Financial Reporting Alert 09-6: Material Modifications to Revenue Arrangements With Multiple Deliverables
November 11, 2009
ASU 2009-13 significantly changes the accounting for revenue in arrangements with multiple deliverables by requiring entities to separately account for individual deliverables in more of these arrangements. The ASU removes the criterion that entities must use objective and reliable evidence of fair value when separately accounting for deliverables, allowing for the recognition of revenue in a manner that more closely aligns with the economics of certain arrangements. These changes and others are summarized in Deloitte’s October 1, 2009, Heads Up, which also highlights some of the challenges expected upon an entity’s adoption of this guidance.
Editor’s Note: The FASB recently issued ASU 2009-14 3 (formerly Issue 09-3 4), which reflects the consensus of the Emerging Issues Task Force and amends ASC 985-605 5 (formerly SOP 97-2 6) to exclude from its scope certain tangible products that contain software that functions together with nonsoftware deliverables to deliver the tangible product’s essential functionality. The ASU does not create any new methods of revenue recognition, but its amendment to the scope of existing guidance can significantly affect an entity’s periodic revenue.
Entities will apply the separation and allocation guidance in ASC 605-25, 7 as recently amended by ASU 2009-13, 8 for multiple-element arrangements that are now outside the scope of the software revenue recognition guidance in ASC 985-605 under the provisions of ASU 2009-14.
See Deloitte’s October 23, 2009, Heads Up, for further information on ASU 2009-14.
ASU No. 2009-13 must be applied prospectively to revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, unless an entity elects retrospective application in accordance with ASC 250 9 (formerly Statement 154 10). Early adoption is permitted. The ASU does not specify how to account for an arrangement that is deemed to have been materially modified. In addition, because the ASU does not provide guidance on when changes to a contract are considered material modifications, entities must use professional judgment to determine when such modifications would be considered material and would be accounted for under the new accounting guidance (see related discussion in the above-referenced Heads Up).
Accounting for Materially Modified Revenue Arrangements
As noted above, ASU 2009-13 does not specify how to account for a revenue arrangement that was accounted for under ASC 605-25 (before the ASU’s amendments) if it is materially modified and now subject to the guidance in the ASU. For example, entities may have deferred revenue associated with an arrangement being accounted for in accordance with ASC 605-25 (before the ASU’s amendments). Once the ASU is effective, if the arrangement is materially modified, prospective application of the ASU is required. However, the ASU does not specify how deferred revenue associated with the arrangement should be adjusted (if at all) upon modification of the contract.
Informal discussions with the SEC staff have indicated that it would be appropriate to account for materially modified revenue arrangements by allocating to the deliverables (in periods both before and after the modification) the arrangement consideration on a relative-selling-price basis. Any amount of revenue allocated to previously delivered items in excess of the revenue actually recognized in the periods that preceded the modification is recognized in its entirety in the period the modification occurs. In applying such an approach, an entity’s objective would be to “true-up” deferred revenue to reflect the amount that would have been deferred had the guidance in the ASU been effective at the time the contract was executed.
While the SEC has noted that the above approach (“Approach 1”) is acceptable, it has also indicated that entities may use an approach in which they would account for the materially modified arrangement as a new arrangement and allocate the total arrangement consideration (defined as deferred revenue recorded on the balance sheet at the time of the modification and any remaining consideration due under the modified terms) to the remaining deliverables on the basis of their relative selling price (“Approach 2”). However, to the extent that total consideration (as defined above) exceeds the sum of the total selling prices for the remaining deliverables, that excess would be recognized in income in the period of the modification, with a corresponding adjustment to deferred revenue. If total consideration (as defined above) is less than the sum of selling prices for the remaining deliverables, a discount would result, which entities would allocate to the remaining deliverables by using the relative-selling-price method. Judgment may be necessary in the application of either of the approaches described herein.
As an illustration of the two approaches, consider an agreement that is “materially modified.” As of the date of the material modification, deferred revenue of $500 is recorded on the company’s balance sheet because there was no objective and reliable evidence of the fair value of the undelivered items. Also assume that the remaining deliverables under the arrangement have an aggregate selling price of $400 and that, had Issue 08-1 been applied at the inception of the arrangement, the amount of deferred revenue recorded on the balance sheet as of the date the contract was modified would have been $50 rather than $500. The remaining consideration to be paid under the contract is $300.
Under Approach 1, a company would “true up” the deferred revenue balance to the amount that would have been recorded had Issue 08-1 always been applied to the contract. Therefore, a company would record $450 as an adjustment to deferred revenue in the period the contract is modified, leaving a remaining deferred revenue balance of $50.
Under Approach 2, a company would also “true up” the deferred revenue balance, but the adjustment would be based on the selling price of the remaining deliverables only. That is, because the remaining deliverables have an aggregate selling price of $400 and the remaining consideration to be paid is $300, the company would adjust the deferred revenue balance from $500 to $100.The adjusted deferred revenue balance of $100, combined with the remaining consideration of $300 to be paid, would then equal the aggregate selling price ($400) of the remaining deliverables. Approach 2 is analogous to a “residual” type approach.
If an entity’s management believes that, because of certain facts or circumstances, using either of the above approaches to account for a materially modified revenue arrangement would be inappropriate or impractical, a discussion with a professional advisor and the SEC staff about the specific situation may be warranted.
1 EITF Issue No. 08-1, “Revenue Arrangements With Multiple Deliverables.”
2 FASB Accounting Standards Update No. 2009-13, Multiple-Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force.
3 FASB Accounting Standards Update No. 2009-14, Certain Revenue Arrangements That Include Software Elements — a consensus of the FASB Emerging Issues Task Force.
4 EITF Issue No. 09-3, “Applicability of AICPA Statement of Position 97-2 to Certain Arrangements That Include Software Elements.”
5 FASB Accounting Standards Codification Subtopic 985-605, Software: Revenue Recognition.
6 AICPA Statement of Position 97-2, Software Revenue Recognition.
7 FASB Accounting Standards Codification Subtopic 605-25, Revenue Recognition: Multiple-Element Arrangements.
8 FASB Accounting Standards Update No. 2009-13, Multiple-Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force.
9 FASB Accounting Standards Codification Topic 250, Accounting Changes and Error Corrections.
10 FASB Statement No. 154, Accounting Changes and Error Corrections.