Chapter 3 — Objective and Scope
Chapter 3 — Objective and Scope
3.1 Objective
ASC 606-10
General
10-1 The
objective of the guidance in this Topic is to establish the
principles that an entity shall apply to report useful
information to users of financial statements about the
nature, amount, timing, and uncertainty of revenue and cash
flows arising from a contract with a customer.
In the revenue recognition project, the FASB, together with the IASB, set key
objectives to guide its development of the new guidance. ASU 2014-09, which
created ASC 606, outlines those key objectives in its Summary as follows:
-
Remove inconsistencies and weaknesses in revenue requirements.
-
Provide a more robust framework for addressing revenue issues.
-
Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.
-
Provide more useful information to users of financial statements through improved disclosure requirements.
-
Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The objectives listed above could be further summarized as follows:
- Establish a comprehensive framework — Create a new comprehensive framework for assessing all revenue transactions (across entities, industries, jurisdictions, and capital markets) to eliminate inconsistencies and fill gaps in legacy U.S. GAAP.
- Enhance revenue disclosures — Improve disclosures by requiring entities to provide more information about revenue, a key financial metric.
The objective of the revenue standard as stated in ASC 606 — “to establish the
principles that an entity shall apply to report useful information to users of
financial statements about the nature, amount, timing, and uncertainty of revenue
and cash flows arising from a contract with a customer” — lays the groundwork for
the overall framework and the detailed recognition, measurement, presentation, and
disclosure principles outlined in the remainder of the standard. The Board believed
that this comprehensive framework would eliminate the need to address revenue topics
in a piecemeal manner through the EITF’s projects or the AICPA’s industry guides.
While it would still be necessary for the EITF and AICPA to work through new and
emerging revenue issues, those groups would all be using the same comprehensive
framework when analyzing revenue questions.
3.1.1 Meeting the Objective
After establishing the objective of the revenue standard, the FASB and IASB
created a core principle that establishes this comprehensive framework and
governs the entire guidance. The core principle is expressed in ASC 606-10-10-2
as follows:
ASC 606-10
Meeting the Objective
10-2 To meet the objective in paragraph 606-10-10-1, the core principle of the guidance in this Topic is that
an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an
amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods
or services.
Many do not focus on this core principle and rush directly into the detailed requirements of the
standard. However, the manner in which the boards developed the core principle and the specific words
they used to articulate it were intentional. At its core, this main principle outlines the answers to the
following key questions that always arise when a revenue transaction is evaluated:
- When (i.e., recognition) — When is it appropriate to recognize revenue?
- How much (i.e., measurement) — What specific amount of revenue should an entity recognize?
The core principle’s answers to these questions are discussed below.
3.1.1.1 When to Recognize Revenue
In accordance with the core principle of the revenue standard, revenue is
recognized when the entity transfers promised goods or services to the
customer.
Specifically, the boards intended to depict performance through the recognition
of revenue. That is, when the entity performs by delivering goods or
services, it should recognize revenue because doing so demonstrates to a
financial statement user that the performance has taken place.
In developing the revenue standard, the boards believed that
it is important to demonstrate to financial statement users when the entity
performs; accordingly, that depiction is the recognition of revenue.
Uncertainties about whether and, if so, how much revenue should be
recognized would be dealt with separately in the measurement of revenue.
3.1.1.2 How Much Revenue to Recognize
Under the core principle, revenue is recognized in an amount that reflects the consideration to which
the entity expects to be entitled in exchange for the promised goods or services.
The measurement concept within the core principle was fiercely debated and
changed over time. In the end, the wording “expects to be entitled,” which
was introduced in the boards’ 2011 revised exposure draft (ED) and
represented a change from their 2010 ED, was deliberate and intended to
reflect a measure of revenue that did not include variability attributable
to customer credit risk. At the time the boards were developing the revenue
standard, they were also debating financial instruments and the impairment
model for those financial instruments. As a result, there were many debates
about whether the measurement of revenue should reflect the risk that the
customer cannot or will not pay the amounts as they become due. The final
decisions of the boards distinguished customer credit risk from other
sources of variability in a revenue contract. Accordingly, the phrase
“expects to be entitled” was intentional — specifically, the phrase “be
entitled” is intentionally different from the word “collect” or the word
“receive” since each of those words would imply that the amount estimated
encompasses all risks, including the risk that the customer cannot or will
not pay. Therefore, unlike a fair value measurement model, the allocated
transaction price approach under the revenue standard generally does not
reflect any adjustments for amounts that the entity might not be able to
collect from the customer (i.e., customer credit risk). However, the
transaction price is inclusive of all other uncertainties. The boards
outlined this allocated transaction price approach in paragraph BC181 of
ASU 2014-09.
