Chapter 6 — Step 3: Determine the Transaction Price
Chapter 6 — Step 3: Determine the Transaction Price
6.1 Overview
The FASB and IASB decided, as described further in paragraph BC181 of
ASU
2014-09, that revenue should be measured on the basis of an
allocated transaction price.
As noted in paragraph BC183 of ASU 2014-09, the allocated transaction price
approach under the revenue standard generally requires an entity to proceed in three
main phases. The first of these phases, determining the transaction price, is the
pillar of that measurement approach. The transaction price determined in the first
phase will be allocated in step 4 to the performance obligations identified in step
2 (phase 2) for recognition in step 5 (phase 3). ASC 606-10-32-2 provides the
following guidance on determining the transaction price:
ASC 606-10
32-2 An entity shall consider
the terms of the contract and its customary business
practices to determine the transaction price. The
transaction price is the amount of consideration to which an
entity expects to be entitled in exchange for transferring
promised goods or services to a customer, excluding amounts
collected on behalf of third parties (for example, some
sales taxes). The consideration promised in a contract with
a customer may include fixed amounts, variable amounts, or
both.
Connecting the Dots
Inherent in ASC 606-10-32-2 is that an entity’s determination of the transaction
price is a measurement at the contract level, as opposed to a lower level
(an individual performance obligation) or a higher level (an overall
customer relationship). The revenue standard’s allocation objective is to
allocate the transaction price to each performance obligation. Accordingly,
the transaction price must be determined in step 3 at the contract level
before it can be allocated to the distinct units of account at a lower level
(i.e., the performance obligations) in step 4.
The revenue standard establishes the “transaction price” as an amount to which
the entity expects to be entitled to under the contract. That is, it is an expected
amount, and so inherently, estimates are required. The boards intentionally used the
wording “be entitled” rather than “receive” or “collect” to distinguish
collectibility risk from other uncertainties that may occur under the contract (see
Section 4.3.5 for
further discussion of where collectibility risk falls in the standard’s revenue
model). The uncertainties that are measured as part of the transaction price
are further discussed in the next sections.
6.1.1 Components of the Transaction Price
ASC 606-10
32-3 The nature, timing, and amount of consideration promised by a customer affect the estimate of the
transaction price. When determining the transaction price, an entity shall consider the effects of all of the
following:
- Variable consideration (see paragraphs 606-10-32-5 through 32-10 and 606-10-32-14)
- Constraining estimates of variable consideration (see paragraphs 606-10-32-11 through 32-13)
- The existence of a significant financing component in the contract (see paragraphs 606-10-32-15 through 32-20)
- Noncash consideration (see paragraphs 606-10-32-21 through 32-24)
- Consideration payable to a customer (see paragraphs 606-10-32-25 through 32-27).
32-4 For the purpose of determining the transaction price, an entity shall assume that the goods or services
will be transferred to the customer as promised in accordance with the existing contract and that the contract
will not be cancelled, renewed, or modified.
Paragraph BC185 of ASU 2014-09 states that the FASB and IASB defined “transaction price” in such
a manner as to require an entity, at the end of each reporting period, “to predict the total amount of
consideration to which the entity will be entitled from the contract” with the customer. In meeting this
objective, an entity should evaluate those elements that affect the nature, timing, and uncertainty of
cash flows related to its revenues and reflect such elements in its measurement of revenue.
In paragraph BC188 of ASU 2014-09, the boards acknowledge that determining the transaction price in
a contract that contains only fixed or known cash flows will be simple. However, because of the nature
of certain pricing features and cash flow structures, determining the amount to which an entity will be
entitled will be inherently complex in many contracts. In light of this, the boards also acknowledge that
determining the transaction price in step 3 will be more difficult when contracts with customers contain:
- Consideration that is variable until the resolution of future uncertainties (i.e., variable consideration).
- Financing components that are significant to the contract’s overall cash flow stream and pricing (i.e., significant financing components).
- Consideration in a form other than cash (i.e., noncash consideration).
- Consideration that is payable by the entity to its customer (i.e., consideration payable to a customer).
Further, paragraph BC187 of ASU 2014-09 notes that it may be more difficult to determine the
transaction price when amounts to which an entity is entitled are sourced from parties other
than a customer (e.g., a manufacturer’s payments to a retailer as a result of a customer’s use of a
manufacturer’s coupon at the retailer’s store). The boards clarified that such amounts are included in an
entity’s determination of the transaction price.
However, because the boards established the transaction price as an amount to
which the entity expects to be entitled (and not an amount that the entity
expects to collect), the transaction price by design generally excludes
one measurement component that is common in other aspects of accounting —
namely, credit risk (see Section
6.1.2).
6.1.2 Effect of a Customer’s Credit Risk on the Determination of the Transaction Price
When measuring the transaction price, an entity should take a
customer’s credit risk into account only to determine (1) the discount rate used
to adjust the promised consideration for a significant financing component, if
any, and (2) potential price concessions.
ASC 606-10-32-2 specifies that the transaction price is the
amount to which an entity expects to be entitled rather than the amount it
expects to collect. The determination of the amount to which an entity expects
to be entitled is not affected by the risk of whether it expects the customer to
default (i.e., the customer’s credit risk) unless a price concession is
expected. Paragraphs BC260 and BC261 of ASU 2014-09 explain that this approach
was adopted to enable users of the financial statements to analyze “gross”
revenue (i.e., the amount to which the entity is entitled) separately from the
effect of receivables management (or bad debts).
However, when the timing of payments due under the contract
provides the customer with a significant benefit of financing, the transaction
price is adjusted to reflect the time value of money. Paragraph BC239 of ASU
2014-09 indicates that in such circumstances, an entity will take a customer’s
credit risk into account in determining the appropriate discount rate to apply.
As illustrated in Section
6.4.5, this rate will affect the amount of revenue recognized for
the transfer of goods or services under the contract.
Further, a customer’s credit risk is also a factor in the
determination of whether a contract exists, because one of the criteria for
identification of a contract in ASC 606-10-25-1 is that collection of
substantially all of the consideration to which the entity is entitled is
probable (specifically, ASC 606-10-25-1(e)). See Section 4.3.5 for further discussion of
how a customer’s credit risk affects an entity’s identification of its contract
with the customer in step 1.
6.2 Fixed Consideration
Cash flows in a contract with a customer that are known as of contract inception and
do not vary during the contract are the simplest inputs in the determination of the
transaction price. Sometimes, both price and quantity in an arrangement are fixed in
such a way that the total transaction price, calculated as price multiplied by
quantity (P × Q), is also fixed.
For example, assume that an entity enters into a contract with a customer to sell 10
widgets every month for 24 months at a price of $100 per widget. Both P ($100 per
widget) and Q (10 widgets per month for 24 months) are known and do not vary during
the term of the contract. Accordingly, the total transaction price is quantitatively
fixed and known and can be calculated as $100 × (10 × 24) = $24,000.
Under the revenue standard, nonrefundable up-front fees are included
in the transaction price in step 3 as if they were any other type of fixed
consideration. That is, if consideration is fixed, it is included in the transaction
price regardless of when it is paid (ignoring any potential significant financing
component, which is discussed in Section 6.4). For example, nonrefundable up-front fees received in
exchange for the future delivery of a good or service may reflect fixed
consideration in a contract with a customer. The consideration may be allocated in
step 4 across performance obligations, but at the contract level, the fee received
by the entity up front is fixed consideration.
As discussed in Section 6.3, the boards established variable consideration as a very
broad concept in the revenue standard. More specifically, the concept includes any
variability in the ultimate amount of consideration to which the entity will be
entitled. As a result, there are many arrangements that will include variable
consideration. While there may be guaranteed minimums in arrangements, or up-front
nonrefundable fixed amounts received in advance of work that may contribute to a
fixed portion of consideration in an arrangement, those circumstances are often
coupled with forms of variable consideration. Unless the amount to which an entity
will be entitled will not vary in the future for any reason, the total consideration
in the arrangement is not fixed.
For example, an arrangement would include variable consideration if
the contract (implicitly or explicitly) allows for the customer to return the
product (e.g., a right of return), past practice indicates that the seller will
accept a lower amount of consideration as a price concession or discount, or there
are any other adjustments to the ultimate amount to which an entity will be entitled
in exchange for its goods or services. Further, an arrangement may include a fixed
amount as a bonus payment if certain conditions are met. Although that amount may be
quantitatively fixed, it nonetheless is not considered fixed consideration because
the ultimate resolution of whether the entity will be entitled to that amount is
subject to the occurrence or nonoccurrence of the event outlined in the contract.
Accordingly, while known or quantitatively fixed amounts of consideration may
sometimes be easier to identify and may even require less challenging estimation
techniques, they will not be considered fixed consideration under the revenue
standard if they can vary in the future for any reason.
Therefore, many arrangements will include some or many different forms of variable
consideration.
6.3 Variable Consideration
ASC 606-10
32-6 An amount of consideration can vary because of discounts, rebates, refunds, credits, price concessions,
incentives, performance bonuses, penalties, or other similar items. The promised consideration also can vary
if an entity’s entitlement to the consideration is contingent on the occurrence or nonoccurrence of a future
event. For example, an amount of consideration would be variable if either a product was sold with a right of
return or a fixed amount is promised as a performance bonus on achievement of a specified milestone.
32-7 The variability relating to the consideration promised by a customer may be explicitly stated in the
contract. In addition to the terms of the contract, the promised consideration is variable if either of the
following circumstances exists:
- The customer has a valid expectation arising from an entity’s customary business practices, published policies, or specific statements that the entity will accept an amount of consideration that is less than the price stated in the contract. That is, it is expected that the entity will offer a price concession. Depending on the jurisdiction, industry, or customer this offer may be referred to as a discount, rebate, refund, or credit.
- Other facts and circumstances indicate that the entity’s intention, when entering into the contract with the customer, is to offer a price concession to the customer.
As noted above, ASC 606 creates a single framework under which an
entity assesses variable consideration in a contract with a customer to determine
the amount to include in its transaction price. The decision tree below illustrates
the application of that framework.
6.3.1 Identifying Variable Consideration
As the FASB and IASB acknowledge in paragraph BC190 of ASU 2014-09, consideration in a contract
with a customer may vary as a result of many different factors, and variability may arise in many different
circumstances. Variable consideration is easiest to identify in a contract when price (P) or quantity (Q), or
both, are not fixed and known at the contract’s inception.
For example, an entity may enter into a contract with a customer to sell 1,000 barrels of crude oil every
month for 12 months at the prevailing market index price for the contract’s delivery location. The entity
determines that (1) the contract meets the criteria in ASC 606-10-25-1 to be accounted for as a contract
with a customer and (2) each barrel of oil delivered is a distinct performance obligation in accordance
with ASC 606-10-25-14(a). In this arrangement, Q is fixed, but P varies on the basis of changes in the
market price of oil. As a result, the total transaction price calculation of P × Q is variable.
The identification of variable consideration may become more complicated when only part of P or Q,
or both, is not fixed and known at the contract’s inception. Assume the facts of the preceding example,
except that the price of each barrel of crude oil is the prevailing market index price plus $5. Now, part
of the transaction price is fixed because regardless of the market price of oil, the entity will receive
consideration of at least P × Q = $5 × (1,000 × 12) = $60,000.
The boards acknowledge in paragraphs BC190 through BC194 of ASU 2014-09 that consideration in a
contract may vary as a result of unresolved contingencies (i.e., variability in transaction price inputs other
than P or Q). In these instances, the occurrence or nonoccurrence of a future event would trigger a
cash flow stream in the contract. Such contingency-based variability may be explicit in a contract (e.g., a
contract providing for a sale with a right of return, as noted in paragraph BC191).
Example 20 in ASC 606 illustrates a performance penalty (bonus) as a form of explicit contingency-based
variable consideration.
ASC 606-10
Example 20 — Penalty Gives Rise to Variable Consideration
55-194 An entity enters into a contract with a customer to build an asset for $1 million. In addition, the terms
of the contract include a penalty of $100,000 if the construction is not completed within 3 months of a date
specified in the contract.
55-195 The entity concludes that the consideration promised in the contract includes a fixed amount of
$900,000 and a variable amount of $100,000 (arising from the penalty).
55-196 The entity estimates the variable consideration in accordance with paragraphs 606-10-32-5 through
32-9 and considers the guidance in paragraphs 606-10-32-11 through 32-13 on constraining estimates of
variable consideration.
The boards also note in paragraph BC192 of ASU 2014-09 that they decided to
include in the determination of the transaction price consideration that is
implicitly variable in the arrangement. The consideration to which an entity is
ultimately entitled may be less than the price stated in the contract because
the customer may be offered, or expects, a price concession. This creates
variability in the amount to which an entity expects to be entitled and is thus
a form of variable consideration even though there is no explicitly stated price
concession in the contractual terms. Accordingly, an entity should consider all
facts and circumstances in a contract with a customer to determine whether it
would accept an amount that is lower than the consideration stated in the
contract. If so, the total transaction price is variable because it is
contingent on the occurrence or nonoccurrence of an event (i.e., the entity’s
grant of an implicit price concession to the customer).
Entities will need to use significant judgment in determining whether they have
provided an implicit price concession (i.e., whether they have the expectation
of accepting less than the contractual amount of consideration in exchange for
goods or services) or have accepted a customer’s credit risk (i.e., whether they
have accepted the risk of collecting less consideration than what they
legitimately expected to collect from the customer). Credit risk, as noted in
Section 6.1.2,
is generally not measured as part of the transaction price (except in the
determination of the discount rate an entity should use when adjusting the
transaction price for a significant financing component [see Section 6.4.4] or in the
determination of potential concessions associated with credit risk [see
Section 6.1.2]) but is addressed in
step 1 of the revenue model as part of the gating analysis of whether revenue
from a contract with a customer should be recognized in accordance with ASC 606.
Further, Section
4.3.5.2 discusses indicators of when the variability between the
contractually stated price and the amount the entity expects to collect is due
to a price concession.
In addition to the forms of variability already discussed, the following are common features in contracts
with customers that also may be more difficult to identify as variable consideration but nevertheless
drive variability in contract consideration:
- Royalty arrangements (further discussed in Section 6.3.5.1).
- Product returns and other customer credits (further discussed in Sections 6.3.5.2 and 6.3.5.3).
- Variable quantities and volumetric optionality (further discussed in Section 6.3.5.4).
- Rebates (volume-based rebates are further discussed in Section 6.3.5.4.2).
- Discounts (cash discounts are further discussed in Section 6.3.5.5.3; and volume discounts are discussed in Example 24 from ASC 606, which is included in Section 6.3.5.4.2).
- Performance-based bonuses or penalties (further discussed in the context of bonuses in Section 6.3.2.1; and also further discussed in the context of both bonuses and penalties and in Example 21 of ASC 606, which is included in Section 6.3.2.3).
6.3.2 Estimating Variable Consideration
Regardless of the form of variability or its complexity, once variable consideration is identified, an entity
must estimate the amount of variable consideration to determine the transaction price in a contract
with a customer.
ASC 606-10
32-5 If the consideration
promised in a contract includes a variable amount, an
entity shall estimate the amount of consideration to
which the entity will be entitled in exchange for
transferring the promised goods or services to a
customer.
32-8 An entity shall estimate an amount of variable consideration by using either of the following methods,
depending on which method the entity expects to better predict the amount of consideration to which it will be
entitled:
- The expected value — The expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. An expected value may be an appropriate estimate of the amount of variable consideration if an entity has a large number of contracts with similar characteristics.
