Carve In/Carve Out Adjustment Example Prospective Merge After Billing

The following example illustrates the carve in/carve out adjustments for a prospective merge after billing. In this example:

A positive revenue arrangement from a sales order in January is prospectively merged in February with another positive revenue arrangement.
The first sales order is partially billed in the first period (January).
All transactions use U.S. dollars for the transaction and base currency.
All revenue plans divide the revenue equally over three periods.

Activity for each month is as follows. Details are provided only for the carve in/carve out calculations.

January Activity – Sales order, partial billing, revenue recognition, and reclassification
February Activity – Sales order, prospective merge, revenue recognition, and reclassification
March Activity – Final billings, revenue recognition, and reclassification
April Activity – Revenue recognition and reclassification

January Activity

During January, the following transactions are created:

Sales order and its revenue arrangement
Invoice for a portion of the sales order
Month-end revenue recognition and reclassification of deferred revenue

Sales Order 1 Revenue Arrangement

The sales order includes four items and no discount. Carving details from the revenue arrangement are as follows:

Item	Qty	Sales Amount	Calculated FV Amount	Revenue Amount	Carve Out	Carve Out Ratio	Carve In	Carve In Ratio
A	1	120	100	112.50	7.50	0.0625	—	—
B	1	180	100	112.50	67.50	0.375	—	—
C	1	60	100	112.50	—	—	52.50	0.7
D	1	90	100	112.50	—	—	22.50	0.3
Total		450	400	450.00	75.00		75.00	1

January Invoice 1

In January, the sales order is partially billed. The carving ratios established for the sales order are applied to the invoice. The allocation of the gross billing amount to individual revenue elements is shown in the following table.

The allocation of the gross billing amount to individual revenue elements is shown in the following table. The amounts for the January carve in/carve out adjustment for each element’s deferred revenue account appear in the column on the right. As in the Projected Carve column of the revenue summary window, positive numbers indicate carve in amounts, and negative numbers show carve out amounts.

Item	Invoice Amount	Gross Cumulative Billing	Carve Out	Carve In	Effective Cumulative Billing	Carving Adjustment This Period
A	120	120	7.50	—	112.50	–7.50
B	—	—	—	—	—	—
C	60	60	—	5.25	65.25	5.25
D	—	—	—	2.25	2.25	2.25
	180	180	7.50	7.50	180.00	0.00

The carve out for the item B element is skipped because there is no gross cumulative billing amount to carve from.

January month-end adjustments, in addition to the carve in/carve out adjustment, are as follows:

Revenue recognition journal entry (run prior to reclassification)
Unbilled receivable adjustment for element level reclassification or net contract asset or liability per element for arrangement level reclassification

February Activity

In February, another sales order is created for one item. The new revenue arrangement is added to the previous revenue arrangement using the prospective merge process.

Sales Order 2 Revenue Arrangement

The sales order is for a single item. When the revenue arrangement is created, it has only one element. Carving applies only to multi-element arrangements. Other values from the revenue arrangement are as follows:

Item	Qty	Sales Amount	Calculated FV Amount	Revenue Amount	Carve Out	Carve Out Ratio	Carve In	Carve In Ratio
E	1	150	100	150	—	—	—	—
Total		150	100	150	—		—

Prospective Merge Revenue Arrangement 3

A prospective merge adds the revenue arrangement 2 to the residual values from the previous revenue arrangement 1. New revenue elements are created for the new prospective merge revenue arrangement. The discounted sales amount is the difference between the original discounted sales amount and the amount recognized at the end of the previous period. Since no revenue had been recognized for item E, its discounted sales amount is the same as its original discounted sales amount.

The prospective merge process uses a residual ratio to prorate other values in the prospective revenue arrangement. The residual ratio equals the amount recognized prior to the prospective merge divided by the original revenue amount. In the prospective merge arrangement, the quantity is the original quantity × (1 – the residual ratio). The other value in this example that is prorated and updated using a similar formula is the calculated fair value amount. (If the Recalculate Residual Fair Value had been checked, the calculated fair value for each element would be $100.)

The effective date of the prospective merge is February 1. This date is the first day of the first open period.

Item	Qty	Discounted Sales Amount	Calculated FV Amount	Revenue Amount	Carve Out	Carve Out Ratio	Carve In	Carve In Ratio
A	0.6667	82.50	66.67	81.82	0.68	0.0085	—	—
B	0.6667	142.50	66.67	81.82	60.68	0.505667	—	—
C	0.6667	22.50	66.67	81.82	—	—	59.32	0.669224
D	0.6667	52.50	66.67	81.82	—	—	29.32	0.330776
E	1	150.00	100.00	122.72	27.28	0.181867	—	—
Total		450.00	366.68	450.00	88.64		88.64	1

February Carve In/Carve Out Adjustment

After the prospective merge, the original locked revenue arrangement must have the same amounts billed and recognized. To accomplish this, all outstanding deferred revenue and unbilled receivable balances are carried over to the new prospective merge revenue arrangement. The carried-over deferred revenue balances are reallocated for the prospective merge revenue arrangement based on the new carve in and carve out ratios.

The first step in reallocating the deferred revenue balances is to reverse the prior carve in/carve out adjustment. The February carve in/carve out adjustment includes both prior period reversal lines and new lines for the current period. Details for the new lines are shown in the following table:

Item	Invoice Amount	Gross Cumulative Billing	Carve Out	Carve In	Effective Cumulative Billing	Carving Adjustment This Period
A	120	82.50	0.68	—	81.82	–0.68
B	—	–37.50	—	—	–37.50	—
C	60	22.50	—	0.46	22.96	0.46
D	—	–37.50	—	0.22	–37.28	0.22
E	—	0.00	—	—	0.00	—
	180	30.00	0.68	0.68	30.00	0.00

Note:

Although the revenue element for item B has a carve out ratio, it has a negative cumulative billed element and cannot participate in carve out.

February month-end adjustments, in addition to the carve in/carve out adjustment, are as follows:

Revenue recognition journal entry (run prior to reclassification)
Unbilled receivable adjustment
Net contract asset or liability per element for arrangement level reclassification

March Activity

In March the remaining amounts are fully billed. Positive amounts are combined with all historical amounts to derive the gross cumulative billing amounts. The gross cumulative billing amount is then allocated during reclassification based on the carving ratios to calculate the effective cumulative billing amounts.

March Invoices 2 and 3

Item	Invoice Amount	Gross Cumulative Billing	Carve Out	Carve In	Effective Cumulative Billing	Carving Adjustment This Period
A	—	82.50	0.68	—	81.82	—
B	180	142.50	60.68	—	81.82	–60.68
C	—	22.50	—	5.25	81.82	58.86
D	90	52.50	—	2.25	81.82	29.10
E	150	150.00	27.28	—	122.72	–27.28
	420	450.00	88.64	88.64	450.00	0.00

March month-end adjustments, in addition to the carve in/carve out adjustment, are as follows:

Revenue recognition journal entry (run prior to reclassification)
Reverse unbilled receivable adjustment and net contract asset or liability per element adjustments

At the end of March, four of the five revenue elements are fully recognized. To complete the revenue arrangement, revenue must be recognized for the element for item E in April.

January Activity

Sales Order 1 Revenue Arrangement

January Invoice 1

February Activity

Sales Order 2 Revenue Arrangement

Prospective Merge Revenue Arrangement 3

February Carve In/Carve Out Adjustment

March Activity

March Invoices 2 and 3

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