Guess what?  It’s the same.

Notwithstanding the debate currently raging about fair-value accounting in this credit crisis, as far as I know, the same revenue recognition guidelines apply whether your company’s revenue is growing in good times, or shrinking in bad times.  All those policies you put in place to comply with US GAAP are still relevant.  The only difference when times are tough is that they will be tested more as pressure on earnings and revenue increases.

Here are some areas that you may be tested on these days.

Side Agreements.  Salespeople may be more inclined to promise things outside the documented arrangement to get an order from a customer.  Now may be a good time to remind everyone about your policy on disclosing such commitments (or get such a policy in place).

Returns.  A downturn is not necessarily a reason to conclude you no longer have the ability to estimate returns under FAS 48 (unless perhaps all your customers are in one industry that is on the verge of collapse).  However, if your practice has never been to offer customers rights of return, stock rotation rights, buy-back arrangements, and the like, then you may start seeing such requests as customers de-risk their own operations.  Trouble is, if you’ve haven’t offered such terms before, you don’t have a history to support your ability to reasonably estimate returns.  Be prepared to have to defer revenue until you can establish a history (which may be a few quarters depending on the length of return cycle you agree to).

Financing.  Resellers and distributors that have had their traditional sources of short term financing for operations either become more expensive or disappear may turn to you as the vendor to help them.  Examples of such assistance are:

• extended payment terms:  this can cause revenue to be considered not fixed or determinable if terms are beyond what you have already defined as “normal”.
• third party financing:  if a bank or other financing source is involved in the transaction, this may change the definition of who your customer is (e.g. if the order comes directly from a leasing company), or may cause you to be incurring incremental risk by participating in the financing (in which case, revenue may have to be recognized as payments are due under the financing arrangement).
• direct financing:  giving a loan or taking an equity stake in a customer not only entails other accounting guidance for that transaction, but could also impact how revenue is recognized (e.g. conversion of outstanding accounts receivable into a longer term note would be considered a concession that would likely make revenue on subsequent sales at least to that customer not fixed or determinable).

Non-standard Arrangements.  Depending on the pressures they face themselves, customers may demand a variety of terms and conditions that you do not routinely deal with.  There is no all inclusive list of what these could be, but some of the more common demands seem to be:  assistance with marketing, commitments to a technology roadmap, PCS buy-downs, and future discounts.  These all have revenue recognition implications that must be assessed at the outset.

VSOE.  All the hard work you did over the past months and years to finally establish VSOE of fair value may be unwound if price reductions impact those elements of your arrangements that typically remain undelivered.  Under the bell-shaped curve approach, lower prices may cause too many outlying transactions.  If you use a stated price approach, not actually charging the stated price when the time comes could lead to a retroactive lack of VSOE of fair value resulting in your losing the ability to apply that method; or worse, a restatement of prior periods if material enough.  Ensure you assess these risks when deciding what element to deep discount.

In the end, bad times may create new and differing facts and circumstances to deal with.  But for any given set of facts and circumstances, the rev rec answer should be the same regardless of the strength of the economy.

No, I’m not talking about TPA 5100.38 – Subsequent Event Related to VSOE.  That just says you can do your VSOE analysis after the balance sheet date, as long as you support it with data that existed on or before the balance sheet date.  What I’m talking about below is what to do when you initially have to recognize an entire arrangement (product, license, everything) ratably because of lack of VSOE of fair value for either PCS or other services.

If you don’t have VSOE of fair value, paragraph 12 of SOP 97-2 actually tells you to defer all revenue “until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist or (b) all elements of the arrangement have been delivered”, but then goes on to provide at least two exceptions:

• “if the only undelivered element is PCS, the entire fee should be recognized ratably”, and
• “if the only undelivered element is services… (for example, training or installation), the entire fee should be recognized ratably”.

So here’s the rule:  if no VSOE of fair value, then ratable treatment over the service period.  I get it.

But what if you establish VSOE of fair value in a subsequent reporting period?  Maybe, with another quarter or two of data, your population of standalone transactions at long last now demonstrates the magic 80/15 bell shape (see discussion of other ways to get VSOE here).

Certainly, we don’t go back and restate prior periods now that we have established VSOE of fair value in a current period.  But what do we do with the millions stuck in the huge deferred revenue waterfall slowly tricking into revenue over the service period?  Do we let that waterfall keep trickling, or do we now reassess those arrangements by applying VSOE of fair value to the remaining undelivered services and recognize the residual in the current period.

Answer:  there isn’t one (which means you get to make a policy choice).  When I chat with some knowledgeable Big 4 colleagues on this topic, about half say the newly established VSOE of fair value should only be applied to new arrangements, while the other half say that you should take the residual revenue in the current period.  One firm actually has come out and explained this issue in their commentary, while others seem not to object to either approach.  In any case, before you go materially altering revenue, ensure your audit team is on board with your choice as these are the sort of judgment calls that evolve.

Personally, I can see it both ways.  Paragraph 12 does indeed say defer revenue until you get VSOE, but doing such a “catch-up” of revenue in a period where nothing else fundamentally happened with the transaction seems like “mark-to-market” accounting for rev rec.

On the other hand, perhaps the exceptions listed in paragraph 12 are supposed to apply for the “life” of the arrangement without our being able to revisit the accounting determined at the outset.

Your call.  Just be consistent.