No. 2012-16
22 March 2012
Technical Line
Financial reporting development
Recognizing revenue on
the sale of virtual goods
In this issue:
What you need to know
Overview ........................................... 1
• Many game publishers generate revenue by selling virtual goods within
online games.
Key considerations ............................ 2
Game-based revenue model............... 3
User-based revenue model ................ 4
Item-based revenue model ................ 4
Initial selection of and change in
recognition method........................ 6
• The timing of revenue recognition can differ significantly, depending on the
revenue recognition model a game publisher uses to determine when virtual
goods are delivered.
• Each of the revenue recognition models requires the game publishers to make
certain estimates about game life or player usage patterns.
Making estimates .............................. 6
Gross versus net revenue
recognition .................................... 8
Overview
Many publishers of social games, virtual worlds and popular multiplayer online role
playing games now offer the games free of charge and give players the opportunity
to purchase virtual goods to enhance their game-playing experience. Virtual goods
are non-physical items represented within the game by images, animations or
three-dimensional objects. Game publishers also sell characteristics that provide
a player with additional or enhanced abilities (such as speed, strength or health)
within a game.
The free-to-play model, which is evolving, represents a big change from the online
game publishing industry’s traditional practice of charging a monthly subscription
fee or a fee for premium services.
Many online game publishers using the free-to-play model facilitate the sale of
virtual goods by incorporating a virtual currency within the game. Virtual currencies
generally are earned either through player actions or through progress within the
game, purchased for cash or acquired by trading previously purchased virtual
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goods. For example, virtual currency can be earned by completing an action for an
advertiser (e.g., completing a marketing survey, subscribing to a mailing list,
signing up for a free trial of an unrelated vendor’s service).
This publication focuses on how to recognize revenue for selling virtual goods for
cash (or purchased virtual currency) in a free-to-play game environment.
Key considerations
Online games provided under a free-to-play model are hosted software applications
for which players generally do not have the ability or the right to take possession of
any software. As a result, publishers generally conclude that the software revenue
recognition literature in ASC 985-605 does not apply to recognition of revenue
derived from free-to-play online games and corresponding virtual goods.
Because there is no specific guidance on the sale of virtual goods, publishers apply
SAB Topic 13.1 Under this guidance, revenue is recognized when persuasive
evidence of an arrangement exists, the seller’s price to the buyer is fixed or
determinable, collection is reasonably assured and delivery has occurred or
services have been rendered.
Because players expect
virtual goods to be
available anytime they
play the game or until
the good is consumed,
determining the timing of
delivery can be tricky.
The evaluation of whether the criteria in SAB Topic 13 have been satisfied depends
on the specific facts and circumstances of each arrangement and often requires
judgment. Publishers generally conclude that the criteria of persuasive evidence
of an arrangement, a fixed or determinable fee and reasonably assured collection
have been satisfied when a player purchases virtual currency or a virtual good.
The reasoning is as follows:
•
The terms and conditions that a player agrees to when purchasing virtual
currency or virtual goods are generally evidence of the arrangement.
•
When a player purchases virtual currency or virtual goods, the fee is
often readily determinable and collection is assured because online game
publishers generally do not provide any refund rights for players’ purchases of
virtual currency or virtual goods and payment is made at point of sale. Further,
the terms and conditions for the sale of virtual items typically state that the
game publisher is under no obligation to continue hosting the game for players
who purchased virtual currency or virtual goods and players have no ongoing
rights to the virtual currency or virtual goods.
Therefore, when a player purchases the virtual currency or virtual good, delivery
is generally the only remaining revenue recognition criterion to be met. In most
situations, a player who purchases a virtual good expects that good to be available
anytime he or she plays the game or until that virtual good is consumed (i.e., the
period of delivery for the virtual good is not clearly defined). Determining the timing
of delivery requires careful analysis and depends on the facts and circumstances.
Three revenue recognition models for the sale of virtual goods are used in practice:
the game-based revenue model (GBRM), the user-based revenue model (UBRM) and
the item-based revenue model (IBRM). Each of these models, as discussed in more
detail below, reflects different expectations about the delivery period and the data
available to support those expectations.
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The GBRM is the simplest of the three models, and the IBRM is the most precise
in terms of the number of variables considered in the estimation process.
Consequently, the data required to support the UBRM is more extensive than what
is required to support the GBRM, and the data required to support the IBRM is more
extensive than what is required for the UBRM.
This publication discusses each model and provides factors to consider in
determining the appropriate policy. This discussion assumes the arrangement
meets the criteria of persuasive evidence of an arrangement, a fixed or
determinable fee and reasonably assured collection. It also assumes there are no
stated terms that require the publisher to make the game or virtual good available
for a specified period.
