Chapter 14 — Presentation
Chapter 14 — Presentation
14.1 Overview
ASC 606-10
45-1 When either party to a
contract has performed, an entity shall present
the contract in the statement of financial
position as a contract asset or a contract
liability, depending on the relationship between
the entity’s performance and the customer’s
payment. An entity shall present any unconditional
rights to consideration separately as a
receivable.
As discussed in Chapter 4,
a contract with a customer creates legal rights and obligations. The rights under
the contract will generally give rise to contract assets as the entity performs (or
accounts receivable, if an unconditional right to consideration exists); and
contract liabilities are created when consideration is received (or receivable) in
advance of performance. Each reporting period, an entity is required to assess its
financial position related to its contracts with customers. Depending on the extent
to which an entity has performed and the amount of consideration received (or
receivable) by the entity under a contract, the entity could record a contract asset
or a contract liability.
Paragraph BC317 of ASU 2014-09 indicates that an entity should present its remaining rights and obligations under a contract on a net basis. The reasoning behind this is that neither party to the contract would continue to fulfill its obligations if it knew that the other party would not perform. Because the rights and obligations in a contract are interdependent, contract assets and contract liabilities that arise in the same contract should be presented net.
Receivables should be recorded separately from contract assets since only the
passage of time is required before consideration is due. That is, receivables are
only subject to credit risk. In contrast, contract assets are subject to more than
just credit risk (e.g., they are also subject to performance risk). As discussed in
paragraph BC323 of ASU 2014-09, the FASB and IASB believed that making a distinction
between contract assets and receivables was important to financial statement users.
Consequently, only contract assets and contract liabilities are reported net.
Accounts receivable should be reported separately.
ASC 606-10-45-5 addresses the use of alternative descriptions for contract assets and contract liabilities as follows:
ASC 606-10
45-5 This guidance uses the terms contract asset and contract liability but does not prohibit an entity from using alternative descriptions in the statement of financial position for those items. If an entity uses an alternative description for a contract asset, the entity shall provide sufficient information for a user of the financial statements to distinguish between receivables and contract assets.
Paragraph BC321 of ASU 2014-09 notes the FASB’s and IASB’s observation that
“some industries have historically used different labels to describe contract assets
and contract liabilities or may recognize them in more than one line item either in
the financial statements or in the notes.” The ASU does not prohibit an entity from
using alternative terms or from using additional line items to present the assets
and liabilities, but it requires an entity to provide appropriate disclosures that
adequately describe the assets and liabilities.
Terms that are commonly used in practice to describe contract assets and contract liabilities include, but are not limited to, the following:
- Contract assets — Unbilled receivables, progress payments to be billed.
- Contract liabilities — Deferred revenue, unearned revenue.
For discussion of income statement presentation matters, including the requirements
in SEC Regulation S-X, see Sections 14.7.3 through
14.7.6.
14.2 Contract Liabilities
ASC 606-10
45-2 If a customer pays consideration, or an entity has a right to an amount of consideration that is unconditional (that is, a receivable), before the entity transfers a good or service to the customer, the entity shall present the contract as a contract liability when the payment is made or the payment is due (whichever is earlier). A contract liability is an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or an amount of consideration is due) from the customer.
A contract liability would exist when an entity has received consideration but has not transferred the related goods or services to the customer. This is commonly referred to as deferred revenue. An entity may also have an unconditional right to consideration (i.e., a receivable) before it transfers goods or services to a customer.
The example below, which is reproduced from ASC 606, illustrates how an entity
would account for a contract liability and receivable. (For further discussion about
receivables, see Section
14.5.)
ASC 606-10
Example 38 — Contract Liability and Receivable
Case A — Cancellable Contract
55-284 On January 1, 20X9, an entity enters into a cancellable contract to transfer a product to a customer on March 31, 20X9. The contract requires the customer to pay consideration of $1,000 in advance on January 31, 20X9. The customer pays the consideration on March 1, 20X9. The entity transfers the product on March 31, 20X9. The following journal entries illustrate how the entity accounts for the contract:
- The entity receives cash of $1,000 on March 1, 20X9 (cash is received in advance of performance).
- The entity satisfies the performance obligation on March 31, 20X9.
Case B — Noncancellable Contract
55-285 The same facts as in Case A apply to Case B except that the contract becomes noncancellable on January 31, 20X9. The following journal entries illustrate how the entity accounts for the contract:
- January 31, 20X9 is the date at which the entity recognizes a receivable because it has an unconditional right to consideration.
- The entity receives the cash on March 1, 20X9.
- The entity satisfies the performance obligation on March 31, 20X9.
55-286 If the entity issued the invoice before January 31, 20X9, the entity would not recognize the receivable and the contract liability in the statement of financial position because the entity does not yet have a right to consideration that is unconditional (the contract is cancellable before January 31, 20X9).
14.3 Refund Liabilities
Some contracts with customers may result in refund liabilities owed
to customers. The most common of such refund liabilities are return provisions in
sales contracts that permit the customer to return the product if certain
circumstances arise. These liabilities may also arise when an entity receives cash
in advance, but the agreement is cancelable because of certain termination
provisions in the agreement (see Section 4.4.1). When these provisions are present in a contract, the
seller would recognize a liability to reflect its obligation to return amounts paid
or payable by the customer (i.e., a refund liability).
