The primary authority for software revenue recognition is AICPA Statement of Position (SOP) No. 97-2, Software Revenue Recognition, which is the result of about 12 years of development work from 1985 through 1997. It applies to both public companies (according to SAB 104) and private enterprises.
Under SOP 97-2, recognition of revenue generally occurs at delivery if a four-part conjunctive test is met. Software delivery should be straightforward and require no special production, modification, or authorization by the software seller (vendor). The four-part conjunctive test is as follows:
Persuasive evidence of an arrangement exists. This means that a bona fide contract needs to exist (see Part 4, Legal Rules, regarding application of Article 2 of the Uniform Commercial Code [UCC] to this arrangement).
Software Vendor has two business models. The first is a premium model, whereby it sells (licenses) to large companies an out-of-the-box software solution bundled with a one-year agreement to provide post-contract customer support (PCS). The second is a standard model, whereby it offers its out-of-the-box software solution to smaller customers in a hosting environment. Software Vendor has seen that it has two classes of customers: 1) larger customers who buy its premium solution and 2) smaller customers who use the standard services. As part of its business practice and revenue recognition policy, Software Vendor requires a written sales agreement for the larger customers who buy the software; however, it only requires a purchase order from its smaller customers.
On September 30 (the last day of the quarter), Software Vendor enters into an agreement with a large company whereby the customer will buy the software solution (bundled with PCS) for $10 million. Software Vendor receives a purchase order on September 30 and delivers the product with terms of “FOB shipping point.” Simultaneously, the CFO…