Game-based revenue model
Under the GBRM, the assumed delivery period is the estimated remaining life of
the game. The characteristics of the virtual good or player usage patterns are not
considered. As a result, the company recognizes revenue generated from the sale
of virtual goods or currency ratably over the estimated remaining life of the game,
starting from the point of sale to the player. Under this model, we believe
publishers can begin recognizing revenue at the point of sale even if the item
purchased is virtual currency that a player can use to buy a virtual good.
Illustration 1 — GBRM
Gaming Co. sells virtual currency to a player. At the time of sale, Gaming Co.
believes the remaining life of the game is four years. Gaming Co. would recognize
the proceeds associated with the sale as revenue ratably over the four years of
expected remaining life of the game. As discussed further in the section on
making estimates, the publisher would be required to continually update its
estimate of the remaining game life and adjust the period of revenue recognition
when and as appropriate.
We believe it would be acceptable for a publisher to select this revenue recognition
model, as a policy, for all games offered under a free-to-play model. In certain
situations, in fact, the GBRM may be the only appropriate revenue recognition
approach. For example, if a publisher does not have sufficient data about player
usage patterns for certain games, it should use the GBRM as the basis to record
revenue for those games.
How we see it
Estimating the remaining game life requires the use of judgment. For example, if
a publisher frequently develops enhancements to a game that could extend the
game’s life, the publisher should consider potential enhancements in its estimate.
One drawback of the GBRM is that the revenue escalates as a game nears the
end of its estimated life. That is, because sales of all virtual goods are amortized
over a period commencing with the sale of the good (which varies from
transaction to transaction) and ending when the game life ends (which will be
the same for all transactions), greater amounts of revenue are recognized at the
end of the life of a game. As a result, the revenue for a game that is winding
down likely will not decrease.
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User-based revenue model
The UBRM is based on the presumption that the publisher has implicitly or explicitly
agreed to make any virtual goods or currencies available to the player during the
player’s entire playing experience and, therefore, the period of delivery is the
estimated average player life. Generally, the average player life is shorter than the
expected game life, resulting in the recognition of revenue over a shorter period
under this model than under the GBRM.
However, a key condition for using the UBRM is that a company must have
sufficient data related to normal usage patterns of its players who purchase virtual
goods or currency to demonstrate that it can reasonably estimate the average
paying player life. As discussed below in the section on making estimates, a
company may be unable to reliably estimate player lives if it has insufficient game
playing history or insufficient data (in terms of both quantity and specificity) of
usage patterns of paying game players. It is important to note that the model is
based only on the playing patterns of players who purchase virtual currency or
virtual goods (paying players), not all players. Experience suggests that the playing
patterns of paying players can differ significantly from the playing patterns of
players who elect not to purchase virtual goods.
If a publisher is not able to reasonably estimate the average player life, applying
the UBRM would not be appropriate, and revenue from the sale of all virtual goods
or currencies would be recognized ratably over the estimated remaining game life
based on the GBRM described above.
Under the UBRM, the characteristics of the item purchased by the paying player
do not affect the expected period of delivery. Consequently, revenue is recognized
ratably over the estimated average paying player life beginning when the paying
player makes a purchase of either virtual currency or a virtual good.
Item-based revenue model
The IBRM is the most complex of the three models and requires the simultaneous
consideration of several variables. Unlike the other models, the IBRM takes into
consideration the characteristics of the virtual good sold to determine the implicit
or explicit expected period of time the virtual good will have to be available in the
game for the game player (called the delivery obligation period). As discussed
further below, the delivery obligation period frequently varies depending on the
nature of the virtual good sold. Because the delivery obligation period cannot be
determined until the virtual good is purchased, the sale of virtual currency is
recognized as deferred revenue. Revenue recognition does not begin under this
model until the game player converts virtual currency into a virtual good.
Once the delivery obligation period has been established, revenue is recognized
commensurate with that period. In some cases, the estimated delivery obligation
period for a particular category of virtual goods is shorter than the estimated player
life. As a result, the revenue recognition period for the sale of virtual goods may be
shorter than under the UBRM.
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To apply this model, a company must be able to reasonably estimate the delivery
obligation period for each category of virtual good (see below). Making these
estimates requires a publisher to collect and maintain extensive data related to
paying game player usage patterns for each category of virtual good. The publisher
also has to consider the features and functionality of each game to ensure that it
can make these estimates. This assessment has to be made on a game-by-game
basis, and requires the use of judgment. However, certain game features may make
it difficult to determine the characteristics of the virtual good purchased by the
game player. For example, certain games allow players to trade purchased virtual
goods with other players. In such situations, since the characteristics of the virtual
good owned by the paying player can change during the game, possibly multiple
times, the publisher may not be able to make a reasonable estimate of the delivery
obligation period for the virtual good at the time of purchase.
