Discuss the criteria used to recognize revenue for contract
Sapient Corporation is a technology consultancy firm. Sapient’s disclosures in a recent Form 10-K filing provided an extensive discussion of its revenue recognition policies, excerpts of which follow:
We recognize revenue from the provision of professional services under written service contracts with our clients. We derive a significant portion of our revenue from fixed-price, fixed-time contracts. Revenue generated from fixed-price contracts, with the exception of support and maintenance contracts, is recognized based on the ratio of labor hours incurred to estimated total labor hours. This method is used because reasonably dependable estimates of the revenues and costs applicable to various stages of a contract can be made, based on historical experience and milestones set in the contract.
Revenue generated from fixed-price support and maintenance contracts is recognized ratably over the contract term.
Certain contracts provide for revenue to be generated based upon the achievement of certain performance standards. Revenue is recognized when such performance standards are achieved, including $956,000 of revenue recognized.
Revenue from multiple element arrangements is accounted for under EITF Issue No. 00-21 (EITF 00-21), “Revenue Arrangements with Multiple Deliverables.” For these arrangements, we evaluate all deliverables in the contract to determine whether they represent separate units of accounting. If the deliverables represent separate units of accounting, we then measure and allocate the consideration from the arrangement to the separate units, based on reliable evidence of the fair value of each deliverable. This evaluation is performed at the inception of the arrangement and as each item in the arrangement is delivered, and involves significant judgments regarding the nature of the services and deliverables being provided and whether these services and deliverables can reasonably be divided into the separate units of accounting.
Required:
a. Sapient recognizes revenues based on the provisions of the written service contracts generated for each client. The primary types of contracts are (1) fixed-price, fixed-time contracts; (2) support and maintenance contracts; and (3) performance standards contracts. Discuss the criteria used to recognize revenue for each type of contract and the difficulties in applying the criteria.
b. Discuss the appropriateness of the revenue recognition techniques employed by Sapient in relation to the general revenue recognition criterion of “substantial portion of services has been provided” as discussed in the text of this chapter.
c. As detailed earlier, some contracts have multiple-element arrangements with separate deliverable components. Discuss the criteria used to distinguish among multiple components of the contract. Also speculate on how the firm recognizes revenue when the contract cannot be separated into distinct deliverable components.
