Question

In: Accounting

If a company sell a software, and it only offers the services to fix system vulnerabilities....

If a company sell a software, and it only offers the services to fix system vulnerabilities.

Are there two performance obligations or one?

Solutions

Expert Solution

If a company sell a software, and it only offers the services to fix system vulnerabilities.

Are there two performance obligations or one

Answer : There are two performance obligations :

  • Selling a software
  • and Fixing system vulnerabilities

Explanation for the answer:

A performance obligation is a promise to provide a “distinct” good or service to a customer. ... There are two criteria for a good or service to be considered distinct, and both of those criteria must be met. The good or service must be capable of being distinct, and it must be distinct in the context of the contract.

After years of debate, revision, and refinement, Accounting Standards Codification (ASC) 606 is finally coming into effect. The Financial Accounting Standards Board (FASB) released its initial major Accounting Standards Update (ASU) about revenue recognition in May of 2014 ASU 2014-09 and has since received thousands of comments and issued six subsequent ASUs on the topic. This major overhaul of the revenue recognition framework formerly ASC 605 takes effect for fiscal years beginning after December 15, 2017 for all public entities, certain not-for-profits, and certain employee benefit plans.

Determining Whether A License In A Hosting, SaaS, And Hybrid-Cloud Arrangements Is Distinct From Other Goods And Services In The Arrangement

The second step in the ASC 606 revenue-recognition model is to identify the separate performance obligations within a contract. Each promised good or service, or bundle of related goods or services, must meet the following two criteria to be considered a separate (distinct) obligation: (1) the customer can derive benefit from the offering either on its own or with readily available resources, and (2) the offering is able to be separated from the other offerings in the contract. The first requirement determines if the offering is capable of being distinct, while the second determines if the offering is distinct within the context of the contract.

In hosting, software as a service(SaaS), and hybrid-cloud arrangements, a software license exists as a distinct performance obligation if the licensee can derive economic benefit independent of the other products or services within the contract. Under ASC 606, the licensing implementation guidance is not applicable in a SaaS arrangement. According to the KPMG

independent of the other products or services within the contract. Under ASC 606, the licensing implementation guidance is not applicable in a SaaS arrangement. According to the KPMG firm guide, SaaS arrangements are accounted for as service obligations, not as a transfer of a license to intellectual property (IP). In order to determine if a license falls under a hosting or SaaS arrangement, the guidance in ASC 985-20-15-5 must be reviewed. ASC 985-20-15-5 defines the two criteria that must be met for the software license to be accounted for as a hosting arrangement:

  1. The customer has the right to take possession of the software at any point during the hosting period without significant penalty
  2. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software

If these requirements are met, the software is part of a hosting arrangement and will likely be considered distinct. Otherwise, the software is, by default, a SaaS arrangement, and will therefore likely not be considered distinct. Significant judgment is required in assessing a software license against the two requirements.

Once the license is determined to be distinct, the next step is to determine if the license is separately identifiable from the other goods or services within the context of the contract. A license is distinct within a contract if it is not significantly related to or dependent on the other goods or services in the contract. To determine if a license is distinct within a contract, the entity may consider, but is not limited to, the following factors:

  • The extent to which the licensor performs significant integration services on the goods or services before the customer receives the goods or services
  • The effect two or more promised goods or services have on each other
  • The utility the customer can derive from each individual promised good or service

Hosted Software

In a hosting arrangement, the licensee has as-needed access to software and related services located on third-party servers. The entity (provider) should first assess if the license meets the criteria of ASC 985-20-15-5. The AICPA Financial Reporting Executive Committee (FinREC) has concluded that software IP subject to a hosting arrangement generally meets the criteria to be distinct within a contract because the licensee derives benefit from the software, independent of other promised goods or services, throughout the license period.

SaaS

With SaaS, software IP is generally accessible to a licensee through the provider’s cloud systems. Unlike many hosting arrangements, Saas arrangements allow the licensee to access the software code only during the contracted-use term. SaaS arrangements typically do not meet the qualifications to be considered distinct because licensees do not obtain the right to use the software code on their own servers, thus these arrangements will result in revenue recognized over time in accordance with the criteria in ASC 606-10-25-27.

Hybrid Software And SaaS

In a hybrid arrangement, the licensee usually receives a combination of on-site and SaaS software IP. The entity should analyze the interdependency of and the separate utility to be obtained from the downloaded and the SaaS software.

Transfer Of Control Of A Software License

The transfer of control from licensor to licensee is a key determinant in the timing of revenue recognition under the new standard. Some common instances within the industry that merit further analysis include: requiring the vendor to provide an access code, point-in-time transfer of control criteria, customer-specific acceptance provisions, timing of the transfer in a hosting arrangement, and contracting to provide software that is not yet available. The discussion of the factors that an entity should consider when determining if control has been transferred from the seller to the buyer of a software license that is distinct within the contract is still in the AICPA evaluation phase as of the publication date of this article.

