Question

In: Accounting

The company A generates revenue primarily through the following means: Software license fees: typically licenses its...

The company A generates revenue primarily through the following means:

Software license fees: typically licenses its software for periods of up to 60 months. Licensees are normally given the following payment options:

Under the first payment option, the company collects the entire license fee at inception. This is categorized as a Paid-Up-Front (PUF) contract. Under a PUF arrangement, company A typically charges a one-time, paid-up- front fee for perpetual usage and the customer does not have the ability to cancel the contract.

Under the second payment option, the licensee pays a portion of the total software license fees at the beginning of the term (initial license fee [ILF]), and the remainder over the license term (ongoing monthly license fee [MLF] for month-to-month usage). In certain arrangements, the customer is contractually committed to making MLF payments for a minimum number of months even when the customer prematurely cancels the contract.

Under either payment option, the company is not obligated to refund any payments received from the customer.

Maintenance fees: These contracts oblige the company to provide post- contract customer support (PCS) to the client over a specified time period. PCS includes a right to periodic upgrades and technical support. The term for PCS is generally shorter than the term of the licensing agreement and is renewable for the duration of the license period.

Services: Other professional services provided by company A include training, installation, and consulting.

Assume that company A entered into a contract with client TDS Inc. for €230,000 on January 1, Year 1, to transfer a software license and an additional €15,000 for installation of the software. The license entitles TDS Inc. to use the software in its current form over an unlimited period and does not include updates. Two years of customer support come free with the license. In recent stand-alone contracts with other customers for the same software, company A has charged €200,000 for the software license, €60,000 for two-year customer support, and €40,000 for installation. The software is usable without customer support from company A and it can be installed by other vendors. The installation is expected to take 250 hours of which 150 hours will be required in Year 1 and the remainder in Year 2. The entire fee of €245,000 is collected on the contract date Based on the five-step revenue recognition process described by the recent revenue recognition rules (IFRS 15 / US GAAP ASC 606),

a. Determine the number of performance obligations, and the contract price to be allocated to each, in the following situations:

i. The installation service does not modify the software.

ii. Installation involves customizing the software to work seamlessly with other software used by the customer. As before, the installation can be performed by other firms as well.

b. Explain if (and if so, why) your responses in i) and ii) above differ, referring to IFRS 15 or to the equivalent US GAAP ASC 606.

c. How much revenue will be booked in Years 1 and 2 from the contract in each case? Assume that all conditions for revenue recognition other than those specified have been met in the situations above.

Solutions

Expert Solution

Case I : The installation service does not modify the software.

Number of Performance Obligations :

a) Software License

b) Installation service

c) Customer Service

Allocation of Contract Price :

Terms used in the calculation are :

i) Total Contract Revenue ( TCR )

ii) Total Standalone Selling Price ( TSSP )

iii) Standalone Price of Individual Services (SPIS)

Total Contract Revenue ( TCR ) ( Excluding Installation Service )	230000
Particulars	Standalone Price of Individual Services ( SPIS )	Allocation of contract Price (TCP * SPIS/TSSP)
Software License	200000	176923
Customer Support	60000	53077
Total Standalone Selling Price ( TSSP )	260000	230000
Installation Service	40000	15000

a) (ii)

Number of Performance Obligations :

I) Software License and Customized Software Installation

II) Customer Service

Allocation of Contract Price :

Particulars	Amount
Total Contract Price	245000
Allocation to Customer Service ( 230000 * 60000/260000)	53077
Allocation to Software License and Installation	191923

b) In the case - a(ii) , although the installation service could be provided by other entities, the analysis required by IFRS 15 indicates that within the context of its contract with the customer, the promise to transfer the licence is not separately identifiable from the customized installation service. In contrast and as before - case a (i), the software updates and technical updates are separately identifiable

ekkarill92 answered 1 year ago

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