DataTech (DT) is a software manufacturer. It develops, markets, and supports software that helps manufacturers improve the competitiveness of their products. DT provides a detailed description of its revenue streams in its SEC 10-K filing, excerpts of which are as follows:
We derive revenues from three primary sources:
(1) Software licenses,
(2) Maintenance services and
(3) Other services, which include consulting and education services. We exercise judgment and use estimates in connection with the determination of the amounts of software license and services revenues to be recognized in each accounting period.
For software license arrangements that do not require significant modification or customization of the underlying software, we recognize revenue when:
(1) Persuasive evidence of an arrangement exists,
(2) Delivery has occurred (generally, FOB shipping point or electronic distribution),
(3) The fee is fixed or determinable, and
(4) Collection is probable.
Substantially all of our license revenues are recognized in this manner. Our software is distributed primarily through our direct sales force. However, our indirect distribution channel continues to expand through alliances with resellers. Revenue arrangements with resellers are recognized on a sell-through basis; that is, when we receive persuasive evidence that the reseller has sold the products to an end-user customer. We do not offer contractual rights of return, stock balancing, or price protection to our resellers, and actual product returns from them have been insignificant to date. As a result, we do not maintain reserves for product returns and related allowances.
At the time of each sale transaction, we must make an assessment of the collectability of the amount due from the customer. Revenue is only recognized at that time if management deems that collection is probable. In making this assessment, we consider customer creditworthiness and historical payment experience. At that same time, we assess whether fees are fixed or determinable and free of contingencies or significant uncertainties. If the fee is not fixed or determinable, revenue is recognized only as payments become due from the customer, provided that all other revenue recognition criteria are met. In assessing whether the fee is fixed or determinable, we consider the payment terms of the transaction and our collection experience in similar transactions without making concessions, among other factors. Our software license arrangements generally do not include customer acceptance provisions. However, if an arrangement includes an acceptance provision, we record revenue only upon the earlier of
(1) Receipt of written acceptance from the customer or
(2) Expiration of the acceptance period.
Our software arrangements often include implementation and consulting services that are sold separately under consulting engagement contracts or as part of the software license arrangement. When we determine that such services are not essential to the functionality of the licensed software and qualify as ''service transactions,'' we record revenue separately for the license and service elements of these arrangements.
Maintenance services generally include rights to unspecified upgrades (when and if available), telephone and Internet-based support, updates and bug fixes. Maintenance revenue is recognized ratably over the term of the maintenance contract on a straight-line basis. It is uncommon for us to offer a specified upgrade to an existing product; however, in such instances, all revenue of the arrangement is deferred until the future upgrade is delivered.
When consulting qualifies for separate accounting, consulting revenues under time and materials billing arrangements are recognized as the services are performed.
Education services include on-site training, classroom training, and computer-based training and assessment. Education revenues are recognized as the related training services are provided.
REQUIRED
a. DT generates revenues from software licenses. Discuss the appropriateness of revenue recognition techniques employed by the firm for software licenses in relation to the two general criteria for revenue recognition presented in the chapter.
b. DT recognizes maintenance service revenue ratably over the term of the maintenance contract unless a specific software upgrade is promised to the customer as part of the maintenance contract. Describe the revenue recognition policy of DT for maintenance contracts that include a specific upgrade. Justify the logic for the policy.
c. DT provides educational services to its clients, such as on-site training and assessment, and recognizes revenue when the services are provided. Speculate on the criteria employed by DT to justify when the services have been provided.
d. DT states that the firm must ''exercise judgment and use estimates in connection with the determination of the amounts of software license and services revenues to be recognized in each accounting period.'' Provide several illustrations of judgments or estimates that DT must employ for determining the amount of software license and service revenues to report each accounting period.