Conclusion

Software license arrangements can be organized as a hosting arrangement, SaaS, a hybrid of both hosting and SaaS, or direct delivery to the customer all of which have different implications for the application of each of the five steps of the new revenue recognition model. Software companies are often tasked with deconstructing the typical bundles of product and services, and then determining the separate selling price of each of those elements. These bundled deliverables complicate an entity’s ability to reasonably estimate the value of each promised good or service within the contract.


Related Solutions

Fix 4 Less is a company for cellphone repair. The business offers variety of services such...
Fix 4 Less is a company for cellphone repair. The business offers variety of services such as refurbishing the screens, selling the parts online (amazon, eBay and bonanza), retail store for walk in customers and mobile repair services for those who don't have time to leave their homes or works. Business would like to add one more service which is selling the parts wholesale to other retail stores in the same market. After everything is settled business is planning to...
Fix 4 Less is a company for cellphone repair. The business offers variety of services s......
Fix 4 Less is a company for cellphone repair. The business offers variety of services s... Question: Fix 4 Less is a company for cellphone repair. The business offers variety of services such as refurbishing the screens, selling the parts online (amazon, eBay and bonanza), retail store for walk in customers and mobile repair services for those who don't have time to leave their homes or works. Business would like to add one more service which is selling the parts...
The Context: If Cambridge Software Corporation (CSC) offers only one version of Modeler, they maximize their...
The Context: If Cambridge Software Corporation (CSC) offers only one version of Modeler, they maximize their profit from the software if they sell the Industrial version at $600. However, two market segments – ‘Small Businesses’ and ‘Students’ remain uncovered in that case. If CSC wants to cover the entire market they must offer the Student version at a price of $50. CSC cannot offer the Student version at price $50 replacing the Industrial version at $600, as the profitability of...
If the system bug fix is a contractual obligation, can the system bug fix be treated...
If the system bug fix is a contractual obligation, can the system bug fix be treated as an assurance warranty? Can it be seen as a separate performance obligation?
What are the vulnerabilities to the internet system that make it susceptible to cyberterrorism?
What are the vulnerabilities to the internet system that make it susceptible to cyberterrorism?
The A Company and the B Company are the only two firms that produce and sell...
The A Company and the B Company are the only two firms that produce and sell a particular product. The inverse demand curve for their product is: P=19-0.5Q where Q=QA+QB The companies have identical cost functions: TCA=3+QA TCB=3+QB a) Suppose that the two companies are owned by Cournot duopolists. Find the output produced by each firm and the market price. Very briefly explain the steps you take in your solution. b)Instead of the Cournot assumption, assume Company A sets its...
Write a discount system for a spa, which provides services and sells products. It offers 3...
Write a discount system for a spa, which provides services and sells products. It offers 3 types of memberships: Premium, Gold and Silver. Premium, gold and silver members receive a discount of 18%, 12%, and 10%, respectively (this might change in future), for all services provided. Customers without membership receive no discount. All members receive a flat 10% discount on products purchased (this might change in future). Your system shall consist of four classes: Customer, Discount, Visit,Product and Services. It...
A company offers machine rental services for material cutting. Consider the following costs of the company...
A company offers machine rental services for material cutting. Consider the following costs of the company over the relevant range of 4,000 to 10,000 hours of operating time for its cutting equipment Total costs: 4,000 hours 5,000 hours 8,000 hours 10,000 hours Variable costs $20,000 ? ? ? Fixed costs 82,000 ? ? ? Total costs 102,000 ? ? ? Cost per hour: Variable costs ? ? ? ? Fixed costs ? ? ? ? Total cost per hour ?...
CompUSA Inc. sells computer hardware. It also markets related software and software-support services. The company prepares...
CompUSA Inc. sells computer hardware. It also markets related software and software-support services. The company prepares annual forecasts for sales, of which the first six months of 2019 are given below. In a typical month, total sales are broken down as follows: cash sales, 30%; VISA® credit card sales, 65%; and 5% open account (the company’s own charge accounts). For budgeting purposes, assume that cash sales plus bank credit card sales are received in the month of sale; bank credit...
This company uses the Dutch auction system to sell its IPO. It wanted to sell 10...
This company uses the Dutch auction system to sell its IPO. It wanted to sell 10 million shares and received the following bids from investors. Bidder​ Bid​ Shares 1​ $40​ 2 million 2​ $37​ 7 million 3​ $36​ 2 million 4​ $34​ 10 million 16.   Which of the following statements is correct? A   Every bidder received some shares. B   Bidder #4 received 1 million shares C   Every successful bidder paid the same price of $36.50 D   All of the above...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT