Office of the Chief Accountant:
Staff Accounting Bulletin No. 101:
Revenue Recognition in Financial Statements
Frequently Asked Questions and Answers
On December 3, 1999, the Securities and Exchange Commission staff
issued Staff Accounting Bulletin No. 101 (SAB 101). Staff Accounting
Bulletins do not represent rules or interpretations of the Commission
but rather represent the interpretations and practices followed by the
Division of Corporation Finance and the Office of the Chief Accountant
in administering the disclosure requirements of the Federal securities
laws. SAB 101 reflects the basic principles of revenue recognition in
existing generally accepted accounting principles (GAAP). SAB 101 does
not supersede any existing authoritative literature.
Studies on financial reporting, such as the Committee of Sponsoring
Organizations (COSO) Report issued in early 1999, indicate that a
significant portion of fraudulent financial reporting involves improper
revenue recognition. In recent years improper revenue recognition has
been the single largest category of financial statement restatements.
One of the goals of SAB 101 is to summarize in one location the
existing guidance on revenue recognition and make that guidance more
accessible to registrants and their auditors.
Since the issuance of SAB 101, the staff has received inquiries from
auditors, preparers, and analysts about how the guidance in accounting
standards and SAB 101 would apply to particular transactions. This
document responds to those inquiries. The staff worked with accounting
firms and preparers to identify the recurring questions and develop
answers to those questions.
The staff has deferred the implementation date of SAB 101 until no
later than the fourth quarter of fiscal years beginning after December
15, 1999. Prior to implementing SAB 101, the staff reminds registrants
and their auditors that certain disclosures are required by SAB Topic
11-M, Disclosure of the Impact that Recently Issued Accounting
Standards will have on the Financial Statements of the Registrant when
Adopted in a Future Period; American Institute of Certified Public
Accountants (AICPA) Professional Standards AU section 9410, Item 3,
The Impact on an Auditor's Report of an FASB Statement Prior to the
Statement's Effective Date; and Regulation S-K, Item 303,
Management's Discussion and Analysis of Financial Condition and Results
of Operations.
For further information contact: Scott Taub (taubs@sec.gov)
or Scott Blackley (blackleys@sec.gov)
in the Office of the Chief Accountant at (202) 942-4400 or Robert
Bayless (baylessr@sec.gov) in the
Division of Corporation Finance at (202) 942-2960.
Contents
I. Topic 13.A. 2 and 13.A.3 Transfer of Title
SAB 101 summarizes the staff's views on selected revenue recognition
issues based upon existing generally accepted accounting principles. SAB
101 identifies four essential criteria that should be met before product
revenue can be recognized. One of the criteria is that delivery has
occurred. The staff's responses to Questions 2 and 3 in SAB 101
emphasize that a necessary element of the delivery of a tangible product
is the transfer of its title. The staff has responded to questions
concerning that guidance, as discussed below.
Question 1
| Q: |
The laws of some countries do not provide for a seller's
retention of a security interest in goods in the same manner as
established in the U.S. Uniform Commercial Code (UCC). In these
countries, it is common for a seller to retain a form of title
to goods delivered to customers until the customer makes payment
so that the seller can recover the goods in the event of
customer default on payment. Is it acceptable to recognize
revenue in these transactions before payment is made and title
has transferred? |
| A: |
Presuming all other revenue recognition criteria have been
met, the staff would not object to revenue recognition at
delivery if the only rights that a seller retains with the title
are those enabling recovery of the goods in the event of
customer default on payment. This limited form of ownership may
exist in some foreign jurisdictions where, despite technically
holding title, the seller is not entitled to direct the
disposition of the goods, cannot rescind the transaction, cannot
prohibit its customer from moving, selling, or otherwise using
the goods in the ordinary course of business, and has no other
rights that rest with a titleholder of property that is subject
to a lien under the U.S. UCC. On the other hand, if retaining
title results in the seller retaining rights normally held by an
owner of goods, the situation is not sufficiently different from
a delivery of goods on consignment. In this particular case,
revenue should not be recognized until payment is received.
Registrants and their auditors may wish to consult legal counsel
knowledgeable of the local law and customs outside the U.S. to
determine the seller's rights.
|
Contents
II. Topic 13.A.3. Substantial Performance and Acceptance
The guidance in Question 3 of SAB 101 applies to the delivery of
products and performance of services not directly addressed by
authoritative literature. For example, a transaction within the scope of
AICPA Statement of Position (SOP) 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts, is not
subject to the staff's views expressed in SAB 101.
The staff's response to Question 3 in SAB 101 discusses accounting
literature that should be considered in a registrant's evaluation of
whether delivery of products or performance of services has occurred.
The staff's response reiterates accounting literature that states:
| (a) |
a seller should substantially complete or fulfill the terms
specified in the sales arrangement,1
and |
| (b) |
after delivery or performance, if uncertainty exists about
customer acceptance, revenue should not be recognized until
acceptance occurs.2 |
The staff has responded to questions concerning that guidance, as
discussed below.
Question 2
| Q: |
When accounting for sales of products and/or services in
accordance with SAB 101, does the failure to deliver one item or
perform one service specified by the sales arrangement always
preclude immediate recognition of any revenue for the sales
arrangement? |
| A: |
No. Assuming all other recognition criteria are met, the
following circumstances exist under which revenue may be
recognized for a sales arrangement, notwithstanding the seller's
remaining obligation for additional performance or delivery.
(a) Revenue from the sales arrangement may be recognized in
its entirety if the seller's remaining obligation is
inconsequential or perfunctory. In this case, costs expected to
be incurred upon fulfillment of the remaining obligation must be
reliably3 estimable and
accrued when the revenue is recognized.4
Question 3 below discusses how the staff evaluates whether the
remaining obligation is inconsequential or perfunctory.
(b) A portion of the contract revenue may be recognized when
the seller has substantially completed5
or fulfilled the terms of a separate element of a
multiple-element arrangement. Question 4 below discusses the
accounting for multiple-element arrangements.
|
Question 3
| Q: |
When applying SAB 101, what factors should be considered in
the evaluation of whether a remaining obligation is
inconsequential or perfunctory? |
| A: |
A remaining performance obligation is not inconsequential or
perfunctory if it is essential to the functionality of the
delivered products or services (see Question 7 below). In
addition, remaining activities are not inconsequential or
perfunctory if failure to complete the activities would result
in the customer receiving a full or partial refund or rejecting
(or a right to a refund or to reject) the products delivered or
services performed to date. The terms of the sales contract
regarding both the right to a full or partial refund and the
right of return or rejection should be considered when
evaluating whether a portion of the purchase price would be
refundable. If the company has a historical pattern of granting
such rights, that historical pattern should also be considered
even if the current contract expressly precludes such rights.
Further, other factors should be considered in assessing whether
remaining obligations are inconsequential or perfunctory. For
example, the staff also considers the following factors, which
are not all-inclusive, in evaluating whether a remaining
performance obligation is substantive rather than
inconsequential or perfunctory:
- The seller does not have a demonstrated history of
completing the remaining tasks in a timely manner and
reliably estimating their costs.
- The cost or time to perform the remaining obligations
for similar contracts historically has varied significantly
from one instance to another.
