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Dr. Fiona Chen
Dr. Fiona Chen, Certified Public Accountant (CPA)
Category: Finance
Satisfied Customers: 355
Experience:  Former IRS Revenue Agent
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I wanted to check Carve Out in Revenue recognition

Customer Question

Hi, I wanted to check Carve Out in Revenue recognition means,when allocated revenue is less than actual Selling price ?
Submitted: 4 months ago.
Category: Finance
Expert:  Dr. Fiona Chen replied 4 months ago.

Dear Revenue Recognition,

Would you please give me some background on the income in which type of businesses?

Thank you,

Fiona Chen, MPA, Ph.D., CPA, ABV, CFF, CITP

Expert:  Dr. Fiona Chen replied 4 months ago.

Dear Revenue Recognition,

This is a relatively long discussion. But hopefully, it is clear.

Part I.

The term of "carve out" has been used in financial statement preparation, which means that it is part and not the whole, complete financial statement. Carve-out financial statements refer to separate financial statements that are

derived or "carved-out" from the financial statements of a larger business. They can be prepared for a variety of purposes - separate financial statements may be used to comply with a buyer's requirement for audited financial statements of an acquired business; they may appear in an initial public offering (IPO) of securities; or they may serve as the basis for final purchase price discussions in an M&A, mergers and acquisitions, transaction.

Part II. Carve out revenue recognition

In terms of revenue recognition, Carving out is for software industry because it has large projects. To wait until the entire project is accomplished to recognize revenue is unrealistic, to recognize revenue when the contract is signed is too early and skew the financial picture of the company, which is not best representing the income picture. We can think this method as the installment revenue recognition for the long-term construction projects. I will provide further reading below. Here is the digest version of the terms. Below continues the discussion.

VSOE is an acronym for vendor-specific objective evidence.

The entire contract must exist and have been signed and agreed upon. At least part of the services or products have been delivered. In accounting practices, vendor-specific objective evidence (VSOE) is a method of revenue recognition allowed by US GAAP that enables companies to recognize revenue on specific items on a multi-item sale based on evidence specific to a company that the product has been delivered.

There are several methods to allocate the revenue.

This method allows companies that sell items that have software licenses, support contracts and hardware items recognizing the revenue of the hardware items on delivery, and the software license or support contract based on the fulfillment of the time the contract it is related to.

VSOE revenue recognition is commonly used by companies that sell software products and services in multiple-element bundles. VSOE focuses on the fair market value of an item sold individually, as opposed to the assigned sales value of the item sold as part of a multiple-element bundle. You can use the VSOE feature to determine VSOE prices of items and defer the recognition of this revenue.

NOTE: The VSOE feature is intended for use by United States companies to maintain GAAP compliance with the American Institute of Certified Public Accountants (AICPA) Statement of Position 97-2 (SOP 97-2) and SOP 98-9 (the residual method).

Part III. Allocated revenue is less than the selling price

There are several aspects to this point. First, if we allocate the part of the delivered products or services as the revenue, of course, it is less than the total selling price. The allocation methods, nevertheless, face the change of actual price and revenue throughout the time frame of the contract. Thirdly, it is practically not always possible to accurately to allocate the entire cost to all the elements of the contract correctly. But this point may not be your point because the variance should be possible to be larger, and not always smaller than the contract price. This part of the discussion also involves in the update of the contracts.

Please review the following references below and links to several interesting articles.

Please feel free to follow up with questions. Otherwise, I am ready to be evaluated by you for your satisfaction of my answer to your question.

Regards,

Fiona

https://www.pwc.com/us/en/technology/assets/software-revenue-recognition-gaap.pdf

https://revenueedge.com/solutions/

https://en.wikipedia.org/wiki/Vendor-specific_objective_evidence

http://contractualcfo.com/documents/WhatstheBigDealaboutVSOE.pdf

VSOE is an acronym for vendor-specific objective evidence.

It has a very specific usage and applies only to the software industry in the cases that the delivery of a project can be traced to certain deliverables. Software contracts often bundle together product offerings which may include a software license, installation, training and postcontract customer support.

VSOE aims to allow vendors to recognize revenue on a partial (or allocated) basis and helps them to determine the value of these revenue allocations, based on historical transactions.

The VSOE Analysis is a "yes or no" checklist that helps to guide companies toward the appropriate accounting treatment.