6.5 Technology, Media, and Telecommunications

6.5.1 Technology

6.5.1.1 Capitalized Software Development Costs

Example of an SEC Comment

We note your policy disclosure regarding internally developed software costs and that no internally developed software costs were capitalized during the periods presented. Please describe for us the development process related to your internal-use software, highlighting recently developed offerings and added functionality, and explain why there [were] no development costs capitalized during the periods presented. Also, describe for us how you apply the guidance in ASC 350-40-25 and what consideration was given to disclosing your policies for internal-use software development costs particularly since your software is provided in a software-as-a-service platform.

ASC 985-20 provides guidance on accounting for costs incurred to purchase or internally develop software that will be sold, leased, or marketed. Under this guidance, costs incurred to establish technological feasibility of the software are expensed as incurred, whereas subsequent production costs (e.g., those for testing or producing master copies) are capitalized.

ASC 350-40 details how to (1) determine whether purchased or internally developed software is for internal use and (2) account for costs incurred for developing or obtaining internal-use software. Under this guidance, costs incurred during the preliminary project and postimplementation stages are generally expensed as incurred, while certain costs incurred during the application development stage are capitalized. Internal-use software is described as being “acquired, internally developed, or modified solely to meet the entity’s internal needs” and as being developed with no substantive plan to “market the software externally.” Therefore, if the software is used to produce a product or is used in a process to provide a service to the customer, but the customer is not given the right to obtain or use the software, the related costs would be accounted for in accordance with ASC 350-40.

The accounting for software development costs can be complex and challenging, and the costs that are eligible for capitalization may depend on whether the costs are accounted for in accordance with ASC 985-20 or ASC 350-40.

6.5.1.2 Costs Related to Contracts With Customers

Examples of SEC Comments

You state that there are no new costs to obtain or fulfill incurred upon renewal unless the client signs on for additional applications, at which time costs to fulfill are minimized. Please tell us whether additional commissions are paid when clients purchase additional applications. If so, tell us whether such costs are commensurate with the initial commissions and the period of time over which you amortize commission costs related to additional purchases. Refer to ASC 340-40-35-1.
Please tell us how you considered whether the [developer fees] are costs incurred to fulfill a contract and whether they meet the criteria for capitalization. Refer to ASC 340-40-15-3 and 40-25-5.
Please tell us, and revise to clarify, whether sales commissions paid upon contract renewal are commensurate with the initial commissions and disclose how commissions paid for renewals are considered in the three to seven year period of benefit for the initial commission. You also disclose that renewals are amortized over the “remaining period of benefit.” Please tell us whether the period of benefit for these commissions exceeds the term of the respective customer contract and if so, explain what the remaining period of benefit represents and how your policy complies with ASC 340-40-35-1. Also refer to ASC 340-40-50-2(b).
You disclose that you apply a practical expedient to expense sales commissions as incurred when the amortization period would have been one year or less. Please tell us whether sales commissions are earned on contract renewals and if so, how you considered those in determining the amortization period.
You disclose that certain sales commissions associated with multi-year contracts are subject to an employee service requirement and are expensed as incurred as they are not considered incremental costs to obtain a contract. Please tell us the nature of the service requirement and how it impacted your consideration in accounting for these sales commissions. Also, tell us whether sales commissions are earned on multi-year contracts that are not subject to an employee service requirement and, if so, how you account for such commissions.
Please tell us, and revise to clarify, whether sales commissions paid upon contract renewals are commensurate with the initial commissions and disclose how commissions paid for renewals are considered in the 8 year period for the initial commission. You also disclose that renewals are amortized over 18 months. Please tell us whether this exceeds the term of the respective customer contract and if so, explain how your policy complies with ASC 340-40-35-1. Lastly, please tell us how you determined the 4 year amortization period for add-ons. Refer to ASC 340-40-50-2(b).
We note that you have determined that sales commissions paid on all third-party agent sales of subscriptions are direct and incremental and, therefore, meet the capitalization criteria. Clarify whether a contract exists with the subscriber at the time the commission is earned. We refer you to ASC 606-10-25-1. That is, confirm that the contract creates enforceable rights and obligations at that time. Also, clarify whether the subscription agreements have substantive termination penalties. Further, tell us whether you pay additional commissions upon contract renewals and whether those renewal commissions are commensurate with the initial commission paid. We refer you to ASC 340-40. In addition, please clarify the nature of direct mail cost and explain why such cost is considered a cost to obtain a contract.