- The most likely amount — The most likely amount is the single most likely amount in a range of possible consideration amounts (that is, the single most likely outcome of the contract). The most likely amount may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes (for example, an entity either achieves a performance bonus or does not).
32-9 An entity shall apply
one method consistently throughout the contract when
estimating the effect of an uncertainty on an amount of
variable consideration to which the entity will be
entitled. In addition, an entity shall consider all the
information (historical, current, and forecast) that is
reasonably available to the entity and shall identify a
reasonable number of possible consideration amounts. The
information that an entity uses to estimate the amount
of variable consideration typically would be similar to
the information that the entity’s management uses during
the bid-and-proposal process and in establishing prices
for promised goods or services.
Paragraph BC199 of ASU 2014-09 notes that when the FASB and IASB deliberated the
guidance to be included in the revenue standard, they “observed that users of
financial statements are most interested in knowing the total amount of
consideration that ultimately will be realized from the contract.” The boards
decided that the most decision-useful information about the transaction price in
a contract with a customer is an estimate that will better predict the amount of
consideration to which the entity will be entitled. The concept of transaction
price (i.e., the amount to which the entity expects to be entitled) differs from
that of fair value. The transaction price is a contract-specific measurement
that is determined on the basis of the entity’s estimation process (which
inherently incorporates historical practice and forward expectations), whereas
fair value is a market-based measurement.
Initially, the boards decided that a probability-weighted model of measuring the
transaction price at its expected value best allowed entities to predict the
amount of consideration to which they will ultimately be entitled. In the
boards’ 2010 exposure draft on revenue (issued by the FASB as a proposed ASU), the boards proposed requiring a single
estimation technique of expected value. However, in light of feedback on the
practical challenges of such an approach, the boards were sympathetic to
stakeholders’ concerns about fact patterns with, for example, an “all or
nothing” performance bonus (in which the entity would either receive the entire
performance bonus or nothing). Specifically, as noted in paragraph BC200 of ASU
2014-09, the boards acknowledged that in a contract with variable consideration
that could result in only one of two outcomes upon the occurrence of a binary
event (such as in the “all or nothing” performance bonus fact patterns), an
expected value calculated through probability weighting would not be one of
those two possible outcomes and thus would not be a decision-useful estimate.
Consequently, the boards decided that both an expected value method and a most
likely amount method are acceptable for an entity to consider when selecting the
most appropriate method of estimating variable consideration within the
parameters of the objective in ASC 606-10-32-8 (see Section 6.3.2.1 for further discussion of
selecting the most appropriate method).
Connecting the Dots
As stated in the first sentence of ASC 606-10-32-9, a single method of estimating variable
consideration should be used throughout the term of the contract with the customer. That is,
the method of estimating variable consideration should not be reassessed or changed once it is
selected as the most appropriate.
In paragraph BC197 of ASU 2014-09, the boards briefly discuss “management’s best estimate”
as a method of estimating variable consideration and acknowledge stakeholders who noted in
deliberations that such a method “would provide management with the flexibility to estimate
on the basis of its experience and available information without the documentation that would
be required when a measurement model is specified.” However, as noted in paragraph BC201
of ASU 2014-09, the boards do not anticipate that either the most likely amount method or the
expected value method of estimating variable consideration will be too costly or complex for
entities to apply to contracts with customers. Specifically, the boards allow that an entity would
not be expected to develop complex modeling techniques to identify all possible outcomes of
variable consideration when determining the most likely outcome or a probability distribution of
outcomes. Thus, the benefits of applying the most likely amount method or the expected value
method to estimate variable consideration exceed the costs of doing so.
Although we think that it is appropriate for an entity
to be pragmatic in deriving an estimate by using either the most likely
amount method or the expected value method as required, we do not
think that it is appropriate to use a method described as management’s
best estimate as either the most likely amount or the expected value of
variable consideration.
6.3.2.1 Selection of Method Used to Estimate Variable Consideration
When determining the appropriate method for estimating
variable consideration, an entity should choose whichever method will better
predict the amount of consideration to which it will become entitled. When a
contract has only two possible outcomes, it will often be appropriate to
estimate variable consideration by using a method based on the most likely
amount. When the entity has a large number of contracts with similar
characteristics and the outcome for each contract is independent of the
others, the expected value method may better predict the overall outcome for
the contracts in the aggregate. This will be true even when each individual
contract has only two possible outcomes (e.g., a sale with a right of
return). This is because an entity will often have better information about
the probabilities of various outcomes when there are a large number of
similar transactions.
It is important, however, to consider carefully whether the
outcome for each contract is truly independent of the others. For example,
if the outcome is binary but is determined by the occurrence or
nonoccurrence of the same event for all contracts (i.e., the variable amount
will be received either for all of the contracts or for none of them), the
expected value is unlikely to be a good predictor of the overall outcome and
the entity may need to use the most likely amount method to estimate the
variable consideration in the contracts.
Example 6-1
Each year, Entity X’s performance is
ranked against that of its competitors in a
particular jurisdiction. All of X’s customer
contracts specify that a fixed bonus of $500 will be
due to X if it is ranked in the top quartile. Entity
X has approximately 1,000 customer contracts.
Entity X should estimate the
variable consideration (i.e., the bonus) on the
basis of the most likely amount. Although X has a
large number of similar contracts, the outcomes are
not independent because they all depend on the same
criterion (i.e., the ranking of X against its
competitors). The bonus will be payable under either
all the contracts or none of them. Thus, the overall
outcome for the contracts in the aggregate will be
binary and the expected value will not be a good
predictor of that overall outcome.
6.3.2.2 Using a Portfolio of Data Versus the Portfolio Practical Expedient When Applying the Expected Value Method
When an entity applies the expected value method, it may consider evidence
(i.e., a portfolio of data) from other similar contracts to form its
estimate of expected value. Stakeholders raised questions about whether the
evaluation of a portfolio of data from other similar contracts in estimating
an expected value of variable consideration would mean that an entity is
applying the “portfolio practical expedient” discussed in Section 3.1.2.2. The concern was exacerbated
by the follow-on question of whether an entity using a portfolio of data to
estimate an expected value would also need to meet the necessary condition
of the portfolio practical expedient that the results of doing so may not
differ materially from the results of applying the guidance to the contracts
individually.
The example below clarifies that an entity’s use of a
portfolio of data from other similar contracts to calculate an estimate of
the expected value of variable consideration is not the same as using
the portfolio practical expedient.
Example 6-2
Entity B enters into a contract to
sell Product X to Customer C for $50. Entity B’s
policy allows unused products to be returned within
30 days for a refund. Therefore, the contract
includes variable consideration. In addition to the
transaction with C, B has a large number of similar
sales of Product X (i.e., a homogeneous population
of contracts) with the same right of return
provision.
There are two methods for estimating
variable consideration under ASC 606: (1) the
expected value method and (2) the most likely amount
method. See Section 6.3.2.1
for guidance on factors to be considered in the
selection of the most appropriate method in
particular circumstances.
Under the expected value method, B
considers a portfolio of historical data that
includes contracts for Product X. Entity B concludes
that this portfolio of historical data is relevant
and consistent with the characteristics of the
contract with C. The portfolio of data indicates
that 10 out of every 100 products were returned.
Using this portfolio of data, B estimates the
expected value to be $45, or $50 – ($50 × 10%), for
the sale of Product X to C. That is, when a
portfolio of data is used to estimate variable
consideration under the expected value method, the
amount estimated may not represent a possible
outcome of an individual contract.
If B were to apply the most likely
amount method, it would consider the two possible
outcomes for this contract (i.e., $0 and $50) and
estimate the variable consideration to be $50.
In accordance with ASC 606-10-32-8,
B should estimate variable consideration by using
whichever method will better predict the amount of
consideration to which it will become entitled. When
selecting which method to use to estimate variable
consideration in accordance with ASC 606-10-32-8, B
concludes that the expected value method will better
predict the amount of consideration to which it will
become entitled (see Section
6.3.2.1). That is, an estimate of $45 is
likely to be consistent with the ultimate resolution
of the uncertainty related to the product return
right in these circumstances. This is because when
there are a large number of similar transactions
(i.e., a homogeneous population of contracts), the
entity’s expectation of the amount of consideration
to which it will be entitled is better predicted by
reference to the probabilities of outcomes exhibited
by that portfolio of similar data. By using a
portfolio of data to make an estimate of variable
consideration, an entity considers evidence from
other, similar contracts to form an estimate of
expected value.
It is important to highlight that in
this example, B is not applying the portfolio
practical expedient.2 An entity’s election to use a portfolio of
contracts to make estimates and judgments about
variable consideration (including evaluating the
constraint) for a specific contract is not the same
as using the portfolio approach as a practical
expedient. Therefore, the restriction on using the
portfolio practical expedient (i.e., the entity does
not expect the results of applying ASC 606 to a
portfolio of contracts with similar characteristics
to be materially different from the results of
applying the guidance to the individual contracts in
the portfolio) does not apply.
The above issue is addressed in Q&A 39 (compiled from
previously issued TRG Agenda Papers 38 and 44) of the FASB staff’s Revenue Recognition Implementation Q&As
(the “Implementation Q&As”). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see Appendix C.
6.3.2.3 Using More Than One Method to Estimate Variable Consideration Within One Contract
When a contract contains multiple elements of variability, an entity can use
more than one method (i.e., the expected value method and the most likely
amount method) to estimate the amount of variable consideration to include
in the transaction price. Example 21 in ASC 606-10-55-197 through 55-200
(reproduced below) shows that an entity should prepare a separate estimate
for each element of variable consideration in a contract (i.e., for each
uncertainty) by using either the expected value method or the most likely
amount method, whichever method better predicts the amount of consideration
to which it will be entitled.
ASC 606-10
Example 21 — Estimating Variable
Consideration
55-197 An entity enters into
a contract with a customer to build a customized
asset. The promise to transfer the asset is a
performance obligation that is satisfied over time.
The promised consideration is $2.5 million, but that
amount will be reduced or increased depending on the
timing of completion of the asset. Specifically, for
each day after March 31, 20X7 that the asset is
incomplete, the promised consideration is reduced by
$10,000. For each day before March 31, 20X7 that the
asset is complete, the promised consideration
increases by $10,000.
55-198 In addition, upon
completion of the asset, a third party will inspect
the asset and assign a rating based on metrics that
are defined in the contract. If the asset receives a
specified rating, the entity will be entitled to an
incentive bonus of $150,000.
55-199 In determining the
transaction price, the entity prepares a separate
estimate for each element of variable consideration
to which the entity will be entitled using the
estimation methods described in paragraph
606-10-32-8:
-
The entity decides to use the expected value method to estimate the variable consideration associated with the daily penalty or incentive (that is, $2.5 million, plus or minus $10,000 per day). This is because it is the method that the entity expects to better predict the amount of consideration to which it will be entitled.
-
The entity decides to use the most likely amount to estimate the variable consideration associated with the incentive bonus. This is because there are only 2 possible outcomes ($150,000 or $0) and it is the method that the entity expects to better predict the amount of consideration to which it will be entitled.
55-200 The entity considers
the guidance in paragraphs 606-10-32-11 through
32-13 on constraining estimates of variable
consideration to determine whether the entity should
include some or all of its estimate of variable
consideration in the transaction price.
Because ASC 606-10-32-9 requires entities to apply one method consistently to
each variable element throughout the contract, it would not be appropriate
to switch between the most likely amount and expected value method for a
particular variable element during the life of a contract.
An entity should also consider the guidance in ASC 606-10-32-11 through 32-13
on constraining estimates of variable consideration to determine whether it
should include some or all of the variable consideration in the transaction
price.
Example 6-3
Entity X, an IT service provider, enters into a
unique contract with a customer to develop the
customer’s Web site. To induce X to complete the
project on a timely basis and to provide a solution
that drives business growth for the customer, the
fee receivable by X under the contract includes
variable consideration that is determined as follows:
-
One element of the fee is based on the performance of the Web site and is determined by using a sliding scale from $500,000 to $1 million. The amount earned is based on a formula that uses a number of metrics (e.g., the number of pages viewed and the number of unique visitors) measured over the two-year period after the Web site is completed and fully functional.
-
The other element of the fee is based on the timely completion of the Web site and is determined as follows:
-
$1 million if the Web site is completed and fully functional within 90 days of the signing of the contract.
-
$500,000 if the Web site is completed and fully functional more than 90 days after the contract is signed.
-
Having considered the guidance in ASC 606-10-32-8 on
selecting an appropriate method for estimating the
amount of variable consideration, X applies the
following methods to each element of variability in
the contract:
-
The amount of consideration related to the performance of the customer’s Web site is estimated by using the expected value method because X estimates that it could be entitled to a wide range of possible consideration amounts (any amount between $500,000 and $1 million).
-
The amount of consideration related to the timely completion of the Web site is estimated by using the most likely amount method because this element of variable consideration has only two possible outcomes ($1 million if the Web site is completed and fully functional within 90 days or $500,000 if it is completed and fully functional after more than 90 days). Since the contract is unique, X does not have a pool of similar contracts from which to develop a portfolio of data it would need to use the expected value method.
Entity X should continue to use the selected method
for each element consistently for the entire
duration of the contract.
It is important to note the distinction between an element
of variable consideration and a performance obligation. The former concept
refers to a unique, incremental driver of variability or uncertainty in the
transaction price, while the latter concept refers to a unit of account
identified in step 2 (see Chapter 5). This distinction is intended to clarify that an
estimate of variable consideration is performed for each incremental driver
of variability at the contract level and not at the performance
obligation level. A total transaction price for the contract, including any
estimates of variable consideration, must be determined in step 3 before it
can be allocated in step 4 to the performance obligations identified in step
2 (unless the invoice practical expedient for measuring progress toward
complete satisfaction of a performance obligation [see Section 8.5.8.1] or
the variable consideration exception under ASC 606-10-32-40 [see Section 7.5] is
applied).
6.3.3 Constraining Estimates of Variable Consideration
Since revenue is one of the most important metrics to users of financial
statements, the boards and their constituents agreed that estimates of variable
consideration are only useful to the extent that an entity is confident that the
revenue recognized as a result of those estimates will not be subsequently
reversed. Accordingly, as noted in paragraph BC203 of ASU 2014-09, the boards
acknowledged that some estimates of variable consideration should not be
included in the transaction price if the inherent uncertainty could prevent a
faithful depiction of the consideration to which the entity expects to be
entitled in exchange for delivering goods or services. Thus, the focus of the
boards’ deliberations on a mechanism to improve the usefulness of estimates in
revenue as a predictor of future performance was to limit subsequent downward
adjustments in revenue (i.e., reversals of revenue recognized). The result of
those deliberations is what is commonly referred to as the “constraint.”
The constraint is thus a biased estimate that focuses on possible future downward revenue adjustments
(i.e., revenue reversals) rather than on all revenue adjustments (i.e., both upward or favorable
adjustments and downward or unfavorable adjustments). In paragraph BC207 of ASU 2014-09, the
boards acknowledge that the constraint requirement “creates a tension with the notion of neutrality in
the Boards’ respective conceptual frameworks” because of the downward bias in estimation. However,
the boards ultimately accepted this bias in favor of user feedback, which placed primacy on the
relevance of the estimate; and in the context of revenue, the preference was for the estimate not to be
subject to significant future reversals.
