3.2 Scope

3.2.1 In General

ASC 606-10

Entities

15-1 The guidance in this Subtopic applies to all entities.

Transactions

15-2 An entity shall apply the guidance in this Topic to all contracts with customers, except the following:

Lease contracts within the scope of Topic 842, Leases.
Contracts within the scope of Topic 944, Financial Services — Insurance.
Financial instruments and other contractual rights or obligations within the scope of the following Topics:

1. Topic 310, Receivables

2. Topic 320, Investments — Debt Securities

2a. Topic 321, Investments — Equity Securities

3. Topic 323, Investments — Equity Method and Joint Ventures

4. Topic 325, Investments — Other

5. Topic 405, Liabilities

6. Topic 470, Debt

7. Topic 815, Derivatives and Hedging

8. Topic 825, Financial Instruments

9. Topic 860, Transfers and Servicing.
Guarantees (other than product or service warranties) within the scope of Topic 460, Guarantees.
Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. For example, this Topic would not apply to a contract between two oil companies that agree to an exchange of oil to fulfill demand from their customers in different specified locations on a timely basis. Topic 845 on nonmonetary transactions may apply to nonmonetary exchanges that are not within the scope of this Topic.

15-2A An entity shall consider the guidance in Subtopic 958-605 on not-for-profit entities — revenue recognition — contributions when determining whether a transaction is a contribution within the scope of Subtopic 958-605 or a transaction within the scope of this Topic.

A key goal of the FASB when creating the new guidance was to improve comparability of similar transactions across industries for financial statement users. That is, the comprehensive revenue framework established in ASC 606 would require entities in disparate industries to evaluate the new guidance consistently.

Connecting the Dots

Consistency in application of the revenue standard across industries has been discussed publicly to emphasize its importance. As noted in Deloitte’s December 15, 2015, Heads Up, the staff in the SEC’s Office of the Chief Accountant (OCA) reiterated at the 2015 AICPA Conference on Current SEC and PCAOB Developments that it is focused on consistent application of the guidance to similar fact patterns both within and across industries. Companies should compare their application of the standard with that of other companies and refer to the AICPA industry task forces’ interpretive guidance, which can be used as a resource to promote consistency among preparers. In addition, companies can contact the OCA for help in addressing implementation questions. Refer to Chapter 18 for recent SEC and AICPA developments related to the revenue standard.

Generally speaking, the boards’ comprehensive framework was intended to cover all revenue transactions across all industries and geographies. Accordingly, the scope of the revenue standard is very broad and is governed by two key terms, “contract” and “customer.” Because of the standard’s broad scope, any arrangement that qualifies as a contract with a customer as those terms are defined should be within the scope of the new guidance. However, during the development of the revenue standard, the FASB acknowledged that it had already developed or was developing comprehensive guidance on certain types of revenue-generating transactions. Specifically, the Board already had or was improving the guidance on leases, financial instruments, and insurance. As a result, it was necessary for the scope exceptions in ASC 606-10-15-2 to be created. Accordingly, a revenue-generating transaction related to a contract with a customer would be outside the scope of the revenue standard only if it is within the scope of one of these other models.

Connecting the Dots

Some revenue-generating transactions associated with insurance contracts may be subject to the guidance in ASC 606. This is because an entity’s insurance contracts are within the scope of ASC 944 only if the entity is one of the types of entities described in ASC 944-10-15-2.

Since the revenue standard focuses on contracts with customers, companies might naturally think that their scope assessment should be performed at the contract level. However, it is important to remember that a contract can be made up of different components (or separate promises). Accordingly, companies should determine whether contracts include revenue and nonrevenue elements. See Section 3.2.10 for further details.

See Section 3.2.12 for a discussion of scope considerations related to contracts accounted for under both ASC 606 and ASC 842.

The revenue standard includes implementation guidance on agreements containing a requirement or option to buy back a good sold to a customer (“repurchase agreements”). When a company has entered into a contract that includes such an obligation or right, it must assess whether control of the product has been transferred to the customer, as discussed in paragraph BC423 of ASU 2014-09. In many circumstances, if these features are present, control of the product is not transferred to the customer and the contract is treated as either a lease (i.e., accounted for in accordance with ASC 842) or a financing (i.e., accounted for in accordance with ASC 606-10-55-70). The assessment of whether control is transferred to a customer (i.e., the entity satisfies its performance obligation) is outlined in step 5. For further discussion of transfer of control, including repurchase agreements, see Chapter 8.

3.2.2 Guarantees

Contracts with customers that are guarantees (other than product or service warranties) within the scope of ASC 460 are specifically excluded from the scope of ASC 606.

Connecting the Dots

It might appear that the scope of IFRS 15 is different from that of ASC 606 because the explicit scope exclusion for guarantees in ASC 606-10-15-2(d) is not included in IFRS 15. However, the inclusion of financial guarantees within the scope of the IASB’s financial instruments standards (IFRS 9 and IAS 39) made it unnecessary to provide a separate scope exclusion in IFRS 15 for guarantees since such an exclusion would be redundant with the financial instruments exclusion in IFRS 15.

3.2.2.1 Performance Guarantees

Many performance guarantees would be outside the scope of ASC 460 or would not be subject to ASC 460’s recognition and measurement requirements. For example, ASC 460-10-15-7(i) states that a guarantee or indemnification of an entity’s own future performance is not within the scope of ASC 460. Therefore, performance guarantees would typically be accounted for as assurance-type warranties (i.e., product warranties that are subject to ASC 460’s disclosure requirements but not its recognition and measurement requirements), service-type warranties that represent performance obligations within the scope of ASC 606, or a form of variable consideration within the scope of ASC 606.

Example 3-6

Entity X has entered into a contract with a customer to operate a call center. The contract includes a service level agreement guaranteeing that the average service call response time will be less than five minutes. If the call center does not meet the five-minute average wait time, X will have to pay the customer $1 million.

This service level guarantee is not within the scope of ASC 460 because it is guaranteeing X’s own future performance under the contract. Therefore, the obligation to operate the call center would be accounted for as a performance obligation within the scope of ASC 606, and the potential payment of $1 million to the customer would be treated as variable consideration.

Some performance guarantees or indemnification agreements would be within the scope of ASC 460, particularly if they are not a guarantee or indemnification of an entity’s own future performance. For example, if an entity guarantees the performance of a third party by agreeing to pay the indemnified party if that third party fails to perform, the guarantee would most likely be subject to the recognition and measurement provisions of ASC 460.

Connecting the Dots

Because the general recognition and measurement requirements of ASC 460 that apply to guarantees differ significantly from the recognition and measurement requirements for product warranties, it is important for entities to appropriately determine whether an arrangement is subject to the guidance that applies to product warranties. On the basis of informal discussions, we understand that the OCA objected to an SEC registrant’s conclusion that its guarantee to a customer of the functionality of a security service provided by another customer was a product warranty. Although the guarantee was part of a revenue arrangement with multiple promised goods or services, the SEC staff believed that a guarantee of a service provided to a customer by another entity cannot be a product warranty because the guarantor was not the entity that provided the service. In the staff’s view, such an arrangement should be accounted for in accordance with the general recognition and measurement guidance in ASC 460 that applies to guarantee obligations.

3.2.2.1.1 Health Care Companies With Value-Based Care Arrangements

Driven by regulatory action, cost pressures, and an overall shift in the health care landscape, health care reimbursement models have started to shift from traditional fee-for-services reimbursement to payments that are tied to quality and cost, broadly defined as “value-based care arrangements.” Unlike traditional reimbursement (or fee-for-services) models, value-based care arrangements incentivize reductions in spending while improving quality and outcomes. The introduction of value-based care arrangements can change the role of existing participants (e.g., health insurers [also referred to as “payers”] and health care providers) and has brought new participants (e.g., managed care organizations or accountable care organizations) into the health care ecosystem. Entities participating in value-based care arrangements may take on obligations similar to those of health insurers or health care providers through managed risk agreements or may serve solely as intermediaries as part of providing value-based care.

The accounting for value-based care arrangements, including the determination of whether an entity is within the scope of ASC 944, may require significant judgment based on the entity’s specific facts and circumstances. If an entity participating in a value-based care arrangement is outside the scope of ASC 944, the entity should consider whether (1) it is a principal or an agent in delivery of the health care or other services, (2) elements in the arrangement should be accounted for as a derivative within the scope of ASC 815, and (3) it is providing a third-party payer with a guarantee that is subject to the guidance in ASC 460.

Example 3-6A

Company X is a health care company that operates a value-based care delivery business that coordinates between payers and providers to deliver high-quality health care outcomes.

During the current fiscal year, X enters into a contract with the Centers for Medicare & Medicaid Services (CMS), an unrelated party. Under the contract, X agrees to be responsible for the cost of Medicare-eligible health care services incurred by covered patients aligned with X. In addition, X is to perform certain services, such as establishing a network of health care providers, coordinating and arranging for Medicare services to be provided to covered patients, and working directly with covered patients to encourage healthy behaviors. Although X sets criteria for who can be a provider within its network, X does not control the in-network health care providers' Medicare services before those services are transferred to the covered patients.

CMS is obligated to pay X a total care capitation (TCC) payment. The TCC payment is a set amount of money per covered patient and is based on an estimated cost of care that CMS would expect to incur for the covered patients over the contract year. Company X earns a profit when the cost of Medicare incurred by covered patients is below the TCC payment and is exposed to losses if the cost of Medicare exceeds the TCC payment.

Although X interacts with patients and directs them to obtain Medicare services from its network of health care providers, covered patients are not restricted to obtaining Medicare services only from its network of health care providers. If a covered patient receives Medicare services from health care providers that do not have an agreement with X, CMS will pay the third-party providers instead of X, thereby reducing the TCC payment due to X. Further, X is required to make a payment to CMS if CMS’s payments to third-party providers exceed the TCC payment due to X. This setup motivates X to establish a process to connect covered patients with high-value health care providers, conduct risk-stratifying exercises to coordinate targeted care, deploy care coordinators to support covered patients, and perform other activities to manage the cost of care for covered patients.

Company X concludes that its contract with CMS includes elements within the scope of ASC 606 since X is required to perform services such as establishing a network of high-value health care providers and coordinating or arranging for Medicare services to be provided to covered patients.

In addition, X considers whether the contract includes a guarantee that should be accounted for under ASC 460. Company X concludes that none of the scope exceptions in ASC 460-10-15-7 apply. Specifically, the scope exception in ASC 460-10-15-7(i) is not met because X is not guaranteeing its performance since it (1) does not control which providers the covered patients select or the Medicare services delivered by the providers and (2) does not control the in-network or out-of-network health care providers' Medicare services before those services are transferred to the covered patients. Further, X’s obligation to pay for Medicare services meets the definition of a guarantee under ASC 460-10-15-4. This is because CMS is responsible for covered patients’ Medicare costs, and X (the guarantor) is required to compensate CMS (the guaranteed party) upon the occurrence of certain conditional events (the occurrence of Medicare services provided to covered patents) related to CMS’s liability. Company X fulfills its obligation to pay for Medicare services as follows:

By making a payment directly to providers (to the extent that the providers are in-network).
By compensating CMS (to the extent that the providers are out-of-network) through either of the following:
- A reduction of the TCC payment.
- A payment made directly to CMS to the extent that costs are incurred in excess of the TCC payment.

