IBM 2004 Annual Report Download - page 52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
International Business Machines Corporation and Subsidiary Companies
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ibm annual report 2004
If these criteria are not met, revenue is deferred until the earlier of when such criteria
are met or when the last undelivered element is delivered. If there is objective and reliable
evidence of fair value for all units of accounting in an arrangement, the arrangement con-
sideration is allocated to the separate units of accounting based on each unit’s relative fair
value. There may be cases, however, in which there is objective and reliable evidence of
fair value of the undelivered item(s) but no such evidence for the delivered item(s). In
those cases, the residual method is used to allocate the arrangement consideration. Under
the residual method, the amount of consideration allocated to the delivered item(s) equals
the total arrangement consideration less the aggregate fair value of the undelivered
item(s). The revenue policies described below are then applied to each unit of accounting,
as applicable.
Services
The company’s primary services offerings include information technology (IT) datacenter
and business process transformation outsourcing, application management services,
technology infrastructure and system maintenance, Web hosting, and the design and
development of complex IT systems to a client’s specifications (Design and Build). These
services are provided on a time and material basis, as a fixed-price contract or as a fixed
price per measure of output contract, and the contract terms generally range from less
than one year to ten years.
Revenue from IT datacenter and business process outsourcing contracts is generally
recognized in the period the services are provided using either an objective measure of
output or a straight-line basis over the term of the contract. Under the output method, the
amount of revenue recognized is based on the services delivered in the period as stated
in the contract.
Revenue from application management services, technology infrastructure and system
maintenance, and Web hosting contracts is typically recognized on a straight-line basis
over the term of the contract. Revenue from time and material contracts is recognized at
the contractual rates as labor hours are delivered and direct expenses are incurred.
Revenue related to extended warranty and product maintenance contracts is deferred and
recognized on a straight-line basis over the delivery period.
Revenue from fixed-price Design and Build contracts is recognized in accordance with
SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Production-
Type Contracts,” generally under the percentage-of-completion (POC) method. Under the
POC method, revenue is recognized based on the costs incurred to date as a percentage
of the total estimated costs to fulfill the contract. If circumstances arise that may change
the original estimates of revenues, costs, or extent of progress toward completion, then
revisions to the estimates are made. These revisions may result in increases or decreases
in estimated revenues or costs, and such revisions are reflected in income in the period in
which the circumstances that give rise to the revision become known by management.
The company performs ongoing profitability analyses of its services contracts in order
to determine whether the latest estimates—revenue, costs, profits—require updating. If, at
any time, these estimates indicate that the contract will be unprofitable, the entire esti-
mated loss for the remainder of the contract is recorded immediately.
In some of the company’s services contracts, the company bills the client prior to per-
forming the services. Deferred income of $3.9 billion and $3.3 billion at December 31,
2004 and 2003, respectively, is included in the Consolidated Statement of Financial Position.
In other services contracts, the company performs the services prior to billing the client.
Unbilled accounts receivable of $1.9 billion and $1.8 billion at December 31, 2004 and
2003, respectively, are included in Notes and accounts receivable— trade in the
Consolidated Statement of Financial Position. Billings usually occur in the month after the
company performs the services or in accordance with specific contractual provisions.
Unbilled receivables are expected to be billed and collected generally within four months,
rarely exceeding nine months.
Hardware
Revenue from hardware sales or sales-type leases is generally recognized when the product
is shipped to the client and when there are no unfulfilled company obligations that affect
the client’s final acceptance of the arrangement. Any cost of warranties and remaining
obligations that are inconsequential or perfunctory are accrued when the corresponding
revenue is recognized. Revenue from rentals and operating leases is recognized on a
straight-line basis over the term of the rental or lease.
Software
Revenue from perpetual (one-time charge) licensed software is recognized at the inception
of the license term. Revenue from term (monthly license charge) arrangements is recog-
nized on a subscription basis over the period that the client is using the license. Revenue
from maintenance, unspecified upgrades and technical support is recognized over the
period such items are delivered. In multiple-element revenue arrangements that include
software that is more than incidental to the products or services as a whole (software mul-
tiple-element arrangements), software and software-related elements are accounted for in
accordance with the following policies. Software-related elements include software products
and services as well as any non-software deliverable(s) for which a software deliverable is
essential to its functionality.
A software multiple-element arrangement is separated into more than one unit of
accounting if all of the following criteria are met:
•The functionality of the delivered element(s) is not dependent on the undelivered
element(s).
•There is vendor-specific objective evidence (VSOE) of fair value of the undelivered
element(s).
•Delivery of the delivered element(s) represents the culmination of the earnings
process for that element(s).