During one of the complimentary revenue recognition webcasts that I teach through Tensoft, an attendee asked the following question about the guidelines for multiple-element arrangements and the criteria for stand-alone value: “If I understand this correctly, only the ‘delivered item’ needs to have stand-alone value; the ‘undelivered item’ does not need to have stand-alone value – is that correct?” The attendee then offered the following example from their company:
“For example, training courses and consulting packages sold with a hosted services contract are still considered to be the delivered items even if they are not actually delivered up-front but rather at some point later in the hosted services term. A simplified common multiple-element arrangement at my company is: 12 months of hosted services, training course, non-implementation hourly consulting.
Since we frequently sell both training and consulting services separately, we have met the stand-alone value criteria. We also do not have a general right of return. Therefore, in the above scenario, once we have allocated based on their relative selling price, we can appropriately recognize the hosted services ratably over 12 months and recognize the training when complete (i.e., month 2) and recognize the consulting as performed (i.e., 50% delivered in month 3, 25% in month 4 and 25% in month 6). Are we handling this correctly?”
Before I answer this question specifically, let’s step back and review how “stand alone value” is determined and allocated for multiple elements. First, it must be determined whether elements can be separated. Next, the value of each separate element must be determined.
In order for multiple elements to be separated, each element must have stand-alone value. That means that each element must provide value that is independent of the other elements. (An example of an element that does not have stand-alone value is a set up fee. In this example, a customer only receives value from the set-up fee in conjunction with monthly use of the service.) If the elements of an arrangement are determined to have stand-alone value, then we can proceed to the next step – allocating value to each element.
We can allocate the value to each element in several ways. For software companies and companies that have not adopted EITF 08-1, the value is determined by allocating the VSOE (Vendor-Specific Objective Evidence) to the undelivered elements and allocating the residual value to the delivered elements. If a company has adopted EITF 08-1, we allocate using either VSOE, TPE (Third Party Evidence) or BESP (Best Estimated Selling Price).
Now, going back to the specific question of whether or not this company’s multiple element arrangements have been handled correctly, I would say that it would be very unusual for a multiple element arrangement to have a delivered item with stand-alone value and an undelivered element without stand-alone value. If that were the case, it would seem that there is actually only have one element to account for: the bundle.
In a transaction with monthly hosted services, training and non-implementation consulting, it would seem that there are three elements with stand-alone value. Each element would need to be allocated a portion of the total fee which may or may not be the invoice amount depending on the facts and the revenue recognition method (Residual or Relative Selling Price). If the training and consulting are frequently sold separately, those separate sales could be used to establish their value. Since the monthly services are undelivered, under the residual method we would need VSOE for these. This could be established with a renewal rate. Under the Relative Selling Price method, we would need to estimate the value of the monthly services and then allocate the total fee to each element using the relative percentage of the total fee.
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About Jeffrey Werner: Jeffrey is revenue recognition expert based in Silicon Valley. He lectures and consults on revenue recognition, and is a frequent contributor to the Tensoft blog.