE. The company would continue to use VSOE unless the situation changed and the company was no longer able to establish VSOE because the pattern of stand-alone sales no longer met the requirements of VSOE.

Q: If we have 2 different ways to sell our product - premise (where the customer buys a perpetual license and has it on site) and SaaS, the premise deals would be under SOP 97-2 and the SaaS deals would be under EITF 08-1, correct?

JW: For software only sales, the company would continue to use SOP 97-2 for allocation and revenue recognition.

For SaaS arrangements, the company would use ETIF 08-1 for allocation and revenue recognition.

If a transaction has both software and SaaS included in one sale, the revenue would be allocated to the separate elements using the relative selling price method of EITF 08-1 and ESP.

Then the software would be recognized using the residual method and VSOE and the SaaS would be recognized using EITF 08-1.

Q: In example 1, how is the ratable revenue split up between hardware, software, and support?

JW: Allocation of the ratable revenue should be on a reasonable and consistent manner to the different classes in the statement of operations/income statement. Pro rata allocation to each element based on contractual amount might be one method. The total revenue would be equal to the total ratable revenue for that period. Consideration would be given to each element. For example, the amount of revenue for support would probably be limited to 1/12^th for each month in the recognition period.

On September 14^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Updates - Requirements of New EITFs and Future Changes to the Revenue Recognition Model.

This blog entry details Werner’s responses to audience questions posed after the live webcast.^*

Foreign Currency Issues

Q:  If a company has multiple-element arrangements set in various foreign currencies, is the estimated selling price set for each currency? Will changes in estimated selling prices be accounted for as a change in estimate?

A:  I think you would set the ESP in the currency of the transaction. This could either be an ESP list for each currency or translation on the date of the transaction from US$ ESP.

Typically, once the ESP is set, it would not change for a transaction once the accounting started, but could change for future transactions as the information used to make the estimate changes. So these would not be accounted for as a change is estimate. This is similar to current accounting for VSOE. Vendors use the VSOE on the date of the transaction. VSOE may change over time and a different VSOE can be used for a similar transaction at a later date.

Support allocation and recognition

Q: I think there is an error in the examples. The software items (licenses and support) should receive their allocation as a bundle. Then, the residual method is applied, which will almost always result in PCS being recognized as its VSOE value. Do you agree?

A: I think if you review the cases in EITF 09-3, when there are tangible product elements and software elements, the allocation is done under the relative selling price method and then the revenue is recognized, depending on whether the element is non-software or software. The Case I (page 15) has an example of non-software and software elements and support on both. In this case the support is separated out for each element.

I do not think the software and support is one bundle. I believe they are separate elements and have stand-alone value. In our example in the webcast slides, the support was on both the hardware and software elements. Since we did not have VSOE for support on only the software, the software and the related support were recognized ratably over the support period. Once you have separated the elements into software and non-software, you would recognize the non-software elements under EITF 08-1 and the software elements under SOP 97-2. 

When you separate out the elements into software and non-software, you may have software elements that are considered non-software because the tangible product and the software work as one product. 

Maybe this is where there is confusion:  In Case A from ETIF 09-3, the computer and the operating system are considered non-software because the computer is not sold without the operating system and the computer and the operating system work as one product. Both the computer and the operating system are accounted for under EITF 08-1.

In Case B, the computer is frequently sold without the operating system. In this case the computer is considered non-software and accounted for under EITF 08-1 and the operating system is considered software and accounted for under SOP 9.

VSOE or ESP for Recognition on Software

Q: For the operating system and the support, why can't you use the best estimate for revenue recognition?   

A: EITF 09-3 requires use of the Relative Selling Price Method for the allocation of revenue to each element. Then the next step is to recognize revenue based on the type of revenue – either non-software under EITF 08-1 or software under SOP 97-2. See paragraph 5 on page 10 of ASU 2009-14.

All software and services – use EITF 08-1 or SOP 97-2

Q: If we have multiple deliverables, where all deliverables are software- and/or services-related (i.e. no hardware or tangibles), do we have to comply with EITF 08-1 or with SOP 97-2? 

A: EITF 09-1 provides the accounting for multiple element arrangements with both tangible elements and software elements. Software only arrangements are still covered by SOP 97-2.

If all the elements are software-related, they would be accounted for under SOP 97-2 and EIF 08-1 would not be used.

Separation of Elements – No stand-alone value

Q: If we do not have the stand-alone value for deliverables, then it would be one unit of accounting and we need not proceed with determining the relative selling price; is that right? Also would you discuss a little more on stand-alone determination?  

A: Correct. If there are not stand-alone values for the different items, then the deliverables would be considered one element. With only one element, we do not need to allocate revenue. Revenue would be recognized when all the delivery for all deliverables is complete.

Elements are considered to have stand-alone value if the customer can use an element independently without the other elements. One indication of stand-alone value is resale value. If the customer can resell an item separately, it probably has stand alone-value.

ESP Methods for SaaS

Q: What are the some of the acceptable BESP methods for SaaS clients offering multiple products to customers?