- The skills or equipment required to complete the
remaining activity are specialized or are not readily
available in the marketplace.
- The cost of completing the obligation, or the fair value
of that obligation, is more than insignificant in relation
to such items as the contract fee, gross profit, and
operating income.
- The period before the remaining obligation will be
extinguished is lengthy. Registrants should consider whether
reasonably possible variations in the period to complete
performance affect the certainty that the remaining
obligations will be completed successfully and on budget.
- The timing of payment of a portion of the sales price is
coincident with completing performance of the remaining
activity.
Registrants' determinations of whether remaining obligations are
inconsequential or perfunctory should be consistently applied.
|
Question 4
| Q: |
Although SAB 101 does not establish a framework for
accounting for multiple-element arrangements, what factors would
the staff consider in assessing whether an arrangement is
accounted for as a multiple-element arrangement? |
| A: |
SAB 101 does not modify existing practice in accounting for
multiple-element arrangements. Recognizing the diversity in
practice in the accounting for multiple-element arrangements and
the complexity of these arrangements, the staff asked the
Emerging Issues Task Force (EITF) and the Auditing
Standards Board (ASB) to provide additional accounting and
auditing guidance on those transactions. The EITF has added
Issue No. 00-21, Accounting for Multiple Element Revenue
Arrangements, to its agenda to address the accounting
issues. Pending additional guidance, registrants should use a
reasoned method of accounting for multiple-element arrangements
that is applied consistently and disclosed appropriately. In
response to questions, the staff has stated that it will not
object to a method that includes the following conditions.
- 1. To be considered a separate element, the product
or service in question represents a separate earnings
process. The staff notes that determining whether an
obligation represents a separate element requires
significant judgment. The staff also notes that the best
indicator that a separate element exists is that a vendor
sells or could readily sell that element unaccompanied by
other elements.
- 2. Revenue is allocated among the elements based on
the fair value of the elements. The fair values used for
the allocations should be reliable, verifiable and
objectively determinable. The staff does not believe that
allocating revenue among the elements based solely on cost
plus a profit margin that is not specific to the particular
product or service is acceptable because, in the absence of
other evidence of fair value, there is no objective means to
verify what a profit margin should be for the particular
element(s). Additional guidance on allocating among elements
may be found in SOP 81-1, paragraphs 35 through 42; SOP
97-2, paragraphs 9 through 14; and SOP 98-9, Modification
of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions. All of the methods of allocating
revenue in those SOPs, including the residual method
discussed in SOP 98-9, are acceptable. If sufficient
evidence of the fair values of the individual elements does
not exist, revenue would not be allocated among them until
that evidence exists. Instead, the revenue would be
recognized as earned using revenue recognition principles
applicable to the entire arrangement as if it were a single
element arrangement. Prices listed in a multiple-element
arrangement with a customer may not be representative of
fair value of those elements because the prices of the
different components of the arrangement can be altered in
negotiations and still result in the same aggregate
consideration.
- 3. If an undelivered element is essential to the
functionality of a delivered element, no revenue allocated
to the delivered element is recognized until that
undelivered element is delivered. See Question 7 below.
|
Question 5
| Q: |
SAB 101 states that, "the staff presumes that such
contractual customer acceptance provisions are substantive,
bargained-for terms of an arrangement. Accordingly, when such
contractual customer acceptance provisions exist, the staff
generally believes that the seller should not recognize revenue
until customer acceptance occurs or the acceptance provisions
lapse." When applying SAB 101, do circumstances exist in which
formal customer sign-off (that a contractual customer acceptance
provision is met) is unnecessary to meet the delivery criterion?
|
| A: |
Yes. Formal customer sign-off is not always necessary to
recognize revenue provided that the seller objectively
demonstrates that the criteria specified in the acceptance
provisions are satisfied. Customer acceptance provisions
generally allow the customer to cancel the arrangement when a
seller delivers a product that the customer has not yet agreed
to purchase or delivers a product that does not meet the
specifications of the customer's order. In those cases, revenue
should not be recognized because a sale has not occurred. In
applying this concept, the staff observes that customer
acceptance provisions normally take one of four general forms.
Those forms, and how the staff generally assesses whether
customer acceptance provisions should result in revenue
deferral, are described below:
(a) Acceptance provisions in arrangements that purport to
be for trial or evaluation purposes.6
In these arrangements, the seller delivers a product to a
customer, and the customer agrees to receive the product, solely
to give the customer the ability to evaluate the delivered
product prior to acceptance. The customer does not agree to
purchase the delivered product until it accepts the product. In
some cases, the acceptance provisions lapse by the passage of
time without the customer rejecting the delivered product, and
in other cases affirmative acceptance from the customer is
necessary to trigger a sales transaction. Frequently, the title
to the product does not transfer and payment terms are not
established prior to customer acceptance. These arrangements
are, in substance, consignment arrangements until the customer
accepts the product as set forth in the contract with the
seller. Accordingly, in arrangements where products are
delivered for trial or evaluation purposes, revenue should not
be recognized until the earlier of when acceptance occurs or the
acceptance provisions lapse.
In contrast, other arrangements do not purport to be for
trial or evaluation purposes. In these instances, the seller
delivers a specified product pursuant to a customer's order,
establishes payment terms, and transfers title to the delivered
product to the customer. However, customer acceptance provisions
may be included in the arrangement to give the purchaser the
ability to ensure the delivered product meets the criteria set
forth in its order. The staff evaluates these provisions as
follows:
(b) Acceptance provisions that grant a right of return or
exchange on the basis of subjective matters. An example of
such a provision is one that allows the customer to return a
product if the customer is dissatisfied with the product.7
The staff believes these provisions are not different from
general rights of return and should be accounted for in
accordance with SFAS No. 48. SFAS No. 48 requires that the
amount of future returns must be reasonably estimable in order
for revenue to be recognized prior to the expiration of return
rights.8 That estimate may
not be made in the absence of a large volume of homogeneous
transactions or if customer acceptance is likely to depend on
conditions for which sufficient historical experience is absent.9
Satisfaction of these requirements may vary from
product-to-product, location-to-location, customer-to-customer,
and vendor-to-vendor.
(c) Acceptance provisions that grant a right of
replacement on the basis of seller-specified objective criteria.
An example of such a provision is one that gives the
customer a right of return or replacement if the delivered
product is defective or fails to meet the vendor's published
specifications for the product.10
Such rights are generally identical to those granted to all
others within the same class of customer and for which
satisfaction can be generally assured without consideration of
conditions specific to the customer. Provided the seller has
previously demonstrated that the product meets the specified
criteria, the staff believes that these provisions are not
different from general or specific warranties and should be
accounted for as warranties in accordance with SFAS No. 5. In
this case, the cost of potentially defective goods must be
reliably estimable based on a demonstrated history of
substantially similar transactions.11
However, if the seller has not previously demonstrated that the
delivered product meets the seller's specifications, the staff
believes that revenue should be deferred until the
specifications have been objectively achieved.
