Subject:
New Revenue Recognition Rules Are Now a Reality

September 2009

Background
At its meetings on September 9 and 10, 2009 FASB’s Emerging Issues Task Force (EITF) reached final consensus on EITF Issues No. 08-1, "Revenue Arrangements with Multiple Deliverables" (EITF 08-1) and No. 09-3, "Certain Revenue Arrangements That Include Software Elements" (EITF 09-3). The EITF chose to address these issues in its latest meeting after concern from constituents that applying the existing guidance in EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables" and AICPA Statement of Position No.97-2, "Software Revenue Recognition" (SOP 97-2) to many multiple element arrangements results in financial reporting that does not reflect the economics of the underlying transactions.

FASB Unanimously Approves New Revenue Recognition Guidance
On September 23, 2009, the FASB unanimously approved the new guidance for how companies will recognize revenue. This new guidance will have a major impact on the economics of many companies as well as their business models and accounting practices. While the new guidance won’t affect the actual amount of a company’s revenue, it will allow them to recognize that revenue more quickly and thus provide a more accurate picture of how much revenue they make quarter to quarter.

A Closer Look at the New Revenue Recognition Guidance
This new accounting guidance will significantly change revenue recognition for many multiple revenue arrangements, particularly those that are typical in the high technology industry. The new rules address how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting as well as how the arrangement consideration should be allocated among the separate units of accounting. The new rules also make a number of changes to the accounting for multiple element arrangements under SOP 97-2 that contain software-enabled products.

EITF Issue No. 08-1, "Revenue Arrangements with Multiple Deliverables"
EITF Issue No. 08-1, "Revenue Arrangements with Multiple Deliverables" will have a significant and positive impact for companies who previously were unable to prove that they had vendor-specific objective evidence (VSOE) of the selling price of each component element in a multiple element arrangement. Lacking such evidence, many of these companies have historically been forced into a situation where they could not recognize revenue for ANY of the elements until ALL of them had been delivered. Under EITF 08-1, companies can now potentially book revenue faster and experience less time between product launches and associated revenue recognition benefits.

On the down side, EITF 08-1 has the potential to generate more work for all companies with multiple element arrangements, as it will require enhanced financial statement disclosure that entails both qualitative and quantitative information surrounding the significant judgments being made with regard to multiple deliverable revenue recognition. EITF 08-1 will interject more complexity and reporting hoops to jump through and, unfortunately, result in more audit focus and tension.

In addition, one can also expect the elimination of the residual method for allocating arrangement consideration to impact the amount of revenue allocated to delivered elements. Public companies, be forewarned… analysts will want to know the expected impact.

Below is a summary of the significant aspects of EITF No. 08-1, “Revenue Arrangements with Multiple Deliverables”.

• A delivered element is now considered a separate unit of accounting only if both of the following criteria are met: (a) the delivered item has stand-alone value to the customer; and (b) if the general right of return exists relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and is substantially in the control of the vendor.

• The requirement to establish fair value of undelivered products or services has been eliminated. Instead, the concept of “estimated selling price” (ESP) has been introduced, giving companies the ability to rely upon internal estimates of selling prices when neither vendor-specific objective evidence (VSOE) nor third-party evidence (TPE) of the selling price is available.

• Use of the residual method for allocating arrangement consideration is no longer allowed. Companies must instead allocate arrangement consideration at the inception of an arrangement to all elements in the arrangement based on its relative selling price, using VSOE, TPE or the new concept of ESP (a company’s best estimate of the selling price).

• Use of “estimated selling price” (ESP) will require more management judgment and entail additional financial statement disclosure.

EITF Issue No. 09-3, "Certain Arrangements That Include Software Elements"
Under EITF 08-1, the requirement to use “estimated selling price” for all deliverables when VSOE or TPE do not exist puts more pressure on determining whether a product is within the scope of SOP 97-2. EITF 09-3 addresses those concerns by amending the scope of SOP 97-2 and its related guidance to exclude certain software-enabled products based on the following criteria:

Tangible products containing software components and non-software components that function together to deliver the product's essential functionality.

If a company sells a joint hardware/software product that meets the criteria set forth in EITF 09-3, it will now be subject to EITF 08-1 instead of SOP 97-2 for purposes of separating units of account and for allocating arrangement consideration. As previously discussed in this Alert, under EITF 08-1, if a company does not have VSOE of selling price for each of the deliverables, it will be required to use either TPE or its best estimate of selling price in order to allocate revenue to each of the deliverables in the arrangement. Companies licensing software and not selling a joint hardware software product will still be required to obtain VSOE of fair value of undelivered products or services in order to recognize revenue for delivered items, in accordance with SOP 97-2.

To aid in determining whether your company’s products now fall under SOP 97-2 or EITF 08-1, the exposure draft of EITF 09-3 contains a number of examples. We urge you to review the examples contained in FASB's Draft Abstracts for Issues EIFT 08-1 and EIFT 09-3.

Effective Date
Both EITF 08-1 and EITF 09-3 are to be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. However, retrospective application of the issues is allowable. Early adoption is permitted as of the beginning of a fiscal year provided the company has not previously issued financial statements for any period within that year.