ASC 340-40 provides guidance on accounting for costs related to an entity’s contract with a customer, including (1) incremental costs of obtaining a contract within the scope of ASC 606 and (2) costs of fulfilling a contract with a customer that are not within the scope of another standard. Under ASC 340-40-25-1 and 340-40-25-3, costs incurred to obtain a contract with a customer that the entity would not have incurred had the contract not been obtained are capitalized and recognized as an asset, while costs of obtaining a contract that would have been incurred regardless of whether the contract was obtained are “recognized as an expense when incurred, unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained.”

ASC 340-40 details how to determine (1) whether particular costs are incurred to obtain a contract with a customer and (2) the amortization period for such costs. Under this guidance, an entity should consider whether such costs would have been incurred had the customer decided that it would not enter into the contract just before the contract was ready to be signed; if so, the costs would not be incremental to obtaining the contract. An example of incremental costs incurred to obtain a contract would be commission payments to employees. The accounting for commission payments requires significant judgment when the entity has a tiered commission structure that includes payments the entity makes upon obtaining new contracts as well as payments the entity makes upon contract renewals. The entity should consider whether the commission paid upon a contract renewal is commensurate with the initial commission. This determination will also affect the determination of the amortization period under ASC 340-40-35-1.

6.5.1.3 Recognition of Revenue From Contracts With Customers

In the technology industry, contracts with customers typically have multiple performance obligations. Consequently, when the SEC staff reviews the filings of registrants in the technology industry, it may comment on the manner in which revenue is measured and recognized in such arrangements as well as on the related disclosures. Historically, registrants have been asked to clarify the descriptions of promised goods or services in an arrangement, how they determined the stand-alone selling prices of those promised goods or services, and the timing of each element’s delivery or performance.

6.5.1.3.1 Identification of Performance Obligations

Examples of SEC Comments

You state in your . . . Form 10-K that you offer specified upgrades and new license products. Please tell us how you have considered these obligations under ASC 606 and clarify if they represent separate performance obligations.
You disclose that certain software licenses and related post-contract support are combined into a single performance obligation when ongoing services provide frequent and critical updates to maintain the continued functionality of the software. Please describe the software licenses and services you combine into a single performance obligation. Explain how you considered the guidance in ASC [606-10-25-21].
You state that you combine intelligence dependent appliances and software licenses with the related intelligence subscription and support as a single performance obligation. Please explain further the nature of your support services and how you determined that such services are not separately identifiable from the appliance and related software. Refer to ASC 606-10-25-19 and 25-21.
We note that during the [last completed fiscal year], the Company began shipping [devices] with features that function independently from its proprietary software subscription (“distinct [devices]”) that are recognized as a separate performance obligation in hardware revenue. We further note that when distinct [devices] are included in a contract, the hosted services performance obligation is comprised of only the Company’s proprietary software. Please help us better understand why when the distinct [devices] are included in a contract, they are recognized as a separate performance obligation from the hosted services performance obligation. We refer you to ASC 606-10-25-19 through 22.
You disclose that your SaaS-based and PaaS-based arrangements represent a single promise to provide continuous access, a stand-ready performance obligation, to your software solutions and [the software’s] processing capabilities. You also indicate that fixed consideration under these arrangements may relate to a material right. Please tell us, and revise your disclosures to clarify, whether the material right is a separate performance obligation and if and how you have allocated consideration to this promise. Reference ASC 606-10-55-41.
Tell us how you considered ASC 606-10-55-56(b) in assessing whether your revenue arrangement includes a software license and SaaS, and whether they are distinct from each other or could be accounted for as a combined item based on their functionality and the degree to which they affect each other. Refer to ASC 606-10-55-56(b).
You disclose . . . that customer licensing arrangements include the term license, implementation services, and annual support inclusive of unspecified upgrades and enhancements, and that these promises represent one combined performance obligation because they are not distinct in the context of the contract. Please tell us how you made this determination and considered the guidance in ASC 606-10-25-21.

When a contract is identified and determined to be within the scope of ASC 606, all promised goods and services should be identified. ASC 606-10-25-18 provides examples of certain items that could constitute promised goods or services in an entity’s contract with a customer, and the entity should evaluate whether such promised goods or services are distinct (i.e., capable of being distinct and distinct within the context of the contract). Such promises could be implied on the basis of business practice or explicitly stated in the contractual agreement; however, the entity is not required to identify immaterial promises.