(d) Acceptance provisions based on customer-specified
objective criteria. These provisions are referred to in this
document as "customer-specific acceptance provisions" against
which substantial completion and contract fulfillment must be
evaluated. While formal customer sign-off provides the best
evidence that these acceptance criteria have been met, revenue
recognition also would be appropriate, presuming all other
revenue recognition criteria have been met, if the seller
reliably demonstrates that the delivered products or services
meet all of the specified criteria prior to customer acceptance.
For example, if a seller reliably demonstrates that a delivered
product meets the customer-specified objective criteria set
forth in the arrangement, the delivery criterion would generally
be satisfied when title and the risks and rewards of ownership
transfers unless product performance may reasonably be different
under the customer's testing conditions specified by the
acceptance provisions. Further, the seller should consider
whether it would be successful in enforcing a claim for payment
even in the absence of formal sign-off. Whether the vendor has
fulfilled the terms of the contract before customer acceptance
is a matter of contract law, and depending on the facts and
circumstances, an opinion of counsel may be necessary to reach a
conclusion. See Question 6 below.
|
Question 6
| Q: |
Some arrangements that call for the transfer of title to
equipment upon delivery to a customer's site include
customer-specific acceptance provisions that permit the customer
to return the equipment unless the equipment satisfies certain
performance tests. If SAB 101 is applicable to that transaction,
must revenue allocable to the equipment always be
deferred until installation and on-site testing are successfully
completed? |
| A: |
No. The staff would not object to revenue recognition for
the equipment upon delivery (presuming all other revenue
recognition criteria, including those appropriate for a
multiple-element arrangement, have been met) if the seller
demonstrates that, at the time of delivery, the equipment
already meets all of the criteria and specifications in the
customer-specific acceptance provisions. This may be
demonstrated if conditions under which the customer intends to
operate the equipment are replicated in pre-shipment testing
unless the performance of the equipment, once installed and
operated at the customer's facility, may reasonably be different
from that tested prior to shipment.
Determining whether the delivered equipment meets all of a
product's criteria and specifications is a matter of judgment
that must be evaluated in light of the facts and circumstances
of a particular transaction. Consultation with knowledgeable
project managers or engineers may be necessary in such
circumstances.
For example, if the customer acceptance provisions were based
on meeting certain size and weight characteristics, it should be
possible to determine whether those criteria have been met
before shipment. Historical experience with the same
specifications and functionality of a particular machine that
demonstrates that the equipment meets the customer's
specifications also may provide sufficient evidence that the
currently shipped equipment satisfies the customer-specific
acceptance provisions.
If an arrangement includes customer acceptance criteria or
specifications that cannot be effectively tested before delivery
or installation at the customer's site, the staff believes that
revenue recognition should be deferred until it can be
demonstrated that the criteria are met. This situation usually
will exist when equipment performance can vary based on how the
equipment works in combination with the customer's other
equipment, software, or environmental conditions. In these
situations, testing to determine whether the criteria are met
cannot be reasonably performed until the products are installed
or integrated at the customer's facility.
Some have requested us to provide examples applying the
guidance in SAB 101 to a variety of circumstances that involve
customer acceptance. The exhibit to this document provides a few
examples. However, the determination of when customer-specific
acceptance provisions of an arrangement are met in the absence
of the customer's formal notification of acceptance depends on
the weight of the evidence in the particular circumstances.
Different conclusions could be reached in similar circumstances
that vary only with respect to a single variable, such as
complexity of the equipment, nature of the interface with the
customer's environment, extent of the seller's experience with
the same type of transactions, or a particular clause in the
agreement. The staff believes management and auditors are
uniquely positioned to evaluate the facts and arrive at a
reasoned conclusion. The staff will not object to a
determination that is well reasoned on the basis of this
guidance.
In light of the integral nature of installation services to
equipment sold on an installed basis, a registrant may elect a
policy of not recognizing any revenue on equipment sold on an
installed basis until installation is complete. Registrants'
accounting policies for these types of transactions should be
consistently applied and appropriately disclosed. The staff
expects that the EITF will provide further guidance on these
arrangements as part of its project on accounting for
multiple-element arrangements.
|
Question 7
| Q: |
When applying SAB 101, if a customer is not obligated to pay
a portion of the contract price allocable to delivered equipment
until installation or similar service has been completed, must
recognition of revenue on the delivered equipment always
be deferred until that service has been performed?
|
| A: |
No. Registrants should evaluate first whether the
undelivered service is essential to the functionality of the
delivered equipment.12
Examples of indicators that installation is essential to the
functionality of equipment include:
- The installation involves significant changes to the
features or capabilities of the equipment or building
complex interfaces or connections;
- The installation services are unavailable from other
vendors.13
Conversely, examples of indicators that installation is not
essential to the functionality of the equipment include:
- The equipment is a standard product;
- Installation does not significantly alter the
equipment's capabilities;
- Other companies are available to perform that job.14
If the undelivered service is essential to the functionality
of the delivered equipment, revenue recognition should be
deferred until that service has been performed.15
If it is determined that the undelivered service is not
essential to the functionality of the delivered product but a
portion of the contract fee is not payable until the undelivered
element is delivered, the staff would not consider that
obligation to be inconsequential or perfunctory. Generally, the
portion of the contract price that is withheld or refundable
should be deferred until the outstanding element is delivered
because that portion would not be realized or realizable.16
However, if the registrant has an enforceable claim at the
balance sheet date through which it can realize some or all of
the withheld or refundable amount even if it failed to fulfill
the remaining obligation, deferral of a lesser amount, but not
less than the fair value of the undelivered product or service,
would be appropriate. The exhibit to this document includes a
few examples demonstrating the analysis of revenue recognition
issues in circumstances of undelivered products or services.
As noted in Question 6 above, due to the integral nature of
installation services to equipment sold on an installed basis, a
registrant may elect a policy of not recognizing any revenue on
equipment sold on an installed basis until installation is
complete. The staff expects that the EITF will provide further
guidance on these arrangements as part of its project on
accounting for multiple-element arrangements.
|
Question 8
| Q: |
If a company (the seller) has a patent to its intellectual
property which it licenses to customers, the seller may
represent and warrant to its licensees that it has a valid
patent, and will defend and maintain that patent. When applying
SAB 101, does that obligation to maintain and defend patent
rights, in and of itself, constitute an element for which
revenue should be allocated and initially deferred? |
| A: |
No. Provided the seller has legal and valid patents upon
entering the license arrangement, existing GAAP on licenses of
intellectual property (e.g., SOP 97-2, SOP 00-2, Accounting
by Producers or Distributors of Films, and SFAS No. 50,
Financial Reporting in the Record and Music Industry) does
not indicate that an obligation to defend valid patents
represents an additional deliverable to which a portion of an
arrangement fee should be allocated in an arrangement that
otherwise qualifies for sales-type accounting. While this clause
may obligate the licenser to incur costs in the defense and
maintenance of the patent, that obligation does not involve an
additional deliverable to the customer. Defending the patent is
generally consistent with the seller's representation in the
license that such patent is legal and valid. Therefore, the
staff would not consider a clause like this to require revenue
deferral.
|
Question 9
| Q: |
Assume that intellectual property is physically delivered
and payment is received on December 20, upon the registrant's
consummation of an agreement granting its customer a license to
use the intellectual property for a term beginning on the
following January 1. Should the license fee be recognized in the
period ending December 31? |
| A: |
No. Revenue should not be recognized before the inception of
the license term.17 Until
the beginning of the license term, the customer does not yet
have the legal right to use the intellectual property. Effective
delivery has not occurred in these situations until the license
term begins. |
Contents
III. Topic 13.A.3. Nonrefundable Payments
The staff's response to Question 5 in SAB 101 highlights the
requirement under GAAP to defer revenue recognition in certain
circumstances, notwithstanding the receipt of a nonrefundable upfront
payment from the customer.18 The
discussion in SAB 101 demonstrates the need to consider two related
questions in the assessment of when a nonrefundable upfront payment may
be recognized as revenue:
- What is the earnings process, and when does it culminate?