ASC 606-10
32-11 An entity shall include
in the transaction price some or all of an amount of
variable consideration estimated in accordance with
paragraph 606-10-32-8 only to the extent that it is
probable that a significant reversal in the amount of
cumulative revenue recognized will not occur when the
uncertainty associated with the variable consideration
is subsequently resolved.
Inherent in the language of ASC 606-10-32-11 is a link between the measurement of variable
consideration in the transaction price (step 3) and the recognition of an appropriate amount of revenue
(step 5; see Chapter 8). That is, the constraint is naturally a measurement concept because it influences
the amount of variable consideration included in the transaction price. However, its application is driven
by a recognition concept and the avoidance of reversing the cumulative amount of revenue previously
recognized.
During the development of the constraint guidance, its placement was debated since, as discussed in
paragraph BC221 of ASU 2014-09, the boards concluded that the constraint includes concepts from
both step 3 (measurement) and step 5 (recognition). Ultimately, the boards included the constraint in
the measurement guidance of step 3, but the constraint guidance’s wording of the phrase “a significant
reversal in the amount of cumulative revenue recognized will not occur” draws on recognition concepts.
As explained in paragraph BC221, the boards observed that constraining the transaction price and limiting the cumulative amount of revenue recognized “are not truly independent objectives because
the measurement of revenue determines the amount of revenue recognized. In other words, the
guidance for constraining estimates of variable consideration restricts revenue recognition and uses
measurement uncertainty as the basis for determining if (or how much) revenue should be recognized.”
ASC 606-10
32-12 In assessing whether it is probable that a significant reversal in the amount of cumulative revenue
recognized will not occur once the uncertainty related to the variable consideration is subsequently resolved,
an entity shall consider both the likelihood and the magnitude of the revenue reversal. Factors that could
increase the likelihood or the magnitude of a revenue reversal include, but are not limited to, any of the
following:
- The amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgment or actions of third parties, weather conditions, and a high risk of obsolescence of the promised good or service.
- The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
- The entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.
- The entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.
- The contract has a large number and broad range of possible consideration amounts.
Inherent in ASC 606-10-32-12 are three key aspects of the assessment necessary to determine whether
an estimate of variable consideration in a contract with a customer should be constrained in an entity’s
transaction price:
- The likelihood of a reversal in the cumulative amount of revenue recognized (i.e., a qualitative aspect).
- The magnitude (or significance) of the potential reversal in the cumulative amount of revenue recognized (i.e., a quantitative aspect).
- The threshold that triggers a constrained estimate (i.e., the use of “probable”).
In paragraph BC214 of ASU 2014-09, the boards acknowledge that the application
of the constraint was designed to be part of a two-step process: (1) estimate
variable consideration (see Section 6.3.2) and then (2) assess whether it is probable that a
significant reversal in the amount of revenue recognized from that estimate of
variable consideration will occur once the underlying uncertainty is resolved.
However, the boards go on to explain in paragraph BC215 that an entity is not
required to perform a two-step process if the entity “already incorporates the
principles on which the guidance for constraining estimates of variable
consideration is based.” The boards recognized that an entity may incorporate
into its existing estimation processes today the qualitative principles inherent
in applying the constraint. This notion is illustrated by the boards’ use of the
indicators in ASC 606-10-32-12, which were derived from legacy, qualitative
revenue guidance related to sales returns.
Further, in paragraph BC212 of ASU 2014-09, the boards address stakeholder
concerns raised during the deliberations on the ASU that the application of the
constraint would require a significantly quantitative process. The boards
expressly acknowledge in their cost-benefit analysis of the standard’s revenue
guidance that a quantitative process is not always required, and a qualitative
analysis is expected to be sufficient for applying the constraint guidance in
many cases.
The term “probable” in ASC 606-10-32-11 is intended to mean that “the future
event or events are likely to occur,” which is consistent with the definition in
ASC 450. Paragraph 56 of IFRS 15, the IFRS counterpart of ASC 606-10-32-11, uses
the term “highly probable” rather than “probable.” Since “probable” is defined
in IFRS 5 as “more likely than not,” paragraph 56 of IFRS 15 uses “highly
probable” to achieve the same meaning as “probable” in ASC 606-10-32-11.
Therefore, despite the difference in wording, there is no difference between the
intended meaning of ASC 606-10-32-11 and that of paragraph 56 of IFRS 15. For a
list of differences between U.S. GAAP and IFRS Accounting Standards regarding
revenue-related issues on which the boards could not converge, see Appendix A.
Connecting the Dots
Although the guidance on constraining estimates of variable consideration is intended to
avoid significant downward adjustments in revenue after it has been recognized, we generally
do not think that it would be appropriate to constrain 100 percent of an estimate of variable
consideration. That is, we do not think that the factors in ASC 606-10-32-12 could be so
significant that an estimate of variable consideration should be entirely constrained from
the transaction price. This concept is different from a $0 estimate of variable consideration.
A 100 percent constraint on an estimate of variable consideration that is not $0, however,
would generally go against the measurement principle of ASC 606, which is to include in the
transaction price the amount to which an entity expects to be entitled for its performance so
that the entity can provide financial statement users a better prediction of future revenues.
While the above is a general interpretation, there are exceptions in the revenue
standard that may allow for a 100 percent constraint on an estimate of
variable consideration. Example 25 in ASC 606-10-55 discusses an
exception in which market-based factors are a significant driver of
variability in the transaction price. Also, in paragraph BC415 of ASU
2014-09, the boards discuss their rationale for providing an exception
for sales- or usage-based royalties in a license of intellectual
property (IP). See Section
6.3.5.1 and Chapter 12 for further discussion of sales- or usage-based
royalties. Outside of these exceptions, an entity should include a
minimum amount of variable consideration in the transaction price if
management believes that this minimum amount is not constrained. While a
minimum revenue amount stated in a contract may help an entity estimate
this amount, management should not choose by default to make its
estimate the minimum amount stated in the contract since there may be an
amount of variable consideration in excess of that minimum for which it
is probable that a significant reversal of revenue will not occur once
the uncertainty is resolved.
Example 23 in ASC 606 (reproduced below) illustrates how an entity evaluates the
constraint on estimates of variable consideration in the determination of the
transaction price at the contract level.
ASC 606-10
Example 23 — Price Concessions
55-208 An entity enters into
a contract with a customer, a distributor, on December
1, 20X7. The entity transfers 1,000 products at contract
inception for a price stated in the contract of $100 per
product (total consideration is $100,000). Payment from
the customer is due when the customer sells the products
to the end customers. The entity’s customer generally
sells the products within 90 days of obtaining them.
Control of the products transfers to the customer on
December 1, 20X7.
55-209 On the basis of its
past practices and to maintain its relationship with the
customer, the entity anticipates granting a price
concession to its customer because this will enable the
customer to discount the product and thereby move the
product through the distribution chain. Consequently,
the consideration in the contract is variable.
Case A — Estimate of Variable
Consideration Is Not Constrained
55-210 The entity has
significant experience selling this and similar
products. The observable data indicate that historically
the entity grants a price concession of approximately 20
percent of the sales price for these products. Current
market information suggests that a 20 percent reduction
in price will be sufficient to move the products through
the distribution chain. The entity has not granted a
price concession significantly greater than 20 percent
in many years.
55-211 To estimate the
variable consideration to which the entity will be
entitled, the entity decides to use the expected value
method (see paragraph 606-10-32-8(a)) because it is the
method that the entity expects to better predict the
amount of consideration to which it will be entitled.
Using the expected value method, the entity estimates
the transaction price to be $80,000 ($80 × 1,000
products).
55-212 The entity also
considers the guidance in paragraphs 606-10-32-11
through 32-13 on constraining estimates of variable
consideration to determine whether the estimated amount
of variable consideration of $80,000 can be included in
the transaction price. The entity considers the factors
in paragraph 606-10-32-12 and determines that it has
significant previous experience with this product and
current market information that supports its estimate.
In addition, despite some uncertainty resulting from
factors outside its influence, based on its current
market estimates, the entity expects the price to be
resolved within a short time frame. Thus, the entity
concludes that it is probable that a significant
reversal in the cumulative amount of revenue recognized
(that is, $80,000) will not occur when the uncertainty
is resolved (that is, when the total amount of price
concessions is determined). Consequently, the entity
recognizes $80,000 as revenue when the products are
transferred on December 1, 20X7.
Case B — Estimate of Variable
Consideration Is Constrained
55-213 The entity has
experience selling similar products. However, the
entity’s products have a high risk of obsolescence, and
the entity is experiencing high volatility in the
pricing of its products. The observable data indicate
that historically the entity grants a broad range of
price concessions ranging from 20 to 60 percent of the
sales price for similar products. Current market
information also suggests that a 15 to 50 percent
reduction in price may be necessary to move the products
through the distribution chain.
55-214 To estimate the
variable consideration to which the entity will be
entitled, the entity decides to use the expected value
method (see paragraph 606-10-32-8(a)) because it is the
method that the entity expects to better predict the
amount of consideration to which it will be entitled.
Using the expected value method, the entity estimates
that a discount of 40 percent will be provided and,
therefore, the estimate of the variable consideration is
$60,000 ($60 × 1,000 products).
55-215 The entity also
considers the guidance in paragraphs 606-10-32-11
through 32-13 on constraining estimates of variable
consideration to determine whether some or all of the
estimated amount of variable consideration of $60,000
can be included in the transaction price. The entity
considers the factors in paragraph 606-10-32-12 and
observes that the amount of consideration is highly
susceptible to factors outside the entity’s influence
(that is, risk of obsolescence) and it is likely that
the entity may be required to provide a broad range of
price concessions to move the products through the
distribution chain. Consequently, the entity cannot
include its estimate of $60,000 (that is, a discount of
40 percent) in the transaction price because it cannot
conclude that it is probable that a significant reversal
in the amount of cumulative revenue recognized will not
occur. Although the entity’s historical price
concessions have ranged from 20 to 60 percent, market
information currently suggests that a price concession
of 15 to 50 percent will be necessary. The entity’s
actual results have been consistent with then-current
market information in previous, similar transactions.
Consequently, the entity concludes that it is probable
that a significant reversal in the cumulative amount of
revenue recognized will not occur if the entity includes
$50,000 in the transaction price ($100 sales price and a
50 percent price concession) and, therefore, recognizes
revenue at that amount. Therefore, the entity recognizes
revenue of $50,000 when the products are transferred and
reassesses the estimates of the transaction price at
each reporting date until the uncertainty is resolved in
accordance with paragraph 606-10-32-14.
Note that in the Codification example above, it is assumed as
part of the fact pattern that control of the products is transferred to the
distributor at contract inception. However, the fact that the distributor
becomes obliged to pay for the products only when it sells them to end customers
is an indication that this might be a consignment arrangement. Consignment
arrangements are discussed in Section 8.6.8.
6.3.3.1 Constraint on Variable Consideration Assessed at the Contract Level
As described in Section 3.1.2, the transaction price
for the contract is determined in step 3 of the revenue model and, hence,
the unit of account for determining the transaction price is the contract
level. The revenue constraint forms part of the determination of the
transaction price; accordingly, the likelihood and significance of a
potential revenue reversal should be assessed at the contract level
Example 6-4
An entity enters into a contract
with a customer to provide equipment and consulting
services. The contractual price for the equipment is
$10 million. The consulting services are priced at a
fee of $100,000, of which $55,000 is fixed and
$45,000 is contingent on the customer’s reducing its
manufacturing costs by 5 percent over a one-year
period.
It is also concluded that:
-
The equipment and consulting services are separate performance obligations.
-
The stand-alone selling prices of the equipment and consulting services are $10 million and $100,000, respectively.
The entity believes that there is a
60 percent likelihood that it will be entitled to
the performance-based element of the consulting
services fee. As a result, by using the most likely
amount approach described in ASC 606-10-32-8(b), the
entity estimates the amount of the variable
consideration as $45,000.
The total transaction price of the
contract before the entity considers the constraint
is, therefore, $10.1 million.
The entity then considers the
constraint to determine whether it is probable that
a significant reversal in the amount of cumulative
revenue recognized will not occur. The entity
considers both the likelihood and the magnitude of a
revenue reversal at the contract level.
There is a 40 percent chance that
the contingent consulting services fee of $45,000
will not be receivable. Accordingly, the entity
concludes that it is not probable that the entity
will be entitled to the variable consideration.
However, the significance of the potential revenue
reversal of $45,000 is evaluated in the context of
the contract ($45,000 as a proportion of $10.1
million, or 0.45 percent of the transaction price)
and not in the context of the performance obligation
($45,000 as a proportion of $100,000, or 45 percent
of the amount assigned to the performance
obligation). Therefore, the entity concludes that
all of the variable consideration should be included
in the transaction price because it is probable that
a significant revenue reversal will not
occur.
The above issue is addressed in Implementation Q&A 30 (compiled from previously
issued TRG Agenda Papers 14 and 25). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
6.3.3.2 Estimating Multiple Elements of Variable Consideration and Assessing the Constraint on Variable Consideration
As stated in Section 6.3.2.3, Example 21 in ASC
606-10-55-197 through 55-200 shows that when a contract contains multiple
elements of variability (e.g., sales returns, discounts, performance
bonuses), an entity should prepare a separate estimate for each element of
variable consideration in a contract (i.e., for each uncertainty) by using
either the expected value method or the most likely amount method, whichever
method better predicts the amount of consideration to which it will be
entitled. Since the revenue constraint forms part of the determination of
the transaction price, the likelihood and significance of a potential
revenue reversal should be assessed at the contract level. Therefore, it is
important for entities to be aware of the distinction between (1) preparing
separate estimates for each element of variable consideration in a
contract and (2) separately evaluating the constraint on estimates of
variable consideration in the determination of the transaction price at the
contract level.
Example 25 in ASC 606 (reproduced below) illustrates how an entity evaluates
the constraint on estimates of each element of variable consideration in the
determination of the transaction price at the contract level.
ASC 606-10
Example 25 — Management Fees Subject
to the Constraint
55-221 On January 1, 20X8, an
entity enters into a contract with a client to
provide asset management services for five years.
The entity receives a 2 percent quarterly management
fee based on the client’s assets under management at
the end of each quarter. In addition, the entity
receives a performance-based incentive fee of 20
percent of the fund’s return in excess of the return
of an observable market index over the 5-year
period. Consequently, both the management fee and
the performance fee in the contract are variable
consideration.
55-222 The entity accounts
for the services as a single performance obligation
in accordance with paragraph 606-10-25-14(b),
because it is providing a series of distinct
services that are substantially the same and have
the same pattern of transfer (the services transfer
to the customer over time and use the same method to
measure progress — that is, a time-based measure of
progress).
55-223 At contract inception,
the entity considers the guidance in paragraphs
606-10-32-5 through 32-9 on estimating variable
consideration and the guidance in paragraphs
606-10-32-11 through 32-13 on constraining estimates
of variable consideration, including the factors in
paragraph 606-10-32-12. The entity observes that the
promised consideration is dependent on the market
and, thus, is highly susceptible to factors outside
the entity’s influence. In addition, the incentive
fee has a large number and a broad range of possible
consideration amounts. The entity also observes that
although it has experience with similar contracts,
that experience is of little predictive value in
determining the future performance of the market.
Therefore, at contract inception, the entity cannot
conclude that it is probable that a significant
reversal in the cumulative amount of revenue
recognized would not occur if the entity included
its estimate of the management fee or the incentive
fee in the transaction price.