In addition, the amount to which an entity expects to be entitled is not always
the price stated in the contract or the invoiced amount, either of which may
be expected on the basis of a common interpretation of the word “entitled.”
For purposes of ASC 606, the term “entitled” is aligned with the
determination of the “accounting” contract (as opposed to the “legal”
contract). Therefore, “entitlement” is influenced by the entity’s past
practices, which affect the enforceable rights and obligations in the
accounting contract. As a result, under ASC 606, the amount to which an
entity expects to be entitled is inclusive of any price concessions that the
entity explicitly or implicitly provides. That is, if the entity will accept
an amount of consideration that is less than the contractually stated or
invoiced price, that amount is a price concession and is treated as variable
consideration. See Chapter
6 for further discussion of the determination of the transaction
price and Chapter 12
for discussion of an exception to the general rule on estimating variable
consideration for sales- or usage-based royalties.
One exception to this “entitlement” notion within measurement is when a
significant financing component is identified in a contract because, for
example, a customer pays in arrears. In that case, customer credit risk will
be reflected in the amount of revenue recognized. This is because an entity
will take customer credit risk into account in determining the appropriate
discount rate (see Section
6.4.4).
In addition, as noted in paragraphs BC260 and BC261 of ASU 2014-09, the FASB and IASB decided that
revenue should be measured at the amount to which an entity expects to be entitled in response to
comments from users of financial statements that “they would prefer revenue to be measured at the
‘gross’ amount so that revenue growth and receivables management (or bad debts) could be analyzed
separately.”
3.1.2 Applying the Standard
After establishing the core principle, the FASB and IASB agreed on the following five steps (as outlined in
Chapter 1) to apply that principle:
The introduction to the standard describes the five steps to be applied. However, those five steps do not
appear sequentially in either the body of the standard or the implementation guidance.
In a manner consistent with the structure of the Codification,
the requirements of ASC 606 adhere to the framework of recognition, measurement,
presentation, and disclosure. As a result, the steps are presented as follows:
- Recognition — Step 1 (identify the contract), step 2 (identify the performance obligations), and step 5 (recognize revenue when [or as] the entity satisfies a performance obligation).
- Measurement — Step 3 (determine the transaction price) and step 4 (allocate the transaction price to the performance obligations in the contract).
An entity should consider all five steps for every contract with
a customer unless a step is clearly inapplicable. After considering the specific
facts and circumstances of a particular contract and understanding the framework
and the five steps, an entity may find that one of the steps is not relevant.
For example, when an entity determines in step 2 that a contract contains only a
single performance obligation, step 4 (allocation of the transaction price) will
often not be applicable. In such a case, the entity can, in effect, jump from
step 3 to step 5.
An entity would generally be expected to apply the five steps in
sequential order. However, the entity may sometimes need to consider a later
step before or concurrently with applying an earlier one.
Example 3-1
In applying step 1 to determine whether
a contract exists and reviewing the collectibility
threshold as required in ASC 606-10-25-1(e), an entity
will need to consider the “[amount] of the consideration
to which it will be entitled in exchange for the
[promised] goods or services.” The amount of
consideration “may be less than the price stated in the
contract if the consideration is variable because the
entity may offer the customer a price concession.” As a
result, the entity would need to apply step 3 (determine
the transaction price) and estimate the expected
discounts or price concessions before being able to
conclude that a valid contract exists under step 1.
