Get Ready for Revenue Recognition Changes for Multiple Deliverables
Due to the complex and often customized structure of arrangements, revenue recognition continues to confound company management and their auditors. These arrangements portend unique revenue recognition issues and significant industry and transaction-specific guidance that companies must properly address.
Accounting Standards Update No. 2009-13 is a new model that will amend the existing rules to account for multiple-element arrangements. The changes are a result of concerns that existing guidance did not reflect the true economics of these transactions. The amendments mean multiple-element arrangements will be separated in more circumstances than under current U.S. Generally Accepted Accounting Principles (GAAP), specifically where a separate deliverable is present but a company lacks the evidence of fair value as defined under existing GAAP. These new rules are effective for fiscal years beginning on or after June 15, 2010, and early adoption is permitted.
Determining Separate Units of Accounting
In an arrangement with multiple deliverables, a company must determine if they should be treated as separate units of accounting for revenue recognition purposes. A deliverable shall be considered a separate unit if (1) the deliverable has standalone value to the customer; and (2) delivery or performance of any undelivered items is probable.
A delivered item that does not meet the criteria as a separate unit shall be combined with other non-delivered items in the arrangement and treated as one separate accounting unit. Separate accounting units could include software on a disk or a monthly consulting element. Both have standalone value to the customer. Payroll services provided under a comprehensive service agreement that include other services could meet the standalone criterion if the company offers those services to other customers on its own.
Selling Price Replaces Fair Value
Under the new guidance, the value allocated to separate accounting units in an arrangement will now be based on vendor-specific objective evidence of selling price instead of vendor-specific evidence of fair value. This change will make the application of this guidance easier because it gives companies a hierarchy for determining selling price:
- The price charged by the company for the deliverable when it is sold separately.
- If the deliverable is not sold separately, the price established by management may be used.
- Third-party selling prices of similar product or services to similar customers.
- Company’s best estimate of selling price (new).
An estimate of the selling price may include, but is not limited to, the consideration of the company’s internal costs, profit margin, established pricing practices and any market constraints limiting the selling price. For example, a company could determine the internal cost incurred of a product or service and apply a reasonable gross margin to that cost in order to establish an estimated selling price. The absence of vendor-specific evidence or third-party selling prices in an arrangement was a common reason why companies did not separate deliverables.
Under current GAAP treatment, if a company does not have vendor-specific evidence of selling price or third-party evidence of a deliverable’s selling price, then that deliverable is grouped with other non-delivered items and the revenue is deferred and recognized as the undelivered items are delivered. The new guidance enables companies to reflect the true underlying economics of these transactions by allowing them to bifurcate various deliverables in an arrangement and recognize their revenue separately. The new amendments also eliminate the residual method of allocation and require consideration to be allocated to all deliverables using the selling-price method. The intention is for revenue to be allocated to different deliverables based on entity-specific assumptions, rather than marketplace participant assumptions.
Ultimately, these changes will cause a greater number of companies to apply multiple-element arrangements to their products and services. Businesses must evaluate their various product and service lines to determine whether they have arrangements with multiple deliverables. If a company enters into customized arrangements with its customers, it should evaluate each arrangement on an individual basis and apply the new concepts.
Gregory M. Rubert, CPA, is a manager at EisnerAmper LLP. He is also a member of the New Jersey Society of CPAs. Contact Rubert at 732-287-1000.