Specified upgrades for software contracts

Specified upgrades for software contracts – Entities may provide customers with the right to specified upgrades or enhancements as part of a software arrangement. Under IFRS 15, entities will need to evaluate whether the rights to receive specified upgrades or enhancements are promised goods or services and potentially separate performance obligations. If the specified upgrade is a separate performance obligation, a portion of the transaction price is allocated to it and revenue recognition is deferred until the specified upgrade is provided. Specified upgrades for software contracts

Specified upgrades for software contractsSome entities may account for a specified upgrade or enhancement as a separate identifiable component under current IFRS and allocate revenue to it, while others may account for it together with other components. Current IFRS does not restrict the methods that may be used to allocate consideration between components. If the specified upgrades are accounted for as a separate identifiable component, entities may use methods, such as relative fair value or a residual approach, to allocate consideration. Other IFRS preparers may look to US GAAP in developing their accounting policies. Specified upgrades for software contracts

The requirements in IFRS 15 represent a significant change from ASC 985-605 for specified upgrades and enhancements. Under ASC 985-605, because vendor-specific objective evidence (VSOE) of fair value is generally unavailable for a yet-to-be-provided upgrade, an entity that includes such a promise in an arrangement is unable to separate the delivered elements from the upgrade. As a result, the upgrade is combined with the delivered elements as a single component, and the recognition of the entire arrangement consideration is typically deferred until the specified upgrade is provided. Specified upgrades for software contracts

Entities that license software are likely to recognize some revenue from contracts that involve specified upgrades earlier than they did under legacy guidance. Under the new standard, if the specified upgrade is determined to be a separate performance obligation, only the revenue allocated to that upgrade is deferred. Under legacy guidance, by contrast, entities that license software are often unable to separate the delivered elements from the specified upgrade because Vendor-specific objective evidence of fair value is generally unavailable for the specified upgrade. Specified upgrades for software contracts

Applying the new guidance may not significantly change revenue recognition for SaaS providers that have historically accounted for specified upgrades as separate deliverables by using the best estimate of selling price under the multiple-element arrangement guidance. Specified upgrades for software contracts

Specified upgrade rights and product roadmaps

As part of its marketing efforts, a software vendor’s plans for future software product releases and the strategic direction of software development initiatives, commonly referred to as product roadmaps, may be referenced or published in various forms. This could include product development plans, press releases, information on the vendor’s website, marketing materials, and executive presentations.

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These communications may influence the customer’s decision to select that particular vendor’s software over the software of another vendor. In such cases, customers may believe that development efforts and strategies are part of what they are buying. Therefore, the vendor has created an expectation that there will be future deliverables and/or specified upgrades and enhancements, which may result in the arrangement being deemed to contain a specified upgrade right. Specified upgrades for software contracts

Software vendors should evaluate whether the customer’s rights (explicit or implicit through product roadmaps) to receive specified upgrades or enhancements are promised distinct goods or services, and therefore, separate performance obligations. Specified upgrades for software contracts

EXAMPLE – Product development roadmap does not create specified upgrade rightEffective

Facts: Software Co. enters into a contract with a customer to provide ERP software. The transaction does not include the right to receive future when-and-if available updates. However, as part of its sales and marketing efforts, the vendor also communicates its product development roadmap to the customer. At the time of sale to the customer, neither the vendor nor the customer anticipates any updates related to the software purchased by the customer in the near future. Specified upgrades for software contracts

Does the discussion of the product development roadmap create a specified upgrade right?

Answer: Probably not.

Why? Although the discussion of the product development roadmap may have influenced the customer’s decision to purchase the software, the sharing of the product development roadmap would likely not give the customer an expectation that the vendor has promised to provide a specified upgrade right, and therefore, would not create a separate performance obligation. In other words, if Software Co. releases any updates to the ERP software, the customer would make an independent buying decision whether to purchase the updated product.

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EXAMPLE – Product development roadmap may create a specified upgrade right

Facts: Software Co. enters into a contract with a customer to provide general ledger software. The transaction also provides the customer with the right to receive future when-and-if available updates. As part of its sales and marketing efforts, Software Co. also communicates its product development roadmap to the customer. Specified upgrades for software contracts

Does the discussion of the product development roadmap create a specified update right?

Answer: It depends.

Why? The inclusion of the product roadmap may result in a promise to the customer in the form of a specified update right since the customer is entitled to receive all future updates. It is a matter of professional judgment and Software Co. may consider the following indicators:

  • Was the product roadmap customized for the customer’s specific needs and requirements?
  • Does the product roadmap contain a high degree of specificity, including features, functionality and the timing of the release, such that it is reasonably likely to have created an expectation by the customer that the customer will receive a specific upgrade?
  • Does the arrangement contain explicit language stating that the customer will have to purchase items on the product roadmap separately in the future?
  • Is the product roadmap generally made available to new and existing customers via the website, or other marketing material?

Specified upgrades for software contracts

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