Company X concludes that no elements in the arrangement meet the definition of a derivative.

Because the arrangement includes components within and outside the scope of ASC 606, X should first apply the separation and measurement guidance in ASC 460-10-30-2. Accordingly, it should initially measure the guarantee at fair value and exclude this amount from the transaction price allocated to elements within the scope of ASC 606.

3.2.2.2 Profit Margin Guarantees

Profit margin guarantees typically do not contain a guarantee within the scope of ASC 460 because they qualify for scope exceptions under ASC 460-10-15-7 — specifically, ASC 460-10-15-7(e) (vendor rebates by the guarantor based on either the sales revenues of, or the number of units sold by, the guaranteed party) or, in certain circumstances, ASC 460-10-15-7(g) (guarantees that prevent the guarantor from being able to recognize in earnings the profit from a sale transaction). Therefore, profit margin guarantees should be accounted for as a form of variable consideration within the scope of ASC 606.

Example 3-7

A clothing manufacturer sells clothing to a retail store (the “retailer”) under a contract that offers the retailer a refund of a portion of the contract’s sales price at the end of each season if the retailer has not met a minimum sales margin (i.e., a profit margin guarantee). The retailer takes title to the clothing, and title remains with the retailer. The profit margin guarantee is agreed to at the inception of the contract and is a fixed amount.

This arrangement does not contain a guarantee within the scope of ASC 460. Therefore, the clothing manufacturer should account for the potential payment to the retailer as a form of variable consideration within the scope of ASC 606.

3.2.3 Contributions

Contributions are not within the scope of ASC 606. The ASC master glossary defines a contribution as follows:

An unconditional transfer of cash or other assets, as well as unconditional promises to give, to an entity or a reduction, settlement, or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. Those characteristics distinguish contributions from:

Exchange transactions, which are reciprocal transfers in which each party receives and sacrifices approximately commensurate value
Investments by owners and distributions to owners, which are nonreciprocal transfers between an entity and its owners
Other nonreciprocal transfers, such as impositions of taxes or legal judgments, fines, and thefts, which are not voluntary transfers.

In a contribution transaction, the resource provider often receives value indirectly by providing a societal benefit although that benefit is not considered to be of commensurate value. In an exchange transaction, the potential public benefits are secondary to the potential direct benefits to the resource provider. The term contribution revenue is used to apply to transactions that are part of the entity’s ongoing major or central activities (revenues), or are peripheral or incidental to the entity (gains). See also [the ASC master glossary’s definition of an inherent contribution] and [the ASC master glossary’s definition of a conditional contribution].

Therefore, a contribution, by definition, is a nonreciprocal transfer and differs from an exchange transaction (e.g., a reciprocal transfer in which an entity exchanges goods or services for consideration).

In June 2018, the FASB issued ASU 2018-08, which amended certain aspects of the Codification’s guidance on contributions to clarify the scope and accounting for contributions received and contributions made. As part of these clarifications, ASU 2018-08 amended ASC 606 to include the guidance in ASC 606-10-15-2A, which states:

An entity shall consider the guidance in Subtopic 958-605 on not-for-profit entities — revenue recognition — contributions when determining whether a transaction is a contribution within the scope of Subtopic 958-605 or a transaction within the scope of [ASC 606].

As explained in paragraph BC28 of ASU 2014-09, ASC 606 applies to only a subset of revenue — specifically, revenue from contracts with customers. Therefore, because contributions are nonreciprocal transfers, the counterparty (e.g., a donor) in a contribution transaction would not meet the ASU’s definition of a customer:

A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration. [Emphasis added]

However, if a not-for-profit entity transfers a good or service for part or all of a contribution (i.e., a reciprocal transfer that is an exchange transaction) and the counterparty to the transaction is a customer, such a reciprocal transfer should be accounted for under ASC 606.

The above issue is addressed in Implementation Q&A 6 (compiled from previously issued TRG Agenda Papers 26 and 34). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

3.2.4 Nonmonetary Transaction Between Entities in the Same Line of Business

An entity is not permitted to recognize revenue from a nonmonetary transaction that is subject to the scope exception in ASC 606-10-15-2(e) related to nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. ASC 606-10-15-2(e) states that an example of such a nonmonetary transaction is “a contract between two oil companies that agree to an exchange of oil to fulfill demand from their customers in different specified locations on a timely basis.”

As explained in paragraphs BC58 and BC59 of ASU 2014-09, since the party exchanging inventory with the entity in a transaction of this nature meets the definition of a customer, the entity might recognize revenue once for the exchange of inventory and do so again for the sale of inventory to the end customer in the absence of the specific scope exclusion. The FASB and IASB concluded that this outcome would be inappropriate because (1) it would gross up revenues and expenses and thereby make it difficult for financial statement users to assess the entity’s performance and gross margins and (2) the counterparty in such an exchange transaction could be viewed as acting as a supplier rather than as a customer.

Questions have arisen about what constitutes the “same line of business” under the scope exception in ASC 606-10-15-2(e). We generally believe that entities are in the same line of business when they are undertaking similar activities or operations, as opposed to only being in the same industry or sector. In determining whether entities are undertaking similar activities or operations, an entity should use judgment and consider factors such as (1) the nature of the activities being performed, (2) the nature of the items being exchanged, and (3) the purpose of the exchange.

In addition, if two entities in the same line of business are exchanging inventories, we believe that for the inventories to qualify for the nonmonetary exchange scope exception (i.e., measurement based on the carrying amount of the inventory transferred in accordance with ASC 845-10-30-16), the exchange should be of like-kind inventory for like-kind inventory (i.e., raw materials or work-in-process inventory exchanged for raw materials, work-in-process, or finished goods inventory; or finished goods inventory exchanged for finished goods inventory) and should be to facilitate sales to end customers. Accordingly, it would generally not be appropriate for an entity to apply the scope exception in ASC 606-10-15-2(e) if it is exchanging finished goods inventory for another entity’s raw materials or work-in-process inventory regardless of whether the entities are in the same line of business.

The scope exception would also apply if cash is exchanged (unless the net cash received by one of the counterparties is at least 25 percent of the fair value of the exchange) as long as the exchange would otherwise meet the scope exception.

Example 3-8

Entity X enters into an inventory buy/sell arrangement with Entity Y. The entities are in the same line of business. Each entity has raw material stored in a location near the other party’s manufacturing facility. The purpose of the buy/sell arrangement is to avoid transportation time and cost and thereby expedite sales to end customers.

Entity X will purchase Raw Material A, which has a fair value of $12, from Y. In exchange, Y will purchase Raw Material B, which has a fair value of $12 and a cost basis of $10, from X. The parties will invoice each other $12. Both entities use Raw Material A and Raw Material B in the same line of business.

This transaction is outside the scope of ASC 606, and ASC 845 indicates that the exchange should be accounted for at carrying value. Therefore, X should record its purchase of Raw Material A from Y at the carrying amount of Raw Material B as follows:

In addition, X should record its sale of Raw Material B to Y as follows:

3.2.4.1 Identifying and Accounting for Boot in an Inventory Buy/Sell Arrangement

In inventory buy/sell arrangements that are within the scope of ASC 845, gross cash is often exchanged. ASC 845-10-15-6 and 15-7 require that if the transactions were entered into in contemplation of one another, they should be combined and accounted for as a single exchange. This requirement applies even though both parties exchanged cash in the arrangement. However, ASC 845-10-15-9 indicates that when determining whether the exchange is monetary or nonmonetary, an entity should consider the guidance on boot in ASC 845-10-15.

ASC 845-10-25-6 indicates that if boot is significant (at least 25 percent of the fair value of the exchange), the transaction should be considered monetary (see Section 3.2.4.2). If the boot is less than 25 percent of the fair value of the exchange, the transaction should be considered nonmonetary. For nonmonetary inventory exchanges recorded at carrying value in accordance with ASC 845, the pro rata gain recognition guidance in ASC 845-10-30-6 should be applied by the receiver of the boot.

Example 3-9

Entity X purchases 10 units of Raw Material A from Entity Y for $100 in cash. In addition, X sells 8 units of Raw Material B to Y, which uses that raw material in the same line of business, for $120 in cash. The 8 units of Raw Material B have a cost basis of $90 to X and a fair value of $120. In this example, the boot should be calculated as the net cash exchanged, which is $20 (i.e., $120 – $100).

The boot would not be considered significant in this example since it is only 16.7 percent ($20 ÷ $120) of the fair value of the exchange. Because the exchange involves raw materials that are used in the same line of business, X should record the exchange at carrying value, except that X can record a pro rata gain of $5 on the exchange. The pro rata gain is calculated as follows:

Alternatively, because ASC 845-10-30-6 defines the realized gain as the amount of monetary receipt that exceeds a proportionate share of the recorded amount of the asset surrendered (the proportion is based on the ratio of monetary consideration to total consideration received), the calculation could be performed as follows:

3.2.4.2 Nonmonetary Exchange Involving Cash

ASC 845-10-30-6 states that nonmonetary exchanges “that would otherwise be based on recorded amounts (see paragraph 845-10-30-3) may include an amount of monetary consideration.” However, there is a point at which monetary consideration is so significant that the entire transaction is considered monetary and, therefore, outside the scope of ASC 845. ASC 845-10-25-6 states:

An exchange of nonmonetary assets that would otherwise be based on recorded amounts but that also involves monetary consideration (boot) shall be considered monetary (rather than nonmonetary) if the boot is significant. Significant shall be defined as at least 25 percent of the fair value of the exchange. If the boot in a transaction is less than 25 percent, the pro rata gain recognition guidance in paragraph 845-10-30-6 shall be applied by the receiver of boot, and the payer of boot would not recognize a gain.

Example 3-10

Entity A is contemplating an exchange of its finished goods inventory for finished goods inventory sold by Customer B. In accordance with ASC 845-10-30-3(b), the transaction would be considered to facilitate sales to customers. Entity A expects that the fair value of the inventory it transfers to B will be approximately 50 percent of the fair value of the inventory to be transferred by B; accordingly, A is expecting to pay cash for the difference in value.

Because the monetary consideration is significant, this exchange (1) should be considered monetary in its entirety under ASC 845-10-25-6 and (2) is outside the scope of ASC 845.

