Accounting Case Study: SOP 97-2 and GradeTech Revenue Recognition

This case study analyzes revenue recognition for GradeTech, a software company, focusing on the application of SOP 97-2 and other relevant accounting guidelines. The analysis examines four different contract scenarios, evaluating whether revenue can be recognized based on the fulfillment of key criteria such as contract existence, product delivery, price determinability, and revenue collectability. The study addresses complexities like vendor-specific objective evidence (VSOE), perpetual licenses, site license agreements, and potential discounts or future upgrades. It identifies issues that need to be addressed with the client, such as the impact of return policies, the allocation of professional consulting services (PCS) revenue, and the timing of revenue recognition when future services or upgrades are included. The analysis provides a detailed breakdown of revenue recognition for each contract, highlighting the conditions under which revenue can be recognized and the potential for deferred revenue recognition.

Background of SOP 97-2
The SOP 97-2 Software revenue recognition was introduced on October 27, 1997 by American
Institute of Certified Public Accountants. (Softrax, 2019)The SOP was established to tackle the
changes in business model of the software industry. The statement of position splits the sales of
software in two categories mainly:
(a) Out of the box software: This type of software are prepacked and are sold to customers
without any modification. For the said type of software, revenue can be recognised as and
when a contract exist, product is delivered, price is determinable and revenue is collectable.
(b) Software Modifications: This type of software are tailored to fit the requirement of customer
before sale and accounting of such software are bit complicated. Under this type of software,
one needs to determine the delivery of modified software before recognising the revenue.
Also, the SOP 97-2 introduced the concept of vendor specific object evidence of fair value. In terms
of the same, the price of the software must be fair as established by the market. The Statement of
Position also introduced the method of recognising the revenue when hardware and software are in
conjunction with each other. If under this type of case, the software is more incidental to hardware,
revenue of hardware shall be deferred until all the commitment of software are delivered.
Issues under SOP 97-2
The following are the issues under SOP 97-2:
(a) Thin line of difference under the two methods of recognising revenue and complications
involved;
(b) Introduction of vendor specific object evidence of fair value;
Cases
Agreement no 1
In the first case, an agreement has been entered for delivering a perpetual license for 1000 units of
Grade buster to the university of High Tech. The delivery of product shall be on 31st October, 2014
and payment date shall be within 91 days of delivery. The product shall have 90 days warranty and
the VSOE for PCS shall be 15% (Stuart, 2019)
Analysis
Under the given case, 1000 units of license are sold with fair valuation of PCS at 150 per unit. For
revenue to be recognised when the following criteria exists:
(a) Contract Exists;
(b) Product delivery;
(c) Price determinable;
(d) Revenue Collectable.
Since, all the four conditions are satisfied, the revenue of 1000 units shall be recognised up till the
extent of $ 850 right now. However, if there is a policy of offering any discount, then third and fourth
condition are not met and the revenue recognition shall be deferred. Further, the amount of PCS
shall be recognised over the period on the rateable basis. Thus, the following clarifications are
required for discount and pricing model. If there is discount and the exact percentage is not
determinable, revenue recognition shall be postponed (D, 2019)

Agreement no 2
In the second case, Grade tech has entered into a site license agreement with Golden Gate
University for $1,000,000 and the same includes PCS.
For revenue to be recognised when the following criteria exists:
(a) Contract Exists;
(b) Product delivery;
(c) Price determinable;
(d) Revenue Collectable.
Since all the four conditions of revenue recognition are not satisfied, revenue shall not be recognised
as on date as there exists no contract, no delivery of products have taken place etc. Thus, revenue
may not be recognised as on date.
Agreement no 3
Under the third case, an arrangement has been entered with Palo Alto. Terms of payment shall be
50% in 30 days and balance in June, 2015. Further, an opportunity to upgrade the software shall be
provided next year.
For revenue to be recognised when the following criteria exists:
(a) Contract Exists;
(b) Product delivery;
(c) Price determinable;
(d) Revenue Collectable.
There exists contract, product delivery is determinable, price of product is determinable extent to
the discount and fair value of any modification that must be included in the contract and the
collection of revenue is determinable to the extent of discount if offered in future.
Thus, revenue shall be recognised only if no future discount is to be provided and cost of any future
upgradation is determinable and removed. Also, PCS amount shall be allocated on a rateable basis.
Agreement no 4
In the given case, an arrangement for unlimited download of copies is permitted for a period of
three years. Fee for the arrangement is $ 2 Million and product had 90 day warranty with 30 day
return policy.
Under the fourth case, there exists no contract as on December, 31 and there is return policy uptill
the date of 30 days from the date of delivery. Under such circumstance, revenue cannot be
recognised as the four conditions of revenue recognition are not satisfied, revenue cannot be
recognised as on date. (Softrax, 2019)

References
D, L. (2019, October 4). VSOE Calculation Using the Bell Curve Approach. Retrieved from
www.bi101.com: http://www.bi101.com/blog/vsoe/vsoe-calculation-using-the-bell-curve-
approac
Softrax. (2019, October 4). Revenue Recognition For Software Companies. Retrieved from
revenuerecognition.com: https://revenuerecognition.com/industry/software/
Softrax. (2019, October 4). Revenue Recognition For Software Companies. Retrieved from
revenuerecognition.com: https://revenuerecognition.com/industry/software/
Stuart, A. (2019, October 4). Why Vendor-Specific Objective Evidence (VSOE) Spells Trouble. Retrieved
from www.aicpastore.com:
https://www.aicpastore.com/Content/media/PRODUCER_CONTENT/Newsletters/
Articles_2008/CorpFin/Spells