55-224 At each reporting
date, the entity updates its estimate of the
transaction price. Consequently, at the end of each
quarter, the entity concludes that it can include in
the transaction price the actual amount of the
quarterly management fee because the uncertainty is
resolved. However, the entity concludes that it
cannot include its estimate of the incentive fee in
the transaction price at those dates. This is
because there has not been a change in its
assessment from contract inception — the variability
of the fee based on the market index indicates that
the entity cannot conclude that it is probable that
a significant reversal in the cumulative amount of
revenue recognized would not occur if the entity
included its estimate of the incentive fee in the
transaction price. At March 31, 20X8, the client’s
assets under management are $100 million. Therefore,
the resulting quarterly management fee and the
transaction price is $2 million.
55-225 At the end of each
quarter, the entity allocates the quarterly
management fee to the distinct services provided
during the quarter in accordance with paragraphs
606-10-32-39(b) and 606-10-32-40. This is because
the fee relates specifically to the entity’s efforts
to transfer the services for that quarter, which are
distinct from the services provided in other
quarters, and the resulting allocation will be
consistent with the allocation objective in
paragraph 606-10-32-28. Consequently, the entity
recognizes $2 million as revenue for the quarter
ended March 31, 20X8.
6.3.4 Evaluating the Impact of Subsequent Events on Estimates of Variable Consideration
In certain circumstances, the uncertainty related to variable
consideration may be resolved shortly after the end of the reporting period.
When additional information (e.g., regulatory approval notification or denial)
is received after the end of the reporting period and before the date on which
financial statements are issued or available to be issued, an entity should
refer to the guidance in ASC 855 on accounting for subsequent events. Paragraph
BC228 of ASU 2014-09 states the following:
The Boards noted that in some cases, an entity might make an estimate of
the amount of variable consideration to include in the transaction price
at the end of a reporting period. However, information relating to the
variable consideration might arise between the end of the reporting
period and the date when the financial statements are authorized for
issue. The Boards decided not to provide guidance on the accounting in
these situations because they noted that the accounting for subsequent
events is already addressed in Topic 855, Subsequent Events, and IAS 10,
Events after the Reporting Period.
ASC 855 distinguishes between recognized subsequent events (ASC 855-10-25-1) and
nonrecognized subsequent events (ASC 855-10-25-3) as follows:
25-1 An entity shall recognize in the financial statements the
effects of all subsequent events that provide additional evidence about
conditions that existed at the date of the balance sheet, including the
estimates inherent in the process of preparing financial statements. See
paragraph 855-10-55-1 for examples of recognized subsequent events.
25-3 An entity shall not recognize subsequent events that provide
evidence about conditions that did not exist at the date of the balance
sheet but arose after the balance sheet date but before financial
statements are issued or are available to be issued. See paragraph
855-10-55-2 for examples of nonrecognized subsequent events.
In the life sciences industry, it is common for a life sciences entity to enter
into a contract with a customer that entitles the life sciences entity to
variable consideration in the event that the customer receives regulatory
approval as a result of the R&D activities performed by the life sciences
entity. Because the variable consideration is contingent on the customer’s
receipt of regulatory approval, the life sciences entity is required to estimate
the amount of variable consideration to include in the transaction price. The
life sciences entity may conclude that such variable consideration should be
constrained until regulatory approval is obtained.
However, ASC 855 does not provide direct guidance on how to account for
additional information about regulatory approval or denial that is received
after the end of the reporting period and before the date on which the financial
statements are issued or are available to be issued. We believe that the
conclusion to account for information received about the regulatory approval
process as either a recognized or a nonrecognized subsequent event will be based
on the facts and circumstances and may require significant judgment.
Accordingly, entities are encouraged to consult with their accounting
advisers.
6.3.5 Application to Different Forms of Variable Consideration
6.3.5.1 Sales- or Usage-Based Royalties
ASC 606-10
32-13 An entity shall apply paragraph 606-10-55-65 to account for consideration in the form of a sales-based
or usage-based royalty that is promised in exchange for a license of intellectual property.
ASC 606-10-55-65 states that an entity may not recognize revenue from sales- or
usage-based royalties related to licenses of IP until the later of (1) the
subsequent sale or usage or (2) the satisfaction of the performance
obligation to which some or all of the royalty has been allocated. See Chapter 12 for further
discussion of sales- or usage-based royalties related to licenses of IP.
Consideration in the form of sales- or usage-based royalties is inherently
variable depending on future customer actions. However, the FASB and IASB
decided that the variability in the transaction price from sales- or
usage-based royalties related to licenses of IP should be accounted for
differently from the variability attributable to sales- or usage-based
royalties that are not related to licenses of IP (see Chapter 12 for further
discussion of licensing). Accordingly, ASC 606-10-55-65 effectively provides
that the requirements related to estimating and constraining variable
consideration are subject to an exception for sales- or usage-based
royalties related to licenses of IP.
It is important to note that sales- or usage-based royalties that are not
related to licenses of IP are still subject to the requirements related to
estimating and constraining variable consideration (discussed in Sections 6.3.2 and 6.3.3, respectively). In
light of this, the boards acknowledge in paragraph BC416 of ASU 2014-09 that
economically similar transactions could be accounted for differently (e.g.,
royalty arrangements not related to licenses of IP could result in timing
and amounts of revenue recognition that differ from those of royalty
arrangements related to licenses of IP).
6.3.5.2 Refund Liabilities
ASC 606-10
32-10 An entity shall
recognize a refund liability if the entity receives
consideration from a customer and expects to refund
some or all of that consideration to the customer. A
refund liability is measured at the amount of
consideration received (or receivable) for which the
entity does not expect to be entitled (that is,
amounts not included in the transaction price). The
refund liability (and corresponding change in the
transaction price and, therefore, the contract
liability) shall be updated at the end of each
reporting period for changes in circumstances. To
account for a refund liability relating to a sale
with a right of return, an entity shall apply the
guidance in paragraphs 606-10-55-22 through
55-29.
Refund liabilities are first introduced in ASC 606 as a form of variable
consideration — specifically, in ASC 606-10-32-10. That is, the fact that an
entity may have to refund to its customer some of the consideration it is
promised in the contract is a creator of variability in the amount of
consideration to which the entity is ultimately expected to be entitled in
exchange for delivering the goods or services in the contract. In ASC
606-10-32-10, the FASB expressly linked the accounting for refund
liabilities to their most common application, in sales with a right of
return (which are discussed in Section 6.3.5.3). However, there could
be other circumstances in which refund liabilities arise in revenue
contracts. Entities should carefully consider circumstances in which cash is
expected to be refunded to a customer when evaluating whether a refund
liability should be recognized.
In addition, as discussed in Section 14.3,
refund liabilities are to be presented separately from contract liabilities
in the balance sheet. Refund liabilities would generally not be presented in
Schedule II — Valuation and Qualifying Accounts as described in SEC
Regulation S-X, Rules 5-04 and 12-09.
Presentation of refund liabilities is further discussed in Chapter 14.
6.3.5.3 Sales With a Right of Return
ASC 606-10
55-22 In some contracts, an
entity transfers control of a product to a customer
and also grants the customer the right to return the
product for various reasons (such as dissatisfaction
with the product) and receive any combination of the
following:
-
A full or partial refund of any consideration paid
-
A credit that can be applied against amounts owed, or that will be owed, to the entity
-
Another product in exchange.
55-23 To account for the
transfer of products with a right of return (and for
some services that are provided subject to a
refund), an entity should recognize all of the
following:
-
Revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (therefore, revenue would not be recognized for the products expected to be returned)
-
A refund liability
-
An asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability.
55-24 An entity’s promise to stand ready to accept a returned product during the return period should not be
accounted for as a performance obligation in addition to the obligation to provide a refund.
In paragraph BC363 of ASU 2014-09, the FASB and IASB acknowledge that
“conceptually, a contract with a right of return includes at least two
performance obligations — a performance obligation [i.e., the original
promise] to provide the good to the customer and a performance obligation
[i.e., a secondary promise] for the return right service, which is a
standready obligation to accept the goods returned by the customer during
the return period.” However, in paragraph BC366, the boards go on to note
that their ultimate conclusions about the implementation guidance on sales
with a right of return were driven by practical considerations such that the
boards “decided that the incremental information provided to users of
financial statements by accounting for the return right service as a
performance obligation would not have justified the complexities and costs
of doing so.” Thus, because “standing ready” to accept returns is not
regarded as a performance obligation in these circumstances, no revenue is
recognized as that activity occurs. Further, as with refund liabilities, the
return right service is viewed instead as a driver of variability in the
amount of consideration to which the entity expects to be entitled for
transferring the goods or services in the contract. See Section 5.2.4.2 for further discussion.
Importantly, under the revenue standard, a sale with a right of return is not a
separate variable consideration model or a “failed” sale model. Rather, the
uncertainty associated with whether a product may be returned is treated,
for measurement purposes, consistently with the uncertainty associated with
whether an entity will receive all or nothing from a bonus payment of $1
million. Accordingly, the boards decided against dealing with this
uncertainty through a step 5, transfer-of-control notion (i.e., a “failed”
sale model). In adopting this approach, the boards chose simplicity over
creating (1) several different categories of variable consideration and (2)
separate measurement models for each of those separate types of
variability.
As a result, although the boards provided more specific measurement and remeasurement guidance
for sales with a right of return in ASC 606-10-55-25 through 55-27 (paragraphs B23 through B25 of IFRS
15), the guidance remains consistent with the standard’s overall measurement principles for variable
consideration.
ASC 606-10
55-25 An entity should apply the guidance in paragraphs 606-10-32-2 through 32-27 (including the guidance
on constraining estimates of variable consideration in paragraphs 606-10-32-11 through 32-13) to determine
the amount of consideration to which the entity expects to be entitled (that is, excluding the products expected
to be returned). For any amounts received (or receivable) for which an entity does not expect to be entitled,
the entity should not recognize revenue when it transfers products to customers but should recognize those
amounts received (or receivable) as a refund liability. Subsequently, at the end of each reporting period,
the entity should update its assessment of amounts for which it expects to be entitled in exchange for the
transferred products and make a corresponding change to the transaction price and, therefore, in the amount
of revenue recognized.
55-26 An entity should update the measurement of the refund liability at the end of each reporting period for
changes in expectations about the amount of refunds. An entity should recognize corresponding adjustments
as revenue (or reductions of revenue).
55-27 An asset recognized for an entity’s right to recover products from a customer on settling a refund liability
initially should be measured by reference to the former carrying amount of the product (for example, inventory)
less any expected costs to recover those products (including potential decreases in the value to the entity of
returned products). At the end of each reporting period, an entity should update the measurement of the
asset arising from changes in expectations about products to be returned. An entity should present the asset
separately from the refund liability.
55-28 Exchanges by customers of one product for another of the same type, quality, condition, and price (for
example, one color or size for another) are not considered returns for the purposes of applying the guidance in
this Topic.
55-29 Contracts in which a
customer may return a defective product in exchange
for a functioning product should be evaluated in
accordance with the guidance on warranties in
paragraphs 606-10-55-30 through 55-35.
6.3.5.3.1 Estimating the Transaction Price When an Entity Promises to Stand Ready to Accept a Returned Product During the Return Period and Provide a Refund
When an entity promises to stand ready to accept a
returned product during the return period and provide a refund, the
transaction price should be estimated in the same way as any other
variable consideration (see Example 22 in ASC 606-10-55-202 through
55-207 below) and should reflect the amount to which the entity expects
to be entitled. The entity should adjust that amount to exclude amounts
expected to be reimbursed or credited to customers by using either the
most likely amount or the expected value method (as discussed in
Section 6.3.2.1).
For example, when a retail store has a policy that
allows customers to return a product within 30 days (for any reason), no
amount of the transaction price is allocated to the “service” of
standing ready to accept the returned product. Instead, the transaction
price is estimated and constrained to the amount for which the entity
expects it is probable that significant reversal will not occur when the
uncertainty associated with expected returns is resolved. An adjustment
to revenue will then be recognized when the level of returns is known
after 30 days or by updating the estimated transaction price as of any
reporting date falling within that period. This is illustrated by
Example 22 in ASC 606-10-55-202 through 55-207, which is reproduced
below.
ASC 606-10
Example 22 — Right of Return
55-202 An entity enters into
100 contracts with customers. Each contract
includes the sale of 1 product for $100 (100 total
products × $100 = $10,000 total consideration).
Cash is received when control of a product
transfers. The entity’s customary business
practice is to allow a customer to return any
unused product within 30 days and receive a full
refund. The entity’s cost of each product is
$60.
55-203 The entity applies the
guidance in this Topic to the portfolio of 100
contracts because it reasonably expects that, in
accordance with paragraph 606-10-10-4, the effects
on the financial statements from applying this
guidance to the portfolio would not differ
materially from applying the guidance to the
individual contracts within the portfolio.
55-204 Because the contract
allows a customer to return the products, the
consideration received from the customer is
variable. To estimate the variable consideration
to which the entity will be entitled, the entity
decides to use the expected value method (see
paragraph 606-10-32-8(a)) because it is the method
that the entity expects to better predict the
amount of consideration to which it will be
entitled. Using the expected value method, the
entity estimates that 97 products will not be
returned.
55-205 The entity also
considers the guidance in paragraphs 606-10-32-11
through 32-13 on constraining estimates of
variable consideration to determine whether the
estimated amount of variable consideration of
$9,700 ($100 × 97 products not expected to be
returned) can be included in the transaction
price. The entity considers the factors in
paragraph 606-10-32-12 and determines that
although the returns are outside the entity’s
influence, it has significant experience in
estimating returns for this product and customer
class. In addition, the uncertainty will be
resolved within a short time frame (that is, the
30-day return period). Thus, the entity concludes
that it is probable that a significant reversal in
the cumulative amount of revenue recognized (that
is, $9,700) will not occur as the uncertainty is
resolved (that is, over the return period).
55-206 The entity estimates
that the costs of recovering the products will be
immaterial and expects that the returned products
can be resold at a profit.
55-207 Upon transfer of
control of the 100 products, the entity does not
recognize revenue for the 3 products that it
expects to be returned. Consequently, in
accordance with paragraphs 606-10-32-10 and
606-10-55-23, the entity recognizes the
following:
6.3.5.3.2 Accounting for Restocking Fees and Related Costs
In some industries, customers are not entitled to a full
refund if they return a previously purchased product to the seller. In
effect, the seller charges a fee for accepting returns, sometimes
referred to as a “restocking” fee. Restocking fees are typically stated
in the contract between the seller and the customer.
Restocking fees can serve a number of purposes for the
seller, including (1) to recover some of the costs the seller expects to
incur in returning such product to saleable inventory (e.g., repackaging
or shipping costs), (2) to mitigate a potential reduced selling price
upon resale, and (3) to discourage customers from returning
products.
Restocking fees for expected returns should be included
in the transaction price. When accounting for restocking fees, an entity
will need to consider the guidance in ASC 606-10-32-5 through 32-9 on
estimating variable consideration.
In accordance with ASC 606-10-55-27, the costs expected
to be incurred when the products are returned should be recognized as of
the date on which control is transferred to the customer as a reduction
of the carrying amount of the asset expected to be recovered.
Example 6-5
Entity X enters into a contract
with Customer Y to sell 10 widgets for $100 each
in cash. The cost of each widget to X is $75.
Customer Y has the right to return a widget but
will be charged a restocking fee of 10 percent
(i.e., $10 per widget). Entity X expects to incur
costs of $5 per widget to ship and repackage each
item returned before it can be resold.