3.2.5 Nonmonetary Exchange and Barter Credit Transactions

3.2.5.1 Nonmonetary Exchange Transactions

Most revenue transactions require the transfer of monetary assets by the customer in exchange for goods and services sold by an entity. However, certain transactions may involve the sale of goods or services in exchange for primarily nonmonetary assets. If the transaction is not subject to the scope exception in ASC 606-10-15-2(e) related to nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers, as described in Section 3.2.4, the transaction would typically be accounted for as a revenue arrangement under ASC 606 with noncash consideration received from a customer (see Section 6.5). If the counterparty is not a customer and the transaction is the sale of nonfinancial assets (or in-substance nonfinancial assets), the transaction may be subject to ASC 610-20 instead of ASC 606.

3.2.5.1.1 Buy/Sell Arrangements That Cross Reporting Periods

If only one side of a buy/sell transaction that is accounted for as the sale of inventory in exchange for other inventory has occurred as of the end of a reporting period, each side of the transaction should be accounted for as it occurs. The amount of the entry to record to inventory depends on whether the exchange is recorded at carrying value or fair value (see ASC 845-10-30-3 and ASC 845-10-30-15 and 30-16). If an exchange is accounted for under ASC 606, any revenue should generally be recognized at the time the customer obtains control of the finished goods.

No additional journal entries are necessary as of the balance sheet date. For an exchange that did not involve the exchange of cash, the balance sheet will already reflect a receivable or payable as a result of recording the first side of the transaction. For an exchange that involves cash, the balance sheet will reflect a receivable or payable for the difference between the cash exchanged and the value of the inventory. It would not be appropriate to accrue for the second half of the exchange, since the contract is executory and an entry would result in a gross-up of the balance sheet.

Example 3-11

Entity X, a calendar-year-end entity, enters into a buy/sell arrangement with Entity Y. Entity X purchases raw materials with a fair value of $100 from Y on December 29, 20X1. In exchange, X will sell finished goods with a carrying value of $80 and a fair value of $100 to Y on January 2, 20X2. The companies will invoice each other $90. The exchange is subject to the guidance in ASC 606. Entity X should record the following entries:

Example 3-12

Assume the same facts as in the example above, except that no cash is exchanged. In this case, Entity X should record the following entries:

3.2.5.1.2 Round-Trip Transactions

Although it can take many forms, a round-trip transaction essentially is a transaction in which one entity sells an item (e.g., goods, services, financial assets) to another entity, which in turn sells something back to the initial seller. Round-trip transactions often lack commercial substance. If such a transaction is not accounted for properly, it can lead to artificial inflation of the revenues of each entity.

The substance of the transaction is critical to determining the appropriate accounting. The individual transactions in a round-trip transaction are often entered into in contemplation of one another. Entities should consider whether those individual transactions should be combined and accounted for as a nonmonetary exchange. ASC 845-10-25-4 identifies factors indicating that transactions may have been entered into in contemplation of one another and that they therefore should be combined. Although the factors are discussed in the context of inventory exchanges, they can be applied, by analogy, to other types of exchanges. If the transactions are combined and accounted for under ASC 845, the exchange should not be accounted for at fair value if it lacks commercial substance or if it was performed to facilitate sales to customers (see ASC 845-10-30-3).

In a speech at the 2002 AICPA Conference on Current SEC Developments, the SEC staff also cautioned entities to evaluate the substance, rather than the form, of transactions to determine the proper accounting treatment. In addition, the SEC staff noted that it is not clear that the substance of the transaction is the same as its form if the customer in a round-trip transaction (1) does not need the goods or services provided, (2) would not normally have purchased the goods or services at that time, (3) purchased quantities in excess of its needs, or (4) would have been unable to pay in the absence of the concurrent investment. Accordingly, when a round-trip transaction lacks substance, revenue recognition is not appropriate.

3.2.5.1.3 Multiparty Exchange Involving Monetary Assets

Companies often structure transactions as “like-kind” exchanges for favorable tax treatment under Section 1031 of the Internal Revenue Code, whereby the tax basis in the new asset is the same as that in the old asset. These transactions are often structured as “three-party” or “three-corner” transactions in which three unrelated parties contribute and receive monetary and nonmonetary assets through an escrow account or trust arrangement.

The transaction, in substance, consists of one monetary transaction, the sale of an asset to one party, followed by another monetary transaction, the purchase of a replacement asset from a different party. As with the accounting for other monetary transactions, a three-party transaction would generally be recorded separately. The involvement of an unrelated third party is critical to this conclusion. Had the transaction involved only two parties, the transaction would be the sale of an asset in exchange for noncash consideration, even if cash was transferred to an escrow agent or both parties transferred equal amounts of cash to each other.

Example 3-13

Entity A will sell a parcel of land to Entity B. The cash purchase price will be placed into an escrow account. At the direction of A, B will use the cash later to purchase a parcel of land from Entity C. Entity A will receive title to the land and C will be paid from the escrow account. Entity A would generally assess whether the sale of the land to B should be accounted for under ASC 606 or ASC 610-20. By using an escrow account, A has avoided the actual exchange of monetary assets. However, in such circumstances, the transaction would generally be accounted for separately as (1) the sale of land in exchange for cash and (2) the purchase of land in exchange for cash.

3.2.5.2 Barter Credit Transactions

In some industries, entities may enter into arrangements referred to as “barter credit transactions.” Barter credit transactions may occur in many forms. In one common form, an entity provides goods or services and in return receives “credits” that can be used for a specific period to acquire products or services from either (1) a specific company that is a party to the exchange of products or services or (2) members of a “barter” exchange network. Barter exchange networks allow one member to exchange products or services of another member even if the member providing the products or services was not the counterparty to the original barter contribution. Barter credit transactions are structured in various ways and may differ significantly in terms of business motives or levels of risk.

Barter credit transactions may include exchanges of items such as the following:

Products or services for advertising credits.
Professional services for travel credits.
Air travel or other vacation travel for advertising credits.

Although barter credit transactions may create opportunities for barter participants, they pose various risks principally related to the measurement of the transaction, including:

Failure to recognize impairment in value of products given up in a barter transaction.
Difficulties in converting products or credits received in a barter transaction to cash when no market for the products or credits exists.
Expiration of unused barter credits.
Inadequate internal controls over barter credits.
Inability to acquire products or services in return that are worth as much as the products or services contributed.
Inability to reasonably determine the value of products or services received in return.

It is important to understand the substance and purpose of the barter credit transaction as well as the appropriate valuation of, and accounting treatment for, the transaction. Further, entering into a barter transaction may indicate a lack of a normal distribution channel or an alternative use for the goods sold by an entity. Such situations may indicate an asset impairment.

Under ASC 845-10-30-19, additional impairment write-downs should be recognized if either of the following is true:

The fair value of any remaining barter credits is less than the carrying amount.
It is probable that the entity will not use all of the remaining barter credits.

Potential uses for the barter credits should be evaluated to determine the true economic benefit (e.g., discounted or “real” prices, rather than list or “rack” rate prices, should be considered). Professional skepticism should be heightened for entities entering into barter transactions involving their own inventory, especially at or near quarter- or year-ends. These transactions may indicate that excess or obsolete inventory exists or that barter activity is merely being used to avoid or delay a necessary write-down.

Since barter credit transactions are akin to nonmonetary exchanges, entities should consider whether particular barter credit transactions are subject to the scope exception for nonmonetary exchanges in ASC 606-10-15-2(e).

In accordance with ASC 606-10-15-2(e), nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers are outside the scope of ASC 606 and may be subject to the guidance in ASC 845 on nonmonetary transactions. Typically, no revenue is recognized when the guidance in ASC 845 is applied to such nonmonetary exchanges outside the scope of ASC 606.

Accordingly, for an entity to determine whether a barter credit transaction should be accounted for under ASC 606 or under ASC 845, the entity should understand the substance and purpose of the barter credit transaction. If the entity determines that the barter credit transaction represents a contract with a customer that is within the scope of ASC 606, it should account for the barter credits received from the customer as noncash consideration, as discussed in Section 6.5.2.

3.2.6 Fixed-Odds Wagering Contracts

Fixed-odds wagers are wagers placed by bettors (i.e., customers) who typically know the odds of winning in gaming activities3 at the time the bets are placed with gaming industry entities. After the revenue standard was issued, stakeholders reporting under U.S. GAAP questioned whether fixed-odds wagering contracts should be accounted for as revenue transactions (i.e., when or as control is transferred in accordance with the revenue standard) or as derivatives (i.e., adjusted to fair value through net income each reporting period). The issue arose for the following reasons:

The revenue standard, which does not apply to contracts accounted for as derivatives under ASC 815, eliminated the legacy guidance in ASC 924-605, under which fixed-odds wagers were generally recognized as revenue when settled.
Regarding an issue that the IFRS Interpretations Committee considered adding to its agenda in 2007, the Committee noted (in an agenda decision reported in the July 2007 IFRIC Update) that an unsettled wager is a financial instrument that is likely to meet the definition of a derivative financial instrument under IAS 39.4

In November 2015, the FASB staff noted its belief that the FASB did not intend to change how entities reporting under U.S. GAAP would account for fixed-odds wagers upon adoption of the revenue standard. That is, the FASB staff believed that the Board intended for entities reporting under U.S. GAAP to continue accounting for fixed-odds wagering contracts as revenue transactions. On the other hand, the FASB staff further indicated in TRG Agenda Paper 47 that “if fixed odds wagering contracts were excluded from the scope of the new revenue standard, then those arrangements likely would be accounted for as derivatives.”

In December 2016, the FASB issued ASU 2016-20 on technical corrections to the revenue standard, which created a derivatives guidance scope exception for fixed-odds wagering contracts. Specifically, ASU 2016-20 added ASC 924-815, which clarifies that such contracts are revenue contracts within the scope of ASC 606.

3.2.7 Scope of Guidance on Contract Costs

Although the clear focus of the boards’ project was to improve the recognition of revenue, the boards also decided to include new guidance on contract costs in the final revenue standard. Accordingly, ASU 2014-09, which added ASC 606, also added ASC 340-40 to provide such cost guidance. Specifically, ASC 340-40 contains guidance on how to account for two types of costs related to a contract with a customer:

“Incremental costs of obtaining a contract with a customer.”
“Costs incurred in fulfilling a contract with a customer that are not in the scope of another Topic.”

For details on accounting for these types of costs, see Chapter 13.

The direct linkage between ASC 606 and ASC 340-40 resides in the following paragraph from the Codification:

ASC 606-10

15-5 Subtopic 340-40 on other assets and deferred costs from contracts with customers includes guidance on accounting for the incremental costs of obtaining a contract with a customer and for the costs incurred to fulfill a contract with a customer if those costs are not within the scope of another Topic (see Subtopic 340-40). An entity shall apply that guidance only to the costs incurred that relate to a contract with a customer (or part of that contract) that is within the scope of the guidance in this Topic.

