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Separate Elements of Software Transactions

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. However, most standards have been silent with respect to an operational and consistently applicable definition of separate elements or deliverables.

The tentative conclusions of the Emerging Issues Task Force (EITF ) Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, provide some insight into a potential resolution.

EITF 00-21 says that a deliverable should be segmented and accounted for separately if

1. There is objective and reliable evidence of fair value to allocate the consideration to the separate deliverables, and
2. The deliverable meets at least one of the following criteria at the inception of the arrangement:
   • It does not affect the quality of use or value to the customer of other deliverables in the arrangement.
   • It can be purchased from an unrelated vendor without affecting the quality of use or value to the customer of the remaining deliverables in the arrangement.

Software companies may consistently include or exclude all deliverables in an arrangement from the revenue accounting (and recognize a liability) for the arrangement if all of the following conditions are met:

• The deliverable does not affect the quality of use or value of other deliverables or could be purchased from another vendor without loss of the quality of use or value of other deliverables.
• Any vendor obligation relating to nonperformance would not result in a refund, revenue reversal, or concession.
• The deliverable is inconsequential or perfunctory.

No allocation is permitted in the absence of verifiable fair value. Third-party evidence may not be a reliable indicator of VSOE if the product or service is unique to the vendor.

When objective and verifiable evidence of fair value is available for the undelivered item(s) but not for one or more delivered items in the arrangement, the residual method (SOP 98-9) can be used to allocate revenue if

• The undelivered item meets all other applicable criteria for separate accounting, and
• The fair value of all the undelivered items is less than the total arrangement fee.

Note: The residual method cannot be used to establish the fair value of an undelivered item.

Treatment of the Discount:

• The residual method [SOP 98-9] allocates the entire discount to the delivered elements.
• The relative fair value allocation method [SOP 97-2] allocates a proportionate amount of the entire discount to each unit of accounting in the arrangement based on the fair value of each unit without regard to the discount.