A: Methods to establish the estimated selling prices for SaaS arrangements could include VSOE or VSOE “Light,” cost-plus-margin and what other companies sell an item for.

For VSOE or VSOE “Light,” this would be an analysis of the prices these elements were sold for when sold on a stand-alone basis. For example if a SaaS vendor sells training and often does so in stand-alone transactions, the fees for the training when sold separately could be used to establish the estimated selling price of the training when sold in a multiple element SaaS arrangement.

For the cost-plus-margin method, the cost of providing the training plus a normal margin on the training services could be used to establish the estimated selling price.

If other companies sell one day of training for a similar type of SaaS service, perhaps the price other companies charge could be used to establish the estimated selling price of one day of training.

Differences between current US GAAP and the proposed FASB IASB revenue model

Q: Under the new revenue model, what are the main differences in the allocation criteria between the old and new revenue models?

A: The proposed FASB IASB revenue model will use the relative selling price method for allocation of revenue to the multiple elements. Estimates will be used to establish the relative selling prices for the allocation of revenue. This approach is similar to the relative selling price method of EITF 08-1. There is no requirement of valuation hierarchy such as ETIF 08-1 has with VSOE, TPE and ESP. Estimates will be used for other considerations. The allocation of revenue will include estimates for the time value of money and collectability. Contingent revenue and rights-of-return will be estimated and the net revenue recognized. Under current US GAAP, contingent revenue and return rights generally require deferral. Revenue is generally deferred if not collectible in full and the time value of money is not taken into consideration.

^* Click here to view this on-demand webcast in its entirety.

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the fifth of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Stand-Alone Value - Delivered and Undelivered Items (Part 2)

To elaborate on whether we have stand-alone value on the undelivered element, we generally sell our hosted services on a stand-alone basis. There is no requirement for the customer to purchase professional services. However, we do have one service offering in which consulting is always sold along with the hosted services as a bundled package. Each element (hosted and consulting) is itemized and assigned a value in the contract. Similar to example 4 in the webcast, my conclusion would be that we do not have stand-alone value for these specific service contracts and therefore must account for the entire arrangement as a single unit of accounting and recognize the revenue ratably over the hosted service term.

Where the guidance gets a little fuzzy for me is with respect to the revenue allocation when there is no stand-alone value for any of the elements in an arrangement. For these scenarios, is it still appropriate to allocate revenue between hosted revenue and consulting revenue on the basis of their relative selling price versus prices stated in the contract? Revenue recognition in total is the same but the classification would be different.

Response

1) If the consulting services are sold separately on a standard hourly or daily basis, then you may be able to establish stand-alone value. If you have adopted EITF 08-1, you would estimate the selling price, assuming that the consulting had a separate value to the customer, independent of the hosted services.

2) If there is separate value to the customer independent of the other elements, the accounting depends on your method. 

If you are under the current accounting of EITF 00-21, without VSOE you would take all the revenue ratably.

If you have adopted EITF 08-1, you would estimate the value of each separate element and use the relative selling price method.

^* Click here to view this on-demand webcast in its entirety.

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the fourth of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Stand-Alone Value - Delivered and Undelivered Items

I attended the webcast yesterday on revenue recognition for SaaS. The presentation helped my understanding of the new guidelines for multiple-element arrangements. I do have a question I’m hoping you can clarify for me regarding the stand-alone value criteria. Only the “delivered item” needs to have stand-alone value; the “undelivered item” does not need to have stand-alone value. Is this correct? So as illustrated in example 3, training courses and consulting packages sold with a hosted services contract are still considered to be the delivered items even if they are not actually delivered up-front but rather at some point later in the hosted services term.

A simplified common multiple-element arrangement at my company is: 12 months of hosted services, training course, non-implementation hourly consulting.

Since we frequently sell both training and consulting services separately, we have met the stand-alone value criteria. We also do not have a general right of return. Therefore, in the above scenario, once we have allocated based on their relative selling price, we can appropriately recognize the hosted services ratably over 12 months and recognize the training when complete (i.e., month 2) and recognize the consulting as performed (i.e., 50% delivered in month 3, 25% in month 4 and 25% in month 6). Am I interpreting and applying the guidance correctly?

Response

There are two issues with "stand alone value" – determining whether elements can be separated and determining the value of each separate element.

First Separation - in order to separate elements of an arrangement, each element must have stand-alone value. That means each element must provide value that is independent of the other elements. An example of an element that does not have stand-alone value is set up fees. The customer only receives value from them in conjunction with the monthly use of the service. If the elements of an arrangement have stand-alone value, then we can proceed to the next step and allocate value to each element.

Second Allocation - we can allocate the value to each element in several ways. 

For software companies and companies that have not adopted EITF 08-1, the value is determined by allocating the VSOE (Vendor-Specific Objective Evidence) to the undelivered elements and allocating the residual value to the delivered elements. 