Entity X concludes that because
a right of return exists, the consideration
promised under the contract includes a variable
amount. Entity X uses the expected value method
for estimating the variable consideration and
estimates that (1) 10 percent of the widgets will
be returned and (2) it is probable that returns
will not exceed 10 percent. Entity X also expects
that the returned widgets can be resold at a
profit.
When control of the 10 widgets
is transferred to the customer, X therefore
recognizes revenue of $900 for 9 widgets sold
($100 × 9) and also includes the restocking fee
for 1 widget of $10 ($100 × 10%) in the
transaction price. Entity X also recognizes a
refund liability of $90 for the 1 widget that is
expected to be returned ($100 transaction price
less $10 restocking fee). This analysis is
reflected in the following journal entry:
On the cost side:
In accordance with ASC
606-10-55-27, X recognizes an asset for its right
to recover the widget from Y on settlement of the
refund liability. The asset is measured at the
former carrying amount of the inventory items as
reduced by the expected costs to recover the
product. Entity X therefore recognizes an asset of
$70 ($75 cost less $5 restocking cost).
The cost of sales is $680, which
is the aggregate of (1) the cost of items sold and
not expected to be returned of $675 (9 widgets ×
$75) and (2) the anticipated restocking cost of
$5.
This cost analysis is reflected
in the following journal entry:
When the widget is returned by
Y, $90 is refunded. The widget is returned to
inventory. Entity X incurs the restocking cost and
includes that cost in the inventory amount as
follows:
The above issue is addressed in Implementation Q&As 42 and 77 (compiled from
previously issued TRG Agenda Papers 35 and 44). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see Appendix C.
6.3.5.4 Variable Consideration Driven by Variable Volumes
6.3.5.4.1 Distinguishing Between Optional Purchases and Variable Consideration
Under the revenue standard, an entity must determine its
contractual rights and obligations, including whether options for future
goods or services give rise to performance obligations under a current
contract with a customer (see Chapter 11). In considering how to
apply the guidance on optional purchases for which an entity does not
identify a material right, stakeholders have questioned whether and, if
so, when customer options to acquire additional goods or services would
be considered (1) a separate contract that arises when the option is
exercised or (2) variable consideration for which an entity would be
required to estimate the amount of consideration to include in the
original contract’s transaction price (subject to the standard’s
constraint on variable consideration). That is, stakeholders have raised
questions about when an entity, as part of determining its transaction
price, should estimate customers’ future purchases that may be made
under options for additional goods or services.
The revenue standard does not require or allow an entity
to estimate the transaction price of future contracts into which it will
enter with a customer. This assertion is supported by the FASB and IASB
in paragraph BC186 of ASU 2014-09, which states that “the transaction
price should include only amounts (including variable amounts) to which
the entity has rights under the present
contract” (emphasis added).
Further, an entity should perform an evaluation of the
nature of its promises in a contract with a customer, including a
careful evaluation of the enforceable rights and obligations in the
present contract (not future contracts). That is, there is a distinction
between (1) customer options and (2) uncertainty that is accounted for
as variable consideration.
Customer options are predicated on a separate customer
action (namely, the customer’s decision to exercise the option), which
would not be embodied in the present contract; unless an option is a
material right, such options would not factor into the accounting for
the present contract. If an option to acquire additional goods or
services represents a material right, part of the transaction price is
allocated to that material right, and recognition of a portion of
revenue is deferred (see ASC 606-10-55-41 through 55-45). The additional
goods or services are not themselves performance obligations under the
contract; instead, the option to acquire them is treated as a
performance obligation if it represents a material right.
Enforceable rights and obligations in a contract are
only those for which the entity has legal rights and obligations under
the contract and would not take economic or other penalties into account
(e.g., (1) economic compulsion or (2) exclusivity because the entity is
the sole provider of the goods or services, which may make the future
deliverables highly probable of occurring). Section 11.4 further expands on this view.
In contrast, uncertainty is accounted for as variable
consideration when the entity has enforceable rights and obligations
under a present contract to provide goods or services without an
additional customer decision. ASC 606 deals separately with the
appropriate accounting for “variable consideration” when the
consideration promised in a contract includes a variable amount (see ASC
606-10-32-5 through 32-14). For example, there may be uncertainty in a
long-term contract that includes variability because of other factors
(e.g., variable quantities that affect the consideration due under the
contract). Entities should consider the need to take variability of this
nature into account in determining the transaction price.
An entity will need to evaluate the nature of its
promises under a contract and use judgment to determine whether the
contract includes (1) an option to purchase additional goods or services
(which the entity would need to evaluate for a material right) or (2) a
single performance obligation for which the quantity of goods or
services to be transferred is not fixed at the outset (which would give
rise to variable consideration).
In exercising such judgment, an entity may find the
following indicators helpful:
-
A determination that an entity’s customer can make a separate purchasing decision with respect to additional distinct goods or services and that the entity is not obliged to provide those goods or services before the customer exercises its rights would be indicative of an option for additional goods or services. For example, suppose that an entity enters into a five-year exclusive master supply agreement with a customer related to components that the customer uses in its products. The customer may purchase components at any time during the term of the agreement, but it is not obliged to purchase any components. Each time the customer elects to purchase a component from the entity represents a separate performance obligation of the entity.
-
Conversely, if future events (which may include a customer’s own actions) will not oblige an entity to provide a customer with additional distinct goods or services, any additional consideration triggered by those events would be accounted for as variable consideration. For example, suppose that an entity agrees to process all transactions for a customer in exchange for fees that are based on the volume of transactions processed, but the volume of transactions is not known at the outset and is outside the control of both the entity and the customer. The performance obligation is to provide the customer with continuous access to transaction processing for the contract period. The additional transactions processed are not distinct services; rather, they are part of the satisfaction of the single performance obligation to process transactions, and the variability in transactions processed results in variable consideration.
The above issue is addressed in Implementation Q&A 23 (compiled from previously
issued TRG Agenda Papers 48 and 49). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
6.3.5.4.2 Volume-Based Rebates
An entity may offer its customers rebates or discounts
on the pricing of products or services once specific volume thresholds
have been met. That is, an entity may either retrospectively or
prospectively adjust the price of its goods or services once a certain
volume threshold has been met.
A volume rebate or discount that is retrospectively applied should
be accounted for under ASC 606 as variable consideration (rather than as
a customer option to be evaluated as a potential material right). In
accordance with ASC 606-10-32-6, which specifically includes discounts
and rebates as a form of variable consideration, the “promised
consideration also can vary if an entity’s entitlement to the
consideration is contingent on the occurrence or nonoccurrence of a
future event” (emphasis added).
However, an offer to prospectively lower the price per unit (once
certain volume thresholds are met) should not be accounted for as
variable consideration. Rather, when a volume rebate or discount is
applied prospectively, an entity will need to evaluate the facts
and circumstances of each contract to determine whether the rebate or
discount represents a material right and therefore should be accounted
for as a performance obligation. As part of this evaluation, the entity
would consider whether the offer to the customer is at a price that
would reflect the stand-alone selling price for that good or service, in
accordance with ASC 606-10-55-43.
Example 24 in the revenue standard (ASC 606-10-55-216
through 55-220) illustrates how an entity would account for a volume
discount incentive as variable consideration.
ASC 606-10
Example 24 — Volume Discount
Incentive
55-216 An entity enters into
a contract with a customer on January 1, 20X8, to
sell Product A for $100 per unit. If the customer
purchases more than 1,000 units of Product A in a
calendar year, the contract specifies that the
price per unit is retrospectively reduced to $90
per unit. Consequently, the consideration in the
contract is variable.
55-217 For the first quarter
ended March 31, 20X8, the entity sells 75 units of
Product A to the customer. The entity estimates
that the customer’s purchases will not exceed the
1,000-unit threshold required for the volume
discount in the calendar year.
55-218 The entity considers
the guidance in paragraphs 606-10-32-11 through
32-13 on constraining estimates of variable
consideration, including the factors in paragraph
606-10-32-12. The entity determines that it has
significant experience with this product and with
the purchasing pattern of the entity. Thus, the
entity concludes that it is probable that a
significant reversal in the cumulative amount of
revenue recognized (that is, $100 per unit) will
not occur when the uncertainty is resolved (that
is, when the total amount of purchases is known).
Consequently, the entity recognizes revenue of
$7,500 (75 units × $100 per unit) for the quarter
ended March 31, 20X8.
55-219 In May 20X8, the
entity’s customer acquires another company and in
the second quarter ended June 30, 20X8, the entity
sells an additional 500 units of Product A to the
customer. In light of the new fact, the entity
estimates that the customer’s purchases will
exceed the 1,000-unit threshold for the calendar
year and, therefore, it will be required to
retrospectively reduce the price per unit to
$90.
55-220 Consequently, the
entity recognizes revenue of $44,250 for the
quarter ended June 30, 20X8. That amount is
calculated from $45,000 for the sale of 500 units
(500 units × $90 per unit) less the change in
transaction price of $750 (75 units × $10 price
reduction) for the reduction of revenue relating
to units sold for the quarter ended March 31, 20X8
(see paragraphs 606-10-32-42 through 32-43).
Example 6-6
Rebate
Applied Retrospectively
Entity X enters into a contract
with a customer to supply widgets. Under the terms
of the contract, each widget is sold for $10, but
if the customer purchases more than 100 widgets in
a calendar year, the price will be reduced
retrospectively to $8 per widget. The contract
does not include any minimum purchase
commitments.
In this example, the volume
rebate of $2 is applied retrospectively. It should
be accounted for as variable consideration under
ASC 606-10-32-5 through 32-14 because X’s
entitlement to consideration for each unit sold is
contingent on the occurrence of a future event
(i.e., the customer’s buying more than 100
units).
Accordingly, X is required to
estimate the amount of consideration to which it
will be entitled for each widget by using either
the expected value method or the most likely
amount (whichever is considered to better predict
the amount of consideration to which X will be
entitled). The $2 variable consideration should
only be included in the transaction price if it is
probable that a significant reversal in the amount
of cumulative revenue recognized will not occur
(i.e., it is likely that the customer will not
purchase more than 100 units).
Example 6-7
Rebate
Applied Prospectively
Entity Y enters into a contract
with a customer to supply widgets. Under the terms
of the contract, each widget is sold for $10, but
if the customer purchases more than 100 widgets in
a calendar year, the price will be reduced
prospectively to $8 per widget (i.e., the $8 price
applies only for subsequent purchases). The
contract does not include any minimum purchase
commitments.
In this example, the customer
has an option to purchase additional widgets at a
reduced price of $8 per unit, which should be
accounted for in accordance with ASC 606-10-55-41
through 55-45. Entity Y will need to evaluate the
facts and circumstances to determine whether the
option gives rise to a performance obligation. The
option would give rise to a performance obligation
if it provides a material right to the customer
that the customer would not receive without
purchasing the first 100 units. As part of this
evaluation, Y should consider whether the reduced
price offered to the customer ($8 per unit)
reflects the stand-alone selling price for the
widgets, in accordance with ASC 606-10-55-43.
Example 6-8
Reassessment
of Volume Discounts Applied
Retrospectively
Assume the same facts as those
in Example
6-6, as well as the following
additional information:
-
Entity X initially estimated total widget sales of 90 items. The $2 variable consideration was included in the transaction price because X believed that it was probable that a significant reversal in the amount of cumulative revenue recognized would not occur (i.e., it was likely that the customer would not purchase more than 100 units).
-
Entity X sells 10 units during the first quarter, sells 20 units during the second quarter, and sells 60 units during the third quarter.
-
In light of recent sales activity, X increases its estimate of total sales volume for the year to 120 units.
In this example, X will be
required to effectively reduce the price per unit
to $8. Accordingly, X should update its
calculation of the transaction price to reflect
the change in estimate. The updated transaction
price is $8 per unit, which is based on the recent
increase in sales activity and updated sales
volume. Therefore, X should recognize revenue of
$420 for the third quarter, which is calculated as
follows:
6.3.5.5 Other Forms of Variability
6.3.5.5.1 Contracts That Include Consideration in a Foreign Currency
Despite the broad definition of variable consideration
in ASC 606, consideration that is fixed in a foreign currency (i.e., a
currency other than the entity’s functional currency) should not be
considered variable consideration. This is because the amount of
consideration promised in the contract does not vary; instead, that
fixed amount of consideration is retranslated into a variable amount of
the entity’s functional currency.
Therefore, an entity is not required to consider whether potential future
adverse movements in the exchange rate could result in a requirement to
limit the amount of revenue recognized in accordance with ASC
606-10-32-11. Instead, the principles of ASC 830 should be applied.
6.3.5.5.2 Variable Consideration in Real Estate Sales
A real estate sales contract may allow the seller to
participate in future profits related to the underlying real estate. As
discussed in Sections
6.3.2 and 6.3.3, some or all of the
estimated variable consideration is included in the transaction price
(and therefore eligible for recognition) to the extent that it is
probable that the cumulative amount of the revenue recognized will not
be subject to significant reversal.
Accordingly, an entity will need to estimate the portion
of the contingent (or variable) consideration to include in the
transaction price, which may be recognized when the performance
obligation is satisfied.
For example, suppose that an entity sells land to a home
builder for a fixed amount plus a percentage of the profits that will be
realized on the sale of homes once constructed on the land by the home
builder. Under the revenue standard, the entity would be required to (1)
estimate the consideration expected to be received from the home builder
and (2) recognize all or some of the amount as revenue (or other gains
and losses, if the transaction is with a noncustomer) up front when the
land is sold. Determining the amount of revenue that is not subject to a
significant revenue reversal could require significant judgment.
Further, an entity that has entered into a real estate sales contract may
need to consider whether the contract contains a significant financing
component (see Section 6.4).
6.3.5.5.3 Cash Discounts for Early Payment
Cash discounts for early payment are a form of variable
consideration. This is because the amount of consideration to which an
entity is entitled in these arrangements depends on a customer’s actions
(i.e., a customer’s decision to pay amounts due in time to take
advantage of an early payment discount). The example below illustrates
how a seller would account for a cash discount it provides to a customer
for making an early payment.
Example 6-9
Entity X offers Customer Y a
cash discount for immediate or prompt payment
(i.e., earlier than required under the normal
credit terms). A sale is made for $100 with the
balance due within 90 days. If Y pays within 30
days, Y will receive a 10 percent discount on the
total invoice. Entity X sells a large volume of
similar items on these credit terms (i.e., this
transaction is part of a portfolio of similar
items). Entity X has elected to apply the
practical expedient in ASC 606-10-32-18 and
therefore will not adjust the promised amount of
consideration for the effects of a significant
financing component.
In the circumstances described,
revenue is $100 if the discount is not taken and
$90 if the discount is taken. As a result, the
amount of consideration to which X will be
entitled is variable.
Therefore, X should recognize
revenue when or as the performance obligation is
satisfied net of the amount of cash discount
expected to be taken. To determine the amount of
revenue to be recognized, X should use either the
“expected value” or the “most likely amount”
method and consider the effect of the
constraint.
For example, if the discount is
taken in 40 percent of transactions, the expected
value will be calculated as follows:
($100 × 60%) + ($90 × 40%) =
$96
If the proportion of
transactions for which the discount is taken is
always close to 40 percent (i.e., it is within a
narrow range of around 40 percent), it is likely
that the estimate of variable consideration will
not need to be constrained, and revenue of $96
will be recognized.