- Is the undelivered or unperformed obligation essential to the
functionality of the performance or product for which the upfront
payment is ostensibly received?
The staff indicated in SAB 101 that a registrant's analysis of these
questions should consider the customer's perspective on the transaction.
The staff has responded to questions concerning that guidance, as
discussed below.
Question 10
| Q: |
In each of the following situations, when should the company
receiving the fee recognize the related revenue?
Example 1: A company charges users a fee for
non-exclusive access to its web site that contains proprietary
databases. The fee allows access to the web site for a one-year
period. After the customer is provided with an identification
number and trained in the use of the database, there are no
incremental costs that will be incurred in serving this
customer.
Example 2: An internet company charges a fee to users
for advertising a product for sale or auction on certain pages
of its web site. The company agrees to maintain the listing for
a period of time. The cost of maintaining the advertisement on
the web site for the stated period is minimal.
Example 3: A company charges a fee for hosting
another company's web site for one year. The arrangement does
not involve exclusive use of any of the hosting company's
servers or other equipment. Almost all of the projected costs to
be incurred will be incurred in the initial loading of
information on the host company's internet server and setting up
appropriate links and network connections.
|
| A: |
Some propose that revenue should be recognized when the
initial set-up is completed in these cases because the on-going
obligation involves minimal or no cost or effort and should be
considered perfunctory or inconsequential. However, the staff
believes that the substance of each of these transactions
indicates that the purchaser is paying for a service that is
delivered over time. Therefore, revenue recognition should occur
over time, reflecting the provision of service.19
In certain cases, the arrangement with the customer may be a
multiple-element arrangement, with separate revenue recognition
for those initial services. Question 4 of this document
discusses multiple-element arrangements.
|
Question 11
| Q: |
Question 5 of SAB 101 addresses a telecommunications
company's accounting for nonrefundable up-front activation fees.
How should the activation fee for telephone service be accounted
for in the following situation?
- Facts: To provide basic local service to
a customer, the registrant must activate the customer's
service at the central office. The registrant charges $50 to
activate basic local service. On-going fees related to basic
local service consist of a flat monthly fee and
usage-related charges. There is no contract between the
customer and the registrant. The costs associated with
activation are $40 and consist primarily of the technician's
salary and related benefits.
|
| A: |
The staff believes that the revenue from the fee should be
deferred and recognized over the expected term of the customer
relationship. The customer can be expected to view activation as
a necessary and inseparable part of buying ongoing telephone
service, and not as a separate service.
Question 5 of SAB 101 describes a situation in which the
activation costs are nominal. The staff has been asked whether
the incurrence of more than nominal costs for activation would
permit revenue recognition when activation was performed.
Question 5 of SAB 101 cited nominal costs solely to make it
clear that there was not a separate earnings event in the
situation described in that question. However, incurrence of
substantive costs does not necessarily indicate that there is a
separate earnings event.20
Whether there is a separate earnings event should be evaluated
on a case-by-case basis.
Some have questioned whether revenue may be recognized in
these transactions to the extent of the incremental direct costs
incurred in the activation. Because there is no separable
element or earnings event, the staff would generally object to
that approach, except where it is provided for in the
authoritative literature (e.g., SFAS No. 51, Financial
Reporting by Cable Television Companies). However, the staff
believes that capitalization of certain contract acquisition and
origination costs may be appropriate in these circumstances, as
addressed below in Questions 14 through 17.
|
Question 12
| Q: |
How should a registrant account for a fee received for
installation of an additional telephone jack in the following
situation?
- Facts: Assume the registrant is a
provider of wireline telecommunications services. To install
a phone jack for a customer, the registrant must dispatch a
field technician to a customer's residence. This service may
be performed at the same time as activation of phone service
or at a different time. The registrant charges the customer
$65 to install the additional phone jack. The costs of
performing this service are $55 and consist primarily of the
field technician's hourly wage, related benefits, materials
(e.g., jack and wiring) and transportation costs (e.g.,
gas). Although rare, the registrant does provide this
installation service in situations where it is not also
providing basic local service. In addition, customers could
choose other vendors to install the additional phone jack in
their residence or they could do it themselves.
|
| A: |
The staff believes that revenue should be recognized when
the additional jack is installed. In this case, installation of
the additional phone jack represents a separate and distinct
earnings process, as indicated by the following factors:
- The functionality of the on-going basic local service is
unaffected by the number of phone jacks that exist at a
customer location, as evidenced by the fact that the timing
of the installation of the jack need not coincide with the
activation of basic service. The functionality of the jack
is unaffected by the extent of future phone service.
- The registrant provides these installation services in
situations where it is not also activating basic local
service.
- The registrant provides telecommunications services
without installation of a phone jack (e.g., when the
customer does not want an additional jack).
- Customers may choose other vendors to install the phone
jack in their residence.
- Customers may install additional phone jacks themselves.
- The installation of the jack provides an enhancement to
the value of the customer's residence, even if no local
telephone service is contracted for.
If the installation of the additional phone jack is one element
in a multiple-element arrangement, there should be sufficient
reliable, objective and verifiable evidence of fair value for
the various elements in order to allocate the related fee among
the elements. The staff expects that the EITF will provide
further guidance on these types of arrangements as part of its
project on accounting for multiple element arrangements.
|
Question 13
| Q: |
Research and development arrangements may have terms that
include up-front payments upon contract signing, scheduled
payments during the term of the arrangement, and additional
payments if and when certain milestones in the product's
development are reached. The arrangements often include
provisions for ongoing product manufacturing and distribution
rights. How should a registrant account for the up-front payment
and the other payments? |
| A: |
The answer depends on the facts and circumstances. Question
5 of SAB 101 specifically addresses only the circumstance when a
nonrefundable fee is received at the outset of an arrangement or
at another specified date without a corresponding performance or
delivery by the registrant that is the culmination of a separate
earnings process. In that situation, the on-going research and
development services are essential for the customer to receive
any benefit from the technology or access to other assets. In
addition, a basis does not exist to objectively determine the
fair value of technology access separate from the on-going
research activities.
Many research and development arrangements in the
pharmaceutical and biotechnology industries are more complicated
and contain multiple elements. As discussed in Question 4 of
this document, the staff has requested that the EITF address the
accounting for multiple-element contracts.