Example 3-2
Under step 2 (identify the performance
obligations), ASC 606-10-25-14(b) requires entities to
identify as a performance obligation a “series of
distinct goods or services that are substantially the
same and that have the same pattern of transfer to the
customer.” In accordance with ASC 606-10- 25-15, that
series is a performance obligation only when the
following two criteria are met: (1) the performance
obligation satisfies the criteria in step 5 to be
recognized over time and (2) the same method to measure
progress is used. Therefore, the determination in step 2
about whether a series of distinct goods or services is
a single performance obligation relies on the
requirements in step 5 for determining how revenue is
recognized. As a result, an entity would need to
understand and make a determination about step 5 before
applying step 2.
Example 3-3
To determine the transaction price in
step 3, an entity is required to identify, estimate, and
potentially constrain variable consideration in
accordance with ASC 606-10-32-11 through 32-13. The
consideration in a contract may vary as a result of many
different factors, including when the price is a fixed
rate per increment of service (e.g., hours) but the
expected increments of service may vary throughout the
contract term. In this situation, step 3 would require
an entity to estimate the increments of service expected
to be provided over the contract term since such
increments would result in variable consideration that
the entity would need to estimate (and potentially
constrain) when determining the transaction price. Step
4 would require the transaction price to be allocated to
the distinct goods or services identified in the
contract on the basis of their relative stand-alone
selling prices, and the entity would need to determine
when (or how) the performance obligation is satisfied as
part of step 5, under which it would need to select a
single measure of progress to determine how control of
the promised services is transferred to the customer
over time. However, if the promise to provide services
qualifies as a series (which would be accounted for as a
single performance obligation), ASC 606-10-55-18
provides a practical expedient that allows an entity
that is recognizing revenue over time by using an output
method to recognize revenue equal to the amount that the
entity has the right to invoice if the invoiced amount
corresponds directly to the value transferred to the
customer.
If the amount that the entity is able to
invoice corresponds directly to the value transferred to
the customer (e.g., the invoiced amount is determined on
the basis of hours of service provided and a rate per
hour that corresponds to the value of the services), the
entity can recognize revenue in the amount that it is
entitled to bill. Thus, the entity effectively combines
steps 3, 4, and 5 when it determines that it can apply
the practical expedient in ASC 606-10-55-18.
3.1.2.1 Applying the Guidance Consistently to Contracts With Similar Characteristics and in Similar Circumstances
ASC 606-10
10-3 An entity shall consider the terms of the contract and all relevant facts and circumstances when applying
this guidance. An entity shall apply this guidance, including the use of any practical expedients, consistently to
contracts with similar characteristics and in similar circumstances.
When the FASB was developing the detailed recognition and measurement guidance, it found many
instances in which estimates and judgments would be required. In each of those instances, the Board
believed that entities should consider all relevant facts and circumstances in applying those estimates
and judgments. As a result, in the “General” section of the standard, the Board outlined requirements
that should be applicable throughout the standard.
For example, the guidance on allocating the transaction price to performance
obligations in accordance with step 4 (see Chapter 7) provides that if the
stand-alone selling price of a good or service is not directly observable,
an entity is required to estimate the stand-alone selling price by choosing
an appropriate method (e.g., the adjusted market assessment approach, the
expected cost plus a margin approach, or, in limited circumstances, the
residual approach). Once an entity decides which method to use, it is
required to apply the same method consistently to similar contracts in
accordance with the general guidance in ASC 606-10-10-3 on consistency in
application. Rather than repeat this general requirement throughout the
detailed guidance on recognition and measurement, the Board decided to state
it once at the beginning of the standard to make it applicable to the
standard’s guidance overall.
3.1.2.2 Portfolio Approach
ASC 606-10
10-4
This guidance specifies the
accounting for an individual contract with a
customer. However, as a practical expedient, an
entity may apply this guidance to a portfolio of
contracts (or performance obligations) with similar
characteristics if the entity reasonably expects
that the effects on the financial statements of
applying this guidance to the portfolio would not
differ materially from applying this guidance to the
individual contracts (or performance obligations)
within that portfolio. When accounting for a
portfolio, an entity shall use estimates and
assumptions that reflect the size and composition of
the portfolio.
During the initial development of the new guidance, the FASB’s and IASB’s proposed concepts were
consistently discussed on the basis of an individual contract. However, feedback on the early drafts of
the guidance indicated that it would sometimes not be practical and cost-effective to apply the guidance
on an individual contract basis. In response to this feedback, discussions ensued regarding the use of a
portfolio approach.
