Continued Discussion on Separate Elements of Software Transactions

- A.C. Sondhi, RevenueRecognition.com

Part 1 noted that separable components or elements of software transactions and vendor specific objective evidence of their fair value are among the most critical building blocks of software revenue recognition. Discussions of this issue by the Emerging Issues Task Force (EITF ) may be affected by the revenue recognition project proposal. I will provide an update on the FASB project and EITF discussions in future columns.

EITF Issue No. 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)
In this issue, the EITF has reconciled selected guidance provided in Issue Nos. 00-14, 00-22, and 00-25. Issues 1 and 2 are concerned with the income statement treatment of cash consideration including sales incentives; the Task Force has reached a consensus requiring a reduction in revenue for cash consideration (including sales incentives) given by vendors unless both of the following conditions are met:

1. The vendor has received, or will receive, a benefit that is sufficiently separable from the customer’s purchase of products and services from the vendor.
2. A reasonable estimate of the fair value of this benefit is available.

When these conditions are met, the consideration must be treated as a cost. The excess of consideration paid over the fair value of the benefit received must be reported as a reduction in revenue.

Vendors must also treat as cost any “free” products or services given to customers. Although the EITF did not reach a consensus on the income statement display of such costs, the SEC staff contends that such costs must be reported as components of cost of sales.

The EITF notes that slotting fees, and other similar product development or placement fees must be reported as reductions in revenue. Because this EITF applies to intermediate and final resellers, cooperative advertising and marketing programs are subject to this consensus.

Financial statements for annual or interim periods beginning after December 15, 2001 must reflect these consensuses. Issues 4 - 6 are concerned with (1) the timing, that is, when to recognize and (2) how to measure the cost of the incentive.

Issue 4 - Sales incentive offered without charge to the customer and voluntarily by the vendor: The Task Force reached a consensus requiring the recognition of the cost of such incentives at the later of the following:

1. The date at which the related revenue is recognized by the vendor.
2. The date at which the sales incentive if offered.

This consensus must be applied no later than in financial statements for annual or interim periods beginning after December 15, 2001.