You are beginning the 2015 annual audit of your client L&H.; This is your second

Question

You are beginning the 2015 annual audit of your client L&H.; This is your second year on the audit team L&H; is a software company that develops speech recognition software (think Apple Siri) and engages in complex software licensing and development arrangements. Their main business is developing speech recognition software applications and then licensing the software to their customers. You notice that they have recorded an asset of $1.5 million for a software license they acquired from a customer, Born Software. You inquire about this asset and the CEO tells you that L&H; wiluse the software in their own internal software development projects so they have capitalized the expense and will amortize it over its useful life of 7 years. You are also told that Born is a customer of L&H; as they had purchased a software license from L&H; for $1.5 million just over a year ago. You are told that Born intends to imbed speech recognition functionality into the software they are developing. As Born had not paid for the software license at the time they entered into the second arrangement, both parties agreed that they would swap checks to make it simple. Born would pay L&H; $1.5 million for the L&H; license and L&H; would pay Born $1.5 million for the Born license, all at the same time. The CEO tells you he will answer any questions you have and provide whatever documentation you would need in order to support the accounting for this transaction. He assures you that Born is an independent company and is not a related party to L&H.; The following is a summary of the accounting by L&H;: Entry in 2014 to record sale of license: Debit Credit Accounts receivable $1.5m Revenue $1.5m

Explanation / Answer

FASB Concept statement:

As per FASB 6 paragraph no.25 which defines asset “ Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Asset has three essential charcaterstics:

By applying the above asset reconition criteria to the current case we can understood the following things:

As software license meets all the applicable criteria for reconition of asset the entity recognisation is correct as per FASB concept-6.

Revenue recognition as per standard:

A company should apply the following five steps to recognise as revenue:

Further Recently introduced License implementation guide which provides additional guidance on determining revenue recoginition of licensing contracts:

In the current situation the entity's promise to provide customer with a right tyo use the entity's intellectual property is satisfied at the point in time the customer is able to use and benefit from the license,because the entity's promise in granting the license is solely to make the underlying intellectual property available for the customers use and benefit.

As the promise is not involved any support or maintenance of the license during the license period consequetly the license granted is significant standalone functionality.

The recognition of revenue at the point of time nothing but point of sale is correct.

Entry:

2014: Debit Credit

Accounting receivable a/c $1.5 m

Revenue $1.5m

2015:

Software license (Asset) a/c $1.5m   

Accounting receivable $1.5m

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