Updated FASB Guidance for Revenue Arrangements That Include Software Elements

January 15, 2011

Does your business sell a product that includes a software component that is essential to the product’s overall functionality? If so, the newly approved FASB Accounting Standards Update (ASU) (2009-14) provides guidance that will be applied prospectively for revenue arrangements entered into or materially modified for fiscal years beginning on or after June 15, 2010, and early adoption is permitted.

The FASB standards require that all hardware components of a tangible product containing software components be excluded from software revenue recognition guidance under Subtopic 985-605 (ASC 985-605.) The amendments also address which software components are excluded from the software revenue recognition guidelines. If the software contained in the tangible product is essential to the product’s functionality, the software is excluded from the scope of the software revenue guidance.

Here are some factors to consider in determining if the software is essential to the product’s main functionality:

  1. Is the tangible product always sold with the software elements as part of the product?
  2. Are different products sold with similar functionality and the only significant difference that one product includes the software and one does not, than they will be considered the same product.
  3. A vendor may sell software on a standalone basis and sell a tangible product that includes the software, the separate sales does not indicate that the software is not essential to the functionality of the product.
  4. Software elements do not need to be embedded within the tangible product to be considered essential.
  5. The non-software elements of the tangible product must contribute to the essential functionality and not just provide a mechanism to deliver the software.

An example of an excluded asset is a computer being sold with an operating system that is essential to the computer’s functionality.  In this case the computer, operating system, and post-contract customer support are all excluded from the scope of the software revenue guidance.

The amendments in this update also provide guidance on how a vendor should allocate arrangement consideration to deliverables in an arrangement that includes both tangible products and software. If the software is not essential to the product’s functionality, than the nonessential software element would fall under ASC 985-605.

Vendors who are affected by the amendments of this update are required to provide disclosures that are included within the amendments of ASU 2009-13.

The amendments in this Update coupled with the amendments resulting from Update 2009-13 will significantly improve the reporting of certain transactions to more closely reflect the underlying economics of the transactions. Currently the absence of vendor-specific objective evidence of selling price of the undelivered item in an arrangement is a common reason entities are unable to separate deliverables in an arrangement involving products that include software (ASU 2009-14.)

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