If, however, the proportion of
transactions for which the discount is taken
varies significantly, it may be necessary to apply
the constraint, which will result in the
recognition of less revenue. For example,
historical records might show that although the
long-term average is 40 percent, there is great
variability from month to month and the proportion
of transactions for which the discount is taken is
frequently as high as 70 percent (but has never
been higher than that). In such a scenario, X
might conclude that only 30 percent of the
variable consideration should be included, because
inclusion of a higher amount might result in a
significant revenue reversal. In that case, the
amount of revenue recognized would be constrained
as follows:
($100 × 30%) + ($90 × 70%) = $93
6.3.5.5.4 Accounting for “Trail Commissions”
Another form of variable consideration is trail
commissions. For example, in many arrangements between an insurance
agent and an insurance carrier, the insurance agent is entitled to
additional consideration in the form of trail commissions each time a
consumer renews an insurance policy with the insurance carrier. Although
the insurance agent may satisfy its performance obligation when it sells
an initial policy to a consumer (because it is not the insurance
carrier), the ultimate consideration to which the insurance agent is
entitled depends on how many times the consumer renews the policy with
the insurance carrier (renewals do not require additional performance by
the insurance agent). The example below illustrates how an insurance
agent would account for additional annual commissions earned for future
expected policy renewals.
Example 6-10
IA, an insurance agent, is engaged by IC, an
insurance carrier, to sell IC’s insurance to the
general public. IA is compensated by IC on a
“trail commission” basis, which means that in
addition to receiving an initial commission from
IC for every consumer IA signs up for IC’s
insurance at the time of purchase (e.g., a $100
initial commission), IA receives annual
commissions from IC in future years every time
those consumers renew their insurance policy with
IC (e.g., an additional $50 commission due upon
each annual renewal of the consumer’s insurance
policy).
IA makes many sales to consumers on behalf of IC
such that IA has a large pool of homogeneous
transactions with historical information about
consumer renewal patterns for insurance
policies.
IA does not have any ongoing obligation to
provide additional services to IC or to the
consumers after the initial sale of insurance.
The consideration promised in this arrangement
includes both fixed and variable amounts. The
initial commission of $100 due to IA upon signing
up a customer is fixed consideration and is
included in the transaction price. In addition,
the transaction price includes variable
consideration in the form of potential additional
commissions due ($50 per each additional year) if
and when the consumer subsequently renews the
insurance policy. In accordance with the guidance
in ASC 606-10-32-8, IA should estimate the
variable consideration. Since IA has a large pool
of homogeneous contracts on which to base its
estimate, the expected value approach is used.
IA should consider evidence from other, similar
contracts to develop an estimate of variable
consideration under the expected value method
since there is a population of data with which IA
can make such an estimate.
IA will also need to consider
the guidance in ASC 606-10-32-11 through 32-13 to
constrain the amount of variable consideration
that should be included in the transaction price.
In considering the factors in ASC 606-10-32-12
that could increase the likelihood or magnitude of
a significant revenue reversal, IA should use
judgment and take into account all relevant facts
and circumstances. This could mean looking to
historical experience with similar contracts to
(1) make judgments about the constraint on
variable consideration and (2) estimate the amount
that is not probable of a significant reversal.
The greater the likelihood of a reversal of the
estimated variable consideration, the greater the
likelihood that the estimate should be
constrained.
6.3.6 Reassessment of Variable Consideration
ASC 606-10
32-14 At the end of each
reporting period, an entity shall update the estimated
transaction price (including updating its assessment of
whether an estimate of variable consideration is
constrained) to represent faithfully the circumstances
present at the end of the reporting period and the
changes in circumstances during the reporting period.
The entity shall account for changes in the transaction
price in accordance with paragraphs 606-10-32-42 through
32-45.
After its initial estimate (and potential constraint) of variable consideration at contract inception, an
entity must reassess that estimate (and potential constraint) at the end of each reporting period as
the uncertainties underlying the variable consideration are resolved or more information about the
underlying uncertainties is known. As noted in paragraph BC224 of ASU 2014-09, the FASB and IASB
“decided that an entity should update its estimate of the transaction price throughout the contract
[because] reflecting current assessments of the amount of consideration to which the entity expects to
be entitled will provide more useful information to users of financial statements.”
However, like the assessment of the transaction price at contract inception,
reassessment of the transaction price is part of a three-step process for
recognizing revenue. That is, once an entity updates an estimate (and potential
constraint) of variable consideration after inception, it generally must
reallocate the transaction price in accordance with step 4, in the same
proportions used in the allocation of the transaction price at inception, to the
performance obligations identified in step 2 so that revenue can be recognized
in step 5 when (or as) the entity satisfies a performance obligation.3 The example below illustrates how this guidance would be applied
Example 6-11
Assume that an entity enters into a contract with a customer for the delivery of
three performance obligations, PO1, PO2, and PO3. The
consideration in the contract is wholly variable for an
amount up to $600, and the entity’s estimate of variable
consideration at contract inception is $300. The entity
determines that a constraint of its estimate of variable
consideration is unnecessary. The stand-alone selling
prices of the three performance obligations are as
follows:
-
PO1 = $100.
-
PO2 = $200.
-
PO3 = $300.
Accordingly, the entity allocates the estimate of variable consideration to the performance obligations on a
relative stand-alone selling price basis as follows:
- PO1 = $100 ÷ $600 × $300 = $50.
- PO2 = $200 ÷ $600 × $300 = $100.
- PO3 = $300 ÷ $600 × $300 = $150.
If the uncertainty in the contract consideration is subsequently resolved (or
the entity’s estimate of variable consideration has
changed, subject to an assessment of the constraint) and
the entity determines that the updated transaction price
is $600, the entity reallocates the updated transaction
price to the performance obligations in proportion to
their relative stand-alone selling prices at contract
inception as follows:
-
PO1 = $100 ÷ $600 × $600 = $100.
-
PO2 = $200 ÷ $600 × $600 = $200.
-
PO3 = $300 ÷ $600 × $600 = $300.
The accounting for a change in the transaction price, including the guidance in
ASC 606-10-32-42 through 32-45 on reallocating that change, is further discussed
in Section 7.6.
Footnotes
1
Variable consideration would not need to be estimated if
an entity is applying (1) the invoice practical expedient to measure
progress toward complete satisfaction of a performance obligation (see
Section
8.5.8.1) or (2) the variable consideration allocation
exception in ASC 606-10-32-40 (see Section 7.5).
2
ASC 606-10-10-4 states that an
entity is permitted to use a portfolio approach as
a practical expedient to account for a group of
contracts with similar characteristics rather than
account for each contract individually. However,
an entity may only apply the practical expedient
if it does not expect the results of applying the
guidance in ASC 606 to a portfolio of contracts to
be materially different from the results of
applying that guidance to individual
contracts.
3
An entity would allocate variable consideration and
subsequent changes to it “entirely to a performance obligation or to a
distinct good or service that forms part of a single performance
obligation” if the criteria in ASC 606-10-32-40 are met.
6.4 Significant Financing Component
In certain contracts with customers, one party may provide a service of
financing (either explicitly or implicitly) to the other. Such contracts effectively
contain two transactions: one for the delivery of the good or service and another
for the benefit of financing (i.e., what is in substance a loan payable or loan
receivable). The FASB and IASB decided that an entity should account for both
transactions included in a contract with a customer when the benefit of the
financing provided is significant.
ASC 606-10
32-15 In determining the transaction price, an entity shall adjust the promised amount of consideration for
the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either
explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer
of goods or services to the customer. In those circumstances, the contract contains a significant financing
component. A significant financing component may exist regardless of whether the promise of financing is
explicitly stated in the contract or implied by the payment terms agreed to by the parties to the contract.
In paragraph BC230 of ASU 2014-09, the boards note that the “objective of
adjusting the promised amount of consideration for the effects of a significant
financing component is to reflect, in the amount of revenue recognized, the ‘cash
selling price’ of the underlying good or service at the time that the good or
service is transferred.” This objective is consistent with the intent of the
allocation guidance in step 4 (see Chapter 7) in that the goal is to arrive at an amount of revenue
recognized that reflects the value of the goods or services transferred to the
customer. If an entity were to ignore a significant financing component included in
a contract, the revenue recognized from, and the cash flows associated with, the
contract with the customer could be misrepresented to users in the entity’s
financial statements. That is because the second service (namely, the financing)
would not be reflected in the financial statements.
6.4.1 Practical Expedient Providing Relief From the Significant Financing Component Guidance
Under ASC 835-30, an entity is exempted from imputing interest on a receivable
if the transaction with the customer is (1) in the normal course of business and
with customary terms and (2) for one year or less. In developing the revenue
standard, the FASB and IASB determined that the benefits to financial statement
users of requiring an entity to account for the effects of significant financing
when the period is for less than a year did not outweigh the costs to
preparers.
Accordingly, the boards decided to grant a practical expedient in ASC
606-10-32-18 (paragraph 63 of IFRS 15) for financing components when the
duration of the financing (i.e., the time between the transfer of control of the
goods or services and when the customer pays for them) is one year or less. In
paragraph BC236 of ASU 2014-09, the boards acknowledge that they provided the
practical expedient as part of efforts to simplify the application of the
revenue standard for financial statement preparers even though the expedient
could produce undesirable reporting outcomes (e.g., when a one-year contract
provides financing that is material to the contract’s value because of a
relatively high interest rate).
ASC 606-10
32-18 As a practical
expedient, an entity need not adjust the promised amount
of consideration for the effects of a significant
financing component if the entity expects, at contract
inception, that the period between when the entity
transfers a promised good or service to a customer and
when the customer pays for that good or service will be
one year or less.
50-22 If an entity elects to
use the practical expedient in either paragraph
606-10-32-18 (about the existence of a significant
financing component) or paragraph 340-40-25-4 (about the
incremental costs of obtaining a contract), the entity
shall disclose that fact.
As indicated in ASC 606-10-10-3 and ASC 606-10-50-22 (the latter of which is
reproduced above), an entity that elects to use this practical expedient should
(1) apply it consistently to contracts with similar characteristics and in
similar circumstances and (2) disclose such election.
6.4.2 Existence and Significance of a Financing Component
ASC 606-10
32-16 The objective when
adjusting the promised amount of consideration for a
significant financing component is for an entity to
recognize revenue at an amount that reflects the price
that a customer would have paid for the promised goods
or services if the customer had paid cash for those
goods or services when (or as) they transfer to the
customer (that is, the cash selling price). An entity
shall consider all relevant facts and circumstances in
assessing whether a contract contains a financing
component and whether that financing component is
significant to the contract, including both of the
following:
-
The difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services
-
The combined effect of both of the following:
-
The expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services
-
The prevailing interest rates in the relevant market.
-
An entity is required to assess the factors in ASC 606-10-32-16 to determine the
existence of a significant financing component for the following reasons:
-
As noted in paragraph BC232 of ASU 2014-09, the fact that an entity sells the goods or services in the contract with the customer at varying prices depending on the timing of the payment terms will generally provide both parties to the contract with relatively observable data to support a determination that the entity’s contracts with customers contain a financing component (and that the entity needs to adjust the transaction price to determine the cash selling price of the goods or services to be delivered).
-
If there is an alignment between the duration of the financing provided in the contract and the market interest rates available for a financing of that duration, there is a strong indication that the parties intend to include a financing transaction in the contract.
However, in the assessment of the factors noted above, a
question arises about whether the “significance” of a financing component should
be in the context of the associated performance obligation, the individual
contract, or a portfolio of similar contracts. Sections 6.4.2.1 through 6.4.2.4 further discuss the
considerations inherent in an assessment of the existence and significance of a
financing component in a contract with a customer.
6.4.2.1 Unit of Account for Assessing the Significance of a Financing Component
ASC 606-10-32-16 specifically requires an entity to consider
all relevant facts and circumstances in assessing whether a contract
contains a financing component and whether that financing component is
significant to the contract. Consequently, the significance of a
financing component should be assessed in the context of the individual
contract rather than, for example, a portfolio of similar contracts or at a
performance-obligation level.
The basis of this requirement is explained in paragraph
BC234 of ASU 2014-09, which states, in part:
During
their redeliberations, the Boards clarified that an entity should only
consider the significance of a financing component at a contract
level rather than consider whether the financing is material at a
portfolio level. The Boards decided that it would have been unduly
burdensome to require an entity to account for a financing component if
the effects of the financing component were not material to the
individual contract, but the combined effects for a portfolio of similar
contracts were material to the entity as a whole.
As a consequence, some financing components will not be
identified as significant — and, therefore, the promised amount of
consideration would not be adjusted — even though they might be material in
aggregate for a portfolio of similar contracts.
Although a financing component can only be quantified
after individual performance obligations are considered, the
significance of a financing component is not assessed at the
performance-obligation level. To illustrate, an entity may typically sell
Product X, for which revenue is recognized at a point in time, on extended
credit terms such that, when Product X is sold by itself, the contract
contains a significant financing component. The entity may also sell Product
X and Product Y together in a bundled contract, requiring the customer to
pay for Product Y in full at the time control is transferred but granting
the same extended credit terms for Product X. If the value of Product Y is
much greater than the value of Product X, any financing component for
Product X may be too small to be assessed as significant in the context of
the larger bundled contract. Therefore, in such circumstances, the entity
(1) would adjust the promised consideration for a significant financing
component when Product X is sold by itself but (2) would not need to adjust
the promised consideration for a significant financing component when
Product X is sold together with Product Y in a single contract.
6.4.2.2 Assessing Whether a Significant Financing Component Exists When the Consideration to Be Received Is Equal to the Cash Selling Price
ASC 606-10-32-16 notes that the “difference, if any, between
the amount of promised consideration and the cash selling price of the
promised goods or services” is one of the factors relevant to an assessment
of whether a significant financing component exists.
Sometimes, the implied interest rate in an arrangement is
zero (i.e., interest-free financing) such that the consideration to be
received at a future date is equal to the cash selling price (i.e., the
amount that would be received from a customer who chooses to pay for the
goods or services in cash when (or as) they are delivered). In such
circumstances, it should not automatically be assumed that the contract does
not contain a significant financing component. A difference between the
amount of promised consideration and the cash selling price is only one of
the indicators that an entity should consider in determining whether there
is a significant financing component.
The fact that an entity provides what appears to be
zero-interest financing does not necessarily mean that the cash selling
price is the same as the price that would have been paid by another customer
who has opted to pay over time. Accordingly, an entity may need to use
judgment when determining a cash selling price for a customer who pays over
time.
The above issue is addressed in Implementation Q&A 32 (compiled from previously
issued TRG Agenda Papers 20, 25, 30, and 34). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
6.4.2.3 Requirement to Discount Trade Receivables When the Significant Financing Component Is Implicit
The example below illustrates when it may be necessary to
discount trade receivables even though a significant financing component is
not explicitly identified in the contract.
Example 6-12
Entity B, a retailer, offers
interest-free financing to its customers. Depending
on the type of product purchased, the financing
arrangement gives the customer interest-free
financing for a period of 12, 15, or 18 months. The
customer pays equal monthly installments from the
date of purchase over the financing period. This is
common industry practice in the country where B is
located, and other retailers offer similar financing
arrangements; no recent cash transactions are
available from which B can make an observable
estimate of the cash sales price. On the basis of
prevailing interest rates in the relevant market, B
estimates that the customer would be able to borrow
from other sources at an interest rate of 18
percent.
Further, on the basis of ASC
606-10-32-16(b), B believes that the arrangement
contains a significant financing component as a
result of the combination of (1) the length of time
between the transfer of the good and payment and (2)
the high interest rates the customer would have to
pay to obtain financing from other sources.
