Improve Your Compliance by Using VSOE-Based Revenue Recognition

  • by Akhilesh Mittal, Lead Consultant, Infosys Technologies Ltd.
  • May 15, 2007
You can break down revenue recognition into two considerations — when to recognize the revenue and how much to recognize. Discover the procedure in your SAP system to apply the vendor-specific objective evidence-based fair value process to address these issues. Determine how much revenue to recognize when individual software elements are bundled in a product.
Key Concept

Revenue recognition for multiple elements falls under the scope of the American Institute of Certified Public Accountants’ (AICPA) Statement of Position (SOP) 97-2, which provides guidance to companies to allocate the revenue to the various elements based on vendor-specific objective evidence (VSOE)-based fair value for each element. As per VSOE, the system only recognizes the revenue when the vendor has established the stand-alone price of individual elements or when all of the elements have been delivered. Thus, VSOE has a direct impact on when and how to recognize the revenue for the individual elements of a multiple- element product from an accounting compliance perspective.

US Generally Accepted Accounting Principles (GAAP) state that companies should recognize revenue when it is realized. Companies may struggle to comply with this principle when dealing with multiple-element products, as the different elements may need to be recognized at different times. Because revenue is an indicator of the financial robustness of an organization, if a company reports revenues inappropriately in its financial statements, it may paint a misleading picture to stakeholders and shareholders. Therefore, it is imperative to recognize the revenue at the correct time for legal compliance with GAAP requirements. I’ll show you a method to compute vendor- specific objective evidence (VSOE)- based fair value before carrying out revenue recognition that complies with GAAP requirements.

I’ll take you through an example in which a company creates a multiple-element product. The product in the example is software that includes an initial version, an upgrade one year later, and services such as a one-year contract for customer support. The company can recognize the revenue for the sale of the initial version of the software on the purchase date, but it can’t do the same for the version upgrade, which happens a year later, or the customer service contract, which happens throughout the year.

This process involves creating a multiple-element product in the SAP system, then computing the VSOE-based fair value for the elements of the product. After creating a multiple- element product, I’ll show you how to carry out revenue recognition for it on the basis of VSOE-based fair value. This process, which derives from my experience, is in accordance with the American Institute of Certified Public Accountants’ (AICPA) Statement of Position (SOP) 97- 2. I’ve created the model on R/3 Release 4.7, but it also works on SAP ERP Central Component (ECC) 5.0 and 6.0. You may face variations to my example at your workplace depending on the product and terms and conditions of sale, but the basic concept remains the same.

Akhilesh Mittal

Akhilesh Mittal is a lead SAP consultant at Infosys Technologies Ltd. with eight years of consulting and industry experience. He has experience in FI and CO along with exposure to SD. Akhilesh is currently a consultant in the SAP space for a leading organization in the high technology domain. He has a degree in electronics and communication engineering from IIT Guwahati and an MBA in finance and systems from IIM Lucknow.

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