If a company has adopted EITF 08-1 or for all calendar year-end companies after January 1, 2011, we allocate using either VSOE, TPE (Third Party Evidence) or BESP (Best Estimated Selling Price).

Regarding your specific question, it is hard for me to understand how a multiple element arrangement would have a delivered item with stand-alone value and an undelivered element without stand-alone value. If that were the case, it would seem we would only have one element to account for: the bundle.

In a transaction with monthly hosted services, training and non-implementation consulting, it would seem that there are three elements with stand-alone value. Each element would need to be allocated a portion of the total fee which may or may not be the invoice amount depending on the facts and the revenue recognition method (Residual or Relative Selling Price). If the training and consulting are frequently sold separately, those separate sales could be used to establish their value. Since the monthly services are undelivered, under the residual method we would need VSOE for these. This could be established with a renewal rate. Under the Relative Selling Price method, we would need to estimate the value of the monthly services and then allocate the total fee to each element using the relative percentage of the total fee.

^* Click here to view this on-demand webcast in its entirety.

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the third of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Monthly User Fees

Have you come across monthly service fees based on a per-user/per-month price, but with a minimum monthly commitment which the customer has to pay?  I was wondering when the actual monthly usage is less than the minimum monthly amount and whether the difference should be deferred and recognized once the minimum is being reported, because the earnings process is only complete up to actual usage.  In a simple example – price per user per month: $1.00 and minimum monthly commitment: $10,000, which the customer must pay.  If in month 1 the customer only reports $7,500 (7,500 users) should we recognize the $10,000 or only $7,500?  In this example, the minimum monthly commitment is non-cancellable and non-refundable.

Response

The answer to your situation could depend on the contract language. 

If the contract specifies that if the minimum is not reached there is no recovery in future periods of the difference, then it would probably be appropriate to recognize the minimum each month. There would be no carry over or credit in following months when the minimum was exceeded.

If the contract allows credits or carryovers to future or prior periods for less than minimum usage, then the lower amount based on actual usage should be recognized.

^* Click here to view this on-demand webcast in its entirety.

Question - Best Estimated Selling Price

How are you seeing the “Best Estimate Selling  Price” (BESP) working in practice, especially where there’s no pricing history and management doesn’t establish firm pricing methodologies? Should we just bundle everything together (set-up, monthly service, etc.) and recognize over the longer of contract or expected customer life?

Response

BESP is required. If there are multiple elements that are separable, then the company must come up with estimated selling prices using the best available information and analysis. 

The elements have to meet the separation criteria in order to have BESP applied. SaaS arrangements often do not have separable elements because the elements do not have stand-alone value. An example is setup fees.

There seem to be a few approaches that are being used consistently for elements that can be separated. 

In companies with significant hardware costs and low volume, high-dollar products are often approaching BESP using a gross margin approach. This approach takes the cost of each element of a transaction and adds the expected or average gross margin to arrive at the estimated selling price. The gross margin is often at a division or product family level. Some companies with fewer product offerings might use a company-wide gross margin.

Other companies are using a discount from list price approach. This works when the company has a consistent pricing approach and a discount range by product or product family that has some consistency. Companies look at the average discount and then apply that to list price for each product to arrive at the BESP.

Some companies are using what I call a "VSOE Light." PwC calls this the “broken” or “failed” VSOE approach. These companies apply the same analysis as a VSOE study but allow greater variances in the covered population and the plus or minus percentage. For example, if the pricing of a product is consistent for say 60% of the population with a 20% plus or minus variance, that might be a good indicator of a Best Estimated Selling Price. This would compare to the normal VSOE analysis of 80-85% of the population covered with a 10-15% variance.

Obviously, there are complexities to these approaches and often there are “devils in the details.” Companies should work with consultants and their auditors to develop a reasonable approach.

^* Click here to view this on-demand webcast in its entirety.

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the first of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Upfront Fees

What is your definition of an upfront fee? If a customer requires additional professional services to customize the SaaS but could actually use the SaaS based on the standard setup, is that defined as “setup fees” or “professional services?” The revenue treatment would be different if VSOE exists on the SaaS. If the services were deemed to be professional services, the revenue could be recognized as delivered. If they were deemed to be setup fees, revenue would be recognized ratably.

Response

Additional professional services that were not required to use the service but instead to enhance it for a specific customer could be considered an independent element.

The facts of the situation would determine this. For example, if the professional services were contracted for separately – several months after the service started and the initial contract was signed – then they would probably be accounted for as a separate element and recognized as provided.

If the professional services were an element of the original agreement, you would need to consider whether they were truly optional. If they are considered optional, you would move to separation and allocation to determine whether they have independent value and thus could be recognized separately. If not, they would be ratable with SaaS revenue.

The thing to remember is whether they are truly separate elements or just a way of pricing. In a true upfront fee, there is no option, and the cost is truly part of the cost-of-use. 

You might want to discuss this with your auditors to understand where they draw the line on being independent or having a relationship to the expected customer relationship period.

^* Click here to view this on-demand webcast in its entirety.