SAB 101 The general rule governing revenue recognition is: y Revenue should not be recognized until it is realizable

and earned.

Because the general rule has been abused by some companies, more specific criteria for revenue recognition have been prescribed by the SEC in SAB 101. As a result, revenue is now considered to be realized and earned when: y y y y Persuasive evidence of an order arrangement exists, Delivery of the ordered goods has occurred or services have been rendered: The sellers prince to the buyer is fixed or determinable, and, Collectibility of the sale proceeds is reasonably assured.

Persuasive Evidence Purchase order and sale agreement documentation practices vary widely between customers, companies, and industries. The SEC appears to be willing to accept as persuasive evidence of an agreement these practices as long as there is some form of written or electronic evidence that a binding final customer purchase authorization, including the terms of sale, is in the hands of the seller before revenue is recognized. Delivery Typically revenue is recognized when delivery has occurred and the customer has taken title and assumed the risks and rewards of ownership of the goods specified in the customers purchase order or sales agreement. More specifically, y y y y Delivery is not considered to have occurred unless the product has been delivery to the customers place of business. If uncertainty exists about a customers acceptance of a product or service, revenue should not be recognized even if the product is delivered or the service performed. Revenue should not be recognized until the seller has substantially completed or fulfilled the terms specified in the purchase order or sales agreement. In licensing and similar arrangements, delivery does not occur for revenue recognition purpose until the license term begins.

Performance SAB 101 requires substantial performance of the sales arrangement by the seller and acceptance by the customer of the product or services rendered before revenue can be recognized SAB 101 notes: y y A seller should substantially complete to fulfill the terms specified in the sales arrangements, and After delivery or performance, if uncertainty exists about acceptance, revenue should not be recognized until after acceptance occurs.

There are two exceptions to the above requirement. Assuming all of the other recognition criteria are met, the first exception is that revenue in its entirety can be recognized if the sellers remaining performance

obligation is inconsequential or perfunctory. In this case, any related future costs must be accrued and expensed when revenue is recognized. A remaining performance obligation is not inconsequential or perfunctory if: y y The remaining performance obligation is essential to the functionality of the delivered products or services. Failure to complete the activities would result in the customer receiving full or partial refund or rejecting the product or services rendered to date.

In considering if a remaining performance obligation is or is not inconsequential or perfunctory, the SEC staff has indicated that the following factors, which are not all-inclusive, would be considered. y y y y y The seller does not have a demonstrated history of completing the remaining tasks in a timely manner and reliably estimating their costs. The cost or time to perform the remaining obligations for similar contracts historically has varied significantly from one instance to another. The skills or equipment required to complete the remaining activity are specialized or are not readily available in the marketplace. The cost of completing the obligation or the fair value of that obligation is more than significant in relation to such items as the contract fee, gross profit, and operating income. The period before the remaining obligation will be extinguished is lengthy. Registrants should consider whether reasonably possible variations in the period to complete performance affect the certainty that the remaining obligations will be completed successfully and on budget. The timing of payment of a portion of the sales price is coincident with completing performance of the remaining activity.

The second exception is a multiple-element deliverables sales arrangement. In this case, a portion of the contract revenue may be recognized when the seller has substantially completed or fulfilled the terms of a separate contract element. Pending additional accounting guidance, on multiple-element revenue arrangements, the SEC indicated that it will accept any reasoned method of accounting for multipleelement arrangements that is applied, consistently and disclosed appropriately. The SEC will not object to a method that includes the following conditions. y y y To be considered a separate element, the product or service represents a separate earnings process. Revenue is allocated among the elements based on their fair value. If an undelivered element is essential to the functionality of a delivered element, no revenue is allocated to the delivered element until the undelivered element is delivered.

In the case where a customer is not obligated to pay a portion of the contract price allocable to delivered equipment until installation or similar service, recognition of revenue on the delivered equipment may be recognized if the installation is not essential to the functionality of the equipment. Examples of indicators that installation is not essential to the functionality of the equipment include: y y y The equipment is a standard product. Installation does not significantly alter the equipments capabilities. Other companies are available to perform that job.

Conversely, examples of indicators that the installation is essential to the functionality of the equipment include: y y The installation involves significant changes to the features or capabilities of the equipment or building complex interfaces or connections. The installation services are unavailable from other vendors. Contractual customer acceptance provisions must be satisfied before revenue can be recognized.

Customer acceptance provisions typically come in one of four forms: 1. Acceptance provisions in arrangements that purport to be for trial or evaluation purposes.

In substance, these transactions are consignment-type sales, and revenue should not be recognized until earlier of acceptance or the acceptance provisions lapses. 2. 3. Acceptance provisions that grant a right of return or exchange on the basis of subjective matters. Acceptance provisions that grant a right of replacement on the basis of seller-specified objective criteria.

Revenue can be recognized rather than deferred so long as a provision can be reasonably determined for the amount of future returns based upon historical return experience of a similar sufficiently large volume of homogeneous transaction. 4. Acceptance provisions based on customer-specified objective criteria. Formal customer sign-off provides the best evidence of acceptance. In its absence, revenue can be recognized rather than deferred if the seller can reliably demonstrate that a delivered product meets the customer-specified objective criteria. Consignment-Type Transactions Products shipped pursuant to a consignment arrangement should not be recorded as revenue since the consignee has not assumed the risks and rewards of ownership. This is long-standing rule. SAB 101 goes further. It states that the following characteristics in a transaction preclude revenue recognition even if title to the product has passed to the buyer: y The buyer has the right to return the product and the buyer does not pay the seller at the time of sale, and the buyer is not obligated to pay the seller at a specified date or dates; the buyer does not pay the seller at the time of sale but rather is obligated to pay at a specified date or dates, and the buyers obligation to pay is contractually or implicitly excused until the buyer resells the product or subsequently consumes or uses the product; the buyers obligation to the seller would be changed (e.g., the seller would forgive the obligation or grant a refund) in the event of theft or physical destruction or damage of the product; the buyer acquiring the product for resale does not have economic substance apart from that provided by the seller, or the seller has significant obligations for future performance to directly bring about resale of the product by the buyer. y The seller is required to repurchase the product (or a substantially identical product or processed goods of which the product is a component) at specified prices that are not subject to change

except for fluctuations due to finance and holding costs, and the amounts to be paid by the seller will be adjusted, as necessary to cover substantially all fluctuations in costs incurred by the buyer in purchasing and holding the product (including interest). The indicators of the latter condition include: The seller provides interest-free or significantly below market financing to the buyer beyond the sellers customary sales terms and until the products are resold. The seller pays interest cost on behalf of the buyer under a third-party financing arrangement or The seller has a practice of refunding (or intends to refund) a portion of the original sales price representative of interest expense for the period from when the buyer paid the seller until the buyer resells the product. y The seller guarantees the resale value of equipment to a purchaser, and the transaction does not qualify for sale-type lease accounting. This transaction should be recorded as an operating lease. y The product is delivered for demonstration purposes.