This topic is another great question from a Proformative reader or webcast attendee.  As a Proformative Topic Expert, I was asked to weigh in on this on that website already, but thought I'd also provide a slightly edited version here.

This is still a newer area in revenue recognition treatment, but it's a scenario that we're seeing more frequently.  E&Y has provided some good guidance in a paper called "Revenue recognition on the sale of virtual goods" - I'd recommend that as a good resource for starters. 

Essentially, there are three revenue recognition models tha may apply:

1. Game-based model (Average life of game) – Rev rec amortized over the anticipated game’s run. This is a bit tricky as it may be challenging to know how long the game will be popular among gamers if it is a new and untested title. Slowest form of revenue recognition as most companies are anticipating 5 year run rates or longer based on the investments made.
2. User-based model (Average user life) – Rev rec amortized over the average player’s gaming activity. The tricky part here is anticipating lulls when users have no activity but may come back months alter to start paying again.
3. Item-based model (Consumption model of virtual goods) – Most difficult rev rec method, but offers the quickest time to start recognizing revenue. Items need to be classified as either:

(a) "Consumable" - This meets the delivery test you mention in the post. But if the virtual item has a lasting effect on the user’s character even after physical consumption and the delivery occurred, the item may still need to be classified as durable.
(b) "Durable" – This is where the item enhances the user’s character over n extended period of time and may require amortization over the user's life (assuming the effects of the virtual item become part of the character’s attributes).

From a systems and general compliance perspective, the issue is how delivery is defined.  Is delivery giving the customer the virtual cash to spend, or is delivery the customer actually purchasing the virtual goods?  The latter has the feel for final delivery, but may necessitate very high volume percent complete / milestone delivery type revenue tracking for relatively small amounts of money.

If there is no physical effort required after the initial purchase transaction - and no additional cost incurred - you may be able to justify a revenue method based on the initial purchase of virtual cash. Options could include amortization of revenue straight line over the usual customer consumption period (sort of an inventory turns model), or on purchase, or two months after purchase. It would be helpful to find a simplifying assumption to help with the detailed revenue transaction management.

The following excerpt from the Zynga 10K (using the Item-based model) may be of interest:

“The proceeds from the sale of virtual goods are initially recorded in deferred revenue. We categorize our virtual goods as either consumable or durable. Consumable virtual goods represent goods that can be consumed by a specific player action. For the sale of consumable virtual goods, we recognize revenue as the goods are consumed, which approximates one month. Durable virtual goods represent virtual goods that are accessible to the player over an extended period of time. We recognize revenue from the sale of durable virtual goods ratably over the estimated average playing period of paying players for the applicable game, which represents our best estimate of the estimated average life of durable virtual goods. If we do not have the ability to differentiate revenue attributable to durable virtual goods from consumable virtual goods for a specific game we recognize revenue on the sale of durable and consumable virtual goods for that game ratably over the estimated average period that paying players typically play that game.”

Going forward, it will be interesting to see how social gaming companies deal with the issue of virtual sales in real life.  I expect that this is evolving.

While discussions related to IFRS (International Reporting Standards) unification with US GAAP continue to drag on, the joint FASB/IASB revised revenue recognition proposal is moving forward.  This specific effort will unify revenue recognition internationally and is slated to go into effect in 2015. 

2015 may seem comfortably far away for many companies.  However, public companies (or companies planning to go public) are required to maintain three years of historical records on the same accounting basis.  These companies will need to start almost immediately if they wish to track revenue by both sets of standards for the required three years. 

In addition, private companies in certain industries – including the technology and software industries – would be wise to review the impact of the FASB/IASB project now, and start planning.  For them, the old revenue standards of SOP 97.2 and EITF 08-01 will going away, moving everyone closer to the 08-01 relative value allocation model for any Multi-Element Arrangement. 

One question that everyone should be asking is: Can my current accounting or ERP system handle complex revenue recognition requirements?

In general, ERP systems are built for broad markets and often lack specific vertical industry functionality such as complex revenue, billing and contract management.  This is why large ERP vendors nurture relationships with third party vendors who provide the complementary products that meet these vertical industry challenges.  And that’s exactly where Tensoft Revenue Cycle Management (RCM) fits into the picture. 

Tensoft RCM currently supports all of the technology industry related revenue standards, and will support the final new GAAP standards when they are finalized next year.   To help keep current with this changing environment, anyone can register on Tensoft’s Resource Center, where we provide access to whitepapers, articles and recorded webcasts such as "The FASB IASB Exposure Draft on Revenue from Contracts with Customers." We also regularly offer CPE-eligible online training and educational webcasts from industry thought leaders, and will notify you about these upcoming events if you’re interested. 

