Recognize the software, recognize the pitfalls.

A CPA could write a book about the various implementation issues in SOP 97-2, Software Revenue Recognition (see "Software Revenue Recognition Updated," JofA, Nov. 97, page 16). In fact, one did. Mary Pat McCarthy, national director of KPMG Peat Marwick's software and services practice, has coauthored Software Revenue Recognition: An Analysis of SOP 97-2. She has examined possible areas of confusion in applying the standard, which brings order to an accounting area long marked by diverse practices. With the SOP already in effect, McCarthy spoke to the Journal about what companies need to know about software revenue recognition.

For example, paragraph 16 of the SOP discusses the use of written contracts as evidence of an arrangement between vendor and customer. "Companies have been asking some questions about how rigid the SOP is on this point--what if the customer signs the contract but the vendor doesn't get it until after the end of the reporting period? Paragraph 16 is clear: Even if the parties have an oral agreement, a written contract must be signed by both parties and received at the vendor before the reporting deadline. This assumes, of course, the vendor uses written contracts as a customary practice."

Another issue McCarthy sees as key involves specified upgrades. A vendor may agree to deliver current software by one date and to provide upgrades or enhancements later. In that case, the company should consider the upgrades as separate elements. "For example, many companies are promising future upgrades designed to be Y2K-compliant or able to handle European monetary unit transactions. These Y2K or EMU enhancements represent specified upgrades even if customers otherwise would be entitled to receive that software as part of maintenance."

A provision added to the SOP after the exposure period addresses, for example, steep discounts for postcontract customer support (PCS) contracts that take effect after the initial year. "It's a matter of judgment whether the discount is so steep that the vendor is actually providing an additional element." (That is, it's not an additional purchase but an additional element of the first one.) McCarthy sees vendors specifying a discount in advance to encourage customers to become long-term maintenance clients. "As a footnote in the SOP says, when a company offers significant discounts, the fee for the current arrangement, plus the anticipated renewal fee, needs to be allocated to all those elements. I think a lot of businesses will miss this in developing licensing agreements."

These are just a few of the changes. McCarthy advises a close examination of all the provisions of SOP 97-2. Institute members with questions on the SOP's guidance can call the Technical Information Hotline at 800-862-4272.

RELATED ARTICLE: Changes for SOP 97-2

Meanwhile, AcSEC, with the FASB's approval, has postponed portions of SOP 97-2 for one year. SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition, will defer for one year the application of the following passages in SOP 97-2, which limit what is considered vendor-specific objective evidence of the fair value of the various elements in a multiple-element arrangement:

* The second sentences of paragraphs 10, 37, 41 and 57.

* Example 3 in "Multiple-Element Arrangement--Products" on page 67 (appendix A).

* Example 3 in "Multiple-Element Arrangement--Products and Services" on page 70 (appendix A).

All other provisions of SOP 97-2 remain in effect. SOP 98-4, effective as of March 31, 1998, applies to all multiple-element software arrangements, as defined in paragraph 9 of SOP 97-2. If an enterprise has already applied SOP 97-2 in an earlier period for financial statements or information already issued, amounts reported in those financial statements or as part of that information may be restated to reflect the deferral of the effective date of the portions noted above.