ASC 606-10-25-19 states that a promised good or service is distinct if (1) the “customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct)” and (2) the “entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract).” If both of these criteria are met, the entity should consider the guidance in ASC 606-10-25-14 to determine whether the promised good or service is part of a series of goods or services that (1) are substantially the same and (2) have the same pattern of transfer to the customer as defined in ASC 606-10-25-15. If the criteria in ASC 606-10-25-14 are not met, the unit of accounting is the individual distinct good or service; alternatively, if these criteria are met, the unit of accounting is the series of distinct goods or services. In accordance with ASC 606-10-25-22, if the promised good or service is not distinct, the entity should “combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct.”

Technology companies need to use significant judgment when identifying performance obligations in a contractual agreement. For example, multiyear license agreements typically contain the software license as well as postcontract customer support (PCS). Under ASC 606, an entity is required to assess whether the software license and the PCS are each distinct; this determination could affect the identification of performance obligations, the allocation of the arrangement’s contract value to each performance obligation, and the timing of revenue recognition. When combining promised goods and services into one performance obligation, the entity should evaluate the guidance in ASC 606-10-25-20 and 25-21.

6.5.1.3.2 Estimation of the Stand-Alone Selling Price

Examples of SEC Comments

You indicate that you use the residual approach to estimate the standalone selling price for your software licenses since the same products are sold to different customers at a broad range of prices, which are highly variable. Please provide a comprehensive, quantitative discussion of such variability to support your conclusion.
Please tell us the methods, inputs, and assumptions used to determine the transaction price and allocation of the transaction price for each of your performance obligations. Clarify how your existing disclosures comply with ASC 606-10-50-20.
We note from your response . . . that you sometimes use the residual approach to estimate the standalone selling price for sales of new products, services and [X] software suite offerings. Please tell us how you met one of the criteria in ASC 606-10-32-34(c), and to the extent material please provide a comprehensive discussion to support use of the residual approach for new products, services and [X] software suite offerings.

Under ASC 606-10-32-28, an entity should allocate the transaction price of a contract with a customer to the promised goods or services “in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.” In arrangements with multiple performance obligations, the transaction price must be allocated to the promised goods or services on a relative stand-alone selling price basis. To determine the stand-alone selling price of each promised good or service, an entity considers the price at which it would separately sell a promised good or service to a customer. The best evidence of this separate price is the price associated with a stand-alone sale of the promised good or service in similar arrangements. However, in the absence of observable evidence, an entity could use alternative approaches, including (1) the adjusted market assessment approach, (2) the expected cost plus a margin approach, and (3) the residual approach.

The residual approach should be used only when the stand-alone selling price of a good or service is not directly observable and is either highly variable or uncertain. In such cases, it may be appropriate for an entity to use the residual approach if, for example, the entity (1) sells the same good or service to different customers at a broad range of prices or (2) has not yet established a price for the good or service.

The SEC staff focuses on how registrants in the technology industry allocate consideration to promised goods or services in arrangements with customers that involve multiple performance obligations, and the staff may request additional information about the factors, inputs, and assumptions used to determine the stand-alone selling price of each promised good or service. The application of these factors, inputs, and assumptions requires judgment, particularly in the evaluation of promised goods or services that are not sold on a stand-alone basis.

For example, suppose that an entity does not sell software licenses on a stand-alone basis but instead sells term-based licenses in bundles that include both a right-to-use software license and PCS. To establish the stand-alone selling prices of the software license and the PCS, the entity must first determine whether the software license and the PCS are each capable of being distinct and distinct within the context of the contract. If the entity determines that the software license and the PCS meet both of these criteria, it should then consider observable data points if they exist. In addition, when the entity is establishing the stand-alone selling prices of the software license and PCS, it may be appropriate for the entity to consider (1) the value relationship between the PCS and the software license if PCS is typically priced as a percentage of the license fee, (2) the economic life of the entity’s software, and (3) the renewal rates of the entity’s customers.