While an outright sale of technology by the registrant may
qualify for separate revenue recognition if sufficient
verifiable and objective evidence of fair value exists, research
and development arrangements commonly involve granting access to
facilities, technology, and other properties along with an
agreement to perform research and development activities.21
In the latter circumstances, immediate recognition of the fee
generally is inappropriate because the registrant has continuing
involvement with the technology through its provision of
research and development services that precludes the ability to
objectively measure the fair value of the any of the elements
individually. Similarly, a nonrefundable fee received without
any corresponding performance or delivery should be treated as a
nonrefundable advance from the customer and recognized as
performance occurs. The accounting for other payments
specifically related to the achievement of milestones or for any
manufacturing or distribution arrangements should be evaluated
based on the specific facts of the arrangements between the
parties.
|
Contents
IV. Topic 13.A.3. Accounting for Certain Costs of Revenues
Footnote 29 of SAB 101 refers to contract acquisition and origination
costs and indicates that certain incremental and direct "set-up costs"
may be deferred and accounted for by analogy to SFAS No. 91,
Accounting for Nonrefundable Fees and Costs Associated with Originating
or Acquiring Loans and Initial Direct Costs of Leases, and FASB
Technical Bulletin ("FTB") No. 90-1, Accounting for Separately Priced
Extended Warranty and Product Maintenance Contracts. The staff has
responded to questions concerning that guidance, as discussed below.
Question 14
| Q: |
In SAB 101, what is the intended scope of the guidance on
incremental direct contract acquisition and origination costs?
|
| A: |
Our comments in footnote 29 of SAB 101 and in this document
should be read to apply only to the deferral of incremental
direct costs of transactions for which revenue has been
deferred. Those comments do not address the accounting for costs
of contract acquisition and origination in transactions that do
not involve deferred revenue. |
Question 15
| Q: |
When applying SAB 101, what is the staff's view of the pool
of contract acquisition and origination costs that are eligible
for capitalization?
|
| A: |
As noted in footnote 29 of SAB 101, SFAS No. 91 includes a
definition of incremental direct costs in its glossary.
Paragraph 6 of SFAS No. 91 provides further guidance on the
types of costs eligible for capitalization as customer
acquisition costs indicating that only costs that result from
successful loan origination efforts are capitalized. The FASB
staff has published an Implementation Guide on SFAS No. 91 that
provides additional guidance on the costs that qualify for
capitalization as customer acquisition costs. Further, FTB 90-1
also requires capitalization of incremental direct customer
acquisition costs and requires that those costs be "identified
consistent with the guidance in paragraph 6 of Statement 91."
Although the facts of a particular situation should be analyzed
closely to capture those costs that are truly direct and
incremental, the staff generally would not object to an
accounting policy that results in the capitalization of costs in
accordance with paragraph 6(a) and (b) of SFAS No. 91 or FTB
90-1. Registrants should disclose their policies for determining
which costs to capitalize as contract acquisition and
origination costs. |
Question 16
| Q: |
When applying SAB 101, over what period should the seller
amortize deferred costs associated with deferred revenue? |
| A: |
When both costs and revenue (in an amount equal to or
greater than the costs) are deferred, the staff believes that
the deferred costs should be charged to expense proportionally
and over the same period that deferred revenue is recognized as
revenue.22 |
Question 17
| Q: |
Is the deferral of contract acquisition and origination
costs in the transactions addressed in SAB 101 required or is it
merely permitted? |
| A: |
Such deferral is permitted. In recognition of diversity in
practice in accounting for contract acquisition and origination
costs, the Accounting Standards Executive Committee (AcSEC) has
added a project on the subject to its agenda. Until new guidance
is adopted, the staff would not object to either expensing or
capitalizing incremental direct costs of contract acquisition
and origination, except in situations where the accounting
literature specifically requires one treatment or the other. The
accounting policy for these costs should be disclosed and
applied consistently. |
Contents
V. Topic 13.A.4. Refundable Fees for Services
Question 7 of SAB 101 discusses the appropriate timing of recognizing
revenue for fees received for services that remain refundable even after
the services are provided. While the staff indicated that the preferable
method is to account for refundable amounts received as deposits in
accordance with SFAS No. 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities, paragraph
16, the SAB also indicates that the staff would not object to accounting
for those fees by analogy to SFAS No. 48 if certain criteria are met.
The staff has responded to questions concerning that guidance, as
discussed below.
Question 18
| Q: |
Will the staff accept an analogy to SFAS No. 48 for service
transactions subject to customer cancellation privileges other
than those specifically addressed in Question 7 of SAB 101, so
long as the criteria specified in Question 7 of SAB 101 are met?
|
| A: |
The staff has accepted the analogy in limited circumstances
due to the existence of a large pool of homogeneous transactions
and satisfaction of the criteria in Question 7 of SAB 101.
Examples of other arrangements involving customer cancellation
privileges and refundable service fees that the staff has
addressed include the following:
- a leasing broker whose commission from the lessor upon a
commercial tenant's signing of a lease agreement is
refundable (or in some cases, is not due) under lessor
cancellation privileges if the tenant fails to move into the
leased premises by a specified date.
- a talent agent whose fee receivable from its principal
(i.e., a celebrity) for arranging a celebrity endorsement
for a five-year term is cancelable by the celebrity if the
celebrity breaches the endorsement contract with its
customer.
- an insurance agent whose commission received from the
insurer upon selling an insurance policy is refundable in
whole for the 30-day period that state law permits the
consumer to repudiate the contract and then refundable on a
declining pro rata basis until the consumer has made six
monthly payments.
In the first two of these cases, the staff advised the
registrants that the portion of revenue subject to customer
cancellation and refund must be deferred until no longer subject
to that contingency because the registrants did not have an
ability to make reliable estimates of customer cancellations due
to the lack of a large pool of homogeneous transactions. In the
case of the insurance agent, however, the particular registrant
demonstrated that it had a sufficient history of homogeneous
transactions with the same characteristics from which to
reliably estimate contract cancellations and satisfy all the
criteria specified in Question 7 of SAB 101. Accordingly, the
staff did not object to that registrant's policy of recognizing
its sales commission as revenue when its performance was
complete, with an appropriate allowance for estimated
cancellations. |
Question 19
| Q: |
If a registrant meets the criteria in Question 7 of SAB 101
regarding reliable estimates of cancellations, in the staff's
view, must it analogize to SFAS No. 48, or may it defer all
revenue until the refund period lapses as suggested by SFAS No.
125? |
| A: |
The analogy to SFAS No. 48 is presented as an alternative
that would be acceptable to the staff when the listed conditions
are met. However, a registrant may choose to defer all revenue
until the refund period lapses. The policy chosen should be
disclosed and applied consistently. |
Question 20
| Q: |
May a registrant that meets the criteria in Question 7 of
SAB 101 for reliable estimates of cancellations choose at some
point in the future to change from the SFAS No. 48 method to the
SFAS No. 125 method of accounting for these refundable fees? May
a registrant in that situation change from the SFAS No. 125
method to the SFAS No. 48 method? |
| A: |
As noted in SAB 101, the staff believes that SFAS No. 125
provides a preferable accounting model for service transactions
subject to potential refunds. Therefore, the staff would not
object to a change from the SFAS No. 48 method to the SFAS No.