Most companies that apply the IBRM categorize virtual goods as either
“consumable” items or “durable” items. Consumable items are goods that can be
consumed by a specific action, such as using virtual fuel for a virtual vehicle. Once
the player consumes the virtual good (i.e., in this example, uses the fuel to power
the virtual vehicle), the publisher has fulfilled its obligation to make available the
virtual good for the game player and, therefore, delivery of the virtual good is
complete. As a result, revenue is recognized for consumable virtual goods when the
goods have been consumed by the player. It is important to note that applying this
model would not be appropriate if the publisher lacks sufficient data to track the
consumption of virtual goods.
Durable items are goods that are available to the player over an extended period of
time. Examples include virtual vehicles, furniture and weapons. When a player
purchases a durable virtual good, assuming that the item can be used only in that
particular online game, the player generally expects the item to be available as long
as the player plays the game. Consequently, we believe the delivery criterion for
many durable virtual goods is generally met ratably over the expected delivery
obligation period which, in this case, is the estimated average player life, assuming
the publisher has sufficient data to reasonably estimate expected average paying
player lives.
How we see it
Although the IBRM is the most precise of the revenue models, it requires the
most data to support reasonable estimates. Publishers need to develop and
maintain sophisticated systems for collecting and analyzing this data. Depending
on the volume of player activity and game complexity, this analysis may require
a significant investment of resources. As a result, some publishers may decide
that the additional precision offered by this model does not justify the increased
cost of data collection, analysis and retention.
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Initial selection of and change in recognition method
Because the literature does not require a specific accounting method, the publisher
needs to set an accounting policy that can be applied consistently. Any changes to
the policy need to be justified as preferable in accordance with ASC 250. Given the
uncertain nature of the underlying estimates, the complexity of the games and the
lack of specific authoritative literature, we believe it would be difficult to justify such
a change in principle.
The importance of selecting an appropriate accounting policy cannot be overstated.
A publisher therefore should carefully weigh its facts and circumstances when
determining its accounting policy. While we believe the GBRM can likely be applied
in all situations, it may not be possible to justify the use of the UBRM or IBRM in
certain circumstances. That is, a publisher must have sufficient data about paying
player usage patterns to reasonably estimate the delivery obligation period under
the UBRM. Likewise, to use the IBRM, a publisher would need to have sufficient data
about the characteristics of virtual goods to reasonably estimate the delivery
obligation period.
The importance of
selecting an appropriate
accounting policy cannot
be overstated.
A publisher may have an accounting policy that specifically identifies a particular
model but does not yet have the data to appropriately apply that method to a
particular game. For example, a publisher may initially select the IBRM as its policy
but it does not have data on the characteristics of the virtual goods for a particular
game, although data is available on average paying player life. As a result, the
publisher would initially base its estimation of revenue recognition for this game on
the most detailed estimate of the delivery obligation period available, which would
be the UBRM in this example. When sufficient data on the characteristics of the
virtual goods subsequently becomes available, the publisher would refine its
estimate of the delivery obligation period, in accordance with its stated policy.
The refined estimate would result in a change from the UBRM to the IBRM. In such
situations, we believe the change in the revenue recognition method resulting from
the refined method is a change in an accounting estimate rather than a voluntary
change in accounting principle.
Publishers need to keep in mind that as accounting policies become more complex,
more disclosure generally will be required in the accounting policy note to the
financial statements. Public companies also are reminded that regardless of which
model is selected, this accounting policy likely would involve significant accounting
estimates and, therefore, the publisher likely would need to discuss the key
estimates involved, the sensitivity of those estimates and the specific provisions of
their policy in management discussion and analysis (MD&A).
Making estimates
To select either the UBRM or the IBRM, a publisher must be able to make
reasonable estimates about certain paying player usage patterns. For example, the
UBRM requires a company to make reasonable estimates of the expected average
paying player life, and the IBRM requires a company to identify the characteristics
of the virtual good purchased and determine the expected delivery obligation
period for different categories of virtual goods. Companies that lack the ability to
make these estimates must use the GBRM.
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To determine average paying player life, companies need to determine the
average period of time between the date the player first purchases a virtual good
or currency and the date the player last logs into the game. The date of first
purchase can be objectively determined, but the last log-in date is more difficult
to determine. For example, players may stop playing for a period of time and then
resume playing the game at a later date. A publisher has to use judgment and data
to support a conclusion that player inactivity indicates that the player has stopped
playing the game.