6.5.1.3.3 Timing of Revenue Recognition

Examples of SEC Comments

You state that on-premise revenue is recognized upon delivery and transfer of control of the underlying license to the customer. Please clarify whether your reference to “the customer” means a channel partner such as reseller, distributor or system integrator, or end-user customer. Also, tell us how you determine when the customer has obtained control. Refer to ASC 606-10-25-30 and 606-10-50-19.
Please help us better understand the nature of services associated with setup fees, including whether they are recurring or one-time. If material, please revise your future filings to describe the timing of revenue recognition associated with these fees. Please refer to ASC 606-10-50-18 and 50-19.
Please tell us what consideration was given in disclosing the measure of progress of each type of service revenue and how each method depicted your performance in transferring control of goods or services promised to a customer. We refer you to ASC 606-10-25-31 and 25-33.
We note that a majority of your SaaS subscription revenues are satisfied over time with certain SaaS performance obligations satisfied at a point in time. Please clarify the nature of the services that are satisfied at a point in time and what consideration was given to disaggregating revenue from contracts with customers into categories that depict how the nature and timing of revenue and cash flows are affected by economic factors. We refer you to ASC 606-10-50-5 and 55-91(f).
[T]ell us whether the nature of the SaaS arrangement is a) a promise to provide access to the SaaS or b) a promise to provide a specified amount of services and in either case, why revenue recognition at a point in time (absent contractually stated ongoing service obligations) would be appropriate. Refer to your basis in the accounting literature.

ASC 606-10-25-23 requires an entity to “recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (that is, an asset) to a customer.” The satisfaction of a performance obligation is determined by the transfer of control of an asset to a customer. ASC 606-10-25-25 states, in part, that “[c]ontrol of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.” If control is transferred over time, revenue will be recognized over time in a manner that depicts the entity’s performance in transferring control of the promised good or service. If control is transferred at a point in time, revenue will be recognized at that point.

For an entity to recognize revenue over time, one of the following criteria in ASC 606-10-25-27 must be met:

“The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.”
“The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced.”
“The entity’s performance does not create an asset with an alternative use to the entity . . . , and the entity has an enforceable right to payment for performance completed to date.”

If any one of these criteria is met, an entity should recognize revenue over time by using a method that depicts the pattern of transfer of control to the customer. ASC 606-10-25-33 indicates that input or output methods are appropriate methods of measuring progress when revenue is recognized over time.

However, ASC 606-10-25-30 indicates that when a performance obligation is not satisfied over time, revenue related to the performance obligation should be recognized at the point in time at which the performance obligation is satisfied. This is typically the case when an entity sells perpetual and term-based software licenses.

6.5.1.4 Disclosures About Non-GAAP Measures and Key Metrics in MD&A

Examples of SEC Comments

In the highlight section, you present non-GAAP organic revenue growth, adjusted EBIT margin growth and adjusted EPS growth without also presenting the change in the comparable GAAP measures. Your presentation appears to give greater prominence to the non-GAAP measures, which is inconsistent with the Question 102.10 of the Compliance and Disclosure Interpretations on Non-GAAP Financial Measures. Please revise your future earnings releases to comply with that guidance.
Your revised disclosure . . . indicates that the Daily Active User growth was relatively flat in the latter part of the quarter . . . . Expand your disclosure to explain the factors that impacted your user growth rate during this period. . . . You state . . . that in the past you relied on third-party analytics to calculate your metrics and that your metrics may not be comparable to prior periods. To understand comparability among periods, revise to disclose when you shifted to using internally generated analytics, particularly Daily Active Users.
We note that you discontinued disclosing net revenue retention rates in your . . . Forms 10-Q. Please explain to us why you removed this metric, including why you determined that it was no longer useful to an investor. Refer to Item 303 of Regulation S-K and SEC Release 33-10751.
We note that you adjust the income tax provision to reflect the expected cash taxes to be paid in your calculation of Non-GAAP adjusted net income. Your income tax adjustment is inconsistent with Question 102.11 of the updated Non-GAAP Compliance and Disclosure Interpretations issued on May 17, 2016. Please revise the tax adjustment in future filings to reflect the current and deferred tax expense commensurate with the non-GAAP measure of profitability.
We note that you present forward looking non-GAAP measures for various financial line-items without providing the reconciliation to the most directly comparable GAAP financial measure or the statement that providing such reconciliation requires unreasonable efforts. Refer to Item 10(e)(1)(i)(B) of Regulation S-K and the guidance in Question 102.10 of the Compliance and Disclosure Interpretations on Non-GAAP Financial Measures and revise your future filings to provide the required information.
You disclose that annual run rate (“ARR”) . . . is an operating metric used to measure the health of your subscription business as it captures expected subscription and support cash generation from customers. We also note that subscription revenue includes on-premises term-based license revenue, for which revenue is recognized at a point-in-time. Please address the following:
- Clarify how this measure is calculated. Specifically address how the up-front revenue received from term licenses is factored into your ARR calculation and provide examples to help explain such calculations. Clarify whether you annualize revenue recognized or invoiced amounts.
- Tell us the length of a typical subscription contract term and explain how you consider contract renewals in your ARR calculations.
- Explain how multi-year contracts are factored into your calculations and tell us the amount of revenue recognized from multi-year contracts for each period presented and the typical terms of such arrangements.
- Explain how any software exchanges, additions to current customer subscriptions, and new customer subscriptions acquired are factored into your calculation. Please provide an example to explain these calculations.
- Clarify whether ARR reflects any actual or anticipated reductions of revenue due to contract non-renewals or cancellations, and discuss any limitations present as a result.
- Revise to describe how ARR differs from GAAP revenue and specifically address the timing of revenue recognition related to the license performance obligation. Additionally, please consider disclosing any of the above information to the extent material.

