Functionality of the software
A significant number of companies sell software which can function on its own without updates or support – indicating the software is a distinct performance obligation. This may be because it would not be commercially viable to sell a software on day 1, only for it to stop working on day 2. If that is the case, on premise software (i.e. hosted at a customer’s premises and therefore provide a right to use) are recognised at a point in time.
Significant integration
A customer may purchase various inputs such as products or services such that the combination of these inputs results in a distinct output specified by the customer.
An example may include the purchase of a right to access licence that forms a component of a tangible good that is integral to the functionality of the good such as vehicle tracking devices.
Another example is where a company may conclude that the software license and the future software updates are not separately identifiable because the software license and the other promises are both inputs
into a combined item in the contract
that results in a distinct output.
Significant modification/ customisation
There might be cases where the other performance obligations are essential to the customer’s ability to benefit from the licence because of the function of the software or the industry in which it operates. Management should exercise careful consideration in forming a view over the identification of distinct performance obligations.
The standard does not include a hierarchy or weighting of the indicators of whether a good or service is separately identifiable from other promised goods or services within the context of the contract. An entity evaluates the specific facts and circumstances of the contract to determine how much emphasis to place on each indicator.
Technology industry revenue
There may be situations where one
or more goods or services provided by
a company significantly modifies or
customises other goods or services promised in the contract. An entity should assess whether there is a transformative relationship between the two items being analysed.
If goods or services are highly
interdependent or highly interrelated, these
would generally be combined as a distinct
performance obligation. For a number of
technology companies it may be extremely difficult to assess whether the promise to deliver software is so inextricably linked to the other promises made to the customer, hence management judgement required.
Example 2 states that the updates significantly modify the functionality of the software by permitting the software to protect the customer from a significant number of additional viruses that the software did not protect
against previously. The updates are also integral to maintaining the utility of the software licence to the customer. As such the customer’s ability to benefit from the software declines significantly without the updates.
Highly interdependent/ highly interrelated
Smith & Williamson view
Example 1
Smith & Williamson view
Smith & Williamson view
Smith & Williamson view
Licenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer.
Microsoft Corporation FY20 accounting policy
Example 2
Example 3
Example 4a
Example 4b
Management would need to form a judgement on whether the other services significantly modify the functionality of the software or are also integral to maintaining the utility of the software licence to the customer.
This might be the case for any significant update to the software, but this factor should be considered, along with the other indicators about the nature or frequency of the updates to determine if such an update is essential to the functionality of the software.
From the above it is clear that management may need to exercise judgement to conclude whether the goods and services are highly interdependent or highly interrelated. The impact on revenue recognition is significant as a company would either recognise revenue up front or over time.
A simplified consideration may be to assess whether the software acquired on day 1 would not function on day 2 without the other promises in a contract. We therefore recommend careful consideration in concluding on the distinct performance obligations.
It is clear that an entity does not merely evaluate whether one item, by its nature, depends on the other (i.e. whether the items have a functional relationship). Instead, an entity evaluates whether there is a transformative relationship between the two items in the process of fulfilling the contract.
Our software solutions typically consist of a term-based subscription as well as when-and-if available software updates and upgrades. We have determined that our promises to transfer the software license subscription and the related support and maintenance are not separately identifiable and therefore consider the software license and related support obligations represent a single, combined performance obligation with revenue recognized over time as our solutions are delivered.
NortonLifeLock FY20 accounting policy
Where a license is required to be substantially customized as part of the implementation service, the entire agreement fee for license and implementation is considered to be a single performance obligation and the revenue is recognised using the percentage of completion method as the implementation is performed.
Oracle Corporation FY20 accounting policy
For licences which are dependent on updates for ongoing functionality, the Group recognises revenue based on time elapsed and thus rateably over the term of the contract. Typically, this includes our payroll and tax compliance software.
Sage FY20 accounting policy
For agreements that combine the delivery of software and the obligation to deliver, in the future, unspecific software products, we recognize revenue at a point in time for licenses that are made immediately accessible to the customer. We recognize revenue ratably over the term of the software subscription contract for the unspecified software products, as our performance obligation is to stand ready to deliver such products on a when-and-if available basis.
SAP FY20 accounting policy
A customer may purchase various inputs such as products or
services such that the combination of these inputs results in
a distinct output specified by the customer.
An example may include the purchase of a right to access licence that forms a component of a tangible good that is integral to the functionality of the good such as vehicle tracking devices.
Another example is where a company may conclude that the software license and the future software updates are not separately identifiable because the software license and the other promises are both inputs into a combined item in the contract that results in a distinct output.
There may be situations where one or more goods or services provided by a company significantly modifies or customises other goods or services promised in the contract. An entity should assess whether there is a transformative relationship between the two items being analysed.
If goods or services are highly interdependent or highly interrelated, these would generally be combined as a distinct performance obligation. For a number of technology companies it may be extremely difficult to assess whether the promise to deliver software is so inextricably linked to the other promises made to the customer, hence management judgement required.
Example 2 states that the updates significantly modify the functionality of the software by permitting the software to protect the customer from a significant number of additional viruses that the software did not protect
against previously. The updates are also integral to maintaining the utility of the software licence to the customer. As such the customer’s ability to benefit from the software declines significantly without the updates.
A customer may purchase various inputs such as products or services such that the combination of these inputs results in
a distinct output specified by the customer.
An example may include the purchase of a right to access licence that forms a component of a tangible good that is integral to the functionality of the good such as vehicle tracking devices.
Another example is where a company may conclude that the software license and the future software updates are not separately identifiable because the software license and the other promises are both inputs into a combined item in the contract that results in a distinct output.
If goods or services are highly interdependent or highly interrelated, these would generally be combined as a distinct performance obligation. For a number of technology companies it may be extremely difficult to assess whether the promise to deliver software is so inextricably linked to the other promises made to the customer, hence management judgement required.
Example 2 states that the updates significantly modify the functionality of the software by permitting the software to protect the customer from a significant number of additional viruses that the software did not protect against previously. The updates are also integral to maintaining the utility of the software licence to the customer. As such the customer’s ability to benefit from the software declines significantly without the updates.
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Smith & Williamson view
Example 3
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Smith & Williamson view
Example 4a
Example 4b
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Smith & Williamson view
Example 2
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Smith & Williamson view
Example 1
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