CHAPTER 5 Revenue Recognition and Profitability Analysis 309 the next six months as the technical support service is provided. If VSOE was not available, the vendor couldn’t recognize any revenue initially, and instead would recognize the entire $90,000 ratably over the six-month period. These revenue deferrals can be material. For example, in its 2013 balance sheet, Microsoft reported a liability for unearned (deferred) software revenue of over $22 billion. In 2009, the FASB’s Emerging Issues Task Force (EITF) issued guidance to broaden the application of this basic perspective to other arrangements that involve “multiple deliverables.” 39 Examples of such arrangements are sales of appliances with maintenance contracts and even painting services that include sales of paint as well as labor. Other examples are products that contain both hardware and software essential to the functioning of the product, such as computers and smartphones that are always sold with an operating system. The new guidance required that sellers allocate total revenue to the various parts of a multipledeliverable arrangement on the basis of the relative stand-alone selling prices of the parts, similar to how software contracts were handled. Sellers had to defer revenue recognition for parts that don’t have stand-alone value, or whose value was contingent upon other undelivered parts. However, unlike software-only arrangements, sellers offering other multipledeliverable contracts were allowed to estimate selling prices when they lacked VSOE from stand-alone sales prices. Using estimated selling prices allowed earlier revenue recognition than would be allowed if sellers had to have VSOE in order to recognize revenue. For some sellers this change had a huge effect. As an example, consider Apple Inc. and the highly successful iPhone. Prior to the change, Apple deferred revenue on iPhones and other products because it didn’t have VSOE of the sales price of future software upgrades included with the phones. This practice resulted in over $12 billion of unearned (deferred) revenue in its balance sheet at the end of the company’s 2009 fiscal year. After this accounting change, Apple recognized almost all of the revenue associated with an iPhone at the time of sale. The only amount deferred was the small amount of revenue estimated for future software upgrade rights. The ASU requires a similar process as was used to account for revenue on contracts that include multiple deliverables. Sellers allocate a contract’s transaction price to the contract’s performance obligations based on the stand-alone selling prices of those performance obligations. Important differences are that the ASU provides much more guidance concerning how to identify performance obligation and eliminates the need for VSOE for software contracts. FRANCHISE SALES The use of franchise arrangements is popular throughout the world. Many retail outlets for fast food, restaurants, motels, and auto rental agencies are operated as franchises. In franchise arrangements, the franchisor , such as McDonald’s Corporation, grants to the franchisee , quite often an individual, the right to sell the franchisor’s products and use its name for a specified period of time. The fees to be paid by the franchisee to the franchisor usually comprise (1) an initial franchise fee and (2) continuing franchise fees. Initial franchise fees compensate the franchisor for the right to use its name and sell its products, as well as for such services as assistance in finding a location, constructing the facilities, and training employees. The initial franchise fee usually is a fixed amount, but it may be payable in installments. In the early 1960s and 1970s, many franchisors recognized the entire initial franchise fee as revenue in the period in which the contract was signed. However, in many cases the fee included payment for significant services to be performed after that period and the fee was collectible in installments over an extended period of time, creating uncertainty as to cash collection. GAAP was modified to require that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee could be recognized as revenue. If the initial franchise fee was collectible in installments, and if a reasonable estimate of bad debts could not be made, the installment sales or cost recovery methods were required. Revenue for multipledeliverable contracts was allocated based on actual or estimated stand-alone selling prices. 39 FASB ASC 605-25-25: Revenue Recognition—Multiple-Element Arrangements-Recognition (Originally EITF 08-1: Revenue Arrangements with Multiple Deliverables (Stamford, Conn.: FASB, 2009)), and EITF 09-3: Applicability of AICPA Statement of Position 97-2 to Certain Arrangements that Include Software Elements (Stamford, Conn.: FASB, 2009)).
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