In certain industries, most notably the automotive supplier and aerospace and defense industries, an entity may incur costs related to activities it performed before producing a good for a customer. Sometimes, an entity may incur costs for these activities before executing a contract with a customer and may even be entitled to consideration from the potential customer in connection with the initial activities. An entity may be willing to incur such costs (even in excess of amounts due from the potential customer) because of an expectation, based on current negotiations or on perceived customer demand for the product, that a contract will be executed in the near term. Costs incurred are typically related to engineering, design, and development activities, along with the manufacturing or purchase of specific equipment, molds, tools, or dies that will be used to produce the good.

With the introduction of the cost guidance in ASC 340-40, stakeholders have questioned whether these sorts of preproduction costs would be within the scope of ASC 340-40 and would therefore need to be assessed for capitalization under the criteria in ASC 340-40-25-5. The cost guidance in ASC 340-40 applies to costs incurred to fulfill a contract with a customer within the scope of ASC 606, noting that the costs could be related to an anticipated contract with a customer. Therefore, in evaluating whether these preproduction costs should be accounted for under ASC 340-40, an entity will need to determine whether the costs in question are incurred in connection with a contract (or anticipated contract) that is within the scope of ASC 606. An entity may need to use judgment when determining whether the preproduction activities are within the scope of ASC 606 because (1) the preproduction activities transfer a good or service to a customer that is part of the entity’s ordinary activities or (2) the costs are fulfillment costs incurred in connection with an anticipated contract with a customer.

The above issue is addressed in Implementation Q&A 66 (compiled from previously issued TRG Agenda Papers 46 and 49). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C. See also Section 13.3.4.

As a result of questions raised by stakeholders and diversity in practice under legacy U.S. GAAP, the FASB instructed its staff to conduct outreach to various stakeholders to better understand how existing practice developed and what, if any, additional education would help stakeholders determine how to apply the new guidance in ASC 606 and ASC 340-40. At the February 15, 2017, FASB meeting, the FASB staff reported to the Board the results of its outreach. In the handout for the meeting, the staff included a decision tree to help stakeholders evaluate whether preproduction activities are within the scope of ASC 606 and ASC 340-40. The decision tree is reproduced below.

“For example, the activities do not constitute an entity’s ongoing major or central operations (Master Glossary – Revenue).”

“This may result in the reimbursement being recorded as other income or as contra-expense.”

“If the NRE and the subsequent production units are in a single contract or the contracts meet the criteria for contract combination in paragraph 606-10-25-9, this may result in revenue being recognized over a period longer than the preproduction period. For example, it may result in revenue being recognized over subsequent production units.”

Although the FASB provided some interpretative guidance in the form of the February 2017 Board meeting handout (illustrated above), stakeholders (particularly in the automotive supplier industry) continued to raise questions about the appropriate guidance to apply to account for preproduction costs and related reimbursements. Specifically, stakeholders in the automotive industry questioned whether diversity in practice would continue to be appropriate upon the adoption of ASC 606 and ASC 340-40. On the basis of discussions with the SEC staff after the February 2017 FASB meeting, we understand that some diversity in practice will continue to be acceptable depending on the facts and circumstances and an entity’s historical conclusions about scope. Specific considerations related to accounting for preproduction costs and related reimbursements in the automotive supplier industry are as follows:

Automotive suppliers that historically concluded that their preproduction costs were within the scope of ASC 340-10 should continue to apply that guidance upon adoption of the revenue standard. Automotive suppliers that historically applied the guidance in ASC 340-10 by analogy should evaluate their preproduction costs under the fulfillment cost guidance in ASC 340-40 upon adoption of the revenue standard.
Diversity in practice will continue to be acceptable for accounting for reimbursements received from original equipment manufacturers for a supplier’s preproduction activities. If a supplier historically accounted for the reimbursements as revenue under ASC 605, it would most likely be acceptable for the supplier to continue to account for the reimbursements as revenue under ASC 606. Similarly, if a supplier historically accounted for the reimbursements as an offset to the related costs (i.e., not revenue), this practice would continue to be acceptable upon the adoption of the revenue standard. The resulting policy should be consistent with the principles of ASC 606 and related discussion of the TRG in November 2015 (see Implementation Q&A 65 [compiled from previously issued TRG Agenda Papers 46 and 49]).
If a supplier would like to change its accounting policy for reimbursements received for preproduction activities, further analysis may be required. We generally believe that a supplier should consider consulting with the SEC staff if the supplier believes that a change in its accounting policy for reimbursements for preproduction activities (i.e., a change from revenue to cost reimbursement, or a change from cost reimbursement to revenue) is warranted under ASC 606.

This topic was addressed by Joseph Epstein, then professional accounting fellow in the OCA, in a speech at the 2017 AICPA Conference on Current SEC and PCAOB Developments. In his speech, Mr. Epstein acknowledged that the SEC staff was engaged in a prefiling consultation with an SEC registrant regarding the accounting for a preproduction arrangement. Mr. Epstein further noted that the SEC staff did not object to the following conclusions reached by the registrant (footnotes omitted):

The “design activities did not transfer control of a good or service to the counterparty, and therefore were not a performance obligation under Topic 606, because the periodic information provided to the counterparty related to the design activities over the course of the arrangement was not detailed enough to enable the counterparty to avoid having to re-perform the design work, for example, if the design efforts were not successful or if the counterparty selected another manufacturer for the specialized good.”
The “pre-production design activities should be accounted for as research and development expenses and . . . payments received should be accounted for as an advance payment for the future sale of the specialized good to the counterparty.”
It was appropriate to treat the change in accounting for a preproduction arrangement as part of the registrant’s transition to ASC 606 rather than as a voluntary change in accounting principle under ASC 250.

Mr. Epstein also noted that the SEC staff would not object if registrants that have historically accounted for preproduction activities as nonrevenue arrangements continue to apply their nonrevenue models to preproduction arrangements after adoption of the revenue standard. However, he encouraged such registrants to consult with the OCA if they are considering either the application of a revenue model under ASC 606 or changes to their historical nonrevenue models.

3.2.8 Determining the Customer in a Contract

ASC 606-10

15-3 An entity shall apply the guidance in this Topic to a contract (other than a contract listed in paragraph 606-10-15-2) only if the counterparty to the contract is a customer. A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.

As noted in the Background Information and Basis for Conclusions of ASU 2014-09, the FASB defined the term “customer” in the glossary of the revenue standard to help companies understand and establish which transactions are within the standard’s scope. For the purposes of ASC 606, a customer is a “party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.” Despite some requests for further clarification, the Board purposefully did not define what constitutes “ordinary activities.” In part, this decision was a compromise since the FASB’s and IASB’s respective conceptual frameworks differ from each other in the words used to define revenue. Specifically, the IASB’s Conceptual Framework description of revenue refers to the “ordinary activities of an entity,” and the legacy definition in the FASB’s Concepts Statements describes revenue in terms of the entity’s “ongoing major or central operations.”8 As discussed in paragraphs BC29 and BC53 of ASU 2014-09, the boards did not reconsider those definitions as part of the development of the revenue standard.

Connecting the Dots

Ordinary Activities Versus Ongoing Major or Central Operations

While the boards compromised on the definition of a customer, at the time ASU 2014-09 was issued, they did not change their respective definitions of revenue, which differ from each other in IFRS 15 and ASC 606. However, despite the difference in wording between “ordinary activities” and “ongoing major or central operations,” we do not expect substantial differences between the two definitions.

There is separate guidance on transactions that do not meet the definition of revenue (i.e., the counterparty to the contract is not a customer). Typically, transactions not occurring with a customer may be one-off or infrequent transactions, such as the sale of a piece of equipment or the sale of a corporate headquarters building. For those instances, the FASB created a new subtopic, ASC 610-20, which is further discussed in Chapter 17.

Updated Definition of Revenue in the FASB’s Concepts Statements

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 Board has not amended the ASC master glossary and ASC 606 to conform the Codification’s definitions of revenue and a customer with the FASB Concepts Statement’s revised definition of revenue, and the FASB Concepts Statement does not represent authoritative guidance. In addition, entities should consider the following in the FASB Concepts Statement’s Basis for Conclusions:

In paragraph BC4.44, the Board states, in part, that it “concluded that delivering or producing goods and rendering services are primary factors in distinguishing revenue from gains and expenses from losses, regardless of whether they are considered major or central to an entity.”
In paragraph BC4.45, the Board observes that “delivery of or producing goods or rendering services should always result in revenues and expenses.”
In paragraph BC4.46, the Board notes that regarding its decision “to retain the phrase other activities” in the FASB Concepts Statement’s revised definition of revenue, (1) “inclusion of that phrase allows sources such as investment income to be considered revenue” and (2) “[i]t is not the Board’s intention to suggest that the phrase other activities is an all-encompassing notion that captures every inflow and outflow.”

Further, paragraph E90 of the FASB Concepts Statement states the following:

The primary purpose of distinguishing gains and losses from revenues and expenses is to make displays of financial information about an entity’s sources of comprehensive income as useful as possible. Ultimately, those decisions will be made at a standards level with considerations for the objective of financial reporting and presentation concepts. [Emphasis added]

On the basis of the above, we do not expect the updated definition of revenue in the FASB Concepts Statement to result in a change in practice regarding the determination of which transactions should be accounted for and presented as revenue under ASC 606.

Contracts With Another Entity That Is Both a Customer and a Vendor

In certain arrangements, an entity may enter into one or more contracts with another entity that is both a customer and a vendor.9 That is, the reporting entity may enter into one or more contracts with another entity to (1) sell goods or services that are an output of the reporting entity’s ordinary activities in exchange for consideration from the other entity and (2) purchase goods or services from the other entity.

In these types of arrangements, the reporting entity will need to use judgment to determine whether the other entity is predominantly a customer or predominantly a vendor. It may not be possible to make this determination solely on the basis of the contractual terms. In such cases, the reporting entity will need to consider the facts and circumstances of the overall arrangement with the other entity. The reporting entity’s conclusion that the other entity in the arrangement is predominantly a customer or predominantly a vendor may determine whether (1) the consideration received from the other entity should be accounted for under ASC 705-20 as consideration received from a vendor or (2) the consideration paid to the other entity should be accounted for under ASC 606 as consideration payable to a customer.

Applying the guidance on consideration payable to a customer and consideration received from a vendor is further discussed in Sections 6.6.2 and 6.6.5, respectively.

3.2.9 Collaborative Arrangements

Companies often enter into arrangements with third parties for the development or commercialization of goods and services in an effort to share in both the costs and risks associated with such activities. When an entity enters into a collaboration, management must consider whether the arrangement meets the U.S. GAAP definition of a collaborative arrangement to determine whether the arrangement is subject to the requirements of ASC 808. The legal characterization of an arrangement (e.g., as a collaboration or a collaborative arrangement) does not necessarily make the arrangement qualify as a collaborative arrangement under U.S. GAAP.

