Frank, Rimerman + Co. LLP | Assurance & Advisory Update
Unraveling the New Revenue Recognition Rules
November 30, 2009
Michael Rewkiewicz, Senior Manager - Assurance and Advisory Services
In recent months, the Emerging Issues Task Force (EITF) has passed two new changes that modify how
certain revenue will be recognized. The impact of the two EITFs are best reviewed jointly as they are
interrelated.
EITF 09-3 Certain Revenue Arrangements That Include Software Elements
The first change, EITF 09-3, Certain Revenue Arrangements That Include Software Elements, states that
tangible products containing software components and non-software components that function together to
deliver the products essential functionality are considered non-software deliverables. These items are
therefore excluded from SOP 97-2 (which applies only to software deliverables). Instead they will be
accounted for under EITF 08-1 (discussed below).
EITF 09-03 has received a lot of press coverage, including commentary from Apple, IBM, and Xerox, all
of whom support the changes it brings. Apple has stated that it will adopt the EITF immediately.
EITF 08-1 Revenue Arrangements with Multiple Elements
The second change, EITF 08-1, Revenue Arrangements with Multiple Elements, modifies how revenue is
recognized under EITF 00-21, Revenue Arrangements with Multiple Elements. The scope of EITF 08-1 is
the same as that of EITF 00-21 and is designed to cover arrangements that involve multiple deliverables,
except that EITF 08-1 does not include purely software or software related arrangements. For these types
of arrangements, revenue recognition remains under the guidance of SOP 97-2.
Under EITF 00-21, companies were not allowed to recognize revenue for separate elements in a multielement arrangement without evidence of “Fair Value” for any undelivered elements. This requirement
often caused companies to defer revenue for delivered elements. EITF 08-1 eliminates the fair value
requirement and allows companies to value elements using a best estimated selling price. However, the
best estimate approach is allowed only when neither Vendor Specific-Objective Evidence (VSOE) nor
Third Party Evidence (TPE) exists to value an element. If a company uses the best estimate approach,
the company must disclose both the qualitative and quantitative methodologies and inputs used in the
estimation process.
This represents a significant change for companies who, under EITF 00-21, had to defer revenue when
VSOE or TPE was not available for undelivered elements. The use of a best estimate selling price
permits many elements to be separated, and potentially allows for items that are delivered to be
recognized immediately (where under EITF 00-21, revenue recognition for these items may have been
deferred).
To separate the elements of an arrangement, all of the following criteria must be met:
1. The arrangement must have multiple deliverables and be within the scope of EITF 08-1.
2. The delivered element must have value to the customer on a stand-alone basis.
3. If the arrangement must include a general right of return relative to the delivered item, delivery of
the undelivered item must be probable and substantially controlled by the Company.
Frank, Rimerman + Co. LLP | Assurance & Advisory Update
If the above three criteria are met, then the delivered item may be treated as a separate element and the
revenue may be recognized. The allocation of revenue amongst the multiple elements within the
arrangement is established in EITF 08-1, via a tier system of qualified evidence for an item’s selling price.
Strength of Evidence
Type of Evidence
Strongest
VSOE
TPE
Weakest
Estimated selling price
Estimated selling prices are to be used only if neither VSOE nor TPE exist. The company should consider
market conditions, labor costs, other expenses, and its gross margin in deriving an estimated price.
If VSOE or TPE exist for all elements, then the separate elements should be valued on this basis. If
VSOE or TPE do not exist for all elements then the estimated selling price for each element should be
used. Essentially, items with VSOE or TPE should be allocated on that basis and other elements valued
using the best estimate approach.
It is anticipated that a company will need to disclose revenue recognized under EITF 00-21 and EITF 081 until such time as the revenue recognized under EITF 00-21 is immaterial. EITF 08-1 is expected to
apply to fiscal years beginning June 15, 2010; however, early adoption is permitted.
Michael joined Frank, Rimerman + Co. LLP in 2005 from the Baker Tilly member
firm in Australia and is a manager in our Assurance and Advisory Department.
Michael has many years experience working in the Pacific Rim region and the
United Kingdom. He has extensive experience working in many industries
including manufacturing, privately held, pre-IPO software and high-technology
companies and venture funds. Michael is experienced in revenue recognition,
standard cost accounting and mergers and acquisition transactions. Michael
graduated from Monash University in 1998 with a Bachelor of Commerce. He is a
member of the Institute of Chartered Accountants in Australia.
Frank, Rimerman + Co. LLP
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