The boards ultimately concluded that the revenue standard should generally be
applied on an individual contract basis. However, as a practical expedient,
a portfolio approach is permitted if it is reasonably expected that the
approach’s impact on the financial statements will not be materially
different from the impact of applying the revenue standard on an individual
contract basis.
Some stakeholders had requested additional guidance on when and how to establish
portfolios. However, the boards declined to list specific conditions that
must be met for an entity to apply the revenue standard to a portfolio of
contracts. Instead, the boards used a principle to establish that a
portfolio approach may be used depending on whether the effects of applying
the guidance to a portfolio of contracts would differ materially from the
effects of applying the guidance to contracts individually. Further, as
noted in paragraph BC69 of ASU 2014-09, the boards “indicated that they did
not intend for an entity to quantitatively evaluate each outcome and,
instead, the entity should be able to take a reasonable approach to
determine the portfolios that would be appropriate for its types of
contracts.”
3.1.2.2.1 Deciding Whether a Portfolio Approach May Be Used
Some entities manage a very large number of customer
contracts and offer an array of product combination options (e.g.,
entities in the telecommunications industry may offer a wide selection
of handsets and wireless usage plan options). For these entities, it
would take significant effort to apply some of the requirements of ASC
606, such as the requirement to allocate the stand-alone selling price
to the identified performance obligations, on an individual contract
basis, and the capability of IT systems to capture the relevant
information may be limited.
An entity in this situation may want to use a portfolio
approach as a practical expedient in accordance with ASC 606-10-10-4.
However, a portfolio approach would be appropriate only if (1) it is
applied to a group of contracts (or performance obligations) with
“similar characteristics” and (2) the entity “reasonably expects” that
the effects on the financial statements of applying ASC 606 to the
portfolio “would not differ materially” from the effects of applying
guidance to the individual contracts (or performance obligations) in
that portfolio.
ASC 606 does not provide explicit guidance on how to (1)
evaluate “similar characteristics” and (2) establish a reasonable
expectation that the effects of using a portfolio approach would not
differ materially from those of applying the guidance at a contract or
performance obligation level. Accordingly, an entity will need to
exercise significant judgment in determining that the contracts or
performance obligations it has segregated into portfolios have similar
characteristics at a sufficiently granular level to ensure that the
outcome of using a particular portfolio approach can reasonably be
expected not to differ materially from the results of applying the
guidance to each contract or performance obligation in the portfolio
individually.
In segregating contracts (or performance obligations)
with similar characteristics into portfolios, an entity should apply
objective criteria associated with the particular contracts or
performance obligations and their accounting consequences. When
determining whether particular contracts have similar characteristics,
the entity may find it helpful to focus particularly on those
characteristics that have the most significant accounting consequences
under ASC 606 in terms of their effect on the timing of revenue
recognition or the amount of revenue recognized. Accordingly, the
assessment of which characteristics are most important for determining
similarity will depend on the entity’s specific facts and circumstances.
However, there may be practical constraints on the entity’s ability to
use existing systems to analyze a portfolio of contracts, and these
constraints could affect its determination of how the portfolio should
be segregated.
The table below lists objective factors that entities
may consider when assessing whether particular contracts or performance
obligations have similar characteristics in accordance with ASC
606-10-10-4. Since any of the requirements in ASC 606 could have
significant consequences for a particular portfolio of contracts, the
list provided is not exhaustive.
|
Objective Factors
|
Examples
|
|---|---|
|
Contract deliverables
|
Mix of products and services;
options to acquire additional goods and services;
warranties; promotional programs
|
|
Contract duration
|
Short-term, long-term,
committed, or expected term of contract
|
|
Terms and conditions of the
contract
|
Rights of return, shipping
terms, bill and hold, consignment, cancellation
privileges, and other similar clauses
|
|
Amount, form, and timing of
consideration
|
Fixed, time and materials,
variable, up-front fees, noncash, significant
financing component
|
|
Characteristics of the
customers
|
Size, type, creditworthiness,
geographic location
|
|
Characteristics of the
entity
|
Volume of contracts that include
the various characteristics; historical
information available
|
|
Timing of transfer of goods or
services
|
Over time; at a point in
time
|
The example below illustrates how such factors may be
applied.