An agreement that includes a provision for termination without penalty may not be a
contract under step 1 of ASC 606 (i.e., a contract may not exist for the cancelable
term). Such a provision may therefore affect the presentation of these arrangements
on the balance sheet. For a cancelable contract (with a termination right without
penalty), funds received in advance should not be classified as a contract
liability. Funds received in advance that are associated with a cancelable term
(with a termination right without penalty) should be presented separately from any
contract liability as a refund liability, or similar liability.
A refund liability should not be presented together with contract
liabilities that arise under the same contract. A contract liability is defined in
ASC 606-10-45-2 as “an entity’s obligation to transfer goods or services to a
customer for which the entity has received consideration (or an amount of
consideration is due) from the customer.” A refund liability, however, represents
the customer’s conditional right to consideration from the seller (as opposed to
consideration receivable from the customer) and does not represent a performance
obligation. Consequently, we believe that the refund liability should be presented
separately from the contract liability. Note that as a result, the refund liability
would not be netted with any contract assets the entity may recognize.
Example 14-1
Entity A sells Product X to 10 separate
customers for $100 each and does not charge a restocking
fee. On the basis of its historic experience, A expects that
one of these products will be returned. As a result, A
should recognize a refund liability of $100 for the one
product out of 10 that it expects will be returned. In
addition to Product X, A also sells Product Z (considered a
separate performance obligation from Product X). One
customer has prepaid for Product Z in the amount of $1,000.
As a result, A has recorded a contract liability of
$1,000.
In accordance with the guidance above, A
should record a refund liability of $100 and a separate
contract liability of $1,000 (i.e., A should not present the
refund liability together with the contract liability).
For a discussion about offsetting refund liabilities against
accounts receivable, see Example
14-6.
14.4 Contract Assets
ASC 606-10
45-3 If an entity performs by
transferring goods or services to a customer
before the customer pays consideration or before
payment is due, the entity shall present the
contract as a contract asset, excluding any
amounts presented as a receivable. A contract
asset is an entity’s right to consideration in
exchange for goods or services that the entity has
transferred to a customer. An entity shall assess
a contract asset for impairment in accordance with
Topic 310 on receivables. An impairment of a
contract asset shall be measured, presented, and
disclosed in accordance with Topic 310 (see also
paragraph 606-10-50-4(b)).
Pending Content (Transition
Guidance: ASC 326-10-65-1)
45-3 If an entity performs by
transferring goods or services to a customer
before the customer pays consideration or before
payment is due, the entity shall present the
contract as a contract asset, excluding any
amounts presented as a receivable. A contract
asset is an entity’s right to consideration in
exchange for goods or services that the entity has
transferred to a customer. An entity shall assess
a contract asset for credit losses in accordance
with Subtopic 326-20 on financial instruments
measured at amortized cost. A credit loss of a
contract asset shall be measured, presented, and
disclosed in accordance with Subtopic 326-20 (see
also paragraph 606-10-50-4(b)).
A contract asset would exist when an entity has a contract with a customer for
which revenue has been recognized (i.e., goods or services have been transferred to
the customer) but customer payment is contingent on a future event (e.g.,
satisfaction of additional performance obligations). Such an amount is commonly
referred to as an unbilled receivable.
The following example from the revenue standard illustrates the recording of a
contract asset for performance completed under a
contract before an unconditional right to
consideration exists:
ASC 606-10
Example 39 — Contract Asset Recognized for the Entity’s Performance
55-287 On January 1, 20X8, an entity enters into a contract to transfer Products A and B to a customer in exchange for $1,000. The contract requires Product A to be delivered first and states that payment for the delivery of Product A is conditional on the delivery of Product B. In other words, the consideration of $1,000 is due only after the entity has transferred both Products A and B to the customer. Consequently, the entity does not have a right to consideration that is unconditional (a receivable) until both Products A and B are transferred to the customer.
55-288 The entity identifies
the promises to transfer Products A and B as performance
obligations and allocates $400 to the performance obligation
to transfer Product A and $600 to the performance obligation
to transfer Product B on the basis of their relative
standalone selling prices. The entity recognizes revenue for
each respective performance obligation when control of the
product transfers to the customer.
55-289 The entity satisfies the performance obligation to transfer Product A.
55-290 The entity satisfies the performance obligation to transfer Product B and to recognize the unconditional right to consideration.
14.5 Receivables
ASC 606-10
45-4 A receivable is an
entity’s right to consideration that is
unconditional. A right to consideration is
unconditional if only the passage of time is
required before payment of that consideration is
due. For example, an entity would recognize a
receivable if it has a present right to payment
even though that amount may be subject to refund
in the future. An entity shall account for a
receivable in accordance with Topic 310. Upon
initial recognition of a receivable from a
contract with a customer, any difference between
the measurement of the receivable in accordance
with Topic 310 and the corresponding amount of
revenue recognized shall be presented as an
expense (for example, as an impairment loss).