ASC 808-10-20 defines a collaborative arrangement as a “contractual arrangement that involves a joint operating activity” and involves two (or more) parties that are both of the following:

“[A]ctive participants in the activity.”
“[E]xposed to significant risks and rewards dependent on the commercial success of the activity.”

On the basis of these criteria, some types of collaborations may not meet the definition of a collaborative arrangement and therefore would not be within the scope of ASC 808. For example, certain arrangements in which one party solely provides financial resources for an endeavor and is generally not an active participant would not meet the definition of a collaborative arrangement. Alternatively, arrangements between two parties that involve codevelopment, comarketing, or copromotion activities, as well as the sharing of risks and rewards based on the success of such activities, would generally meet the definition of a collaborative arrangement.

A collaboration can begin at any point in the life cycle of an endeavor (e.g., during the research and development [R&D] phase or after a product has been commercially launched). The facts and circumstances associated with the arrangement will dictate whether the parties (1) represent active participants and (2) are exposed to significant risks and rewards.

ASC 808-10-15-8 cites the following examples of situations in which active participation may exist:

Directing and carrying out the activities of the joint operating activity
Participating on a steering committee or other oversight or governance mechanism
Holding a contractual or other legal right to the underlying intellectual property.

In addition, ASC 808-10-15-11 lists circumstances that might indicate that participants are not exposed to significant risks and rewards:

Services are performed in exchange for fees paid at market rates.
A participant is able to exit the arrangement without cause and recover all (or a significant portion) of its cumulative economic participation to date.
Initial profits are allocated to only one participant.
There is a limit on the reward that accrues to a participant.

Further, in accordance with ASC 808-10-15-12, an entity should also consider other factors when evaluating participants’ exposure to significant risks and rewards, including (1) the “stage of the endeavor’s life cycle” and (2) the “expected duration or extent of the participants’ financial participation . . . in relation to the endeavor’s total expected life or total expected value.”

A collaborative arrangement may, in whole or in part, represent a contract with a customer that should be accounted for under ASC 606. The Background Information and Basis for Conclusions of ASU 2014-09 explains that the relationship between a customer and a vendor varies from industry to industry and that companies will therefore have to consider their own facts and circumstances to determine who is a customer in an arrangement. For many contracts, this will not be very difficult to determine; however, paragraph BC54 of ASU 2014-09 provides the following examples of arrangements in which the facts and circumstances would have to be assessed:

Collaborative research and development efforts between biotechnology and pharmaceutical entities or similar arrangements in the aerospace and defense, technology, and healthcare industries, or in higher education.
Arrangements in the oil and gas industry in which partners in an offshore oil and gas field may make payments to each other to settle any differences between their proportionate entitlements to production volumes from the field during a reporting period.
Arrangements in the not-for-profit industry in which an entity receives grants and sponsorship for research activity and the grantor or sponsor may specify how any output from the research activity will be used.

The example below illustrates how an entity would determine whether an arrangement is a collaborative arrangement and, if so, whether it should be accounted for under ASC 606.

Example 3-14

Biotech B and Pharma P enter into an agreement to research, develop, and commercialize drug X. Biotech B will perform the R&D, and Pharma P will commercialize the drug. Both parties agree to participate equally in all activities that result from the research, development, and commercialization. The reporting entity concludes that a collaborative arrangement exists because both parties are active participants and have agreed to share in the risks and rewards.

Despite this conclusion, however, there still could be an entity-customer relationship as a result of the collaborative agreement or other contracts between the two entities. If such a relationship exists, those parts of the contract that are related to the entity-customer relationship should be accounted for under ASC 606.

It is important to understand that a contract could be within the scope of both the revenue standard and the guidance on collaborative agreements, as indicated in paragraph BC55 of ASU 2014-09:

The Boards noted that a contract with a collaborator or a partner (for example, a joint arrangement as defined in IFRS 11, Joint Arrangements, or a collaborative arrangement within the scope of Topic 808, Collaborative Arrangements) also could be within the scope of Topic 606 if that collaborator or partner meets the definition of a customer for some or all of the terms of the arrangement.

This is important because companies may have to assess the scope of both ASC 606 and ASC 808 for these types of arrangements.

In November 2018, the FASB issued ASU 2018-18, which made targeted improvements to the guidance on collaborative arrangements in ASC 808, including the following clarifications:

In the evaluation of whether a transaction in a collaborative arrangement is within the scope of ASC 606, the unit of account is a distinct good or service.
When the collaborative participant is a customer, the recognition, measurement, presentation, and disclosure requirements of ASC 606 should be applied to the transaction.
An entity in a collaborative arrangement is precluded from presenting a transaction as revenue if the collaborative participant counterparty is not a customer.

While the amendments in ASU 2018-18 primarily affected the guidance in ASC 808, the ASU also amended ASC 606-10-15-3 to remove the following guidance:

A counterparty to the contract would not be a customer if, for example, the counterparty has contracted with the entity to participate in an activity or process in which the parties to the contract share in the risks and benefits that result from the activity or process (such as developing an asset in a collaboration arrangement) rather than to obtain the output of the entity’s ordinary activities.

3.2.9.1 Collaborative Arrangements Outside the Scope of ASC 606

In determining the accounting for collaborative arrangements outside the scope of ASC 606, many entities have historically applied revenue recognition guidance by analogy. These entities often conclude that the collaborative activities do not represent separate deliverables (i.e., they conclude that there is one “unit of account,” which represents the right to actively participate in the collaborative arrangement over its term and to share in the profits or losses from the underlying endeavor).

Before the FASB issued ASU 2018-18, we believed that when analogizing to authoritative accounting literature, an entity should apply all (as opposed to limited) aspects of that literature to the extent applicable. For example, suppose that a biotechnology company entered into a collaborative arrangement with a pharmaceutical company and, as part of the collaboration, (1) provided the pharmaceutical company a license to use IP related to a drug candidate and (2) performed R&D services jointly with the pharmaceutical company. The biotechnology company may have concluded that while the arrangement meets the definition of a collaborative arrangement in accordance with ASC 808, none of its elements are within the scope of ASC 606. Nevertheless, the biotechnology company may have further concluded that revenue literature (e.g., ASC 606) represents appropriate authoritative guidance that the company should apply by analogy to determine the unit(s) of account, recognition, and measurement. Accordingly, if the company concluded that the license is not a distinct performance obligation, the revenue literature would require the license and R&D services to be combined for accounting purposes. Further, with respect to the appropriate income statement presentation for consideration allocated to the combined unit of account (in this case, the license and R&D services), such consideration would generally be presented consistently in the same category for income statement presentation purposes given the conclusion that the license and R&D services should be combined for accounting purposes.

However, as noted above, the FASB issued ASU 2018-18 in November 2018. Although the Board decided to provide unit-of-account guidance in ASC 808 and align that guidance with the guidance in ASC 606 for distinct goods or services, the Board decided not to include recognition and measurement guidance for nonrevenue transactions in a collaborative arrangement. The Board’s reason for not including such guidance was to avoid developing a “one size fits all” accounting model for the various types of collaborative arrangements. The decision to align the unit-of-account guidance with the guidance in ASC 606 for distinct goods or services is limited to the context of assessing the scope of the revenue guidance. As noted in paragraph BC31 of ASU 2018-18, “the Board decided to continue to permit an entity to apply the revenue guidance in Topic 606 by analogy or, if there is no appropriate analogy, as a policy election, without requiring the entity to apply all the guidance in Topic 606, as long as it presents the transaction separate from revenue recognized from contracts with customers” (emphasis added). Accordingly, it is possible for an entity to conclude on the basis of its facts and circumstances that ASC 606 represents an “appropriate analogy” for determining the nonrevenue unit(s) of account but may not represent an appropriate analogy for recognizing or measuring such unit(s) of account. In such a case, the above guidance would support a conclusion that analogizing to ASC 606 could be limited to an entity’s determination of the unit(s) of account. The entity would then be required to establish a policy that is “reasonable, rational, and consistently applied” as long as the nonrevenue transaction is presented separately from any revenue recognized from contracts with customers under ASC 606.

3.2.10 Contracts That Include Both Revenue and Nonrevenue Elements

ASC 606-10

15-4 A contract with a customer may be partially within the scope of this Topic and partially within the scope of other Topics listed in paragraph 606-10-15-2.

If the other Topics specify how to separate and/or initially measure one or more parts of the contract, then an entity shall first apply the separation and/or measurement guidance in those Topics. An entity shall exclude from the transaction price the amount of the part (or parts) of the contract that are initially measured in accordance with other Topics and shall apply paragraphs 606-10-32-28 through 32-41 to allocate the amount of the transaction price that remains (if any) to each performance obligation within the scope of this Topic and to any other parts of the contract identified by paragraph 606-10-15-4(b).
If the other Topics do not specify how to separate and/or initially measure one or more parts of the contract, then the entity shall apply the guidance in this Topic to separate and/or initially measure the part (or parts) of the contract.

When a contract includes multiple performance obligations, or deliverables (see Chapter 5 for information about defining a performance obligation), some of which are within the scope of other standards, any separation and initial measurement requirements of the other standards are applied first and the deliverables within the scope of the revenue model are ascribed any residual amount. For example, if a contract includes performance obligations subject to ASC 606 and a guarantee subject to ASC 460 (e.g., an indirect guarantee of the indebtedness of others), the guarantee would typically be recognized at its fair value, with the residual transaction price recognized under ASC 606.

If there are no separation or initial measurement requirements in those other standards, the requirements in ASC 606 are applied. That is, the guidance in ASC 606 is the default guidance to be used if there is no other relevant guidance. For example, consider an entity that enters into a single contract to lease a boat to a customer and provide cleaning services for that boat. Assume that the entity assesses the promises in the contract and determines that (1) the lease of the boat is within the scope of the guidance on leases and (2) the cleaning services are within the scope of ASC 606. Further, assume that the entity has adopted both the revenue standard and the leasing standard (ASC 842) and that the entity has not elected to use the available practical expedient that would allow it to avoid separating lease and nonlease components (as discussed in Section 3.2.12 of this Roadmap and Section 4.3.3.2 of Deloitte’s Roadmap Leases). In accordance with ASC 606, the entity would first look to the other guidance (the leasing standard, in this situation) for guidance on how to allocate the consideration from the contract; if the other standard did not have allocation guidance, the entity would apply the allocation guidance in ASC 606. In this situation, the leasing standard says to apply the allocation guidance in ASC 606. Therefore, the entity would use the revenue standard’s guidance to identify the performance obligations and allocate consideration between the revenue and nonrevenue (i.e., lease) components.

