Accelerating Revenue Recognition to the
Speed of Business
New Rules on Revenue Arrangements with Multiple Deliverables
Current Issue
Companies with multiple element arrangements are no strangers
to the rigid exercise and stringent accounting literature requirements of establishing verifiable and objective fair value in order
to recognize revenue for elements delivered up front.
The recent release of two Accounting Standards (ASU 2009-13
and ASU 2009-14), formerly known as Emerging Issues Task
Force (EITF) 08-1 and 09-3, have undoubtedly brought some
good news to most companies previously applying EITF 00-21
and/or Statements of Position (SOP) 97-2. From device manufacturers with embedded software to software-as-a-service
providers, companies are gearing up the efforts to understand
the impact of the new guidance and planning for policy, process
and system updates to adapt to the changes. Companies that
sell software licenses for customer possession, however, are
not affected by the new standards and still need to comply with
the software revenue recognition guidance formerly known as
SOP 97-2.
Summary of Key Changes
Before:
EITF 00-21
New Consensus:
EITF 08-01 (ASU 2009-13)
Need to have verifiable
fair value to separate an
undelivered element, in
addition to two other
criteria
Eliminated the criteria
of having verifiable fair
value for separation of
the undelivered from
delivered elements
Only Vendor-Specific
Objective Evidence (VSOE)
or Third-Party Evidence (TPE)
are allowed for revenue
allocation*
Added Estimated Selling
Price (ESP) along with
VSOE or TPE for revenue
allocation*
Relative or residual method
for allocation*
Eliminated residual method
for allocation*
* Revenue allocation refers to the allocation of the total contract amount
into each of the elements that can be separately recognized when all
the revenue recognition criteria are met.
With the relaxed rule of establishing the fair value allocation
basis, all companies should be able to develop at least an
estimated selling price (ESP) for each separate element in the
arrangement. Therefore, this change will likely result in more
elements being separated and earlier revenue recognition for
delivered items in multiple element arrangements.
Before:
SOP 97-2
New Consensus:
EITF 09-03 (ASU 2009-14)
Applicable to software,
or tangible elements that
include more-than-incidental
software and services
Tangible elements and
related software/services
no longer in scope under
SOP 97-2
VSOE for allocation
Same
Relative or residual method
of allocation
Same
With more types of elements pulled out of scope from the
stringent SOP 97-2 requirements, combined with relaxed rules
for establishing fair values in multiple element arrangements,
these changes will likely result in earlier revenue recognition
for devices sold with software.
Timing and Disclosure
ASU 2009-13 and 14 must be adopted on a prospective basis
no later than the first fiscal year beginning on or after June 15,
2010. Companies are also allowed to early adopt but must
provide comparative financial statements for the affected
prior periods.
Although the overall requirements of revenue recognition have
been modified to better reflect the underlying economics of a
transaction, the new rules significantly expand the disclosures
related to vendor multiple element arrangements.
• Ongoing: Need to provide both qualitative and quantitative
information regarding the significant judgments made in
applying the new guidance and their effect on revenue.
•Transition disclosure requires comparative revenue data.
•Early adoption during interim period requires disclosures of
revenue recast on all prior interim periods presented.
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Some Practical Considerations
© 2010 Protiviti Inc. 107087-1
•Although ESP is now allowed to be the third alternative
of revenue allocation
basis, the new guidance
VSOE
establishes a hierarchy
among the three. This
TPE
means companies that
previously were able
Estimated Selling Price
to establish VSOE/TPE
would need to continue
to use those alternatives and cannot switch to ESP without
adequate justification.
•Prospective adoption will only impact new arrangements or
materially modified arrangements entered after the adoption
date. Early adoption requires retrospective application to the
beginning of the early adopt year. This means existing arrangements will continue to use old authoritative requirements.
•Heavy use of spreadsheets for VSOE analysis and manual
allocation for pre-adoption date arrangements will probably
still remain.
