Revenue recognition is an increasingly important topic for private companies operating in the technology and life sciences (T&LS) sector. Revenue recognition policies are scrutinized by investors, potential acquirers, and regulators alike.
As businesses move into a phase of rapid growth, they commonly enter into increasingly complex sales arrangements and different revenue streams. Revenue recognition accounting is consistently one of the key accounting risk areas for companies in this sector. Whether reporting under accounting standards for private enterprise (ASPE), international financial reporting standards (IFRS,) or even U.S. standards, understanding the risks when dealing with multiple deliverable arrangements and considering all relevant factors is critical for financial executives working in the T&LS sectors.
There are three topic areas that are of most concern for organizations when dealing with multiple deliverable arrangements when reporting under ASPE.
How do I determine whether the revenue recognition criteria are applied to the deliverables as a single unit of account or multiple units of account?
Factors to consider:
- Are the transactions entered into at or near the same time?
- Do the individual components have value to the customer on a stand-alone basis?
- Is the occurrence of one transaction dependent on the occurrence of the other transaction?
- Do other vendors sell both components together?
- Does the entity routinely sell the components together or separately?
- Is there another vendor that can sell the undelivered component to the entity and be compatible with the delivered component?
- Is the pricing of the individual components reasonable or is the total price for all the components together more supportable?
- Is there an upfront fee that is not linked to any deliverable?
- Are there requirements to repurchase the product?
- Has the delivery occurred or services been rendered?
- What are the remaining performance obligations of the entity?
| Examples | Key factors |
|---|---|
ABC Company sells a complete business solution, which consists of the following deliverables: equipment X and Y and software Z. ABC does not sell X, Y, and Z separately; however, other companies do sell the three deliverables separately. ABC Company delivered equipment X and software Z on March 1st, but did not deliver equipment Y until April 1st. Without equipment Y, the customer cannot use X and Z. The contract provides that if all pieces of equipment are not delivered, the customer may return equipment X and software Z and have no liability to ABC. |
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Talk Time Inc. is a telecommunications company serving residential and commercial customers. Recently, the Company signed a contract with a customer to provide teleconferencing equipment and data services. The price of the teleconferencing equipment is $5m and the price of the data services is $2.5m. The data services are necessary for the teleconferencing equipment to work. The data plan is for 5 years. The risks and rewards of the equipment will be transferred to the customer Immediately. Talk Time receives payment on the equipment at time of delivery and payment on data services every year for 5 years. All payments are non-refundable. Talk Time does not sell the equipment and data services separately. While it may be possible to get another vendor to provide data services separately, the Industry practice is that vendors provide the equipment and the related data. |
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How is consideration allocated to each component of a multiple deliverable arrangement?
When the substance of the arrangement follows that the revenue recognition criteria are applied to the deliverables as multiple units of account, there are usually three methods for allocation of the consideration:
- relative fair value;
- residual method; or
- cost plus margin.
When the substance of the arrangement follows that all of the elements represent a single unit of account, then revenue is typically deferred and amortized over the contract term or until all significant performance obligations have been performed.
The example below illustrates that the method used will result in different amounts of revenue that are recognized for each component. Therefore, it is important that the method of allocation is disclosed appropriately.
Assume a multiple deliverable arrangement with two deliverables X and Y. The total consideration is $120 for a two-year contract. Assume at year end, X has been delivered and Y has not been delivered.
| Multiple deliverable arrangement | Single unit of account | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Relative fair value method | Residual method | Cost plus margin | Deferral and amortization of revenues | ||||||||||||
Assume the fair value of X is $ 100 and fair value of Y is $50. Based on the fair values, 100/150 of the total consideration of $120 should be allocated to component X and 50/150 should be allocated to component Y. Therefore, the following amount of revenue is recognized for each element: X-580 Y- $40 | The fair value of Y is $50. Based on the fair value of the undelivered component, $70 should be recognized in revenue for the delivery of X and the remaining $50 should be deferred until component Y is delivered. Therefore, the following amount of revenue is recognized for each element: X-$70 Y-$50 | Assume that the entity does not have a reliable estimate for fair values of X or Y so It uses its best estimate of selling price for each deliverable to allocate the consideration. The following Information exists for component X and component Y based on management's best estimate.
Based on the relative selling prices, 84/149* $120 should be allocated to X and (65/149* $120) should be allocated to Y. Therefore, the following amount of revenue is recognized for each element: X-$68 Y- $52 | The total revenues are amortized over the life of the contract. Therefore, $60 would be recognized as revenue each year ($120/2 years). Assume of the $120 of total consideration, $70 has been received at the end of year one. DR Cash $5.5 = $70 CR Revenues $1.5 = $60 CR Deferred Revenues = $10 | ||||||||||||
What type of disclosure is required for an arrangement with multiple deliverables?
- Accounting policy for each element
- How multiple elements are determined
- How multiple elements are valued
- Description and nature of arrangement
- Description of any performance, cancellation, termination or refund-type provisions
- Description of judgments applied in determining whether the elements are treated distinctly or bundled
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