3.2.10.1 Customer Litigation Settlements

Entities may enter into litigation settlements that are partially or entirely within the scope of ASC 606. Often, litigation brought against a party can result in countersuits in which each party holds claims for infringement of another party’s intellectual property (IP). In these instances, it is common for each party to be required to pay the other party for the use of IP; the payments can be effected through gross or net settlement. Proper identification of each part of the settlement, including obtaining an understanding of the value of each part, is critical to accounting for the consideration given or received by each party.10

3.2.10.1.1 Litigation Consideration Received From a Customer

Litigation settlements may include both consideration received within the scope of ASC 606 (because it represents a payment for the entity’s goods or services, such as a license of IP) and consideration received within the scope of other Codification topics. ASC 606-10-15-4 provides guidance on measuring contracts with a customer that may be partially within the scope of ASC 606 and partially within the scope of other Codification topics. ASC 606-10-15-4(a) clarifies that “[i]f the other Topics specify how to separate and/or initially measure one or more parts of the contract, then an entity shall first apply the separation and/or measurement guidance in those Topics. An entity shall exclude from the transaction price the amount of the part (or parts) of the contract that are initially measured in accordance with other Topics.” Further, ASC 606-10-15-4(b) states that “[i]f the other Topics do not specify how to separate and/or initially measure one or more parts of the contract, then the entity shall apply the guidance in this Topic [i.e., ASC 606] to separate and/or initially measure the part (or parts) of the contract.”

How settlement proceeds are accounted for is entirely dependent on specific facts and circumstances. Proper identification of each part of a settlement is critical to appropriately accounting for the settlement transactions. If a litigation settlement contains parts that are not attributable to ASC 606, an entity should first identify whether other Codification topics apply to specific parts of the settlement and, if so, measure each part in accordance with the applicable topic. After considering the measurement guidance of other topics as directed by ASC 606-10-15-4(a), the entity should allocate the remaining consideration to the other elements on the basis of the stand-alone selling prices of the remaining part or parts (as discussed in Chapter 7). While it is possible that this method may result in the allocation of little or no consideration to the revenue part, we generally believe that when there is an ongoing revenue relationship for which the entity expects to receive consideration, a portion of the consideration exchanged in the litigation settlement should be allocated to revenue. When little or no settlement consideration is allocated to a revenue part but an ongoing revenue relationship exists, entities should consult with their accounting advisers and auditors.

Generally, the allocation of consideration, or the lack thereof, to the revenue part of a settlement should not lead to an accounting treatment that is different from what would be the case if the settlement did not exist (i.e., if an entity only entered into a contract with a customer). For example, consider that Entity A, in its ordinary operations, issues royalty-bearing licenses to customers and receives up-front payments upon entering into license agreements. If, as part of a litigation settlement related to unauthorized use of A’s license, A issues a royalty-bearing license to Entity B and B makes a settlement payment to A to resolve the litigation, the payment that A receives would most likely be treated, at least in part, as consideration for entering into the license agreement. This could include payment for past use of the licensed IP before A and B entered into a contract as part of the litigation settlement.

If an entity receives a settlement payment for activities that are unrelated to the customer relationship, it would be inappropriate for the entity to classify any of that payment as revenue. For example, if an entity enters into litigation against a customer for using patented technology that the entity does not sell in the ordinary course of business, any payments received to settle the litigation most likely should not be classified as revenue.

When a litigation settlement contains multiple parts within the scope of ASC 606, the guidance in ASC 606-10-32-28 through 32-30 would apply. The residual approach to allocating consideration in a contract, which is discussed in Section 7.3.3.2, may be appropriate when the observable stand-alone selling price of a performance obligation is uncertain. However, as further discussed in Section 7.3.3.2, if the residual approach in ASC 606-10-32-34(c) results in the allocation of little or no consideration to a good or service, the entity should consider whether the estimate of the stand-alone selling price is appropriate. Application of the residual approach to determine the stand-alone selling price requires judgment, and entities should continually reassess whether the use of this approach remains appropriate.

We believe that other Codification topics would not specify how to separate and/or initially measure any settlement gains resulting from litigation consideration received from a customer. Therefore, an entity might apply a residual approach to allocating consideration to the settlement part of a multipart agreement resulting in a settlement gain when there is observable pricing for other elements to which the settlement payment is related. This could result in the allocation of little or no consideration to the settlement gain.

3.2.10.1.2 Litigation Consideration Paid to a Customer

When litigation results in consideration paid by an entity to its customer, the guidance on consideration payable to a customer needs to be considered (see Section 6.6). An entity’s relationship with the counterparty should be considered in the determination of how litigation payments should be classified. Litigation settlements involving existing or new customer relationships would typically be evaluated as consideration payable to a customer. Often, payments to a customer due to litigation will be recorded as a reduction of the transaction price since they are not for a distinct good or service. For example, settlement of litigation that returns consideration to a customer for amounts equal to overbillings or compensates the customer because of claims related to the provision of the vendor’s goods or services would generally be accounted for as a reduction of revenue.

When payments to a customer are made, consideration needs to be given to whether the payments are related to past or future performance. Payments related to past performance should be considered a price concession and recorded immediately as an adjustment to revenue (see Section 7.6). If an entity has a reasonable expectation that a payment attributable to past performance will be made, the entity should evaluate the payment as variable consideration, which may result in a reduction of the transaction price (i.e., revenue recorded) before the settlement payment is received. See Section 6.3.3 for additional information about constraining estimates of variable consideration. Payments related to future performance would generally be accounted for as either a contract modification (a change in the transaction price) for an in-process contract or an incentive for entering into a future contract. See Chapter 9 for additional information about contract modifications.

Determining whether consideration paid to settle litigation with a customer is a result of past or future performance may require significant judgment.

Litigation settlements arising from lawsuits and countersuits with customers must be carefully evaluated to determine whether and, if so, when and how much consideration should be recognized as revenue or as reductions of revenue. Special attention should be given when countersuits between an entity and its customer result in a net settlement. Proper identification and measurement of each part of the settlement are critical to appropriately accounting for the consideration exchanged.

3.2.11 Contracts That Pose Scope Challenges

Some contracts may pose scope challenges. Entities will need to use judgment to determine whether the performance obligations in contracts meet one of the scope exceptions of the revenue standard.

3.2.11.1 Lapsed Unexercised Warrants

Entities often issue warrants (options issued on the entity’s own shares) for cash. If these warrants meet the definition of equity instruments under ASC 815-40, the amount received for issuing them is credited to equity. When the warrants lapse unexercised, revenue should not be recognized. The issuance of warrants for cash is not a transaction with customers; rather, it is a transaction with equity participants. The definition of comprehensive income (which encompasses both revenue and gains in accordance with the conceptual framework) excludes contributions from equity participants. The fact that an equity participant no longer has an equity claim on the assets of the entity does not convert the equity contribution into income. Amounts for warrants classified as equity instruments may be transferred to another account within equity (e.g., contributed surplus) as of the date the warrants expire.

3.2.11.2 Incentive-Based Capital Allocation Arrangements

Compensation for asset managers commonly consists of both management fees (usually a percentage of assets under management) and incentive-based fees (i.e., fees based on the extent to which a fund’s performance exceeds predetermined thresholds). Often, a private-equity or real estate fund manager (who may be the general partner and have a small ownership percentage in the fund) will receive incentive-based fees by way of an allocation of capital from the fund’s limited partnership interests (commonly referred to as “carried interests”).

One common arrangement is referred to as “2 and 20” (i.e., 2 percent and 20 percent). The 2 percent refers to an annual management fee computed on the basis of assets under management. Management fees are generally separate and distinct from performance-based capital allocations since management fees are usually in the form of a cash-based contractual relationship between the asset manager and the fund. Therefore, management fees would be subject to ASC 606.

The 20 percent refers to a term in a performance fee arrangement under which the asset manager participates in a specified percentage (e.g., 20 percent) of returns after other investors have achieved a specified return on their investments, which is referred to as a hurdle rate (e.g., 8 percent).

Under a prevalent form of such an arrangement, the performance fee is in the legal form of a capital account within the equity structure of the fund, or “carried interest.” As noted above, the asset manager’s capital account receives allocations of the returns of a fund when those returns exceed predetermined thresholds. In addition to the carried interest, the asset manager or affiliates often acquire a small ownership interest in the fund through general partner or limited partner interests on the same basis as other investors. Such interests receive only pro rata allocations of fund returns and are not typically subject to the accounting guidance in ASC 606 since there are no incentive or performance aspects to the arrangement.

In other cases, the fund manager’s performance fee may be in the form of a contractual arrangement with the fund rather than an allocation of capital within an equity interest.

Under the revenue standard, the incentive fee portion of an asset management arrangement is likely to represent variable consideration, as discussed further below. As illustrated in Example 25 of the standard (ASC 606-10-55-221 through 55-225), the application of the variable consideration constraint may result in a delay in recognition of incentive fees. In some cases, this delay may be significant.

3.2.11.2.1 Views Proposed by Stakeholders

While Example 25 of the revenue standard contains implementation guidance that demonstrates how to apply the variable consideration constraint to an asset management contract, “the example does not state that the form of the incentive fee is a capital allocation or cash (or some other asset).”11 That is, Example 25 does not specify whether it “applies to equity-based arrangements in which the asset manager is compensated for performance-based fees via an equity interest (that is, incentive-based capital allocations such as carried interest).”12 Consequently, stakeholders have expressed the following views on whether carried interests are within the scope of the revenue standard:

View A — Carried interests are within the scope of the revenue standard.
View B — Carried interests are outside the scope of the revenue standard.
View C — An entity’s accounting for carried interests may vary in accordance with the nature and substance of the arrangement.

Proponents of View A believe that carried interests are revenue transactions and analogize such interests to performance bonuses in contracts with customers in other industries (i.e., they believe that the purpose of carried interest arrangements and other similar arrangements is to compensate asset managers for their services). Accordingly, under View A, carried interests would be included in the transaction price subject to the constraint guidance on variable consideration. (See Chapter 6 for further discussion about estimating and constraining estimates of variable consideration.) Further, entities would be required to disclose additional information about these contracts in accordance with ASC 606-10-50.

Conversely, supporters of View B believe that the arrangements “are ownership interests and should be accounted for under other GAAP”13 because an asset manager’s investment in a limited partnership may meet the definition of financial assets or financial instruments, which are outside the scope of ASC 606.

Proponents of View C believe that because these arrangements vary, entities would need to apply significant judgment in evaluating their nature and substance to determine the appropriate accounting.

At the TRG meeting in April 2016, the FASB staff supported View A because it believes that:

Example 25 is evidence that the Board intended asset management service contracts, including those with incentive- or performance-based fees, to be within the scope of ASC 606.
Carried interests are designed to compensate an asset manager for its services (i.e., in managing and investing in the fund).
The Board confirmed that carried interests are more akin to services than to an ownership interest when it excluded performance-based fees from an entity’s consolidation analysis (i.e., in determining whether the entity is the primary beneficiary of a variable interest entity) during its deliberations of ASU 2015-02.