In accordance with ASC 606-10-32-15,
entities are required to adjust the promised amount
of consideration, even when a significant financing
component is not explicitly identified in the
contract. However, ASC 606-10-32-18 provides a
practical expedient for contracts with a significant
financing component when the period between the
transfer of goods and the customer’s payment is, at
contract inception, expected to be one year or
less.
Consequently, in the circumstances
described, B is required to adjust the sales price
for all arrangements other than those with a
contractual period of 12 months or less. For
arrangements with a contractual period of 12 months
or less, B is permitted to adjust the sales price
when it identifies a significant financing
component, which it may wish to do to align with its
other contracts; however, it is not required to do
so.
If B takes advantage of the practical expedient under
ASC 606-10-32-18, it is required to do so
consistently in similar circumstances for all
contracts with similar characteristics.
6.4.2.4 How to Evaluate a Material Right for the Existence of a Significant Financing Component
The determination of whether there is a significant
financing component associated with the material right depends on the facts
and circumstances. Entities are required to evaluate material rights for the
existence of significant financing components in a manner similar to how
they would evaluate any other performance obligation. That is, there is no
safe harbor that a material right would not have a significant financing
component. See Section 11.6 for an
example of a material right that gives rise to a significant financing
component.
The above issue is addressed in Implementation Q&A 35 (compiled
from previously issued TRG Agenda Papers 18, 25, 32, and 34). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix
C.
6.4.3 Circumstances That Do Not Give Rise to a Significant Financing Component
In paragraph BC231 of ASU 2014-09, the FASB and IASB acknowledge that the mere
separation between the timing of delivery and the timing of payment does not
always mean that a benefit of financing has been provided in the contract. That
is, there are other economically substantive reasons for the existence of a
significant period between delivery and payment. In light of this, the boards
wanted to reflect in paragraph BC232 of ASU 2014-09 their intent for entities to
account for a significant financing and not necessarily all aspects of the time
value of money, which has a broader economic context than just the benefit of a
financing. To further emphasize this distinction, the boards also provided
indicators in ASC 606-10-32-17 (paragraph 62 of IFRS 15) of circumstances in
which a difference in timing between delivery and payment does not require an
entity to adjust the transaction price to reflect the cash selling price of the
good or service delivered.
ASC 606-10
32-17 Notwithstanding the assessment in paragraph 606-10-32-16, a contract with a customer would not have
a significant financing component if any of the following factors exist:
- The customer paid for the goods or services in advance, and the timing of the transfer of those goods or services is at the discretion of the customer.
- A substantial amount of the consideration promised by the customer is variable, and the amount or timing of that consideration varies on the basis of the occurrence or nonoccurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales-based royalty).
- The difference between the promised consideration and the cash selling price of the good or service (as described in paragraph 606-10-32-16) arises for reasons other than the provision of finance to either the customer or the entity, and the difference between those amounts is proportional to the reason for the difference. For example, the payment terms might provide the entity or the customer with protection from the other party failing to adequately complete some or all of its obligations under the contract.
The boards describe in paragraph BC233 of ASU 2014-09 a number of examples they had in mind when
considering the factors included in ASC 606-10-32-17 (paragraph 62 of IFRS 15):
Connecting the Dots
It is important to note that the examples considered by
the boards in paragraph BC233 of ASU 2014-09 illustrate more instances
in which an advance payment is in return for something other than
financing than instances in which a deferred payment is in return for
something other than financing. We think that this disparity indicates
that the boards thought that there are fewer real-life scenarios in
which an entity would allow for a deferred payment from a customer for
reasons other than to provide the customer with the benefits of
financing. Accordingly, we think that it would generally be easier to
align the indicators in ASC 606-10-32-17 with a contract that contains
an advance payment and harder to align the indicators with a contract
that contains a deferred payment. This understanding is consistent with
discussions by TRG members as outlined in TRG Agenda Paper 34, which states, “TRG members
discussed the factor in paragraph 606-10-32-17(c) [62(c)] relating to
whether the difference in promised consideration and cash selling price
is for a reason other than financing, noting that it might be more
likely that an advance payment would meet that factor compared to
payments in arrears.”
6.4.3.1 Difference Between Consideration and Cash Selling Price That Arises for Reasons Other Than Financing
A difference in timing between the transfer of goods or
services and the payment of consideration does not create a presumption that
a significant financing component exists, even if there is a difference
between the consideration and the cash selling price. ASC 606-10-32-17(c)
states that a contract would not have a significant financing component if
the difference between the promised consideration and the cash selling price
of the goods or services “arises for reasons other than the provision of
finance to either the customer or the entity, and the difference between
those amounts is proportional to the reason for the difference.”
An entity should use judgment to determine (1) whether the
payment terms are intended to provide financing or are for another valid
reason and (2) whether the difference between the promised consideration and
the cash selling price of the goods or services is proportional to that
reason.
The above issue is addressed in Implementation Q&A 31 (compiled from previously
issued TRG Agenda Papers 20, 25, 30, and 34). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
6.4.3.1.1 SEC Staff Observations Regarding Significant Financing Components
In a speech at the 2018 AICPA Conference on Current SEC
and PCAOB Developments, Sarah Esquivel, associate chief accountant in
the SEC’s Office of the Chief Accountant (OCA), made the following
observations about an SEC registrant’s consultation with the OCA on
evaluating the existence of a significant financing component, in which
the registrant concluded that there was no significant financing
component in the arrangement:
In this consultation,
the registrant was a retailer looking to expand a non-core existing
line of business. To achieve this, the registrant entered into an
arrangement with a third party to operate the non-core existing line
of business, so that the registrant could maintain focus on its core
operations. The registrant determined that the arrangement contained
a symbolic license of intellectual property (IP), requiring revenue
to be recognized over time, as the arrangement provided the third
party with the right to access the registrant’s trademarks and
brand. As part of the consideration exchanged in the transaction,
the registrant received a large up-front payment. As a result of the
timing difference between the up-front payment and the transfer of
the symbolic IP license over time, the registrant considered whether
there was a significant financing component in the contract.
The registrant’s analysis focused on consideration
of the guidance in Topic 606 that indicates a contract would not
have a significant financing component if the difference between the
promised consideration and the cash selling price arises for reasons
other than the provision of finance, and the difference between
those amounts is proportional to the reason for the difference. In
this consultation, the registrant asserted that it did not
contemplate a financing arrangement with the third party when
including a large up-front payment in the contract. Instead, the
large up-front payment was to provide the registrant protection from
the possibility that the third party could fail to adequately
complete some or all of its obligations under the contract. The
registrant concluded that the difference between the promised
consideration and the cash selling price arose for reasons other
than financing and that the difference between the up-front payment
and what the customer would have paid, had the payments been made
over the term of the arrangement, was proportional to the reason
identified for the difference. In reaching this conclusion, the
registrant considered the following:
-
A large up-front payment was critical in this arrangement to incentivize the third party to maximize value, and therefore profits to both parties, due in part to the registrant’s negative experience with other third parties where there was no up-front payment;
-
By the third party having sufficient “skin in the game” through the large up-front payment, it would mitigate some of the risk associated with third-party use of the registrant’s brand;
-
As evidenced by its strong operating results, the registrant believed that it would be able to obtain financing at favorable rates in the market place, if needed, and thus did not need the cash from the large up-front payment to finance its operations; and
-
Consideration was not given to structuring the transaction without a large up-front payment.
For these reasons, the registrant
concluded that the contract did not have a significant financing
component as the up-front payment was for reasons other than to
provide a significant financing benefit. Like other Topic 606
revenue consultations that OCA has evaluated, this was a facts and
circumstances evaluation, and in this fact pattern, the staff did
not object to the registrant’s conclusion that the contract did not
have a significant financing component based on the nature of the
transaction and purpose of the up-front payment. [Footnotes
omitted]
6.4.3.1.2 Codification Examples
The Codification examples below illustrate situations in
which withheld payments or an advance payment would not indicate the
existence of a significant financing component.
ASC 606-10
Example 27 — Withheld Payments
on a Long-Term Contract
55-233 An entity enters into
a contract for the construction of a building that
includes scheduled milestone payments for the
performance by the entity throughout the contract
term of three years. The performance obligation
will be satisfied over time, and the milestone
payments are scheduled to coincide with the
entity’s expected performance. The contract
provides that a specified percentage of each
milestone payment is to be withheld (that is,
retained) by the customer throughout the
arrangement and paid to the entity only when the
building is complete.
55-234 The entity concludes
that the contract does not include a significant
financing component. The milestone payments
coincide with the entity’s performance, and the
contract requires amounts to be retained for
reasons other than the provision of finance in
accordance with paragraph 606-10-32-17(c). The
withholding of a specified percentage of each
milestone payment is intended to protect the
customer from the contractor failing to adequately
complete its obligations under the contract.
Example 30 — Advance Payment
55-244 An entity, a
technology product manufacturer, enters into a
contract with a customer to provide global
telephone technology support and repair coverage
for three years along with its technology product.
The customer purchases this support service at the
time of buying the product. Consideration for the
service is an additional $300. Customers electing
to buy this service must pay for it upfront (that
is, a monthly payment option is not
available).
55-245 To determine whether
there is a significant financing component in the
contract, the entity considers the nature of the
service being offered and the purpose of the
payment terms. The entity charges a single upfront
amount, not with the primary purpose of obtaining
financing from the customer but, instead, to
maximize profitability, taking into consideration
the risks associated with providing the service.
Specifically, if customers could pay monthly, they
would be less likely to renew, and the population
of customers that continue to use the support
service in the later years may become smaller and
less diverse over time (that is, customers that
choose to renew historically are those that make
greater use of the service, thereby increasing the
entity’s costs). In addition, customers tend to
use services more if they pay monthly rather than
making an upfront payment. Finally, the entity
would incur higher administration costs such as
the costs related to administering renewals and
collection of monthly payments.
55-246 In assessing the
guidance in paragraph 606-10-32-17(c), the entity
determines that the payment terms were structured
primarily for reasons other than the provision of
finance to the entity. The entity charges a single
upfront amount for the services because other
payment terms (such as a monthly payment plan)
would affect the nature of the risks assumed by
the entity to provide the service and may make it
uneconomical to provide the service. As a result
of its analysis, the entity concludes that there
is not a significant financing component.
6.4.3.2 Accounting for Financing Components That Are Not Significant
When an entity concludes on the basis of ASC 606-10-32-16
and 32-17 that a significant financing component exists, the entity is
required under ASC 606-10-32-15 to adjust the promised consideration for the
effects of the time value of money in its determination of the transaction
price. However, while there is no requirement for an entity to adjust for
the time value of money when a financing component exists but is not
significant, an entity is not precluded from doing so in such
circumstances.
The above issue is addressed in Implementation Q&A 33 (compiled from previously
issued TRG Agenda Papers 30 and 34). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
6.4.4 Determining the Discount Rate
In paragraph BC238 of ASU 2014-09, the FASB and IASB discuss an example in which an entity is
receiving financing from a customer through an advance payment instead of obtaining that financing
from a third party (e.g., a bank). The entity needs to obtain financing before it can perform its obligations
under the contract with its customer. The boards note in discussing this example that the resulting
financial reporting for the entity’s revenue in the contract with the customer should not differ depending
on the source of the financing. The same can be said of the intent of the boards’ guidance in ASC
606-10-32-19 (paragraph 64 of IFRS 15) for determining the discount rate an entity should use to
measure the significant financing component and adjust the promised consideration in the contract to
the cash selling price.
ASC 606-10
32-19 To meet the objective
in paragraph 606-10-32-16 when adjusting the promised
amount of consideration for a significant financing
component, an entity shall use the discount rate that
would be reflected in a separate financing transaction
between the entity and its customer at contract
inception. That rate would reflect the credit
characteristics of the party receiving financing in the
contract, as well as any collateral or security provided
by the customer or the entity, including assets
transferred in the contract. An entity may be able to
determine that rate by identifying the rate that
discounts the nominal amount of the promised
consideration to the price that the customer would pay
in cash for the goods or services when (or as) they
transfer to the customer. After contract inception, an
entity shall not update the discount rate for changes in
interest rates or other circumstances (such as a change
in the assessment of the customer’s credit risk).
In their deliberations, the boards considered requiring the use of either a
risk-free rate or the rate explicitly specified in the contract with the
customer. However, as noted in paragraph BC239 of ASU 2014-09, the boards
reasoned that neither alternative would reflect the economics of the financing
provided or the appropriate profit margin built into the contract (e.g., the
entity could specify a “cheap” financing rate as a marketing incentive, which
would be inappropriate for the entity to use in determining the transaction
price). Consequently, as indicated in ASC 606-10-32-19 (paragraph 64 of IFRS
15), the boards decided that an entity should “use the discount rate that would
be reflected in a separate financing transaction between the entity and its
customer.”
Because of the practical expedient in ASC 606-10-32-18 (paragraph 63 of IFRS 15) and the indicators
of when a significant benefit of financing is not being provided to a party in the contract, the
boards reason in paragraph BC241 of ASU 2014-09 that “in those remaining contracts in which an entity
is required to account separately for the financing component, the entity and its customer will typically
negotiate the contractual payment terms separately.” That is, in many circumstances in which there is an
identified significant financing component that affects the transaction price, the entity will have access in
the negotiation process to information about the discount rate implied in the arrangement.
The Codification examples below illustrate how an entity would determine the
discount rate when adjusting the amount of consideration received in a
significant financing arrangement.
ASC 606-10
Example 28 — Determining the Discount Rate
55-235 An entity enters into
a contract with a customer to sell equipment. Control of
the equipment transfers to the customer when the
contract is signed. The price stated in the contract is
$1 million plus a 5 percent contractual rate of
interest, payable in 60 monthly installments of
$18,871.
Case A — Contractual Discount Rate Reflects the Rate in a Separate Financing
Transaction
55-236 In evaluating the discount rate in the contract that contains a significant financing component, the
entity observes that the 5 percent contractual rate of interest reflects the rate that would be used in a separate
financing transaction between the entity and its customer at contract inception (that is, the contractual rate of
interest of 5 percent reflects the credit characteristics of the customer).
55-237 The market terms of
the financing mean that the cash selling price of the
equipment is $1 million. This amount is recognized as
revenue and as a loan receivable when control of the
equipment transfers to the customer. The entity accounts
for the receivable in accordance with Topic 310 on
receivables and Subtopic 835-30 on the imputation of
interest.
Pending Content (Transition Guidance: ASC
326-10-65-1)
55-237 The market terms of the financing
mean that the cash selling price of the equipment
is $1 million. This amount is recognized as
revenue and as a loan receivable when control of
the equipment transfers to the customer. The
entity accounts for the receivable in accordance
with Topic 310 on receivables, Subtopic 326-20 on
financial instruments measured at amortized cost,
and Subtopic 835-30 on the imputation of interest.
Case B — Contractual Discount Rate Does Not Reflect the Rate in a Separate
Financing Transaction
55-238 In evaluating the discount rate in the contract that contains a significant financing component, the
entity observes that the 5 percent contractual rate of interest is significantly lower than the 12 percent interest
rate that would be used in a separate financing transaction between the entity and its customer at contract
inception (that is, the contractual rate of interest of 5 percent does not reflect the credit characteristics of the
customer). This suggests that the cash selling price is less than $1 million.