 While Tensoft RCM 5.5 isn't a major release, it does provide some important enhancements for many of our customers.  And, it's release provides me with an opportunity to discuss our release cycles.

Because Tensoft's products are web applications, delivery of updates is greatly simplified for our customers.  We use a phased approach to our releases, so customers can choose when they'd like to upgrade, at a time that's convenient to them.  For smaller private companies with a test environment, they can download the new version and test it themselves before rolling it out to their live environment.  Or, for larger companies - or for anyone who'd like some additional support - Tensoft can help with the upgrade.  It's a very individual decision and we leave it up to our customers.  

This flexible approach allows us to provide incremental updates to customers, as rapidly as once a quarter, if that's what they choose.  The bottom line is: we support customers according to their preferred schedule, with as little or as much support from us as they wish. 

 Increasingly complex regulatory requirements, along with the often challenging business models in the technology industry, may make it difficult to analyze your company's revenue recognition needs.  Because of this, it can be extremely helpful to use a framework to analyze your company revenue processes.  Categorizing and organizing the company’s business needs can help you build the processes and systems required for accurate revenue recognition.

One such framework organizes the requirements into three distinct categories.  These categories are based on an overall revenue process model consisting of: a) determining the revenue model; b) applying the revenue model to sales that occur; and, c) recognizing revenue based on the revenue recognition concepts.  These three categories are described in more detail here:

1)     Determination.  Effective revenue processes begin with identifying the appropriate compliance regulations and the revenue rules for the products sold based on these concepts. For many technology companies, an independent analysis and valuation of the items sold in multi-element models is also required.  Determination is generally completed on an annual basis and may also be monitored during the year.

2)  Application. While the determination occurs in a static environment, it is useful only if the determined revenue rules and values are applied to real company transactions as they occur.   Application considers your sales model (how sales occur), as well as the transactions that are created for which the determined revenue rules are applied, and then automates the consistent processing of the revenue.

3) Recognition. If you apply revenue rules and policy to the appropriate sales transactions as they occur, revenue recognition is much more streamlined.  However, it is still a good idea to review the sub-ledger validation, special case or exception rules needed, as well as the general processes around revenue recognition.

Arequest to understand the fair value of a single element within a multi-element sale thus becomes a Determination need.  Likewise, a need to ensure a consistent approach to revenue recognition based upon company policy and compliance requirements is an Application need.  Once the proposed framework is applied, addressing the requirements becomes significantly more manageable.

A solid, documented understanding of your company’s go-to-market model(s) is a good starting point.  "Go-to-market" means the combination of channels, sales efforts, and customer actions that result in sales.  This type of process and analysis is critical when thinking about how to best manage and implement the required revenue recognition processes and systems.

For more information about this topic, you may be interested in Tensoft's white paper, "Revenue Regulatory Compliance Considerations in Business Software Implementation," co-authored by Bob Scarborough and Jeffrey Werner.

 In this webinar, we will compare and contrast the current and proposed approaches to revenue from contracts with customers.  While there are no pre-requisites for this CPE-eligible event, the information below may be helpful to know in advance.

Under the Proposed Exposure Draft, revenue recognition will follow this new five step process:

1.      Identify the Contract with Customer

2.      Identify the Separate Performance Obligations

3.      Determine Transaction Price

4.      Allocate Transaction Price to Obligations

5.      Recognize Revenue on Satisfaction of Performance Obligation

Here are some of the differences between current US GAAP and the proposed Standard:

·         Significant use of estimates

·         Significant increase in disclosures

·         Relative selling price method

·         Delivery on “transfer of control” to customer

·         Variable and contingent revenue is estimated instead of deferred

·         Time value of money (revised to greater than 1 year)

·         Collectability is estimated and reduces revenue

·         Re-measurement and adjustments to recorded revenue

·         Warranties are revenue obligations (like software PCS)

·         Percentage of completion accounting – (based on transfer of control – continuous transfer of control issues)

·         Consideration to customer may be separable (revenue and expense)

·         Return accounting – estimated

Sound like some significant changes?  If approved as expected, they will be.  This is why many companies are planning to prepare asap to apply the new standard.  So, please join us for this informative and timely topic.

Webinar Agenda:

            ·         Overview – Who, What, When, Where, Why

·         Process and Scope

·         Exposure Draft Outline

·         Five New Principles of Revenue Recognition

·         Differences from Current US GAAP

·         Implementation Guidance

·         Effect of Changes on Technology Companies

To ensure that your questions and comments will be addressed and included in the webcast, please submit them in advance.

