Renewals of and modifications to rights granted in a license arrangement occur frequently. Entities should consider the nature and provisions of license renewals and modifications when determining the appropriate accounting treatment. In addition, the discussions in this section should be considered in conjunction with those in Chapter 9 on contract modifications.
The alternatives outlined in this section are premised on the assumption that the entity does not have an implied obligation to provide PCS during the lapse period.
In this instance, it is assumed that the SaaS arrangement is accounted for as a service contract because the customer does not have the ability to take possession of the underlying software on an on-premise basis in accordance with the requirements of ASC 985-20-15-5.
This alternative view is consistent with the accounting for on-premise term-based software licenses that enable the customer to terminate the license agreement without penalty. For example, if a customer paid for a one-year on-premise term-based software license but had the ability to cancel the arrangement for a pro rata refund with 30 days’ notice, the term of the initial arrangement would be 30 days, with optional renewals thereafter. In those circumstances, the right of return guidance would not be applied.
While the material right’s stand-alone selling price could be adjusted for any discount the customer could receive without exercising the option, this example assumes that the customer could not receive a discount without exercising the option.
The allocation of the transaction price based on relative stand-alone selling price is included for illustrative purposes only and uses simplistic assumptions; judgment will be required to determine stand-alone selling prices in this and similar fact patterns.
The variable consideration resulting from the right of return would generally be estimated on the basis of the transaction price allocated to the on-premise software and related PCS and the amount of that allocated transaction price that is expected to be refunded as a credit to the SaaS arrangement (i.e., the pro rata portion of the on-premise software and related PCS that is “unused”). If the credit plus any incremental fee required to convert to the SaaS arrangement is less than the stand-alone selling price of the SaaS, the entity may need to consider whether a material right has also been granted.
Under ASC 606-10-32-11, an entity includes variable consideration in the transaction price “only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.”
A liability for a return right is typically recognized as a refund liability in accordance with ASC 606-10-55-23(b). However, we believe that if an entity’s contract with a customer is noncancelable and consideration therefore would not be refunded to the customer, it would be acceptable to recognize the liability as a contract liability (e.g., deferred revenue) for the entity’s expected performance associated with a SaaS arrangement.
The amount of variable consideration to include in the transaction price is provided for illustrative purposes only and uses simplistic assumptions; judgment will be required to estimate variable consideration and the related constraint in this and similar fact patterns.
Note that if an entity’s contract does not contain a cloud conversion right at contract inception, a practice of allowing customers to convert their on-premise software license to a SaaS arrangement may create an implied right that is similar to the explicit right provided to the customer in Example 12-24. Significant judgment will be required to determine when an implied right is created in these circumstances.
Entity B would generally allocate the $125,000 between PCS and the SaaS on the basis of their relative stand-alone selling prices if required to do so for presentation or disclosure purposes. However, because both PCS and the SaaS are stand-ready obligations that are recognized ratably over the same period, the $125,000 was not allocated between the two services for purposes of this illustration.
Entity B would generally allocate the $325,000 between PCS and the SaaS on the basis of their relative stand-alone selling prices if required to do so for presentation or disclosure purposes. However, because both PCS and the SaaS are stand-ready obligations that are recognized ratably over the same period, the $325,000 was not allocated between the two services for purposes of this illustration.