Some stakeholders in the software industry have questioned how the interaction of paragraphs 606-10-55-42 and 606-10-55-65 affects the accounting for a customer’s option to purchase or use additional copies of software. Consider the following examples:

Stakeholders have reported different views about whether Examples A through C include an “option to acquire additional goods or services,” as referenced in paragraph 606-10-55-42. The staff considered the following two views could be acceptable when a customer has an option to acquire additional software rights (such as incremental user seats or incremental copies), depending on the nature of the arrangement. However, this is not to say that selection of the appropriate view is a choice; in some facts and circumstances, one view will be more appropriate than the other. TRG members agreed that, consistent with practice under previous GAAP, judgment will be needed based on the specific facts and circumstances of the arrangement to determine whether rights to additional copies, seats, or users represent a right to acquire additional licenses or variable consideration with respect to an existing license and thought the staff paper provided a useful framework for making those judgments.

In each of the three examples (A through C), the customer has the option to acquire additional software rights (the incremental users or copies above 500), which are akin to additional goods. Therefore, the option to acquire additional goods or services guidance is applicable to all three examples. Accordingly, the vendor must determine whether the option represents a material right. If the option does not represent a material right, then there would be no accounting for the additional purchases until the purchases occur. If the option does represent a material right in accordance with paragraph 606-10-55-42, then the company would allocate a portion of the transaction price for the initial licenses to the material right. In situations in which a material right exists, because the customer is in effect paying the vendor in advance for future licenses, the vendor would recognize revenue related to the material right when those future licenses are transferred or when the option expires.

In each of the three examples (A through C), additional users or copies represent incremental usage of the software license, rather than an option to acquire additional software licenses (additional rights). The customer’s ability to access or download additional copies of the software for additional users do not change the nature, characteristics, or functionality of the software; they only affect the amount of usage of the rights the customer already controls. As such, additional usage of the software license the customer already controls (for which the customer will pay an incremental fee) is not an option to receive additional goods; instead the fees for additional usage are variable consideration for the license (that is, the rights) already transferred to the customer. Therefore, the variable consideration guidance in Topic 606 is applicable to all three examples. The variable consideration in those examples would be considered a usage-based or sales-based royalty for software (that is, additional users’ equal additional usage). Accordingly, revenue would be recognized in accordance with paragraph 606-10-55-65.

The staff understands the fine-line distinction between treating additional users or seats as additional licenses (View A) or as usage of the software (View B). Naturally, increased user or seat rights reflect increased usage of software. The staff also understands why View B might be considered a preferable interpretation to some software entities. This is because the specific software exception in previous GAAP from having to consider whether a right to additional licenses of previously delivered software is a more-than-insignificant discount has been superseded. Consequently, entities would, under View A, have to undertake an evaluation of whether the right to additional licenses provides the customer with a material right and, if so, have to allocate consideration to, and account for, that material right. This effort would be incremental to what those same entities have to do today if they determine the arrangement is one for multiple licenses.

However, the staff thinks the fundamental question in those types of examples is similar to the question that arises in previous GAAP. Is the contract for a single license or for multiple licenses (that is, are additional users/seats/copies additional rights to use software)? The staff thinks it should be clear that, if the contract includes an optional right to purchase additional software licenses, then there is no basis for not considering whether the customer’s right to do so is a material right. If that right is a material right, then the entity must account for that material right in the same manner as any other material right to purchase other optional goods. Under Topic 606, there is not separate guidance for different types of material rights. Consider other licensing scenarios. If additional rights are offered at a significant incremental discount to the range of discounts typically given for those rights to similar customers, the licensor would account for the initial license in the contract and a material right offered to the customer (that is, there would be two performance obligations). The staff does not think the nature of the additional rights in Examples A through C (in this case, additional capacity) rather than additional geographic or use rights should affect the accounting conclusion reached by the licensor, and also do not think an option to obtain additional geographic or use rights represent additional usage of a single license.

Judgment, based on the specific facts and circumstances of a contract, is required to determine whether an arrangement is for a single license or for multiple licenses under the previous accounting guidance in GAAP. Determining the substance of a licensing arrangement as one for a single license or for multiple licenses frequently will require judgment under Topic 606. It seems to the staff that very similar considerations and judgments would apply under Topic 606 as under previous GAAP, such as to what extent the provision or availability of additional copies of software is effectively a convenience to the customer versus correlated to the benefit the customer can derive from the arrangement (for example, when the number of seats or users grants additional rights to the customer that directly affect the number of clients the customer can service using the software), and that judgment would continue to be necessary to determine whether rights to additional copies/seats/users represent additional licenses based on the facts and circumstances of the arrangement.