Pending Content (Transition Guidance: ASC
326-10-65-1)
45-4 A receivable is an entity’s right
to consideration that is unconditional. A right to
consideration is unconditional if only the passage
of time is required before payment of that
consideration is due. For example, an entity would
recognize a receivable if it has a present right
to payment even though that amount may be subject
to refund in the future. An entity shall account
for a receivable in accordance with Topic 310 and
Subtopic 326-20. Upon initial recognition of a
receivable from a contract with a customer, any
difference between the measurement of the
receivable in accordance with Subtopic 326-20 and
the corresponding amount of revenue recognized
shall be presented as a credit loss expense.
The revenue standard was not intended to change either the timing of receivable
recognition or the subsequent accounting for receivables. While both
contract assets and receivables are similar in that they represent
an entity’s right to consideration, the risks associated with each
differ. As noted in Section 14.1, receivables are only exposed to credit
risk since only the passage of time is required before receivables
are due. However, contract assets are exposed to both credit risk
and other risks (e.g., performance risk).
An entity could have a present and unconditional right to payment, and therefore
a receivable, even if there is a refund obligation that may require
the entity to pay consideration to a customer in the future (e.g.,
when a product is returned, or when rebates are earned on a
specified volume of purchases). Since refund obligations give rise
to variable consideration, they could affect the transaction price
(see Section
6.3.5.2) and the amount of revenue recognized.
However, an entity’s present right to consideration may not be
affected by the potential need to refund consideration in the
future. Consequently, in certain circumstances, a gross receivable
could be recorded along with a liability. This is discussed further
in paragraph BC326 of ASU 2014-09 and is illustrated in the
following example from ASC 606:
ASC 606-10
Example 40 — Receivable Recognized for the Entity’s Performance
55-291 An entity enters into a contract with a customer on January 1, 20X9, to transfer products to the customer for $150 per product. If the customer purchases more than 1 million products in a calendar year, the contract indicates that the price per unit is retrospectively reduced to $125 per product.
55-292 Consideration is due when control of the products transfer to the customer. Therefore, the entity has an unconditional right to consideration (that is, a receivable) for $150 per product until the retrospective price reduction applies (that is, after 1 million products are shipped).
55-293 In determining the
transaction price, the entity concludes at
contract inception that the customer will meet the
1 million products threshold and therefore
estimates that the transaction price is $125 per
product. Consequently, upon the first shipment to
the customer of 100 products the entity recognizes
the following.
55-294 The refund liability (see paragraph 606-10-32-10) represents a refund of $25 per product, which is expected to be provided to the customer for the volume-based rebate (that is, the difference between the $150 price stated in the contract that the entity has an unconditional right to receive and the $125 estimated transaction price).
Connecting the Dots
At the April 2016 FASB-only TRG meeting,
the FASB staff noted that it has received questions
about the point in time at which a receivable should
be recorded under a contract with a customer
(including when contract assets would be
reclassified as accounts receivable). The FASB staff
agreed that some confusion could have resulted from
the wording in Example 38, Case B, of the revenue
standard (reproduced in Section 14.2), which
some believed was not aligned with the guidance that
identifies a receivable as a right to consideration
that is unconditional other than for the passage of
time. Partly in response to stakeholders’ concerns
acknowledged at the meeting, the FASB later issued
ASU
2016-20, which contains guidance
aimed at clarifying the timing of revenue
recognition related to receivables (referred to in
ASU 2016-20 as “Issue 9”). See Section
18.3.3.6 for further information about
the ASU’s clarifications related to Issue 9.
At the TRG meeting, the staff also noted
that it has received other questions, including
inquiries about situations in which performance
occurs over time and whether receivables should be
recorded as performance occurs or when amounts are
invoiced and due. The staff observed that there is
diversity in practice today regarding how and when
receivables are recorded and that such diversity is
not likely to be eliminated under the revenue
standard. However, the staff reiterated that these
questions do not affect revenue recognition; rather,
they affect the presentation of assets on an
entity’s balance sheet.
The example below illustrates how an entity that
satisfies its sole performance obligation in a contract with a
customer and plans to invoice the customer in multiple annual
installments should reflect the transaction on its balance
sheet.
Example 14-2
On March 1, 20X1, Entity A
enters into a contract with one performance
obligation (software license that is determined to
be satisfied at a point in time on March 1, 20X1)
for $3,600. Entity A delivers the software license
on March 1, 20X1, and will invoice the customer in
three equal and annual installments of $1,200 on
March 1 of 20X1, 20X2, and 20X3. Payment is due by
April 1 of each year.
Entity A should record a
receivable for the full contract amount ($3,600)
when it satisfies the performance obligation on
March 1, 20X1. That is, the $3,600 should be
recorded as a receivable in accordance with ASC
606-10-45-4, which states that a “receivable is an
entity’s right to consideration that is
unconditional” and a “right to consideration is
unconditional if only the passage of time is
required before payment of that consideration is
due.” As noted in paragraph BC323 of ASU 2014-09,
“making the distinction between a contract asset
and a receivable is important because doing so
provides users of financial statements with
relevant information about the risks associated
with the entity’s rights in a contract. That is
because although both would be subject to credit
risk, a contract asset also is subject to other
risks, for example, performance risk.” In this
scenario, A’s rights are only subject to credit
risk because the sole performance obligation has
been satisfied as of March 1, 20X1 (i.e., A has an
unconditional right to cash for the full contract
amount).