125 method. However, if a registrant had previously chosen the
SFAS No. 125 method when it could otherwise have qualified to
use the SFAS No. 48 method, the staff would object to a
subsequent change from the SFAS No. 125 method to the SFAS No.
48 method. |
Question 21
| Q: |
Question 7 of SAB 101 indicates that refundable membership
fees can be recognized over the membership term so long as
certain criteria are met (i.e., homogeneous pool, ability to
reliably estimate refunds, etc.). Is there a minimum level of
customers that must be projected not to cancel before use of
SFAS No. 48 type accounting is appropriate? |
| A: |
SFAS No. 48 does not include any such minimum. Therefore,
the staff does not believe that a minimum must apply in service
transactions either. However, as the refund rate increases, it
may be increasingly difficult to make reasonable and reliable
estimates of cancellation rates. |
Question 22
| Q: |
When a registrant first determines that reliable estimates
of cancellations of service contracts can be made (e.g., two
years of historical evidence becomes available), how should the
change from the complete deferral method to the method of
recognizing revenue, net of estimated cancellations, over time
be reflected? |
| A: |
Changes in the ability to meet the criteria set forth in
Question 7 of SAB 101 should be accounted for in the manner
described in paragraph 6 of SFAS No. 48, which addresses the
accounting when a company experiences a change in the ability to
make reasonable estimates of future product returns.
|
Question 23
| Q: |
When the "retrospective approach" to account for changes in
estimates of deferred revenue is used in connection with a
service transaction that meets the criteria in Question 7 of SAB
101, in the staff's view should related deferred costs being
amortized on a basis consistent with the deferred revenue be
similarly adjusted? |
| A: |
Yes.23 |
Contents
VI. Topic 13.A.4. Estimates and Changes in Estimates
Accounting for revenues and costs of revenues requires estimates in
many cases; those estimates sometimes change. Registrants should ensure
that they have appropriate internal controls and adequate books and
records that will result in timely identification of necessary changes
in estimates that should be reflected in the financial statements and
notes thereto. The staff has responded to questions concerning the
reporting of estimates and changes in estimates when applying SAB 101,
which are discussed below.
Question 24
| Q: |
Is the requirement cited in Question 9 of SAB 101 for
"reliable" estimates meant to imply a new, higher requirement
than the "reasonable" estimates discussed in SFAS No. 48? |
| A: |
No. "Reliability" of financial information is one of the
qualities of accounting information discussed in SFAC No. 2. The
staff's expectation that estimates be reliable does not change
the existing requirement of SFAS No. 48. If management cannot
develop an estimate that is sufficiently reliable for use by
investors, the staff believes it cannot make a reasonable
estimate meeting the requirements of that standard. |
Question 25
| Q: |
Question 7 of SAB 101 identifies specific criteria that
should be met if the guidance in SFAS No. 48 is applied by
analogy to refundable revenues from service transactions. Does
the staff expect registrants to apply the guidance in Question 7
of SAB 101 to sales of tangible goods and other transactions
specifically within the scope of SFAS No. 48? |
| A: |
The specific guidance in Question 7 of SAB 101 does not
apply to transactions covered by SFAS No. 48. The views set
forth in Question 7 of SAB 101 are applicable to the service
transactions discussed in that Question. Service transactions
are explicitly outside the scope of SFAS No. 48.
As noted in Question 7 of SAB 101, the staff has not objected
to analogies to SFAS No. 48 for service transactions, provided
that all of the criteria discussed in that question are
satisfied. This guidance is intended to ensure that revenue is
recognized based on estimates of cancellation when those
estimates are consistent, comparable, reliable, and
appropriately disclosed. |
Question 26
| Q: |
Question 7 of SAB 101 states that the staff would expect a
two-year history of selling a new service in order to be able to
make reliable estimates of cancellations. How long a history
does the staff believe is necessary to estimate returns in a
product sale transaction that is within the scope of SFAS No.
48? |
| A: |
The staff does not believe there is any specific length of
time necessary in a product transaction. However, SFAS No. 48
states that returns must be subject to reasonable estimation.
Preparers and auditors should be skeptical of estimates of
product returns when little history with a particular product
line exists, when there is inadequate verifiable evidence of
historical experience, or when there are inadequate internal
controls that ensure the reliability and timeliness of the
reporting of the appropriate historical information. Start-up
companies and companies selling new or significantly modified
products are frequently unable to develop the requisite
historical data on which to base estimates of returns. |
Question 27
| Q: |
If a company selling products subject to a right of return
concludes that it cannot reasonably estimate the actual return
rate due to its limited history, but it can conservatively
estimate the maximum possible returns, does the staff believe
that the company may recognize revenue for the portion of the
sales that exceeds the maximum estimated return rate? |
| A: |
No. If a reasonable estimate of future returns cannot be
made, SFAS No. 48 requires that revenue not be recognized until
the return period lapses or a reasonable estimate can be made.24
Deferring revenue recognition based on the upper end of a wide
range of potential return rates is inconsistent with the
provisions of SFAS No. 48. |
Contents
VII. Topic 13.A.4. Fixed or Determinable Fees
Question 28
| Q: |
Company M performs claims processing and medical billing
services for healthcare providers. In this role, Company M is
responsible for preparing and submitting claims to third-party
payers, tracking outstanding billings, and collecting amounts
billed. Company M's fee is a fixed percentage (e.g., five
percent) of the amount collected. If no collections are made, no
fee is due to Company M. Company M has historical evidence
indicating that the third-party payers pay 85 percent of the
billings submitted with no further effort by Company M. May
Company M recognize as revenue its five percent fee on 85
percent of the gross billings at the time it prepares and
submits billings, or should it wait until collections occur to
recognize any revenue? |
| A: |
The staff believes that Company M must wait until
collections occur before recognizing revenue. Before the
third-party payer has remitted payment to Company M's customers
for the services billed, Company M is not entitled to any
revenue. That is, its revenue is not yet realized or realizable.25
Until Company M's customers collect on the billings, Company M
has not performed the requisite activity under its contract to
be entitled to a fee.26
Further, no amount of the fee is fixed or determinable or
collectible until Company Ms' customers collect on the billings.
|
Contents
VIII. Topic 13.B.2. Implementing the Guidance in SAB 101
The staff has responded to questions concerning how registrants
should implement the guidance in SAB 101, as discussed below.