Within MD&A, registrants in the technology industry often use non-GAAP measures and key metrics to convey additional relevant information to investors.

The metrics used may differ significantly among such registrants given the different service offerings provided. Metrics commonly used in the industry include (1) number of “likes,” (2) revenue per user, (3) daily or monthly active users, (4) retention rates, (5) annual recurring revenue or annual run rate, and (6) weighted-average duration of contracts.

The SEC staff has questioned registrants in the industry when (1) certain metrics are not explained in MD&A, (2) changes are not appropriately quantified, and (3) it is unclear whether metrics represent key performance indicators. Accordingly, the staff may ask registrants to provide a detailed quantitative and qualitative discussion and analysis of the impact of changes in their key metrics disclosed in MD&A.

Because of the vast volume of the metrics used, the SEC staff has been concerned that (1) metrics may not be presented with appropriate context and (2) the link between registrants’ key metrics and their income and future profitability may not be clear. Registrants should review their metrics to ensure that the metrics are clearly defined, portray a balanced discussion, and remain relevant. For additional considerations related to non-GAAP measures and certain financial or operating metrics, see Section 3.4.

6.5.2 Telecommunications

The SEC staff has provided comments to registrants in the telecommunications industry on the application of ASC 606, the revenue standard.

6.5.2.1 Revenue Recognition

Examples of SEC Comments

Please tell us the nature of the specific goods and services that you consider separate performance obligations, particularly as it relates to video entertainment, legacy voice and data as well as strategic services. Please refer to ASC 606-10-50-12.
Please clarify the nature of the equipment and services for which you recognize revenue on a gross basis and those for which you recognize revenue on a net basis. In addition, provide us with a comprehensive analysis regarding how you concluded you were the principal or agent in the related arrangements. Please refer to ASC 606-10-50-12(c) and ASC 606-10-55-36 through 55-40.
For contracts that require the use of certain equipment in order to receive service, please tell us the significant judgements used in determining if equipment should be considered a separate performance obligation. Please refer to ASC 606-10-25-19 through 25-22.
Please identify the specific products and/or services transferred to your customers within your distribution and affiliate agreements. Tell us if you have combined any products and/or services for purposes of determining your performance obligations. . . . Please also describe the judgements used in determining both the timing of satisfaction and amounts allocated to each performance obligation. Refer to ASC 606-10-50-12 and 606-10-50-17.

The SEC staff has asked registrants in the telecommunications industry to expand or clarify their disclosures related to revenue recognition under ASC 606. For example, the staff has asked registrants in the industry to provide details about their compliance with the revenue standard’s expanded disclosure requirements. The staff has indicated that such registrants must provide more comprehensive information related to the significant judgments that affect the amount of revenue recognized and the timing of revenue recognition.

As the telecommunications industry continues to evolve and new products are introduced, registrants in the industry must consider updating their disclosures about the significant judgments that may affect revenue recognition, including judgments related to performance obligations, transaction prices, and costs of obtaining a contract with a customer. For example, various service and equipment offerings that wireless operators make available to subscribers through multiple distribution channels can affect factors such as the allocation of transaction prices, the timing of satisfaction of performance obligations, and the determination of whether the reporting entity is acting as a principal or as an agent. The conclusions reached may be matters of judgment that can have significant implications for revenue recognition and disclosures under the revenue standard. Changes in judgments made in the application of the standard may require registrants to provide additional disclosures that clarify comparability for investors. As registrants’ businesses and offerings evolve, their new business practices are likely to draw further SEC staff scrutiny if their relevant revenue recognition policies and considerations are not clearly disclosed.

For information about other revenue-related considerations, see Section 2.18.