The example below illustrates how an entity that
satisfies its performance obligation over time in its contracts with
customers and plans to invoice each customer with different payment
terms should reflect the transactions on its balance sheet.
Example 14-3
On March 1, 20X1, Entity A
enters into two identical (other than payment
terms) noncancelable contracts with two different
customers, Customer Y and Customer Z. The
contracts each contain the same single performance
obligation (i.e., cleaning services) that is
satisfied over time. The transaction price is
$2,400. Each customer is issued an invoice on
March 1, 20X1, and A provides continuous service
from March 1, 20X1, through February 28, 20X2.
Customer Y’s payment is due on March 31, 20X1, but
is received by A on April 15, 20X1. Customer Z’s
payment is due on April 15, 20X1. There are
multiple views on how A should reflect these
transactions on its balance sheet as of March 31,
20X1:
-
Alternative A — Entity A should record a receivable when it issues an invoice to its customer and begins satisfying the performance obligation. The right to consideration is unconditional because only the passage of time up to the due date is required (since A has already begun performing the services). Accordingly, A’s transactions with Y and Z would be reflected in the financial statements as follows:
-
Alternative B — Until the invoice is due, A should build up its receivable balance incrementally as it satisfies its performance obligation. For Y, since payment is due on March 31, 20X1, the full receivable balance is recorded. For Z, the full receivable balance would be recorded once payment is due on April 15, 20X1. Accordingly, A’s transactions with Y and Z would be reflected in the financial statements as follows:
Discussions with the FASB staff confirmed that the Board
did not intend to change practice related to when receivable
balances are recorded. Depending on an entity’s existing accounting
policies, either Alternative A or Alternative B could be
acceptable.
Connecting the Dots
As further discussed in Section
14.7.1, contract assets and contract
liabilities should be determined at the contract
level (i.e., not at the performance obligation
level), and only a net contract asset or net
contract liability should be presented for a
particular contract. Receivables, however, would be
presented separately from contract assets and
contract liabilities, as also discussed in that
section. This issue is addressed in Q&As 61
through 63 (compiled from previously issued
TRG Agenda Papers 7 and
11) of the FASB staff’s
Revenue Recognition Implementation
Q&As (the “Implementation
Q&As”). For additional information and
Deloitte’s summary of issues discussed in the
Implementation Q&As, see Appendix
C.
Implementation Q&A 34 (compiled from
previously issued TRG Agenda Papers 30 and
34) discusses the difficulty of
determining when a customer paid for a particular
good or service under a contract involving multiple
promised goods or services because of the fungible
nature of cash (see Section 7.7 for
additional discussion about allocating cash payments
to specific performance obligations). Since
receivables are presented separately from contract
assets and contract liabilities, the allocation of
cash to performance obligations in a contract
involving multiple performance obligations could
also affect the recognition of receivables, contract
assets, and contract liabilities. Consider the
example below.
Example 14-4
On January 1, 20X1, Entity A
enters into a noncancelable contract with a
customer that contains two performance
obligations: a software license (satisfied at a
point in time) and a service (satisfied over time
from January 1, 20X1, through December 31, 20X3).
Entity A issues an invoice on January 1, 20X1, for
the first year (due on February 1, 20X1) and
subsequently issues an invoice on each anniversary
for the next two years. The transaction price of
the contract is $6,000 (invoiced at $2,000 per
year). As a result of allocating the transaction
price to each performance obligation on a relative
stand-alone selling price basis, 60 percent of
revenue ($3,600) is allocated to the license and
40 percent of revenue ($2,400) is allocated to the
service. Contractually, each $2,000 invoice
provides the right to receive service for one year
($800) and applies to one-third of the total
license fee of $3,600 ($1,200). Entity A has the
contractual right to bill and collect payment for
the remaining license fee independent of providing
any future service.
On January 1, 20X1, the
software license is transferred to the customer
and the service commences. The customer pays the
$2,000 invoice in full on February 1, 20X1. Entity
A has an accounting policy of recording the
receivable when amounts are invoiced and the
associated performance obligation has been
satisfied or has commenced.
There are multiple views on how this
transaction should be presented as of and for the
period ended March 31, 20X1:
-
Alternative A — To identify the receivable amount in this contract, A must first allocate the payment made on February 1, 20X1, to the performance obligations contractually tied to the payment. Entity A would then determine the remaining receivable for performance obligations satisfied when payment is unconditional. Accordingly, the transaction would be reflected in the financial statements as follows:
-
Alternative B — Entity A would allocate cash entirely to the satisfied performance obligations (i.e., the software license and the satisfied portion of the service) and record the remaining consideration due that is associated with the satisfied performance obligations as a receivable. Consequently, as illustrated below, A would not present any contract liability for services paid for by the customer before performance.
Because cash is fungible and
can be allocated at either the contract level or
the performance obligation level, either
Alternative A or Alternative B could be
acceptable. Entities should apply a consistent
approach for similar contracts and in similar
circumstances.
14.6 Classification as Current or Noncurrent
If an entity presents a classified balance sheet, it should determine whether certain
revenue-related balances should be presented as current or noncurrent (or bifurcated
between the two).