After significant discussion, the TRG did not reach general agreement on whether carried interests in asset management arrangements are within the scope of ASC 606 and thus subject to the revenue standard’s variable consideration constraint guidance. The Board reiterated that its intention was to include these arrangements within the scope of ASC 606 because the Board viewed these incentive-based fees as compensation for services provided (i.e., part of revenue transactions). Many TRG members agreed that the arrangements are within the scope of ASC 606.14

However, some TRG members expressed an alternative view that a carried interest could be regarded as an equity arrangement because it is, in form, an interest in the entity. As a result of this view, those TRG members indicated that if the arrangements are considered equity interests outside the scope of ASC 606, questions could arise in a consolidation analysis — specifically, questions related to whether the asset managers should consolidate the funds.

The SEC staff’s view is characterized in Implementation Q&A 3 as follows:

The SEC staff observer at the TRG meeting indicated that he anticipates the SEC staff would accept an application of Topic 606 for those arrangements. However, the observer noted that there may be a basis for following an ownership model. If an entity were to apply an ownership model, then the SEC staff would expect the full application of the ownership model, including an analysis of the consolidation model under Topic 810, the equity method of accounting under Topic 323, or other relevant guidance.

We believe that an entity contemplating the ownership model view under ASC 323 should consider consulting with its accounting advisers and auditors.

The minutes of the TRG meeting (TRG Agenda Paper 55) suggest that the FASB staff does not recommend that the Board undertake standard-setting activity with respect to this topic.

3.2.11.2.2 Acceptable Views

We believe that there are two acceptable views (“View 1” and “View 2”) on whether carried interests are within the scope of ASC 606:

View 1 — Carried interests are within the scope of the revenue standard.
View 2 — Carried interests may be outside the scope of the revenue standard depending on the nature and substance of the arrangement.

View 1 was supported by all seven FASB board members at the April 2016 FASB-only TRG meeting. The Board reiterated that its intention was to include these arrangements within the scope of ASC 606 because the Board viewed these incentive-based fees as compensation for services provided (i.e., part of revenue transactions). At the same meeting, the SEC staff observer indicated that he anticipates that the SEC staff would find it acceptable to apply ASC 606 to such arrangements (i.e., View 1 could be acceptable).

However, the SEC staff observer also noted that there may be a basis for using an ownership model such as that in ASC 323 (i.e., View 2 could be acceptable). Specifically, certain entities may be able to demonstrate that their incentive-based capital allocation arrangements that involve an equity interest are financial instruments within the scope of other U.S. GAAP, particularly ASC 323. In such cases, these arrangements would qualify for the following scope exception in ASC 606-10-15-2(c):

c. Financial instruments and other contractual rights or obligations within the scope of the following Topics:

1. Topic 310, Receivables

2. Topic 320, Investments — Debt Securities

2a. Topic 321, Investments — Equity Securities

3. Topic 323, Investments — Equity Method and Joint Ventures

4. Topic 325, Investments — Other

5. Topic 405, Liabilities

6. Topic 470, Debt

7. Topic 815, Derivatives and Hedging

8. Topic 825, Financial Instruments

9. Topic 860, Transfers and Servicing. [Emphasis added]

Entities should carefully evaluate the scope guidance in these ASC topics to determine whether their incentive-based capital allocation arrangements can be accounted for under ASC 323. Entities should consider the nature and legal form of such arrangements — specifically, whether the incentive fee is an attribute of an equity interest in the fund (e.g., a disproportionate allocation of fund returns to a capital account owned by the manager).

When the incentive fee is not an allocation of fund returns among holders of equity interests (e.g., when the fee is in the form of a contractual arrangement with the fund), it should be accounted for under ASC 606.

In addition, we understand that it is customary industry practice for entities to use incentive-based capital allocation arrangements if they were to reach a conclusion that such arrangements are subject to the guidance in ASC 323.

We believe that under View 2, there are two acceptable approaches that an entity can use to present carried interest arrangements in its statement of performance:

Approach A: present within revenue — Proponents of this approach believe that incentive fees in carried interest arrangements continue to represent revenue15 earned by an entity and should therefore be presented within revenue. However, since these revenues are outside the scope of the revenue standard, they should not be labeled as (or be under a caption related to items that include) revenue from contracts with customers in an entity’s financial statements or in the accompanying footnotes and disclosures. If an entity has one or more captions related to revenue from customers, a separate, appropriately labeled caption would be necessary.
Approach B: present outside of revenue — Proponents of this approach believe that since incentive fees in carried interest arrangements are derived from an entity’s investment in equity method investees, they should be presented within the earnings of the entity’s equity method investee(s) in the statement of performance.

Connecting the Dots

If an entity determines that fees under carried interest arrangements may be accounted for outside of ASC 606, we would encourage the entity to consult with accounting advisers regarding the nature and legal form of those arrangements. On the basis of informal discussions with the SEC staff, we understand that the staff would not object to a conclusion that (1) carried interests in the form of incentive-based capital allocation arrangements may be accounted for within the scope of either ASC 606 or ASC 323 (if the considerations described above are met) and (2) this is an accounting policy choice. Further, from a performance statement perspective, the SEC staff would not object to the presentation of performance-based capital allocation fees in accordance with either Approach A or Approach B as described above.

3.2.11.3 Financial Institution Transactions

The revenue standard excludes transactions from its scope that are accounted for under other ASC topics, including those within the scope of ASC 405 (liabilities), ASC 460 (guarantees), ASC 815 (derivatives and hedging), and ASC 860 (transfers and servicing). The standard also notes that entities should apply ASC 606 to contracts with a customer or portions thereof if other ASC topics do not contain guidance on separation or initial measurement. To determine which guidance applies to the fees associated with certain common financial institution transactions, stakeholders have asked the FASB to clarify whether (1) mortgage servicing rights16 should be accounted for under ASC 860, (2) deposit-related fees17 should be accounted for under ASC 405, (3) fees from financial guarantees18 should be accounted for under ASC 460 or ASC 815, and (4) rights and obligations under a credit card issuing bank’s contract as well as the corresponding reward program should be accounted for under ASC 310. These matters were discussed at the July 2015 and April 2016 TRG meetings, and the TRG generally agreed with the FASB staff’s analysis and conclusions.

3.2.11.3.1 Mortgage Servicing Rights

The FASB staff noted that assets and liabilities associated with mortgage servicing rights should be accounted for under ASC 860. The staff believes that servicing arrangements within the scope of ASC 860 are outside the scope of ASC 606 and that ASC 860 addresses both the initial recognition and subsequent measurement of mortgage servicing assets and liabilities. In the staff’s view, since the subsequent measurement of the mortgage servicing assets and liabilities depends on the cash flows associated with the mortgage servicing rights, entities should apply the guidance in ASC 860 to account for such cash flows.19

The above issue is addressed in Implementation Q&A 4 (compiled from previously issued TRG Agenda Papers 52 and 55). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

3.2.11.3.2 Deposit-Related Fees

The FASB staff noted that entities should account for revenue from deposit-related fees in accordance with ASC 606. Financial institutions should (1) record liabilities for customer deposits because the deposits meet the definition of a liability and (2) account for customer deposits in accordance with ASC 405. However, because ASC 405 does not contain specific guidance on how to account for deposit fees, financial institutions should apply ASC 606 for deposit-related fees. The FASB staff suggested that implementation concerns raised by some stakeholders could be alleviated by careful analysis of the contract terms between the financial institution and the customer. Because customers generally have the right to cancel their depository arrangement at any time, the FASB staff believes that most contracts would be short term (e.g., day to day or minute to minute). As a result, revenue recognition patterns would be similar regardless of the number of performance obligations identified.

The above issue is addressed in Implementation Q&A 5 (compiled from previously issued TRG Agenda Papers 52 and 55). For additional information and Deloitte’s summary of the Implementation Q&As, see Appendix C.

3.2.11.3.3 Fees Related to Financial Guarantees

The FASB staff noted that fees related to financial guarantees should be accounted for in accordance with either ASC 460 or ASC 815. The basis for the staff’s view is partly due to its belief that “the fee would not be received unless the guarantee was made, and the guarantee liability is typically reduced (by a credit to earnings) as the guarantor is released from the risk under the guarantee.”20 Further, the staff believes that ASC 460 or ASC 815 provides a framework that addresses both initial recognition and subsequent measurement of the guarantee. In addition, the staff cited paragraph BC61 of ASU 2014-09 as further evidence of the Board’s intent to exclude guarantees from the scope of ASC 606.

In December 2016, the FASB issued ASU 2016-20, which amends the guidance in ASC 942-825-50-2 and ASC 310-10-60-4 to clarify that guarantee fees within the scope of ASC 460 or ASC 815 (other than product or service warranties) are not within the scope of ASC 606. For further discussion of the amendments in ASU 2016-20, refer to Section 18.3.3.6.

See TRG Agenda Paper 52 for additional information.

3.2.11.3.4 Arrangements Involving Bank-Issued Credit Cards

Stakeholders have asked whether the guidance in ASC 310 or the guidance in ASC 606 should be applied to the rights and obligations under a credit card issuing bank’s contract as well as the corresponding reward program (i.e., a loyalty program). The guidance that is applied would affect the timing of revenue recognition.

Credit card arrangements are typically accounted for under ASC 310 because they are related to credit lending activities. ASC 606-10-15-2 indicates that financial instruments within the scope of other Codification topics, including ASC 310, are excluded from the scope of the revenue standard. However, ASC 606-10-15-4 notes that a contract may be partially within the scope of ASC 606 if other Codification topics “do not specify how to separate and/or initially measure one or more parts of the contract.”

ASC 310-20-35-5 states:

Fees deferred in accordance with paragraph 310-20-25-15 shall be recognized on a straight-line basis over the period the fee entitles the cardholder to use the card. This accounting shall also apply to other similar card arrangements that involve an extension of credit by the card issuer.

In contrast, if it is determined that some or all of the arrangement is within the scope of ASC 606, an assessment must be made to determine whether the rewards the customer earns are a material right and therefore a performance obligation. If the rewards are a performance obligation, the revenue allocated to the performance obligation cannot be recognized until the rewards are redeemed for goods or services under the reward program. This period could be longer than the period over which revenue would be recognized under ASC 310.

This issue is addressed in Implementation Q&As 1 and 2 (compiled from previously issued TRG Agenda Papers 36 and 44), which summarize the following observations and conclusions of the FASB staff:

The FASB staff notes that all credit card fees have historically been accounted for under ASC 310 because they are related to credit lending activities (i.e., akin to loan origination fees). The staff also notes that the revenue standard does not include consequential amendments to ASC 310. Accordingly, the staff believes that entities should account for services exchanged for credit card fees under ASC 310 rather than ASC 606. However, the staff notes that as an anti-abuse measure, entities need to assess whether credit card fees and services should be accounted for under ASC 606 when the issuance of a credit card appears incidental to the arrangement (e.g., when a card is issued in connection with the transfer of (1) an automobile or (2) asset management services).
The FASB staff indicates that if an entity concludes that the credit card arrangement is within the scope of ASC 310, the associated reward program would also be within the scope of ASC 310.