Question 29
| Q: |
SAB 101 indicates that the staff will not object to
cumulative effect-type transition so long as the prior
accounting does not represent an error. Could a company whose
prior accounting does not represent an error voluntarily adopt a
new method consistent with SAB 101 by restatement of prior
periods, rather than through a cumulative catch-up adjustment?
|
| A: |
In most instances, no. APB Opinion No. 20 does not permit
restatement of financial statements for a change in accounting
principle that does not represent correction of an error, except
in very rare circumstances.27
An exception is a company that is filing publicly for the first
time. As stated in paragraph 29 of APB Opinion No. 20, those
companies are permitted to reflect the adoption of the new
policy via a restatement, and the staff believes that approach
is usually necessary to avoid confusing investors in an initial
public offering.
|
Question 30
| Q: |
Should a registrant reporting a change in accounting
principle as a result of SAB 101 file a preferability letter?
|
| A: |
No preferability letter is required if an accounting change
is made in response to a newly issued Staff Accounting Bulletin.
|
Question 31
| Q: |
If a company had not previously adjusted sales revenues, but
deferred recognition of the gross margin of estimated returns
for a transaction subject to SFAS No. 48, how should it present
a current change in accounting to reduce revenue and cost of
sales for estimated returns? |
| A: |
Paragraph 7 of SFAS No. 48 states that "sales revenue and
cost of sales reported in the income statement shall be
reduced to reflect estimated returns." SFAS No. 48 does not
provide for recognition of sales and costs of sales while
deferring gross margin under any circumstance. SAB 101 provided
no new guidance on this point. If a registrant has failed to
comply with GAAP, the registrant should retroactively revise
prior financial statements in the manner set forth in Accounting
Principles Board (APB) Opinion No. 20, Accounting Changes
and SFAS No. 16, Prior Period Adjustments.
|
Contents
Exhibit A: Effects of Customer Acceptance and Unfulfilled
Obligations on Revenue Recognition
Example 1
Company E is an equipment manufacturer whose main product is
generally sold in a standard model. The contracts for sale of that model
provide for customer acceptance to occur after the equipment is received
and tested by the customer. The acceptance provisions state that if the
equipment does not perform to Company E's published specifications, the
customer may return the equipment for a full refund or a replacement
unit, or may require Company E to repair the equipment so that it
performs up to published specifications. Customer acceptance is
indicated by either a formal sign-off by the customer or by the passage
of 90 days without a claim under the acceptance provisions. Title to the
equipment passes upon delivery to the customer. Company E does not
perform any installation or other services on the equipment it sells and
tests each piece of equipment against its specifications before
shipment. Payment is due under Company E's normal payment terms for that
product which is 30 days after customer acceptance.
For each response below, all of the above facts apply, in addition
to any others specifically stated in the "Additional Facts" section.
Scenario A:
Additional Facts: Company E receives an order from a new
customer for a standard model of its main product. Based on the
customer's intended use of the product, location and other factors,
there is no reason that the equipment would operate differently in a
customer's environment than it does in Company E's facility.
Assuming all other revenue recognition criteria are met (other than
the issue raised with respect to the acceptance provision), when should
Company E recognize revenue from the sale of this piece of equipment?
Response: While the staff presumes that customer acceptance
provisions are substantive provisions that generally result in revenue
deferral, that presumption can be overcome as discussed in Question 5 of
this document. Although the contract includes a customer acceptance
clause, acceptance is based on meeting Company E's published
specifications for a standard model. Company E demonstrates that the
equipment shipped meets the specifications before shipment, and the
equipment is expected to operate the same in the customer's environment
as it does in Company E's. In this situation, Company E should evaluate
the customer acceptance provision as a warranty under SFAS No. 5. If
Company E can reasonably and reliably estimate the amount of warranty
obligations, the staff believes that it should recognize revenue upon
delivery of the equipment, with an appropriate liability for probable
warranty obligations.
Scenario B:
Additional Facts: Company E enters into an arrangement with a
new customer to deliver a version of its standard product modified as
necessary to fit into a space of specific dimensions while still meeting
all of the published vendor specifications with regard to performance.
In addition to the customer acceptance provisions relating to the
standard performance specifications, the customer may reject the
equipment if it does not conform to the specified dimensions. Company E
creates a testing chamber of the exact same dimensions as specified by
the customer and makes simple design changes to the product so that it
fits into the testing chamber. The equipment still meets all of the
standard performance specifications.
Assuming all other revenue recognition criteria are met (other than
the issue raised with respect to the acceptance provision), when should
Company E recognize revenue from the sale of this piece of equipment?
Response: Although the contract includes a customer
acceptance clause that is based, in part, on a customer specific
criterion, Company E demonstrates that the equipment shipped meets that
objective criterion, as well as the published specifications, before
shipment. Therefore, the staff believes that Company E should evaluate
the customer acceptance provision as a warranty under SFAS No. 5. If
Company E can reasonably and reliably estimate the amount of warranty
obligations, it should recognize revenue upon delivery of the equipment,
with an appropriate liability for probable warranty obligations.
Scenario C:
Additional Facts: Company E enters into an arrangement with a
new customer to deliver a version of its standard product modified as
necessary to be integrated into the customer's new assembly line while
still meeting all of the standard published vendor specifications with
regard to performance. The customer may reject the equipment if it fails
to meet the standard published performance specifications or cannot be
satisfactorily integrated into the new line. Company E has never
modified its equipment to work on an integrated basis in the type of
assembly line the customer has proposed. In response to the request,
Company E designs a version of its standard equipment that is modified
as believed necessary to operate in the new assembly line. The modified
equipment still meets all of the standard published performance
specifications, and Company E believes the equipment will meet the
requested specifications when integrated into the new assembly line.
However, Company E is unable to replicate the new assembly line
conditions in its testing.
Assuming all other revenue recognition criteria are met (other than
the issue raised with respect to the acceptance provision), when should
Company E recognize revenue from the sale of this piece of equipment?
Response: This contract includes a customer acceptance clause
that is based, in part, on a customer specific criterion, and Company E
cannot demonstrate that the equipment shipped meets that criterion
before shipment. Accordingly, the staff believes that the contractual
customer acceptance provision is substantive and is not overcome upon
shipment. Therefore, the staff believes that Company E should wait until
the product is successfully integrated at its customer's location and
meets the customer-specific criteria before recognizing revenue. While
this is best evidenced by formal customer acceptance, other objective
evidence that the equipment has met the customer-specific criteria may
also exist (e.g., confirmation from the customer that the specifications
were met).
Example 2
Company A develops, manufactures, and sells complex manufacturing
equipment. Company A enters into a sales contract with Customer B to
sell and install a specific piece of equipment for $20 million. Company
A is experienced in the production and installation of this type of
equipment and has a history of successfully installing the equipment.
Company A concludes that installation is neither (a) inconsequential or
perfunctory nor (b) essential to the functionality of the equipment.
Company A has developed its own internal specifications for the model
of equipment Customer B ordered and has previously demonstrated that the
equipment meets those specifications. Company A provides a warranty on
all equipment sales that guarantees the delivered equipment will meet
Company A's published specifications and be free of defects in materials
and workmanship. Title to the equipment passes to the customer upon
delivery.
Company A sells the equipment separately to some customers, without
installation, for $19,500,000. In those cases, a general contractor
installs the equipment. Company A routinely sells separately its
services of the type required for equipment installation on a time and
materials basis. Based on the extent of effort expected in an
installation of this equipment, Company A determines that the fair value
of the installation services approximates $500,000.
For each response below, all of the above facts apply, in addition
to any others specifically stated in the "Additional Facts" section.
Scenario A:
Additional Facts: The equipment must be integrated into a
larger production line that includes other manufacturer's equipment. At
Customer B's request, the contract includes a number of
customer-specific technical and performance criteria regarding speed,
quality, interaction with other equipment, and reliability. Because of
the nature of the equipment, Company A is unable to demonstrate that the
equipment will meet the customer-specific specifications before
installation. The contract includes a customer acceptance provision that
obligates Company A to demonstrate that the installed equipment meets
all specified criteria before customer acceptance. If customer
acceptance is not achieved within 120 days of installation, Customer B
can require Company A to remove the equipment and refund all payments.