14.6.1 Contract Assets and Contract Liabilities
In a manner similar to the treatment of assets and liabilities
related to the receipt or use of cash (e.g., receivables, prepaid assets, or
debt), contract assets and contract liabilities should be bifurcated between
current and noncurrent when presented in a classified balance sheet. Note that
the contract asset or contract liability determined at the contract level (i.e.,
after the contract assets and contract liabilities for each performance
obligation within a single contract have been netted, as discussed in Section 14.7.1) is the contract asset or
contract liability that should be bifurcated between current and noncurrent when
presented in a classified balance sheet
14.6.2 Refund Liabilities
The example below considers whether it is appropriate for an
entity to classify refund liabilities (or similar liabilities) as a noncurrent
liability in a classified balance sheet.
Example 14-5
Entity P, an entity with an operating cycle of less than
12 months, expects to return proceeds related to refund
liabilities (or similar liabilities) more than 12 months
after the reporting date. However, the counterparty can
demand a refund of amounts previously paid at any
time.
Entity P should not classify the portion that it expects
to repay more than 12 months after the reporting date as
a noncurrent liability in a classified balance sheet.
All amounts related to such liabilities should be
recorded as a current liability because the counterparty
can demand a refund at any time.
On a classified balance sheet, the refund liability should not be presented as
noncurrent if the customer can cancel the contract at any point or within 12
months or less. Rather, all amounts should be recorded as a current liability.
The refund liability is excluded from contract liabilities because the customer
must, in effect, make a separate purchase decision when the noncancelable term
ends, at which point it could demand a refund of funds previously paid.
ASC 470-10-45-10, which
specifies that loans due on demand should be presented as a current liability,
supports this view.
ASC 470-10
45-10 The current liability
classification shall include obligations that, by their
terms, are due on demand or will be due on demand within
one year (or operating cycle, if longer) from the
balance sheet date, even though liquidation may not be
expected within that period. The demand provision is not
a subjective acceleration clause as discussed in
paragraph 470-10-45-2.
14.6.3 Capitalized Contract Costs
It is acceptable for costs of obtaining or fulfilling a contract to be bifurcated
between current and noncurrent in a classified balance sheet. Alternatively, in
a manner similar to the treatment of (1) intangible assets, (2) inventory, or
(3) property, plant, and equipment, capitalized costs of obtaining or fulfilling
a contract may be presented as a single asset and neither bifurcated nor
reclassified between current and noncurrent assets. That is, the assets would be
classified as long-term unless they had an original amortization period of one
year or less.
14.7 Other Presentation Matters
14.7.1 Unit of Account for Presentation
Under ASC 606, a contract asset can arise when the amount of
revenue recognized by an entity exceeds the amount that
has already been paid by the customer together with any unpaid amounts
recognized as receivables. Conversely, a contract liability can arise when the
amount of revenue recognized by an entity is less than
the amount that has already been paid by the customer together with any unpaid
amounts recognized as receivables.
When there are multiple performance obligations in a contract
(or in multiple contracts accounted for as a single combined contract in
accordance with ASC 606-10-25-9), it is possible that revenue recognized is in
excess of amounts paid or receivable for some performance obligations but less
than amounts paid or receivable for other performance obligations. In such
circumstances, the appropriate unit of account for presenting contract assets
and contract liabilities is the contract. Accordingly, it is not appropriate to
present both contract assets and contract liabilities for a single contract;
instead, a single net figure should be presented.
ASC 606-10-45-1 states that “[w]hen either party to a contract
has performed, an entity shall present the contract in the statement of
financial position as a contract asset or a contract liability, depending on the
relationship between the entity’s performance and the customer’s payment. An
entity shall present any unconditional rights to consideration separately as a
receivable.”
This also applies to circumstances in which multiple contracts
are combined and are accounted for as a single contract in accordance with the
requirements for combination in ASC 606-10-25-9.
Paragraph BC317 of ASU 2014-09 explains that the “Boards decided
that the remaining rights and performance obligations in a
contract should be accounted for and presented on a
net basis, as either a contract asset or a contract liability. . . . The
Boards decided that those interdependencies are best reflected by accounting and presenting on a net basis the remaining
rights and obligations in the statement of financial position” (emphasis
added).
See also Section 14.7.2.1 for discussion of offsetting contract assets
and contract liabilities against other assets and liabilities.
Unit of account considerations for presentation purposes are
addressed in Implementation Q&As 61 through 63 (compiled from
previously issued TRG Agenda Papers 7 and 11). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
Connecting the Dots
As a corollary to the discussion in Section 6.3.5.5.1 that variability due
to changes in the foreign currency exchange is not variable
consideration, questions have been raised about the accounting for
receivables, contract assets, and contract liabilities in contracts that
include consideration denominated in a foreign currency. Specifically,
stakeholders have asked how an entity should apply the guidance in ASC
830 on foreign currency matters to the recognized assets and liabilities
in a customer contract with the expectation that more contract assets
may arise in contracts under ASC 606.
ASC 606 requires an entity to recognize (1) a contract
asset if the entity performs by transferring goods or services to a
customer before the customer pays consideration or before payment is due
or (2) a contract liability if the entity receives (or has an
unconditional right to receive) consideration before it transfers goods
or services to the customer.
