Software Revenue Recognition

By Levine, Marc H.; Siegel, Joel G. et al. | The CPA Journal, May 1999 | Go to article overview

Software Revenue Recognition


Levine, Marc H., Siegel, Joel G., Fitzsimons, Adrian P., The CPA Journal


THE RIGHTS TRANSFERRED UNDER SOFTWARE LICENSES are substantially the same as those transferred in sales of other kinds of products.

The Accounting Standards Executive Committee (AcSEC) issued SOP 97-2, Software Revenue Recognition, to provide guidance on when revenue on software arrangements (such as licensing, selling, leasing, or otherwise marketing computer software) should be recognized and in what amounts. The arrangements covered range from those providing a license for a single software product to those that, in addition to the delivery of software or a software system, require significant production, modification, or customization. The SOP notes that the rights transferred under software licenses are substantially the same as those trans ferred in sales of other kinds of products and that the legal distinction between a license and a sale should not cause revenue recognition on software products to differ from other types of products.

The effective date of certain provisions of the SOP was deferred first by SOP 984, Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition, and later by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. SOP 98-9 also modified the income recognition criteria for certain transactions.

Basic Principles

If an arrangement requires significant production, modification, or customization of software, the entire arrangement should be accounted for in conformity with Accounting Research Bulletin (ARB) No. 45, Long-term Construction-Type Contracts, using the relevant guidance of SOP 97-2 and SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Otherwise, revenue should be recognized when all of the following are met: evidence of an arrangement exists, delivery has occurred, vendor's fee is fixed or determinable, and collectability is probable.

Software arrangements can provide licenses for multiple software products or for multiple software products and services (multiple elements). Multiple elements may include additional software products, upgrades or enhancements, post-contract customer support (PCS), or services, including elements deliverable only on a when-and-if-available basis. SOP 97-2 applies to all additional products and services specified in the arrangements.

If a software arrangement has multiple elements, the vendor's fee must be allocated to the various elements based on vendor-specific objective evidence of fair values, regardless of any separate prices stated within the contract for each element. Such fair value is limited to the price charged when the same element is sold separately or the price established by management (if the element is not yet sold separately). It must be probable that the price will not change before the element is introduced into the marketplace.

The amount allocated to the undelivered elements should not be subject to adjustment. Nevertheless, if it becomes probable that the amount allocated to an undelivered element will result in a loss, the loss should be recognized pursuant to SFAS No. 5, Accounting for Contingencies.

When a vendor's pricing is based on multiple factors such as number of products and number of users, the amount allocated to the same element when sold separately must consider the vendor's pricing structure. If a discount is offered in a multiple-element arrangement, a proportionate amount of that discount based on fair value should be applied to each element included in the contract. However, no portion of the discount should be allocated to any upgrade rights.

If objective evidence of fair value does not exist to allocate revenue to the elements of the arrangement, all revenue from the arrangement should be deferred until the earlier of when sufficient evidence exists or all elements have been delivered. The following exceptions to this guidance apply:

If the only undelivered element is PCS or the arrangement is in substance a subscription, the entire fee should be recognized ratably. …

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