Example 3-4
Entity A, a telecommunications
company, offers various combinations of handsets
and usage plans to its customers under two-year
noncancelable contracts. It offers two handset
models: an older model that it offers free of
charge (stand-alone selling price is $250) and the
most recent model, which offers additional
features and functionalities and for which the
entity charges $200 (stand-alone selling price is
$500). The entity also offers two usage plans: a
400-minute plan and an 800-minute plan. The
400-minute plan sells for $40 per month, and the
800-minute plan sells for $60 per month (which
also corresponds to the stand-alone selling price
for each plan).
The table below illustrates the
possible product combinations and allocation of
consideration for each under ASC 606.
As the table indicates, the
effects of each product combination on the
financial statements differ from those of the
other product combinations. The four customer
contracts have different characteristics, and it
may be difficult to demonstrate that the entity
“reasonably expects” that the financial statement
effects of applying the guidance to the portfolio
(the four contracts together) “would not differ
materially” from those of applying the guidance to
each individual contract. The percentage of
contract consideration allocated to the handset
under the various product combinations ranges from
15 percent to 34 percent. The entity may consider
that this range might be too wide to apply a
portfolio approach; if so, some level of
segregation would be required. Alternatively, the
entity might determine that there are two
portfolios, one for old handsets and the other for
new handsets. Under this alternative approach, the
entity would need to perform additional analysis
to assess whether the accounting consequences of
using two rather than four portfolios would result
in financial statement effects that differ
materially.
The example above is relatively straightforward. In
practice, however, the contracts illustrated could involve additional
layers of complexity, such as (1) different contract durations; (2)
different call and text messaging plans; (3) different pricing schemes
(e.g., fixed or variable pricing based on usage); (4) different
promotional programs, options, and incentives; and (5) contract
modifications. Accounting for such contracts could be further
complicated by the high pace of change in product offerings.
In general, the more specific the factors an entity uses
to segregate its contracts or performance obligations into portfolios
(i.e., the “greater” the extent of disaggregation), the easier it should
be for the entity to conclude that the results of applying the guidance
to a particular portfolio are not expected to differ materially from the
results of applying the guidance to each individual contract (or
performance obligation) in the portfolio. However, further
disaggregation into separate sub-portfolios is likely to improve the
overall accuracy of estimates only if those sub-portfolios have some
different characteristics. For instance, segregating on the basis of
geographic location may not be beneficial if similar combinations of
products and services that have similar terms and conditions are sold to
a similar group of customers in different geographic areas. Likewise,
segregating on the basis of whether contract terms allow a right of
return may not be necessary if the returns are not expected to be
significant.
While there is no requirement in ASC 606 to
“quantitatively evaluate”1 whether using a portfolio approach would produce an outcome
materially different from that of applying the guidance at the contract
or performance obligation level, an entity should be able to demonstrate
why it reasonably expects the two outcomes not to differ materially. The
entity may do so by various means depending on its specific facts and
circumstances (subject to the constraints of a cost-benefit analysis).
Such means include, but are not limited to, the following:
-
Data analytics based on reliable assumptions and underlying data (internally or externally generated) related to the portfolio.
-
A sensitivity analysis that evaluates the characteristics of the contracts or performance obligations in the portfolio and the assumptions the entity used to determine a range of potential differences in applying the different approaches.
-
A limited quantitative analysis, supplemented by a more extensive qualitative assessment that may be performed when the portfolios are disaggregated.
Typically, some level of objective and verifiable
information would be necessary to demonstrate that using a portfolio
approach would not result in a materially different outcome. An entity
may also wish to (1) consider whether the costs of performing this type
of analysis potentially may outweigh the benefits of accounting on a
portfolio basis and (2) assess whether it is preferable to invest in
systems solutions that would allow accounting on an individual contract
basis.
3.1.2.2.2 Applying the Portfolio Approach to Some, but Not Other, Similar Contracts
The practical expedient in ASC 606-10-10-4 is available
only if it is reasonably expected that the financial statement
effects of applying ASC 606 to a portfolio of contracts would not differ
materially from the effects of applying ASC 606 to the individual
contracts within that portfolio. Accordingly, it is possible for
entities to prepare their consolidated financial statements by using a
mixture of approaches because the resulting accounting effects are not
reasonably expected to differ materially.