Contract liabilities are nonmonetary liabilities because they require an
entity to perform a service in the future. Contract assets are monetary
assets because they will ultimately be settled for a fixed amount of
cash.
A separate issue arises if a single contract with a
customer contains a performance obligation that is in a contract asset
position and another performance obligation that is in a contract
liability position. ASC 606 requires an entity to present contract
assets and contract liabilities on a net basis in the balance sheet.
Therefore, questions have arisen about whether the guidance in ASC 830
should be applied to the gross contract asset and liability balances
separately or only to the net contract asset or liability for a single
contract. We believe that the guidance in ASC 830 should be applied on a
gross basis. For a complete discussion of this issue, see Section 4.8 of
Deloitte’s Roadmap Foreign Currency Matters.
14.7.2 Balance Sheet Offsetting
14.7.2.1 Offsetting Contract Assets and Contract Liabilities Against Other Assets and Liabilities
ASC 606 uses the terms “contract asset” and “contract
liability” (defined in ASC 606-10-20) in the context of revenue arising from
contracts with customers and provides guidance on the presentation of
contract assets and contract liabilities in the statement of financial
position (see ASC 606-10-45-1 through 45-5). Entities may also recognize
other types of assets or liabilities as a result of revenue or other
transactions related to customers. Examples might include costs of obtaining
a contract capitalized in accordance with ASC 340-40-25-1, financial assets
or liabilities as defined in ASC 825-10-20 (e.g., receivables), and
provisions as defined in ASC 460.
In practice, it will not be possible for entities to offset
contract assets and contract liabilities against other assets and
liabilities given that the contract assets and contract liabilities do not
represent determinable amounts owed by each party. ASC 210-20 prohibits
offsetting of assets and liabilities unless required or permitted by another
Codification subtopic, and neither ASC 606-10 nor any other Codification
subtopic includes such a requirement or permission with respect to contract
assets and contract liabilities.
The above issue is addressed in Implementation Q&A 63 (compiled from previously
issued TRG Agenda Papers 7 and 11). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
14.7.2.2 Offsetting Refund Liabilities Against Accounts Receivable
For an entity to offset refund liabilities against accounts
receivable, all of the following criteria in ASC 210-20-45-1 must be met:
-
Each of two parties owes the other determinable amounts.
-
The reporting party has the right to set off the amount owed with the amount owed by the other party.
-
The reporting party intends to set off.
-
The right of setoff is enforceable at law.
If an entity has a legally enforceable contract and amounts have been billed
(i.e., there is an unconditional right to payment for amounts billed), but
because of a termination right a contract has not been identified under step
1 of ASC 606, the entity will generally recognize a refund liability (or
similar liability) and accounts receivable.
If the contract is legally enforceable and the recognition of accounts
receivable is appropriate, presenting the amounts net would generally be
inappropriate. ASC 210-20 provides guidance on evaluating whether an asset
and a liability may be netted. For example, ASC 210-20-45-1 outlines the
criteria used to determine whether a right of setoff exists, including the
requirement that the reporting party have both the legal right and the
intent to set off. If the reporting entity does not expect the customer to
terminate, it effectively believes that the customer will pay in the normal
course and that the entity will provide goods or services. In such a case,
the criteria related to the right of setoff would not be met and the entity
should not net the amounts.
However, when the criteria related to the right of offset are met, a
reporting entity is not required to net the amounts. An entity’s decision to
offset when the criteria in ASC 210-20-45-1 are met is an accounting policy
election that should be applied consistently to all similar types of
transactions.
The example below illustrates how to determine whether it is
permissible to offset a refund liability against accounts receivable.
Example 14-6
Company P manufactures widgets and
sells them to various retailers, which ultimately
sell the widgets to end customers. Company P has
concluded that the retailers are its customers and
that control of the widgets is transferred to the
retailers upon delivery to them. Upon receipt of the
widgets, retailers have 90 days to return any unsold
widgets to P. If a retailer exercises its right to
return a widget, P provides a credit against the
retailer’s accounts receivable balance. That is, P
does not pay cash to settle the refund liability;
rather, it offsets the refund liability against any
currently outstanding accounts receivable.1 In accordance with ASC 606-10-32-10, P
estimates a refund liability for widgets that it
expects retailers to return.
Company P must evaluate the criteria
in ASC 210-20 to determine whether it is permitted
to offset the refund liability against accounts
receivable in P’s balance sheet.
In practice, P may not have the
legal right to offset the refund liability against
amounts receivable from a retailer. Further, the
estimated refund liability may not represent a
determinable amount because P estimated the refund
liability by using a portfolio of information.
The notion that an entity should apply ASC 210-20 to
determine whether offsetting is appropriate is consistent with the
considerations related to offsetting contract assets and contract
liabilities against other assets and liabilities (see Section 14.7.2.1 for
a discussion of that issue).
The above issue is addressed in Implementation Q&A 63 (compiled
from previously issued TRG Agenda Papers 7 and 11). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix
C.