•The new ESP evidence brings more flexibility and, as a result,
more judgment into the picture. The new disclosure rules
require companies to provide more documentation of the
methodology and critical factors to support the key estimates
and assumptions made.
The Impact on Business –
Six Elements of Infrastructure
At Protiviti, we have established a proven methodology that
highlights the six elements of infrastructure that every business
is built upon. We apply this methodology to help our clients
address new issues, and adapt to new challenges. We believe
the new revenue recognition rules will likely impact all of the
infrastructure elements, and a thorough consideration of each
element helps a company identify appropriate actions. Below
are some examples of consideration points.
Methodology – Companies shall revisit and modify their current
revenue recognition methodology. Key changes to consider are:
1.The timing of adoption and determination of assumptions
and assertions
2.A new approach for estimating selling price for each
element
3.An ongoing review and monitoring of the methodology
Policy – Companies need to update the existing revenue recognition policy. In addition, a review of existing pricing/discount
policies may also be appropriate, as the newly allowed ESP
allocation method provides more flexibility in compliance with
accounting rules, while giving management better control in
pricing to respond to market demand.
System – Companies can take this opportunity to review current
system capabilities and data availability in reporting key revenue
and sales information. Additionally, companies will need to
assess system functionalities in automating element allocation and revenue calculation. This will also result in a review of
system controls around integrity of key revenue data.
Process – As part of the adoption of the guidance, companies
will need to assess and update existing controls around revenuerelated estimates. Should companies attempt to automate the
process, this will require revision of business processes such
as order entry, invoicing and revenue recognition to facilitate
these changes and the extensive disclosure requirements for
the new guidance.
People – The new procedures and internal controls could
initially bring additional workload for the revenue accounting
team. Management should ensure there is the appropriate level
of competency in the finance and accounting teams for proper
application of the guidance. Various departments, such as
order administration, legal and sales operations, should also
be educated on the changes and the implications to the internal
control environment. New procedures and controls should be
properly communicated to the accounting team for revenue
recognition purposes, the sales team for contract negotiation
and the legal team for contract review requirements.
Report – A change in guidance gives companies an opportunity
to evaluate accessibility of key data to be used and reassess
existing reporting capabilities. This will also determine future
reporting requirements based on disclosure requirements of
the new guidance.
Six Elements of Infrastructure
Business
Policies
Business
Processes
People and
Organization
Management
Reports
Methodologies
Systems
and Data
© 2010 Protiviti Inc. 107087-2
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Final Thoughts
About Protiviti
The new multiple element revenue recognition guidance has
the advantages of better aligning the accounting treatment
with the nature of the economic transactions, more transparency in disclosures, better allocation of revenue among
elements, and moving closer to the International Financial
Reporting Standards (IFRS).
Protiviti (www.protiviti.com) is a global business consulting
and internal audit firm composed of experts specializing in
risk, advisory and transaction services. The firm helps solve
problems in finance and transactions, operations, technology,
litigation, governance, risk, and compliance. Protiviti’s highly
trained, results-oriented professionals provide a unique perspective on a wide range of critical business issues for clients
in the Americas, Asia-Pacific, Europe and the Middle East.
As we enter into a new decade in 2010, the adoption deadlines
are quickly approaching. Start writing down action items with
your finance and IT teams, marking your calendar to meet with
external auditor and outside consultants, because change is on
its way!
Contacts
Steven W. Hobbs
Managing Director
+1.408.808.3253
steve.hobbs@protiviti.com
Paresh Raghani
Managing Director
+1.408.808.3223
paresh.raghani@protiviti.com
Protiviti has more than 60 locations worldwide and is a wholly
owned subsidiary of Robert Half International Inc. (NYSE
symbol: RHI). Founded in 1948, Robert Half International is a
member of the S&P 500 index.
Protiviti is not licensed or registered as a public accounting firm and does not
issue opinions on financial statements or offer attestation services.
Sherry Xu
Senior Manager
+1.408.808.3250
sherry.xu@protiviti.com
© 2010 Protiviti. An Equal Opportunity Employer. PRO-0210-107087
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