IBM 2014 Annual Report Download - page 90

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
89
Financing
Financing income attributable to sales-type leases, direct financ-
ing 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.
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 deter-
mined 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 uses 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.
The company determines BESP by considering multiple factors
including, but not limited to, overall market conditions, including
geographic or regional specific factors, competitive positioning,
competitor actions, internal costs, profit objectives and pricing
practices. The determination of BESP is a formal process that
includes review and approval by the company’s management.
In addition, the company regularly reviews VSOE and TPE for its
products and services, in addition to BESP.
Services Costs
Recurring operating costs for services contracts, including costs
related to bid and proposal activities, are recognized as incurred.
For fixed-price design and build contracts, the costs of external
hardware and software accounted for under the POC method
are deferred and recognized based on the labor costs incurred
to date, as a percentage of the total estimated labor costs to fulfill
the contract. Certain eligible, nonrecurring costs incurred in the
initial phases of outsourcing contracts are deferred and subse-
quently amortized. These costs consist of transition and setup
costs related to the installation of systems and processes and
are amortized on a straight-line basis over the expected period
of benefit, not to exceed the term of the contract. Additionally,
fixed assets associated with outsourcing contracts are capital-
ized and depreciated on a straight-line basis over the expected
useful life of the asset. If an asset is contract specific, then the
depreciation period is the shorter of the useful life of the asset
or the contract term. Amounts paid to clients in excess of the fair
value of acquired assets used in outsourcing arrangements are
deferred and amortized on a straight-line basis as a reduction of
revenue over the expected period of benefit not to exceed the
term of the contract. The company performs periodic reviews to
assess the recoverability of deferred contract transition and setup
costs. This review is done by comparing the estimated minimum
remaining undiscounted cash flows of a contract to the unamor-
tized contract costs. If such minimum undiscounted cash flows
are not sufficient to recover the unamortized costs, an impairment
loss is recognized.
Deferred services transition and setup costs were $2,230
million and $2,402 million at December31, 2014 and 2013, respec-
tively. Amortization of deferred services transition and setup costs
was estimated at December31, 2014 to be $738 million in 2015,
$525 million in 2016, $388 million in 2017, $250 million in 2018 and
$329 million thereafter.
Deferred amounts paid to clients in excess of the fair value
of acquired assets used in outsourcing arrangements were $64
million and $89 million at December31, 2014 and 2013, respec-
tively. Amortization of deferred amounts paid to clients in excess
of the fair value of acquired assets is recorded as an offset of rev-
enue and was estimated at December31, 2014 to be $27 million
in 2015, $15 million in 2016, $7 million in 2017, $6 million in 2018 and
$8million thereafter. In situations in which an outsourcing con-
tract is terminated, the terms of the contract may require the client
to reimburse the company for the recovery of unbilled accounts
receivable, unamortized deferred costs incurred to purchase
specific assets utilized in the delivery of services and to pay any
additional costs incurred by the company to transition the services.
Software Costs
Costs that are related to the conceptual formulation and design of
licensed software programs are expensed as incurred to research,
development and engineering expense; costs that are incurred to
produce the finished product after technological feasibility has
been established are capitalized as an intangible asset. Capital-
ized amounts are amortized on a straight-line basis over periods
ranging up to three years and are recorded in software cost within
cost of sales. The company performs periodic reviews to ensure
that unamortized program costs remain recoverable from future
revenue. Costs to support or service licensed programs are
charged to software cost within cost of sales as incurred.
The company capitalizes certain costs that are incurred to pur-
chase or to create and implement internal-use software programs,
including software coding, installation, testing and certain data
conversions. These capitalized costs are amortized on a straight-
line basis over periods ranging up to two years and are recorded
in selling, general and administrative expense.