 The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have recently published important exposure drafts on “Revenue from Contracts with Customers.”  The proposed joint standard seeks to clarify the principles for recognizing revenue and to adopt a single revenue model for both International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP) reporters, across industries and markets.  If adopted, this would represent a significant step toward global convergence in financial reporting.

These proposed standards will likely result in significant changes in the key financial performance measures of many companies, in many industries.  For most, this will require changes to the business management systems that measure and recognize revenue, as well as updates to revenue recognition process controls.  Although the effective date is no earlier that January 1, 2015, it’s not too early to prepare, since this may take substantial planning and effort to implement, depending on your company’s current contract and revenue processes.

Tensoft will be providing further insight to our customers, partners and other interest parties, including an upcoming webcast on March 13 – just in time to help inform any additional comments that you’d like to make on the exposure drafts! 

 Revenue management functionality is available either as part of a few financial and accounting software solutions, or as an independent solution that provide some level of integration to your system of record.  Vendors on both sides can be glib about their product’s ability to handle anything that you can think of.  If your company is in either the technology or software industries, you’re probably well aware that your needs in this area are beyond what most solutions are designed to handle.  When in doubt, be sure that the vendors that you’re considering can demonstrate - not just talk about or give a slick slide presentation on - the following capabilities:

1)    Ability to handle multi-element arrangements.

2)    Robust support for fair value methodology.

3)    The system can match the transaction flow of your go-to-market model(s), providing, for example, contract administration or integration to your website or CRM system.  

This is just a starting point, of course, but these three points will help narrow the field a bit.

 Multi-element arrangements are created when multiple inter-dependent items are sold to customers.  For SaaS companies, some examples of this include: setup fees, subscriptions, training, and professional services.  When multi-element arrangements occur, they’re subject to EITF 08-01.

Consumer businesses may try to eliminate the multi-element arrangements requirements of EITF 08-01 by offering only subscription licensing.   However, companies who are in the business-to-business space often don’t have that option.  Your market will dictate what mix of products and services that you need to offer your customers, not the hope to streamline the revenue recognition process.

A special scenario occurs when you offer product modifications – where there is a required delivery component tied to the subscription sale.  This scenario can require the use of SOP 81-1, along with EITF 08-01.  SOP 81-1 requires recognition of software revenue based on the delivery of the required modifications, often by percent complete methodology.

Often these product modification scenarios are something that happens early in a company’s history, when your product is still maturing.  If this is the case, the need to offer product modifications should disappear as your product matures and your installed base and reputation grow.  However, if offering product modifications is part of your long-term go-to-market strategy, then you may want to look at options such as isolating the customization layer in your product so that it becomes an implementation challenge rather than a product extension requirement.

Whenever possible, it’s reasonable and smart to try to simplify revenue recognition requirements.  A revenue recognition expert can help with planning for this, as well as providing tactical assistance with agreement negotiations, to make sure the agreement optimizes your revenue opportunities. 

 Re-posted from ERP SoftwareBlog:

Think for a minute about how ubiquitous software has become.  How many everyday consumer products, such as mobile devices, have embedded software today?  How would businesses function without software?  How many online services depend on software to take care of their customers?  Every day new smart products or helpful services are created – software is pervasive.

When software (or software based) products are sold the sale is often a combination of related items.  One example of this is the sale of software plus maintenance.   These are normally sold as two separate line items but are inextricably related to each other; so they constitute a multi-element sale.   Another example is an online subscription that includes setup as well as ongoing service.  A multi-element sale is, simply, the sale of multiple related items to a customer.

Okay, so lots of companies are affected – what’s the big deal?  The issue is that the EITF and the FASB have recently issued guidance that many companies have not yet adopted, and their auditors are starting to call that to their attention.   We’re seeing – and hearing about – significant amounts of pain at companies who have not yet analyzed their various sales arrangements and taken steps to ensure correct revenue recognition for such multiple-deliverable arrangements. 

Tensoft can help.   In addition to Tensoft Revenue Cycle Management (RCM), a suite of products that brings together the specific revenue recognition, recurring billing, and contract management functionality that today’s technology companies need, we offer an optional Compliance Module.  Integrated with Microsoft Dynamics, the determined rules are applied based on sales transactions, the appropriate method, and the independent revenue valuation for each item.   With fully auditable processes and reports,   Tensoft RCM is the only solution of its kind that has passed the rigorous Certified for Microsoft Dynamics (CfMD) testing process. 

For additional information about this topic, you may want to review the recorded webcasts in Tensoft’s Resource Center (www.tensoft.com/resources), including “EITF 08-1 and the Relative Selling Price Method for Multiple Element Arrangements.”  This webcast was presented live on 9/20/11.  Tensoft regularly hosts webcasts that are eligible for CPE credit, and is an accredited member of the National Registry of CPE Sponsors.