Since so many of the elements may be judgmental (e.g., entity strategy) how does this improve revenue recognition?
Answers
To start – I’m making an assumption while answering this question. My assumption is you are referring to the new EITF 08-01 standard that changes the revenue determination models for non-software company multi-element sales.
Revenue should be recognized when it is earned and realizable. Multi-element sales, or sales of multiple related items or bundles, presented a challenge for revenue recognition. The challenges boil down to assigning value to each of the elements based on a consistent and comparable methodology.
Prior to the new EITF standard the main multi-element standard in use was SOP 97.2 – or the residual method. This standard used VSOE (verifiable specific objective evidence) for determining the value for each element in a multi-element sale. VSOE was easier for items that sold separately (like maintenance renewal) and harder for items always sold in a bundle (like the software the maintenance was applied to). Revenue was allocated to the various elements in a multi-element sale using the residual method - fully funding some items while allocating the remainder of the transaction revenue over the other elements on a weighted average basis.
There are a couple of justifications I’ve hear for the new standard. One of the ‘issues’ was the belief by many companies that VSOE was too tough of a standard to meet. The second issue was the residual method itself, which treated some elements in a multi-element sale with higher priority than other items (fully funding some lines while allocating over the others). So the new EITF standard adds possibilities for value determination beyond VSOE (TPE, ESP) as well as implementing the proportional allocation method (weighted average allocation based on the value of each element).
In the end the question of whether revenue recognition was improved by this change is a philosophical question that is open to debate. However it does appear the trend is toward the new proportional allocation model with the value determination methods for a broader set of circumstances (including software companies and others who may not have considered their sales multi-element) before.