The use of the IBRM requires a number of estimates relating to the delivery
obligation period for each type of virtual good sold. For example, a company using
the IBRM has to identify when a game player “consumes” a consumable virtual
good. This may be a single point in time or may be a series of times (for example,
the virtual good provides multiple power-ups). To make these estimates, a publisher
has to retain, collect and analyze player behavior data, which can require extensive
effort. Additionally, a publisher has to consider the effect the features and
functionality of the game have on its ability to select a particular revenue model.
While this is not a comprehensive list, we believe companies would have to collect
the following data when considering the IBRM:
•
Virtual goods purchased by players with virtual currency that was purchased
with cash separately from virtual goods purchased with virtual currency earned
for player actions
•
Revenue by type of virtual good (i.e., consumable item or durable item)
•
For consumable items, the dates that the virtual goods are purchased and the
dates that such items are consumed
•
For durable items, the data necessary to determine the average paying player
life (the determination of which is discussed above)
To make these estimates, we do not believe that the publisher is limited only to the
data available for a particular game. For example, when a game publisher launches a
new game, we do not believe that the publisher always has to default to an initial
GBRM policy because it does not have historical data related to that newly launched
game. A publisher may determine that it has other games in its portfolio that have
sufficiently similar characteristics (e.g., game genre, game mechanics, demographics
of players, common paying players and types of virtual goods available) to provide a
basis for it to reasonably estimate average player life or expected usage patterns of
virtual goods. In these situations, we believe it would be appropriate to base the initial
estimates on the available data from similar games and adjust these estimates as
needed when data from the new game becomes available.
Any periods used for the expected game life, average paying player life and the
delivery obligation period should reflect management’s best estimate of those
amounts. However, like any significant estimate, those estimates are likely to
change. As a result, it is important that the publisher implement a process to
continually update the data these estimates are based on and maintain appropriate
documentation. Further, we expect the updating process to consider how actual
results compare with historical estimates in addition to how future results may
differ from past results.
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Once a change in estimate is identified, the publisher should account for that
change in accordance with ASC 250-10-45, which provides guidance on accounting
for estimates. That guidance requires the effect of the change in estimate to be
accounted for in the period of change and future periods, if the change affects
both. The change in estimate would apply to prior transactions for which revenue
was initially deferred and continues to be recognized as well as future transactions.
How we see it
As the free-to-play model continues to evolve, finance personnel may face
new challenges. Estimates of player usage patterns may become more complex
and require greater judgment. In addition, new processes and controls may need
to be developed to monitor these patterns and adequately document changes
in estimates.
The following table summarizes when it would be appropriate for an online game
publisher to use each of the revenue recognition methods discussed above, based
on the data that is available.
Only
game life
data
available
Game life
and user life
data
available
Game life, user life
and virtual good
characteristics data
available
GBRM
Required
Permitted
Permitted
UBRM
Not permitted
Permitted
Permitted
IBRM
Not permitted
Not permitted
Permitted
Gross versus net revenue recognition
Publishers often sell their virtual currency and virtual goods using intermediaries
such as social media websites and online application stores. In these situations, the
publisher may be required to give the intermediary a portion of the proceeds
related to the sale of virtual currency or virtual goods. Questions may then arise
about whether revenue should be recognized based on the gross amount billed to
the player or the net amount the publisher retains.
ASC 605-45 provides several indictors to consider when addressing this issue,
many of which do not apply to virtual goods. As a result, in our experience, a key
consideration is determining which party has the ability to set the price of the
virtual currency or good. For example, certain intermediaries require players to
purchase virtual currency or goods through their websites rather than directly from
the online game publisher. If the intermediary has the ability to unilaterally control
the price ultimately paid for the virtual currency or good, a strong indicator may
exist for the intermediary to present revenue on a gross basis and the publisher to
present revenue on a net basis.
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Next steps
The timing of revenue recognition can vary significantly, depending on which
virtual good revenue recognition model a publisher chooses and the amount of
data that is available. To determine an appropriate accounting policy and model
to apply in a given situation, publishers should carefully assess their facts and
circumstances, including their ability to make reasonable estimates about player
patterns based on available data.
The free-to-play virtual goods model is evolving rapidly. New products and changes
to the business model will continue to raise challenges for publishers in determining
the most appropriate manner in which to account for these transactions.
Endnote:
1
SEC Staff Accounting Bulletin Topic 13, Revenue Recognition
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22 March 2012 Technical Line Recognizing revenue on the sale of virtual goods