IBM 2010 Annual Report Download - page 72

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies70
Hardware
The company’s hardware offerings include the sale or lease of
system servers, storage solutions, retail store systems and the
sale of semiconductors. The company provides warranties for its
hardware products that range up to three years, with the majority
being either one year or three years. The company also offers
installation services for its more complex products.
Revenue from hardware sales and sales-type leases is recog-
nized when risk of loss has transferred to the client and there are
no unfulfilled company obligations that affect the client’s final
acceptance of the arrangement. Any cost of standard warranties
and remaining obligations that are inconsequential or perfunctory
are accrued when the corresponding revenue is recognized.
Revenue from extended warranty contracts, for which the company
is obligated to perform, is recorded as deferred income and
subsequently recognized on a straight-line basis over the delivery
period. 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) license software
is recognized at the inception of the license term if all revenue
recognition criteria have been met. Revenue from term (recurring
license charge) license software is recognized on a subscription
basis over the period that the client is entitled to use the license.
Revenue from subscription and support, which includes unspecified
upgrades on a when-and-if-available basis, is recognized on a
straight-line basis over the period such items are delivered. In
multiple-deliverable arrangements that include software that is
more than incidental to the products or services as a whole (soft-
ware multiple-deliverable arrangements), software and software-
related elements are accounted for in accordance with software
revenue-recognition guidance. Software-related elements include
software products and services for which a software deliverable
is essential to its functionality. Tangible products containing soft-
ware components and non-software components that function
together to deliver the tangible product’s essential functionality
are no longer within the scope of software revenue-recognition
guidance and are accounted for based on other applicable
revenue-recognition guidance.
A software multiple-deliverable 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). VSOE of fair value is based on
the price charged when the deliverable is sold separately by
the company on a regular basis and not as part of the multiple-
deliverable arrangement; and
• Delivery of the delivered element(s) represents the culmination
of the earnings process for that element(s).
If any one of these criteria are not met, the arrangement is accounted
for as one unit of accounting which would result in revenue being
recognized ratably over the contract term or being deferred until
the earlier of when such criteria are met or when the last undeliv-
ered element is delivered. If these criteria are met for each element
and there is VSOE of fair value for all units of accounting in an
arrangement, the arrangement consideration is allocated to the
separate units of accounting based on each unit’s relative VSOE
of fair value. There may be cases, however, in which there is VSOE
of fair value of the undelivered item(s) but no such evidence for
the delivered item(s). In these 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 aggre-
gate VSOE of fair value of the undelivered elements.
The company’s multiple-deliverable arrangements may have a
stand-alone software deliverable that is subject to the existing
software revenue recognition guidance. The revenue for these
multiple-deliverable arrangements is allocated to the software deliv-
erable and the non-software deliverables based on the relative
selling prices of all of the deliverables in the arrangement using
the hierarchy: VSOE, third-party evidence (TPE) or best estimate of
selling price (BESP). In the limited circumstances where the company
cannot determine VSOE or TPE of the selling price for all of the
deliverables in the arrangement, including the software deliverable,
BESP is used for the purpose of performing this allocation.
Financing
Financing income attributable to sales-type leases, direct financing
leases and loans is recognized on the accrual basis using the
effective interest method. Operating lease income is recognized
on a straight-line basis over the term of the lease.
Determination of Best Estimate of Selling Price
In certain limited instances, the company is not able to establish
VSOE for all elements in a multiple-deliverable arrangement. When
VSOE cannot be established, the company attempts to establish
the selling price of each element based on TPE. TPE is determined
based on competitor prices for similar deliverables when sold
separately.
When the company is unable to establish selling price using
VSOE or TPE, the company uses BESP in its allocation of arrange-
ment consideration. The objective of BESP is to determine the
price at which the company would transact a sale if the product
or service were sold on a stand-alone basis. Due to the fact that
the company sells its products and services on a stand-alone
basis, and therefore has established VSOE for its products and
services offerings, the company expects to use BESP to determine
the relative selling price for a product or service in a multiple-
deliverable arrangement on an infrequent basis. An example of
when BESP would be used is when the company sells a new
product, for which VSOE and TPE does not yet exist, in a multiple-
deliverable arrangement prior to selling the new product on a
stand-alone basis. During the full year 2010, BESP was used in 20
transactions and the effects of its use were immaterial.