Note that outcomes under U.S. GAAP may differ from those under IFRS Accounting Standards because of differences between ASC 310 and IFRS 9.

3.2.11.4 Physically Settled Commodity Contracts That Are Derivatives

Entities that enter into contracts to deliver commodities (e.g., oil and gas, power and utilities, mining and metals, agriculture) may enter into firm contracts to deliver nonfinancial assets that are actively traded on the open market (e.g., electricity, grains) on a forward basis in exchange for a fixed amount of consideration. Even if an entity expects to physically settle a contract of this nature (i.e., by delivering the agreed-upon amount of the specified nonfinancial asset(s) on the forward date), if the contract could be net settled, the contractual rights and obligations might be within the scope of ASC 815.

If the rights and obligations associated with the contract are within the scope of ASC 815, then the contract is outside the scope of ASC 606 even if the derivative settles and the commodity is physically delivered to the customer in exchange for cash consideration. This is the case regardless of whether the entity’s ordinary activities may include selling and physically delivering the commodity to third parties that would otherwise meet the definition of a customer. Further, because the contract is within the scope of ASC 815, the consideration received upon physical settlement of the derivative contract is also within the scope of ASC 815 (rather than ASC 606).

“Customer” is defined in ASC 606-10-20 as a “party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.” If an entity’s ordinary activities include selling and physically delivering commodities to independent third parties in exchange for cash consideration, one might conclude that the counterparty in such a contract is a customer and that the contract is therefore within the scope of ASC 606. However, ASC 606-10-15-2 states, in part:

An entity shall apply the guidance in this Topic to all contracts with customers, except the following: . . .

c. Financial instruments and other contractual rights or obligations within the scope of the following Topics: . . .

7. Topic 815, Derivatives and Hedging. [Emphasis added]

The scope assessment for contractual rights and obligations is performed at contract inception. That is, the contract is within the scope of ASC 815 both at contract inception and throughout the contract term. Therefore, even when the settlement of the contract — and physical delivery of the underlying commodity — are an output of the entity’s ordinary activities, the contract is outside the scope of ASC 606 on the basis of the guidance in ASC 606-10-15-2(c)(7).

Further, ASC 815-10 provides a comprehensive framework for recognition, measurement, and presentation of derivatives, which covers settlement (including physical delivery). Consequently, the settlement of a contract should be presented in accordance with the guidance in ASC 815 and should not be included as a component of revenue from contracts with customers.

Example 3-15

Entity X, an agribusiness company whose ordinary activities include selling and physically delivering corn to independent third parties in exchange for cash consideration, enters into a contract to sell and physically deliver 5,000 bushels of corn on a forward basis for a fixed amount of cash consideration. In accordance with ASC 815-10-15-83, X has concluded the following:

The contract has an underlying (i.e., the price of corn).
The contract has a notional (i.e., 5,000 bushels of corn).
Entity X makes no initial net investment in the contract.
The underlying commodity to be physically delivered under the contract (i.e., corn) is readily convertible to cash (i.e., it meets the net settlement criteria).

On the basis of the characteristics of the contract described above, X has concluded that the rights and obligations associated with the contract should be accounted for as a derivative within the scope of ASC 815. Therefore, the contract is initially and subsequently measured at fair value, with changes in fair value recognized through net income. Since the scope assessment for contractual rights and obligations is performed at contract inception, the contract is within the scope of ASC 815 both at contract inception and throughout the contract term. Therefore, even when the settlement of the contract — and physical delivery of the corn — are an output of the entity’s ordinary activities, the contract is outside the scope of ASC 606 on the basis of the guidance in ASC 606-10-15-2(c)(7).

3.2.11.5 Accounting for Proceeds From the Sale of Scrap Materials or By-Products

Generally, we would expect proceeds from an entity’s sale of scrap materials or by-products that are produced as a result of the entity’s manufacturing process to be treated as revenue within the scope of ASC 606. To determine whether to account for the proceeds as revenue under ASC 606, the entity must consider whether the proceeds represent revenue from a contract with a customer. Revenue is defined in the ASC 606 glossary as “[i]nflows . . . from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations” (emphasis added). The ASC 606 glossary defines a customer as a “party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration” (emphasis added). Determining the entity’s “ongoing major or central operations” and “ordinary activities” requires careful consideration of its specific facts and circumstances.

If it is determined that the proceeds from the sale are income from activities outside the entity’s ongoing major or central operations and are therefore outside the scope of ASC 606, the proceeds may be within the scope of ASC 610-20 (see Chapter 17) and recognized outside operations as other income.

3.2.12 Scope Considerations for Lessors

In accordance with ASC 842-10-15-2, an entity is required at contract inception to determine whether a contract is or contains a lease. Not all leases will be labeled as such, and a lease component may be embedded in a larger arrangement. Therefore, entities should consider whether a contract, or part of a contract, is within the scope of the leasing standard. See Chapter 3 of Deloitte’s Roadmap Leases for more information on determining whether a contract is or contains a lease.

If, after consideration of ASC 842-10-15-2, a lease component is identified, further analysis may be necessary. In July 2018, the FASB issued ASU 2018-11, under which lessors may elect not to separate lease and nonlease components when certain conditions are met. A lessor may elect to combine lease and associated nonlease components provided that the nonlease component(s) would otherwise be accounted for under ASC 606 and both of the conditions in ASC 842-10-15-42A(a) and (b) are met. Those conditions require (1) the timing and pattern of transfer for the components to be the same and (2) the lease component, if accounted for separately, to be classified as an operating lease. See Section 4.3.3.2 of Deloitte’s Roadmap Leases for additional considerations.

3.2.13 Business Combinations

In October 2021, the FASB issued ASU 2021-08 on accounting for contract assets and contract liabilities from contracts with customers acquired in a business combination. Under current guidance, revenue contracts acquired in a business combination are subject to the general requirements of ASC 805, in accordance with which most assets and liabilities acquired in a business combination are measured at fair value on the acquisition date.

ASU 2021-08 amends ASC 805 to address inconsistencies and diversity in practice related to the accounting for revenue contracts with customers acquired in a business combination. The ASU’s amendments to ASC 805 require an entity to apply the guidance in ASC 606 when recognizing and measuring contract assets and contract liabilities arising from those contracts. In addition to revenue contracts with customers, the scope of the ASU includes other contracts that are subject to the provisions of ASC 606 (e.g., contracts within the scope of ASC 610-20). The guidance in ASC 606 on measuring contract assets and contract liabilities differs from the fair value measurement model that is applied to most assets and liabilities (e.g., customer relationship intangibles) acquired in a business combination.

Further, ASU 2021-08 provides practical expedients in ASC 805 related to an entity’s application of the guidance in ASC 606 on (1) previously modified contracts and (2) the determination of stand-alone selling prices. Those practical expedients can be elected on an acquisition-by-acquisition basis. An entity is required to disclose its election to use any of the practical expedients provided.

ASU 2021-08 is effective (1) for public business entities (PBEs) for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, and (2) for all other entities for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for periods for which financial statements have not yet been issued or made available for issuance. An entity that elects to early adopt the amendments in the ASU in an interim period should apply the ASU’s guidance retrospectively to all business combinations for which the acquisition date occurs on or after the beginning of the fiscal year that includes the interim period of early adoption. In addition, once adopted, the amendments in the ASU should be applied prospectively to business combinations that occur on or after the effective date with no transition disclosures.

Footnotes

See Section 3.2.12 for a discussion of scope considerations related to contracts accounted for under both ASC 606 and ASC 842.

Common gaming activities include table games, slot machines, keno, bingo, and sports and race betting.

Currently, an entity that is required to adopt IFRS 9 should apply IFRS 9 rather than IAS 39 when accounting for derivatives.

“For example, the activities do not constitute an entity’s ongoing major or central operations (Master Glossary – Revenue).”

“This may result in the reimbursement being recorded as other income or as contra-expense.”

The concept of ordinary activities is derived from the legacy definition of revenue in FASB Concepts Statement 6, which states that 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 other activities that constitute the entity’s ongoing major or central operations.”

The ASC master glossary defines a vendor as a “service provider or product seller, such as a manufacturer, distributor, or reseller.”

In a speech at the 2007 AICPA Conference on Current SEC and PCAOB Developments, Eric West, then an associate chief accountant in the OCA, discussed the accounting for a litigation settlement that also includes a separate element (such as a revenue element) and how to separate the elements. Although the guidance referred to in his speech has been superseded by ASC 606, we believe that it is still appropriate for entities to consider the principles discussed by Mr. West because they are consistent with the separation and measurement principles for arrangements that include elements within the scope of ASC 606 and elements outside the scope of ASC 606.

Quoted from Implementation Q&A 3 (compiled from previously issued TRG Agenda Papers 50 and 55).

Quoted from paragraph 12 of TRG Agenda Paper 50.

See footnote 11.

Q&A 3 of the FASB Staff Implementation Q&As summarizes the views presented by the TRG members at the TRG’s April 2016 meeting and states that “[t]he [FASB] staff’s view is that incentive-based capital allocations are within the scope of Topic 606.”

The legacy definition of revenue in paragraph 78 of FASB Concepts Statement 6 states that “[r]evenues 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 other activities that constitute the entity’s ongoing major or central operations.” 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 Board has not amended the ASC master glossary and ASC 606 to conform the Codification’s definitions of revenue and a customer with the FASB Concepts Statement’s revised definition of revenue, and the FASB Concepts Statement does not represent authoritative guidance. Therefore, we do not expect the updated definition of revenue in the FASB Concepts Statement to result in a change in practice regarding the determination of which transactions should be presented as revenue under ASC 606. See Section 3.2.8 for more information.

After originating a loan (or selling an originated loan but retaining rights to service the loan), a financial institution may perform services that include communicating with the borrower; collecting payments for interest, principal, and other escrow amounts; and performing recordkeeping activities.

Deposit-related fees are those that a financial institution charges to a customer for amounts on deposit with the financial institution. Fees may be charged to give customers access to their funds and to cover other activities, including recordkeeping and reporting. In addition, fees may be transaction-based (such as fees to withdraw funds through an automated teller machine) or may not be transaction-based (such as account maintenance fees).

Fees charged by a financial institution to a borrower on a loan, for example, in return for the financial institution’s acting as a third-party guarantor on the borrower’s debt.

As noted by the FASB staff, some entities believe that there is a close link between ASC 860’s asset and liability remeasurement requirements and the collection of servicing fees (which gives rise to mortgage servicing income).

Quoted from paragraph 61 of TRG Agenda Paper 52.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.