Payment terms are 80% due 30 days after delivery and 20% due 30 days
after customer acceptance.
Assuming all other revenue recognition criteria are met (other than
the issues raised with respect to the acceptance provision), when should
Company A recognize revenue on this transaction?
Response: While Company A believes that its equipment can be
made to meet the customer's specifications, it is unable to demonstrate
that it has delivered what Customer B ordered until installation and
testing occurs. Accordingly, the staff believes that it would be
inappropriate for Company A to recognize any revenue until it has
demonstrated that it has delivered equipment meeting the specifications
set forth in the contract. This would normally occur upon customer
acceptance.
Scenario B:
Additional Facts: The equipment must be integrated into a
larger production line. At Customer B's request, the contract includes a
number of customer-specific technical and performance criteria regarding
speed, quality, and reliability. However, the integration of the product
into Customer B's factory and production line is not complex. Because of
this, the product is tested in Company A's facility before shipment and
is shipped only after all specifications are met. The contract includes
a customer acceptance provision that obligates Company A to demonstrate
that the installed equipment meets all specified criteria before
customer acceptance. Because the integration is not complex, there is
virtually no uncertainty as to whether the product will continue to meet
those specifications, without further modification, once installed in
the customer's facility. However, the customer is obligated to pay the
fee only upon completed installation. The contract specifies that if
Company A does not complete the installation to Customer B's
satisfaction, Customer B can require Company A to remove the equipment
with no payment becoming due.
Assuming all other revenue recognition criteria are met (other than
the issues raised with respect to the acceptance provision), when should
Company A recognize revenue on this transaction?
Response: Upon delivery, Company A has completed the earnings
process and met the delivery criterion with respect to the equipment
because it has demonstrated that the equipment delivered to the customer
meets the requirements of the customer's order. However, because the
customer is not obligated to pay Company A if installation of the
equipment is not completed, the staff believes that no revenue may be
recognized until installation is complete and the customer becomes
obligated to pay. Conversely, if Company A has an enforceable claim at
the balance sheet date through which it can realize some or all of the
$20 million fee even if it failed to fulfill the installation
obligation, deferral of a lesser amount, but not less than the estimated
fair value of the installation (i.e., $500,000), would be appropriate.
Alternatively, if Company A's policy is to defer all revenue until
installation is complete, recognition of the $20,000,000 fee upon
completion of installation would be appropriate. Company A's policy
should be appropriately disclosed and consistently applied.
Scenario C:
Additional Facts: The equipment must be integrated into a
larger production line. At Customer B's request, the contract includes a
number of customer-specific technical and performance criteria regarding
speed, quality, and reliability. However, the integration of the product
into Customer B's factory and production line is not complex. Because of
this, the product is tested in Company A's facility before shipment and
is shipped only after all specifications are met. The contract includes
a customer acceptance provision that obligates Company A to demonstrate
that the installed equipment meets all specified criteria before
customer acceptance. Because the integration is not complex, there is
virtually no uncertainty as to whether the product will continue to meet
those specifications, without further modification once installed in
Customer B's facility. Customer B is obligated to pay one hundred
percent of the fee no later than 90 days after delivery regardless of
whether installation has occurred.
Assuming all other revenue recognition criteria are met (other than
the issues raised with respect to the acceptance provision), when should
Company A recognize revenue on this transaction?
Response: Upon delivery, Company A has completed the earnings
process and met the delivery criterion with respect to the equipment
because it has demonstrated that the equipment delivered to the customer
meets the requirements of the customer's order. In addition, Company B's
obligation to pay the fee is not contingent upon completion of
installation. Therefore, Company A should recognize the revenue
allocable to the equipment, $19,500,000, as revenue upon delivery. The
staff believes that the remaining $500,000 of the arrangement fee should
be recognized when installation is performed.
Alternatively, if Company A's policy is to defer all revenue until
installation is complete, recognition of the $20,000,000 fee upon
completion of installation would be appropriate. Company A's policy
should be appropriately disclosed and consistently applied.
Footnotes
|
1 |
Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Concepts (SFAC) No. 5, Recognition and
Measurement in Financial Statements of Business Enterprises,
paragraph 83(b). |
|
2 |
SOP 97-2, Software Revenue Recognition, paragraph 20. |
|
3 |
Reliability is defined in SFAC No. 2, Qualitative
Characteristics of Accounting Information, as "the quality
of information that assures that information is reasonably free
from error and bias and faithfully represents what it purports
to represent." Paragraph 63 of SFAC No. 5 reiterates the
definition of reliability, requiring that "the information is
representationally faithful, verifiable, and neutral." |
|
4 |
This view is consistent with Statement of Financial
Accounting Standards (SFAS) No. 45, Accounting for Franchise
Fee Revenue, paragraph 17. |
|
5 |
SFAC No. 5, paragraph 83(b). |
|
6 |
See, for example, SOP 97-2, paragraph 25. |
|
7 |
SFAS No. 48, Revenue Recognition When Right of Return
Exists, paragraph 13. |
|
8 |
SFAS No. 48, paragraph 6(f). |
|
9 |
SFAS No. 48, paragraphs 8(c) and 8(d). |
|
10 |
SFAS No. 5, Accounting for Contingencies, paragraph
24 and SFAS No. 48, paragraph 4(c). |
|
11 |
SFAS No. 5, paragraph 25. |
|
12 |
See SOP 97-2, paragraph 13. |
|
13 |
See SOP 97-2, paragraphs 68-71 for analogous guidance. |
|
14 |
Ibid. |
|
15 |
See SOP 97-2, paragraph 13. |
|
16 |
SFAC No. 5, paragraph 83(a) and SFAS No. 48, paragraph 6(b). |
|
17 |
See SOP 00-2, paragraphs 7(c), 14, and 76. |
|
18 |
SFAC No. 5, paragraph 83(b). |
|
19 |
SFAC No. 5, paragraph 84(d). |
|
20 |
See footnote 51 of SFAC No. 5 for a description of the
"earnings process." |
|
21 |
The arrangements may fall within the scope of SFAS No. 68,
Research and Development Arrangements. Provided that the
conditions that require accounting for proceeds received as a
liability to repay the funding party are not met, SFAS No. 68,
paragraph 10, requires that the arrangement be accounted for as
an obligation to perform contractual research and development
services. If the research and development arrangement is with
the Federal Government, then the arrangement may be within the
scope of the AICPA Audit and Accounting Guide, Audits of
Federal Government Contractors, paragraphs 3.49 through
3.56. |
|
22 |
FTB 90-1, paragraph 4. |
|
23 |
Such an approach is generally consistent with the
amortization methodology in SFAS No. 91, paragraph 19. |
|
24 |
SFAS No. 48, paragraph 6(f). |
|
25 |
SFAC No. 5, paragraph 83(a). |
|
26 |
SFAC No. 5, paragraph 83(b). |
|
27 |
See, for example, APB Opinion No. 20, paragraph 27. |
|