As discussed in Section 3.1.2.1, entities are required
to apply the revenue standard consistently to similar contracts. In
light of this, a company that uses the portfolio approach to account for
some of its contracts may wonder whether it is required to use the same
approach to account for all of its contracts. The example below
illustrates a situation in which it is acceptable for an entity to apply
the portfolio approach to some contracts and not apply it to others.
Example 3-5
Assume the following facts:
- Entity A consolidates Subsidiary B and Subsidiary C, both of which have a large number of contracts with customers with similar characteristics.
- Subsidiary B has elected to use a portfolio approach under ASC 606-10-10-4 when accounting for revenue from those contracts and does not have computer systems that would enable it to recognize revenue on a contract-by-contract basis.
- Subsidiary C does not elect to use a portfolio approach specified in ASC 606-10-10-4 when accounting for revenue from those contracts; instead, it has developed specialized computer systems that enable it to recognize revenue on a contract-by-contract basis.
In its consolidated financial statements, A may
apply a portfolio approach to contracts with B’s
customers without applying that approach to
contracts with C’s customers if it reasonably
expects that the use of that approach would not
differ materially from applying ASC 606 on a
contract-by-contract basis. In these
circumstances, B and C are materially applying the
same accounting policy to A’s revenue contracts
that have similar characteristics.
Connecting the Dots
A question was raised regarding the use of the
portfolio approach when an entity applies the guidance on
estimating and constraining variable consideration.
Specifically, the TRG discussed at its July 13, 2015, meeting
whether an entity is using the portfolio practical expedient
when it evaluates evidence from other similar contracts in
applying the expected value method of estimating variable
consideration. Q&A 39 of the FASB’s Revenue Recognition Implementation
Q&As (the “Implementation
Q&As”) specifies that an entity’s use of a portfolio of data
to establish an estimate is not the same process as using the
portfolio expedient in ASC 606-10-10-4. See Section 6.3.2
for the FASB staff’s conclusion.
3.1.3 Practical Expedients
An entity must make several policy elections and consider electing certain
practical expedients when accounting for revenue under ASC 606. The table below
provides a summary of practical expedients available to entities. Entities are
not required to adopt the practical expedients in ASC 606. An entity should
apply the use of any practical expedients consistently to contracts with similar
characteristics and in similar circumstances.
|
Codification Reference
|
Practical Expedient
|
Availability Under U.S. GAAP, IFRS Accounting Standards,
or Both
|
|---|---|---|
|
Policy Elections Affecting the Measurement and
Recognition of Revenue
| ||
|
ASC 606-10-32-18
|
Significant financing component — An entity does
not need to adjust the promised amount of consideration
for the effects of a significant financing component if
it expects, at contract inception, that the period
between the entity’s transfer of a promised good or
service to a customer and the customer’s payment for
that good or service will be one year or less.
|
U.S. GAAP and IFRS Accounting Standards
|
|
ASC 606-10-32-2A
|
Sales taxes — An entity may elect to exclude from
its transaction price any amounts collected from
customers for all sales (and other similar) taxes.
|
U.S. GAAP only
|
|
ASC 340-40-25-4
|
Costs of obtaining a contract — An entity “may
recognize the incremental costs of obtaining a contract
as an expense when incurred if the amortization period
of the asset that the entity otherwise would have
recognized is one year or less.”
|
U.S. GAAP and IFRS Accounting
Standards
|
|
ASC 606-10-25-18B
|
Shipping and handling — An entity may elect to
account for shipping and handling activities that occur
after control of the related good transfers as
fulfillment activities instead of assessing such
activities as performance obligations.
|
U.S. GAAP only
|
|
ASC 606-10-10-4
|
Portfolio approach — An entity may apply the
revenue standard to a portfolio of contracts (or
performance obligations) with similar characteristics if
it “reasonably expects that the effects on the financial
statements of applying this guidance to the portfolio
would not differ materially from applying this guidance
to the individual contracts (or performance obligations)
within that portfolio.”