14.7.3 Income Statement Classification of Interest
Many companies offer financing arrangements to customers who
purchase their products. Some of these companies may also offer financing of
products sold by other vendors. Often, the financing is offered through a wholly
owned subsidiary of the parent company. In other situations, the parent itself
may also offer this financing.
For purposes of the consolidated financial statements, the interest income generated from certain financing arrangements may be classified as revenue in the income statement. Paragraph BC29 of ASU 2014-09 states that the FASB and IASB “decided not to amend the existing definitions of revenue in each of their conceptual frameworks.” The legacy guidance in paragraph 79 of FASB Concepts Statement 6 indicates that cash inflows, such as interest, that
are the result of an entity’s ongoing major or central
operations represent revenue. When the major activity of a subsidiary is
the financing of products, the interest income generated from this financing
would represent its major revenue-generating activity. Therefore, this interest
income would continue to be classified as revenue for consolidated financial
statement purposes. However, the interest income (i.e., the financing component)
should be presented separately from the revenue from the sale (i.e., revenue
from contracts with customers) in accordance with the requirements of ASC
606-10-32-20.
Connecting the Dots
In December 2021, the FASB updated the definition of revenue in FASB Concepts Statement 8, Chapter 4 (the “FASB Concepts
Statement”). Under the revised definition, revenues are “inflows or
other enhancements of assets of an entity or settlements of its
liabilities (or a combination of both) from delivering or producing
goods, rendering services, or carrying out other activities.” Notably,
the FASB eliminated the phrase “ongoing major or central operations.”
However, the updated definition of revenue in the FASB Concepts
Statement did not amend the ASC master glossary’s definition of revenue
or the definition of a customer within the scope of ASC 606. In
addition, the FASB Concepts Statement does not represent authoritative
guidance. Further, paragraph E84 of the FASB Concepts Statement states,
in part, that “[o]ther activities . . . are those activities that permit
others to use the entity’s resources, which, for example, result in
interest.” Therefore, we do not expect that the updated definition of
revenue in the FASB Concepts Statement would result in a change in
practice regarding the determination of (1) which transactions should be
accounted for and presented as revenue under ASC 606 and (2) whether
interest income can be classified as revenue (presented separately from
revenue from contracts with customers). See Section 3.2.8 for more
information.
Conversely, if interest income is generated as a result of an activity that does not derive from an entity’s ongoing major or central operations (i.e., an activity that is peripheral or incidental to an entity’s central activities, as described by paragraph 75 of FASB Concepts Statement 6),
such income is unlikely to be classified as revenue.
SEC registrants’ analysis of whether the activity generating the
interest income is a result of the ongoing major or central operations should
include questions such as the following:
-
Does management discuss the financing operation in the MD&A or Business sections of the Form 10-K?
-
Does management provide focus on the financing operation in other external communications (e.g., analyst calls, press releases)?
-
Is the financing operation a separate reportable segment?
SEC registrants should also consider the guidance in SEC
Regulation S-X, Rule 5-03, regarding separate disclosure of revenue from
services and revenue from products when presenting this interest income in the
statement of comprehensive income.
The examples below demonstrate the concepts explained above.
Example 14-7
Company A sells machinery. The company
has a subsidiary, B, whose sole operations are to
provide financing to customers who purchase the
machinery from A. In this situation, the interest income
generated by B from its product financing is part of the
consolidated entity’s major ongoing operations and
should therefore be classified as revenue in A’s
consolidated statement of comprehensive income,
separately from revenue from contracts with
customers.
Example 14-8
Company X sells vehicles. The company
does not have a financing subsidiary, has not previously
provided financing to its customers, and does not have
any intent to provide financing in the future. However,
as a result of a large order placed by Customer Y, X has
agreed to provide financing to Y. In this situation,
because X has no history of providing financing to
customers, and because financing arrangements are not
part of X’s ongoing operations, the interest income
generated from Y should not be classified as revenue in
X’s consolidated financial statements.
14.7.4 Income Statement Classification of Amortized Contract Costs
Generally, the amortization of any incremental costs of
obtaining a contract that are capitalized under ASC 340-40 should be classified
in the income statement as selling, general, and administrative (SG&A)
expense.
Under ASC 340-40, an entity is required to recognize the
incremental costs of obtaining a contract (i.e., those costs that would not have
been incurred if the contract had not been obtained) as an asset if the entity
expects to recover them.2 When capitalized, the costs are “amortized on a systematic basis that is
consistent with the transfer to the customer of the goods or services to which
the asset relates.” However, ASC 340-40 does not include guidance on the
presentation of amortized contract costs in the income statement.
In addition, the Codification does not contain guidance on the
types of expenses that represent SG&A expense or cost of sales. SEC
Regulation S-X, Rule 5-03(b), provides limited guidance by indicating the
various line items that should appear on the face of the income statement (if
applicable). Rule 5-03(b) indicates that the cost of any tangible goods sold and
the cost of any services sold are “[c]osts and expenses applicable to sales and
revenues.” Further, Rule 5-03(b) requires a separate line item for SG&A
expenses.
Despite the limited authoritative guidance, we believe that
SG&A expense in the income statement would be the preferred classification
of the amortization of incremental costs of obtaining a contract that are
capitalized under ASC 340-40. This is because such costs represent costs of
acquiring a contract (e.g., selling costs), as opposed to costs of fulfilling a
contract that generally would be included in cost of goods sold (or a similar
line item).
