The accounting rules for a software company have seen continual fine-tuning over the last decade. Deals for the sale and distribution of product can be complex, making it difficult to know when to recognize revenue. In a conventional manufacturing business revenue is recorded to the financial statement in a period when the product or service is fully rendered, usually meaning upon delivery to the customer. "Delivery" can be a moving target as some shipments park at a custom house before forwarding to a customer, some software requires the issuance of a key code, some payment terms can stretch out for years and there are a multitude of other situations customized for every deal. However, there are a few generalities that might fit most situations.

The company should:

  • strive for predictability in revenue streams
  • seek business models that allow for more ratable revenue recognition
  • be consistent in the interpretation and application of the rules
  • err on the side of conservatism

If an arrangement to deliver software does not require significant production, modification, or customization of the software, there are a few criteria that must be met prior to recognizing revenue for a single-element arrangement or for amounts allocated to individual elements in a multiple-element arrangement. These are:

Persuasive Evidence of an Arrangement
If a vendor has a customary business practice of using written contracts, evidence of the arrangement is provided only by a contract signed by both parties.
The transfer of software to a fulfillment house or other delivery agent does not satisfy the delivery criterion. The delivery of a permanent key is not required to satisfy the delivery. For software that is delivered electronically, delivery is considered to have occurred when the customer either (a) takes possession of the software via an electronic download, or (b) has been provided with access codes that allow the customer to take immediate posession of the software on its hardware pursuant to an agreement or purchase order for the software.
Fixed or Determinable Fee
The fee would not be presumed to be fixed or determinable if payment of a significant portion of the licensing fee is not due until after expiration of the license or more than 12 months after delivery. If at the outset of the arrangement the vendor concludes that the fee is not fixed or determinable, the entire fee would be recognized as payments become due and payable. A vendor is not permitted to recognize revenue on a rolling 12-month basis.
Collectibility must be probable.
Significant Vendor Obligation
Old accounting rules specified that if the arrangement includes significant vendor obligations after deliery of the software, revenue will not be recognized until the vendor obligations are no longer significant. New rules provide definitions and guidelines for multiple element arrangements and unbundle the elements based on prices stated in the agreement. For instance, a contract for a software maintenance agreement for twelve months might include the release of an upgrade or it might be embedded with Oracle. The contract should specify a price for each element with revenue being recognized for the maintenance on a rolling 12-month basis and the revenue attached to the embedded software recognized when the customer takes possession. This reasoning does not apply to software that is:

Incidental to the Product as a Whole
It is expected that consumer products will have embedded software. The following indicators determine whether software is incidental:
  • Whether the software is a significant focus of the marketing efforts or is sold separately. If the product is marketed or sold based on the performance or functionality of the software component and/or if the software is sold on a stand-alone basis, that would indicate that the software is not incidental to the product as a whole.
  • Whether the vendor is providing postcontract customer support. If upgrades and enhancements for the software component of the product periodically are provided to existing users of the product, that would indicate that the software is not incidental.
  • Whether the vendor incurs significant costs. If the vendor incurs significant development costs related to the software component of the product, that would indicate that the software is not incidental.
  • If the software component of the product is replaceable by software provided by a competitor, that would indicate that the software is not incidental.
  • If, for example, RatherGoodStuff, Inc. manufactures tv sets, the tvs will contain microprocessors which will include embedded software to enhance the features of the television. RatherGoodStuff, Inc. doesn't provide customers with upgrades or any other services specifically related to the software embedded in the television. This software would be considered incidental to the product, so none of the provisions for software revenue recognition would apply. If, instead, RatherGoodStuff, Inc. manufactures robots and those robots contain software that enable them to perform specific tasks, then RatherGoodStuff might enter into an arrangement to provide services to customize the software component of the robot and provide the customer with upgrades. This software would not be incidental to the product, thus RatherGoodStuff would recognize revenue on the robots shipped based on the multiple elements of the arrangement as outlined in the contract.

    An important business deal for Oracle was rescinded in July 2002 because of inconsistencies in software revenue recognition guidelines. Oracle's booking the revenue from the California deal resulted in them exceeding their end of quarter forecast and their stock price rising by 13%. However, a hearing later found that two of the criteria for revenue recognition were not satisfied, collectibility and persuasive evidence of an arrangement. Their financing arrangements were put together last minute to make the end of quarter closing and the contract skirted around state requirements for collection of bids. In the following quarter, Oracle unbooked the revenue due to provisions in the contract that cast doubt on their financing arrangements which had still not been ironed out. A year later the deal was canceled. Surprisingly, the deal had been examined and approved by the accounting firm of Arthur Andersen.

Log in or register to write something here or to contact authors.