Bottom line revenue is a key factor in assessing the financial viability of an organization
The implications of fairly recognizing revenue are far and wide and have resulted in guidelines that affect both software and bundled product/service delivery organizations such as clearly identified costing for each individual bundled element, when and how revenue can be recognized and specific situations that require deferred recognition.
Vendor Specific Objective Evidence (VSOE) was originally introduced to govern how a company licensed, sold, leased and recognized revenue for software sold. However, FASB’s “Emerging Issues TASK Force” implemented EITF 08-1, expanding Revenue Recognition and Fair Value across all industries in which products/services were bundled by requiring identification of all elements and the determination of Fair Market Value for each component.
There are four criteria required for all revenue recognition transactions:
- There is evidence of an agreement
- The price is fixed and determinable
- Collection is probable
- Delivery has occurred
Establishing VSOE – High-levelfff overview:
New Software or Upgrade?
- For a new product sold in a bundle, the vendor must demonstrate that VSOE of fair value exists, for all of the elements, including the new product, or it must defer all revenue until either the VSOE of fair value exists, or all the elements are delivered. If the element is an upgrade or enhancement, a vendor must determine if the customer’s right to receive the upgrade is specified or unspecified (a classification that states whether the upgrade is separate from the original software or not).
Concessions and Discounts?
- Vendors may also offer concessions or discounts, including extended payment terms, price breaks, future discounts, or reduced payment. Note though, that providing additional products or services for a corresponding increase in fees and eliminating a vendor’s obligation to deliver products or services without a corresponding refund are not considered concessions. If an organization has a history of granting concessions, the organization may be required to delay revenue recognition on all arrangements with extended payment terms until payments become due.
Recognition should occur the moment the service is rendered or is earned, however, services are not always straightforward and recognition of revenue for services follows suit. There are three methods available:
- Specific Performance Method
- If the arrangement (contract/PO) requires one act of service, the revenue is recognized when the act is complete.
- Proportional Performance Method
- If the arrangement (contract/PO) requires more than one act of service, the revenue will be recognized as the service is being performed
- May use straight-line if no other rational basis can be determined
- Customer must receive value from the services before revenue can be recognized
- Completed Performance
- If service requires multiple acts but the final act is significant to the arrangement with the customer
- The customer has final acceptance
This is just a high-level overview of some of the complexities you need to consider relating to VSOE. Establishing VSOE of fair value can be extremely challenging, yet it is essential for revenue recognition compliance. If a vendor improperly reports revenue in its financial statements based on inaccurate VSOE of fair values, it could result in serious consequences. There are a number of resources available to help you determine how you and your organization can adhere to the guidelines set out by FASB.