|
U.S. GAAP and IFRS Accounting Standards
|
|
ASC 606-10-55-18
|
Right to invoice — For performance obligations
satisfied over time, “if an entity has a right to
consideration from a customer in an amount that
corresponds directly with the value to the customer of
the entity’s performance completed to date (for example,
a service contract in which an entity bills a fixed
amount for each hour of service provided), the entity
may recognize revenue in the amount to which the entity
has a right to invoice.”
|
U.S. GAAP and IFRS Accounting Standards
|
|
ASC 952-606
|
Private-company franchisor — A franchisor that is
not a PBE (a “private-company franchisor”) may use a
practical expedient when identifying performance
obligations in its contracts with customers (i.e.,
franchisees) under ASC 606. When using the practical
expedient, a private-company franchisor that has entered
into a franchise agreement would treat certain
preopening services provided to its franchisee as
distinct from the franchise license. In addition, a
private-company franchisor that applies the practical
expedient must make a policy election to either (1)
apply the guidance in ASC 606 to determine whether the
preopening services that are subject to the practical
expedient are distinct from one another or (2) account
for those preopening services as a single performance
obligation. The practical expedient and policy election
are intended to reduce the cost and complexity of
applying ASC 606 to preopening services associated with
initial franchise fees.
|
U.S. GAAP only
|
|
Policy Elections Affecting Disclosures
| ||
|
ASC 606-10-50-14 and 50-14A
|
Disclosure:
|
The first exemption is available under U.S. GAAP and IFRS
Accounting Standards, and the second exemption is
available under U.S. GAAP only.
|
For many of the practical expedients outlined above, the revenue standard
requires disclosure that an entity has elected such policy. See Chapter 15 for disclosure requirements.
Footnotes
1
Paragraph BC69 of ASU 2014-09 states that the
FASB and the IASB “acknowledged that an entity would need to
apply judgment in selecting the size and composition of the
portfolio in such a way that the entity reasonably expects that
application of the revenue recognition model to the portfolio
would not differ materially from the application of the revenue
recognition model to the individual contracts or performance
obligations in that portfolio. In their discussions, the Boards
indicated that they did not intend for an entity to
quantitatively evaluate each outcome and, instead, the entity
should be able to take a reasonable approach to determine the
portfolios that would be appropriate for its types of
contracts.”
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, Receivables2. Topic 320, Investments — Debt Securities2a. Topic 321, Investments — Equity Securities3. Topic 323, Investments — Equity Method and Joint Ventures4. Topic 325, Investments — Other5. Topic 405, Liabilities6. Topic 470, Debt7. Topic 815, Derivatives and Hedging8. Topic 825, Financial Instruments9. 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.
2
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.
3.2.2.2 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 (as amended by ASU 2018-08) 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 amends certain
aspects of the guidance to clarify the scope and accounting for contributions
received and contributions made. As part of these clarifications, ASU 2018-08
amends 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 Example
3-11, 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.
5
“For example, the activities do not constitute
an entity’s ongoing major or central operations (Master Glossary
– Revenue).”
6
“This may result in the reimbursement being
recorded as other income or as contra-expense.”
7
“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 below 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.
3.2.11 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).”10 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).”11 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”12 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 606.13
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 revenue14 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 DotsIf 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 rights15 should be accounted for under ASC 860, (2) deposit-related fees16 should be accounted for under ASC 405, (3) fees from financial
guarantees17 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.18
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.”19 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
2
See Section 3.2.12 for a
discussion of scope considerations related to contracts
accounted for under both ASC 606 and ASC 842.
3
Common gaming activities include table games, slot
machines, keno, bingo, and sports and race betting.
4
Currently, an entity that is required to
adopt IFRS 9 should apply IFRS 9 rather than IAS 39 when
accounting for derivatives.
5
“For example, the activities do not constitute
an entity’s ongoing major or central operations (Master Glossary
– Revenue).”
6
“This may result in the reimbursement being
recorded as other income or as contra-expense.”
7
“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.”
8
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.”
9
The ASC master glossary defines a vendor as a
“service provider or product seller, such as a manufacturer,
distributor, or reseller.”
11
Quoted from paragraph 12 of TRG Agenda Paper
50.
12
See footnote 10.
13
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.”
14
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.
15
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.
16
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).
17
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.
18
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).
19
Quoted from paragraph 61 of TRG Agenda Paper 52.