6.9 Revenue-Based Payments
6.9.1 Background
This section discusses payment features that are based on specified volumes of
sales or service revenues. For example, some instruments require payments that
are indexed to revenues from the sale of goods or services or from royalty
income. In practice, we most commonly observe revenue-based payments in lease
contracts, but it is also possible for such a feature to be embedded in a debt
or equity host.
6.9.2 Bifurcation Analysis
The table below presents an overview of the bifurcation analysis of a payment
feature indexed to specified volumes of sales or service revenues of one of the
parties to the contract. However, an entity should always consider the terms and
conditions of a specific feature in light of all the relevant accounting
guidance before reaching a conclusion.
|
Bifurcation Condition
|
Condition Met?
|
Analysis
|
|---|---|---|
|
Not clearly and closely related (see
Section 4.3.2)
|
It depends
|
Revenue-based payments are not clearly
and closely related to a lease host contract (see
discussion in Section
6.9.3).
Revenue-based payments linked to
specified volumes of sales or service revenues are also
not clearly and closely related to a debt or equity
host.
|
|
Hybrid instrument not measured at fair
value through earnings on a recurring basis (see
Section 4.3.3)
|
It depends
|
From the perspective of the lessor and
the lessee, a lease host contract is not recorded at
fair value through earnings on a recurring basis.
From the issuer’s perspective, legal
form debt is not measured at fair value on a recurring
basis unless the issuer elects the fair value option in
ASC 815-15 or ASC 825-10. The fair value option cannot
be elected for debt that contains a separately
recognized equity component at inception. In the case of
(1) an outstanding share that qualifies for equity
presentation but was determined to have a debt host
contract or (2) an equity host contract, the issuer
would not measure the instrument at fair value, with
changes in fair value recorded through earnings, on a
recurring basis.
From the perspective of a holder of a
debt or equity host contract, the determination of
whether the hybrid instrument is measured at fair value,
with changes in fair value recorded through earnings,
will depend on whether the instrument is (1) considered
a debt security within the scope of ASC 320 (and the
related classification of the debt security) or (2) an
equity security within the scope of ASC 321.
|
|
Meets the definition of a derivative
(see Section 4.3.4)
|
Yes
|
Payment features that are based on
specified volumes of sales or service revenues meet the
definition of a derivative (see Section 6.9.4).
|
|
Meets a scope exception (see Section
4.3.5)
|
It depends
|
ASC 815-10-15-59 and 15-60 contains a
scope exception for non-exchange-traded contracts with
payments based on specified volumes of sales or service
revenues of one of the parties to the contract. See
Section 2.3.5.3 for discussion of this
scope exception.
|
As shown in the table above, the determination of whether a revenue-based payment
feature requires bifurcation as an embedded feature will vary on the basis of
the nature of the host contract, whether the hybrid instrument is remeasured at
fair value through earnings, and whether the revenue-based payment feature is
exempt from the scope of derivative accounting if a specific scope exception is
met.
6.9.3 Clearly-and-Closely-Related Analysis
As indicated above, revenue-based payment features are most commonly identified
in lease host contracts. An example of such a provision would be a scenario in
which a lessee’s monthly lease payment is composed of a base component plus a
sales component (e.g., a base fee of $100,000 plus 10 percent of the lessee’s
total sales from that month). Aside from the likely application of a derivative
scope exception, if an entity were to determine whether the payment feature is
clearly and closely related to the lease host contract, it would conclude that
the underlying nature and economics of the revenue-based payment is not clearly
and closely related to the risks and rewards of a lease host. That is, the
economic risks and rewards of a lease contract typically would not expose the
lessee or lessor to the variability of the revenue of one party to the
contract.
The economic characteristics and risks of a payment feature indexed to specified
volumes or sales or service revenues would also not be considered clearly and
closely related to the economic characteristics and risks of a debt instrument
(i.e., interest rates, credit risk, and inflation rates). Similarly,
revenue-based payment features are not generally considered to be clearly and
closely related to an equity host because the risks and economics of such
features do not align with the risks and economics of an equity holder. Although
there may be a correlation between an entity’s revenues and its equity value,
the economic risks and characteristics would typically not be sufficiently
aligned so as to be considered clearly and closely related.
In practice, we would generally not expect an entity to perform
this evaluation because revenue-indexed features will often meet the scope
exception in ASC 815-10-15-59(d). Accordingly, an entity may not even need to
consider whether the revenue-based payment is clearly and closely related to the
host because the scope exception alone would indicate that bifurcation is not
required (see Example
2-16 for illustration of this scope exception).
6.9.4 Derivative Analysis
The table below presents an analysis of whether a payment
feature indexed to specified volumes of sales or service revenues meets the
definition of a derivative (see Section 4.3.4). However, an entity should
always consider the terms and conditions of a specific feature in light of the
applicable accounting guidance before reaching a conclusion.
|
Characteristics of a Derivative
|
Characteristic Present?
|
Analysis
|
|---|---|---|
|
Underlying and notional amount or
payment provision (see Section 1.4.1)
|
Yes
|
A feature that could adjust the payments
of a contract on the basis of specified volumes of sales
or service revenues has both an underlying (specified
volumes of sales or service revenues) and a notional
amount (e.g., the debt’s outstanding amount, number of
shares) or a payment provision.
|
|
Initial net investment (see Section
1.4.2)
|
Yes
|
The initial net investment in an
embedded feature is its fair value (i.e., the amount
that would need to be paid to acquire the feature on a
stand-alone basis without the host contract). Generally,
a feature that adjusts the payments of a contract on the
basis of specified volumes of sales or service revenues
has an initial net investment that is smaller than would
be required for a direct investment that has the same
exposure to changes in the value of the specified
volumes of sales or service revenues (since the
investment in the host contract does not form part of
the initial net investment in the embedded feature).
|
|
Net settlement (see Section
1.4.3)
|
Yes
|
Adjustments to the payments of a host
contract on the basis of specified volumes of sales or
service revenues meet the net settlement condition
because the feature is cash settled (neither party is
required to deliver an asset that is associated with the
underlying and whose principal amount, stated amount,
face value, number of shares, or other denomination is
equal to the feature’s notional amount).
|
As shown in the table above, a payment feature indexed to specified volumes of
sales or service revenues typically meets the definition of a derivative.
However, such a feature often qualifies for a scope exception. Section 2.3.5.3 includes a variety of examples
for which this scope exception applies.