It appears that the rules related to accounting for specified upgrades were specifically written for
situations in which the upgrade will be licensed separately. Many vendors make major upgrades available
to customers without charging an upgrade fee, as the specified upgrades are included as part of PCS.
This represents an accounting issue for such vendors, because specified upgrades will not be licensed
separately, and, therefore, no VSOE of fair value can be determined for the undelivered specified
upgrade. Accordingly, no revenue from the arrangement can be recorded until the upgrade is delivered.
Note that even a when-and-if-available specified upgrade cannot be accounted for as PCS, as it is not
unspecified. We believe that these rules substantially impact a vendor's business practices and its
willingness to offer upgrades in contracts on a specific or an implied basis, and may even impact whether
a vendor decides to charge a separate fee for major upgrades of its software products.
SOP 97-2 indicates that when a vendor is allocating an arrangement fee based on VSOE of the elements
that are covered by the arrangement, the value that is to be assigned to a specified upgrade right is the
price that will be charged to existing users of the software upon its being upgraded. In practice, this
amount will often vary according to whether a customer is current with its PCS payments or whether it has
not paid for PCS. Sometimes a vendor will require customers to become current with their PCS payments
before they can be entitled to the reduced upgrade prices, or the vendor will require the customer to pay
the full price of a license for the upgraded software. This raises the question of what Paragraph 37 of
SOP 97-2 means by “the price...that would be charged to existing users of the software being updated.”
The amount could vary from the upgrade fee to the full price of a license for the upgraded software. We
believe that, for cases such as this, the intent of SOP 97-2 is that the fees from an arrangement should be
allocated based on the upgrade fee for customers that are current on their PCS payments.
License arrangements may include rights to specified upgrades or enhancements. Such rights may be
evidenced by a specific agreement, commitment, or the vendor's established practice. Allocation of
revenue to the specified upgrade or enhancement is required even if the customer will be entitled to
receive the upgrade or enhancement under PCS, because the obligation is specified. However, the
amount allocated may be reduced for the percentage of licenses that are not expected to be upgraded if
sufficient evidence exists to support this expectation. If the vendor does not have sufficient evidence to
estimate the percentage, then it should be presumed that all customers would exercise the upgrade right.
The estimate of the number of customers who will take advantage of an upgrade needs to be periodically
reviewed. Due to the nature of the software industry, products and customers tend to change frequently.
As a result, the objective evidence that once supported an estimate may change in the future. If a change
is made to the estimate, the effect of the change should be accounted for as a change in an accounting
estimate and dealt with prospectively.
Several situations that may cause customers not to exercise the upgrade right are presented below.
These are also relevant to determining VSOE of the estimated upgrade percentage:
The benefits gained from the related upgrade or enhancement may not be important to the
The customer may not wish to learn how to use the upgraded software for what may be perceived
by that customer as marginal improvements;
The upgrade or enhancement would require more hardware functionality than the customer
currently has; and/or
The implementation of the upgrade may require too much effort on the part of the customer.