14.7.5 Income Statement Presentation of Reimbursements for Out-of-Pocket Expenses
ASC 606 does not explicitly address out-of-pocket
reimbursements. However, ASC 606-10-32-2 defines the transaction price as “the
amount of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer, excluding amounts
collected on behalf of third parties (for example, some sales taxes).”
Therefore, generally all consideration provided to the entity from the customer
should be included in the transaction price and allocated to the promised goods
or services identified in the contract. This includes reimbursements for
out-of-pocket expenses incurred in connection with fulfilling the entity’s
performance obligation(s) to the customer. However, the transaction price should
not include reimbursements related to goods or services transferred to the
customer if the entity is merely acting as an agent in purchasing such goods or
services on behalf of the customer.
The example below illustrates how to present reimbursements
received from a customer for out-of-pocket expenses.
Example 14-9
Company X enters into an agreement to identify and
acquire specified goods on behalf of Customer P from a
third party for which X will earn a commission
calculated as a percentage of the agreed purchase price.
Company X has determined that it is acting as an agent
in this arrangement, in accordance with ASC 606-10-55-36
through 55-40. In addition, as part of the agreement, P
will reimburse X for reasonable out-of-pocket expenses
(e.g., hotels, meals, transportation). Consequently, X
must determine how to present the out-of-pocket expenses
and reimbursements.
Company X should first determine the nature of the
out-of-pocket expenses reimbursed by P. If such costs
are incurred for X to fulfill its agency service and are
not incurred on behalf of P, X’s out-of-pocket costs and
related reimbursements should generally be presented
gross. Alternatively, if in the course of providing its
agency services to P, X were to incur and be reimbursed
for costs on behalf of P that provide a good or service
to P, such costs should generally be presented net.
Assume that X determines that its
reimbursable out-of-pocket expenses (e.g., hotels,
meals, transportation) are expenses that (1) X incurs in
fulfilling its agency service, (2) are not incurred on
behalf of P, and (3) do not provide a good or service to
P. On the basis of this determination, X will include
any amounts collected (or expected to be collected) as
reimbursements in the transaction price for the agency
service delivered to P. As a result, such reimbursements
will be presented gross in X’s income statement.
14.7.6 Interaction Between ASC 606 and SEC Regulation S-X, Rule 5-03(b)
SEC Regulation S-X, Rule 5-03(b)
§210.5-03 Statements of comprehensive income. . .
.
(b) If income is derived from more than
one of the subcaptions described under § 210.5-03.1,
each class which is not more than 10 percent of the sum
of the items may be combined with another class. If
these items are combined, related costs and expenses as
described under § 210.5-03.2 shall be combined in the
same manner.
1. Net sales and gross revenues. State
separately:
(a) Net sales of tangible products (gross sales
less discounts, returns and allowances), (b)
operating revenues of public utilities or others;
(c) income from rentals; (d) revenues from
services; and (e) other revenues. Amounts earned
from transactions with related parties shall be
disclosed as required under § 210.4-08(k). A
public utility company using a uniform system of
accounts or a form for annual report prescribed by
federal or state authorities, or a similar system
or report, shall follow the general segregation of
operating revenues and operating expenses reported
under § 210.5-03.2 prescribed by such system or
report. If the total of sales and revenues
reported under this caption includes excise taxes
in an amount equal to 1 percent or more of such
total, the amount of such excise taxes shall be
shown on the face of the statement parenthetically
or otherwise.
SEC Regulation S-X, Rule 5-03(b), indicates the various line items that should
appear on the face of the income statement. Specifically, a registrant should
separately present any amounts that represent 10 percent of the sum of income
derived from net sales of tangible products, operating revenues of public
utilities or others, income from rentals, revenues from services, and other
revenues. Aside from minor revisions, no updates have been made to Rule 5-03(b)
since the issuance of ASU
2014-09. Further, there is limited guidance on interpreting
the requirements of Rule 5-03(b) — for example, the terms “income from rentals,”
“revenues from services,” “products,” and “services” are not specifically
defined. Despite the long-standing need for registrants to use judgment when
applying Rule 5-03(b), stakeholders have raised concerns about the interplay
between Rule 5-03(b) and new accounting standards, including the revenue
standard.
The interaction between ASC 606 and Rule 5-03(b) was discussed at the March 2018
CAQ SEC Regulations Committee joint meeting with the SEC staff. As indicated in
the highlights of that meeting, the SEC
staff noted that it is encouraging registrants to submit real-life examples of
potential inconsistencies in income statement classification that may arise
between ASC 606 and Rule 5-03(b). For additional information, see Deloitte’s May
22, 2018, journal entry.
For considerations related to the disaggregation of revenue in accordance with
the disclosure requirements of ASC 606, see Section
15.2.2.
Footnotes
1
Company P would pay cash to
settle the refund liability only if the customer
did not have an outstanding accounts receivable
balance.
2
ASC 340-40-25-4 provides a practical expedient under
which “an entity may recognize the incremental costs of obtaining a
contract as an expense when incurred if the amortization period of the
asset that the entity otherwise would have recognized is one year or
less.”