55-239 In accordance with
paragraph 606-10-32-19, the entity determines the
transaction price by adjusting the promised amount of
consideration to reflect the contractual payments using
the 12 percent interest rate that reflects the credit
characteristics of the customer. Consequently, the
entity determines that the transaction price is $848,357
(60 monthly payments of $18,871 discounted at 12
percent). The entity recognizes revenue and a loan
receivable for that amount. The entity accounts for the
loan receivable in accordance with Topic 310 on
receivables and Subtopic 835-30 on the imputation of
interest.
Pending Content (Transition Guidance: ASC
326-10-65-1)
55-239 In accordance with paragraph
606-10-32-19, the entity determines the
transaction price by adjusting the promised amount
of consideration to reflect the contractual
payments using the 12 percent interest rate that
reflects the credit characteristics of the
customer. Consequently, the entity determines that
the transaction price is $848,357 (60 monthly
payments of $18,871 discounted at 12 percent). The
entity recognizes revenue and a loan receivable
for that amount. The entity accounts for the loan
receivable in accordance with Subtopic 310-10 on
receivables, Subtopic 326-20 on financial
instruments measured at amortized cost, and
Subtopic 835-30 on the imputation of interest.
Example 29 — Advance Payment and Assessment of Discount Rate
55-240 An entity enters into a contract with a customer to sell an asset. Control of the asset will transfer to
the customer in two years (that is, the performance obligation will be satisfied at a point in time). The contract
includes 2 alternative payment options: payment of $5,000 in 2 years when the customer obtains control of the
asset or payment of $4,000 when the contract is signed. The customer elects to pay $4,000 when the contract
is signed.
55-241 The entity concludes that the contract contains a significant financing component because of the
length of time between when the customer pays for the asset and when the entity transfers the asset to the
customer, as well as the prevailing interest rates in the market.
55-242 The interest rate implicit in the transaction is 11.8 percent, which is the interest rate necessary to make
the 2 alternative payment options economically equivalent. However, the entity determines that, in accordance
with paragraph 606-10-32-19, the rate that should be used in adjusting the promised consideration is
6 percent, which is the entity’s incremental borrowing rate.
55-243 The following journal entries illustrate how the entity would account for the significant financing
component.
- Recognize a contract liability for the $4,000 payment received at contract
inception.
- During the 2 years from contract inception until the transfer of the asset, the
entity adjusts the promised amount of
consideration (in accordance with paragraph
606-10-32-20) and accretes the contract liability
by recognizing interest on $4,000 at 6 percent for
2 years.
- Recognize revenue for the transfer of the asset.
6.4.4.1 Determining the Appropriate Discount Rate on an Individual Contract Basis
If an entity gives its customers a significant benefit of
financing, it should adjust the transaction price and corresponding amount
of revenue recognized for the sale to take into account the effects of the
time value of money. If the entity does not intend to apply a portfolio
approach in determining the effects of this financing benefit, it should use
the discount rate that would be reflected in a separate financing
transaction between itself and its customer at contract inception in
accordance with ASC 606-10-32-19. The way in which the entity identifies
this rate will depend on the type of information to which it has access for
individual customers.
In determining an appropriate discount rate, an entity may
find it useful to consider the following:
-
The normal rate at which the entity would provide secured or unsecured lending (whichever is appropriate) to its customer (e.g., any interest rate that would be normal for the entity to offer the customer).
-
The normal rate at which other entities would provide secured or unsecured lending (whichever is appropriate) to the customer (e.g., the rate charged to the customer for bank loans). Note, however, that ASC 606-10-32-19 requires a rate specific to a financing transaction between the entity and its customer.
-
The cash sales price offered for the good or service to customers with similar demographic characteristics.
-
Any interest rate explicitly stated in the contract with the customer. However, this will not always be an appropriate rate (e.g., when a customer is offered interest-free credit or when a low interest rate is used to incentivize the customer).
-
The level of certainty regarding the customer’s credit characteristics that the entity obtains as a result of its due diligence processes (e.g., obtaining credit ratings).
-
Historical evidence of any defaults or slow payment by the customer.
Appropriate adjustments should be made to rates associated
with any of these factors when they are not directly comparable to those of
the transaction being considered.
6.4.4.2 Determining the Appropriate Discount Rate Under a Portfolio Approach
In accordance with ASC 606-10-32-15, if an entity determines
that the contract terms give customers a significant benefit of financing
the purchase of the entity’s products, the entity should adjust the
transaction price and corresponding amount of revenue recognized for the
sale of the goods to take into account the effects of the time value of
money.
Further, if the entity has a large number of similar
contracts with similar payment terms and reasonably expects that the
financial statement effects of calculating a discount rate that applies to
the portfolio of contracts would not differ materially from the discount
rates that would apply to individual contracts, it may apply a portfolio
approach in accordance with ASC 606-10-10-4. See Section 3.1.2.2.1 for guidance on how to decide whether an
entity may use a portfolio approach when applying ASC 606.
In applying a portfolio approach, the entity will need to consider the
demographic characteristics of the customers as a group to estimate the
discount rate on a portfolio basis. If the demographic characteristics of
customers within this group vary significantly, it may not be appropriate to
treat them as a single portfolio. Rather, it may be necessary for the entity
to further subdivide the customer group when determining the appropriate
discount rate.
6.4.5 Measuring the Amount of Revenue When a Transaction Includes a Significant Financing Component Related to Deferred Payments
When a significant financing component is identified, ASC 606-10-32-15 requires
an entity to “adjust the promised amount of consideration for the effects of the
time value of money.”
ASC 606-10-32-16 states, in part:
The
objective when adjusting the promised amount of consideration for a
significant financing component is for an entity to recognize revenue at an
amount that reflects the price that a customer would have paid for the
promised goods or services if the customer had paid cash for those goods or
services when (or as) they transfer to the customer (that is, the cash
selling price).
However, ASC 606-10-32-19 states, in part:
To meet the objective in paragraph 606-10-32-16 when adjusting the promised
amount of consideration for a significant financing component, an entity
shall use the discount rate that would be reflected in a separate financing
transaction between the entity and its customer at contract inception. That
rate would reflect the credit characteristics of the party receiving
financing in the contract, as well as any collateral or security provided by
the customer or the entity, including assets transferred in the
contract.
ASC 606-10-32-19 also notes that “[a]n entity may be able to determine that rate by identifying the
rate that discounts the nominal amount of the promised consideration to the
price that the customer would pay in cash for the goods or services when (or as)
they transfer to the customer” (emphasis added).
Accordingly, although the objective described in ASC
606-10-32-16 is to determine the “cash selling price,” ASC 606-10-32-19 makes
clear that such price is required to be consistent with the price that would be
determined by using an appropriate discount rate to discount the promised
consideration.
Therefore, in practice, the entity may make an initial estimate
of the amount of revenue either (1) by determining the appropriate discount rate
and using that rate to discount the promised amount of consideration or (2) by
estimating the cash selling price directly — but only if the discount rate
thereby implied is consistent with a rate that would be reflected in a separate
financing transaction between the entity and its customer.
Regardless of the approach it adopts, the entity may need to
perform further analysis if the amounts estimated appear unreasonable or
inconsistent with other evidence related to the transaction. For example:
-
If the entity estimates revenue by discounting the promised consideration, it may be required to perform further analysis if that estimate appears unreasonable and inconsistent with other evidence of the cash selling price. For example, if the amount of revenue estimated appears significantly higher than the normal cash selling price, this may indicate that the discount rate has not been determined on an appropriate basis.
-
If the entity estimates revenue by estimating the cash selling price directly, it may be required to perform further analysis if the resulting discount rate appears unreasonable and inconsistent with other evidence of the rate that would be reflected in a separate financing transaction between the entity and its customer. If the rate is clearly significantly lower or higher than would be reflected in a separate financing transaction, it will not be appropriate to measure revenue by reference to the cash selling price; instead, the entity should estimate revenue by discounting the promised consideration at an appropriately estimated discount rate.
The example below illustrates how an entity would (1) estimate
revenue by discounting promised consideration and subsequently recognize the
associated financing component and (2) determine and subsequently recognize the
financing component when revenue is estimated on the basis of the cash selling
price.
Example 6-13
On January 1, 20X1, Entity B sells an
item of equipment for $100,000 under a financing
agreement that has no stated interest rate. On the date
of sale, B transfers control of the equipment to the
customer, and B concludes that the contract meets the
criteria in ASC 606-10-25-1, including the
collectibility criterion. The first annual installment
of $20,000 is due on December 31, 20X1, one year from
the date of sale, and each subsequent year for five
years. The policy of not charging interest is consistent
with normal industry practice. Entity B has separately
determined that the transaction includes a significant
financing component.
Case A —
Discounting on the Basis of Interest
Rate
To estimate the transaction price by
discounting the future receipts, B uses a “rate that
would be reflected in a separate financing transaction
between [Entity B] and its customer at contract
inception.” Entity B determines that the appropriate
annual rate is 10 percent. Assume that the receivable
arising from the transaction is measured at amortized
cost after initial recognition.
Step A — Calculate the Net Present Value
of the Stream of Payments
If there is no down payment and there
are five annual installments of $20,000 with an interest
rate of 10 percent, the net present value of the stream
of payments forming the consideration is $75,816.
Therefore, upon transfer of control of
the equipment, $75,816 is recognized as revenue from the
sale of goods, and the related receivable is
recognized.
Step B — Calculate the Amount of
Interest Earned in Each Period
The difference between $100,000 and
$75,816 (i.e., $24,184) will be recognized as interest
income as it becomes due each year, as calculated
below.
Step C — Record Journal Entries
On the date of sale, control of the
equipment transfers to the customer and B records the
following journal entry:
To record the first annual payment due
one year from the date of purchase:
As of each subsequent year-end, B should
record the same journal entry by using the amounts from
the table above.
Note that this example does not take
into account any impairment assessment that would be
required in accordance with ASC 310 (or ASC 326-20, once
adopted4).
Case B —
Discounting to Current Cash Sales
Price
If the buyer had paid in full for the
equipment at the point of transfer, B estimates that the
cash selling price would have been $76,000.
Assume that the receivable arising from
the transaction is measured at amortized cost after
initial recognition.
Step A — Determine the Discount Rate for
the Customer
ASC 606-10-32-19 indicates that a
selling entity may be able to determine the discount
rate to be used to adjust the transaction price “by
identifying the rate that discounts the nominal amount
of the promised consideration to the price that the
customer would pay in cash for the goods or services
when (or as) they transfer to the customer.” Therefore,
Entity B determines the interest rate that discounts
$100,000 to $76,000 (i.e., the cash selling price) over
a five-year period, given no down payment and five
annual installments of $20,000. This interest rate is
approximately 9.905 percent per annum, which is judged
to be consistent with a rate that would be reflected in
a separate financing transaction between B and its
customer. Upon transfer of the equipment, $76,000 is
recognized as revenue from the sale of goods, and the
related receivable is recognized.
Step B — Calculate the Amount of
Interest Earned in Each Period
The difference between $100,000 and
$76,000 (i.e., $24,000) will be recognized as interest
income as it becomes due each year, as calculated
below.
Step C — Record Journal Entries
On the purchase date, control of the
equipment transfers to the customer, and B records the
following journal entry:
Entity B records the following journal
entry to reflect the first annual payment due one year
from the date of purchase:
As of each subsequent year-end, B should
record the same journal entry by using the amounts from
the table above.
Note that this example does not take
into account any impairment assessment that would be
required in accordance with ASC 310 (or ASC 326-20, once
adopted5).
6.4.6 Measuring the Amount of Revenue When a Transaction Includes a Significant Financing Component Related to an Advance Payment
The example below illustrates how an entity should account for
an advance payment that represents a significant financing component.
Example 6-14
Entity A, a home builder, is selling
apartment units in a new building for which construction
has not yet commenced. The estimated time to complete
construction is 18 months. Entity A has concluded that
its performance obligation (i.e., delivery of the
apartment) will be satisfied upon completion of
construction (i.e., at a point in time), which is also
when title and possession are passed to the customer.
The cash sales price upon completion of construction is
$500,000. Customers are offered a discount of $75,000 on
the cash sales price if they pay in full in advance;
therefore, the price for customers paying in advance is
$425,000.
Entity A has concluded after analysis of
the contract that the advance payment represents a
significant financing component; that is, its customers
are providing financing to pay for construction costs.
On the basis of interest rates in the market, A has
concluded that an annual rate of approximately 10
percent reflects the rate at which A and its customer
would have entered into a separate financing
transaction. Consequently, A imputes a discount rate of
approximately 10 percent to discount the cash sales
price (i.e., $500,000) to the “advance” sales price
(i.e., $425,000).
When an advance cash payment is received
from a customer, A recognizes a contract liability of
$425,000. Subsequently, A accrues interest on the
liability balance to accrete the balance to $500,000
over the 18-month period in which A expects to complete
construction and satisfy its performance obligation.
Entity A capitalizes into inventory the interest in
accordance with ASC 835-20 (i.e., interest expense is
not recognized). When control of the apartment transfers
to the customer, A recognizes $500,000 as revenue (and
recognizes the related inventory balance as cost of
goods sold). Essentially, the transaction price is
increased by the amount of interest recognized over the
18-month period. As a result, revenue is recognized in
an amount greater than the amount of initial cash
collected.
The following journal entries illustrate
how A should account for the significant financing
component:
Step 1
Journal Entry: At
contract inception
Step 2
Journal Entry: Over
18 months from contract inception to transfer of
asset
Step 3
Journal Entry: On
transfer of control of the asset
6.4.7 Presenting the Effects of Financing
ASC 606-10
32-20 An entity shall present
the effects of financing (interest income or interest
expense) separately from revenue from contracts with
customers in the statement of comprehensive income
(statement of activities). Interest income or interest
expense is recognized only to the extent that a contract
asset (or receivable) or a contract liability is
recognized in accounting for a contract with a customer.
In accounting for the effects of the time value of
money, an entity also shall consider the subsequent
measurement guidance in Subtopic 835-30, specifically
the guidance in paragraphs 835-30-45-1A through 45-3 on
presentation of the discount and premium in the
financial statements and the guidance in paragraphs
835-30-55-2 through 55-3 on the application of the
interest method.
In paragraph BC244 of ASU 2014-09, the FASB and IASB note that the presentation
of a significant financing component in the financial statements should not be
any different from the presentation that would have resulted if the party
receiving the financing in the arrangement had instead obtained financing from a
third-party source (e.g., if instead of obtaining the financing from the entity,
the customer had obtained financing from the bank and purchased the good or
service from the entity at the cash selling price). Accordingly, as a result of
the presentation requirements in ASC 606-10-32-20, economically similar
transactions are reflected similarly in the financial statements.
Interest income arising from a significant financing component should be
presented separately from revenue from contracts with customers in an entity’s
statement of comprehensive income in accordance with ASC 606-10-32-20. However,
this requirement to separately present interest income does not necessarily
prevent interest income from being presented as revenue on the face of the
statement of comprehensive income. For more information about whether it is
appropriate to classify interest income as revenue, see Section 14.7.3.
Example 26 in ASC 606, which is reproduced below, illustrates (1) the
presentation of the effects of financing in a contract with a customer that also
contains a right of return and (2) the concept in the second sentence of ASC
606-10-32-20 that a significant financing component affects profit and loss at
the time the contract asset (receivable) or liability is recognized rather than
at contract inception.
ASC 606-10
Example 26 — Significant Financing Component and Right of Return
55-227 An entity sells a product to a customer for $121 that is payable 24 months after delivery. The customer
obtains control of the product at contract inception. The contract permits the customer to return the product
within 90 days. The product is new, and the entity has no relevant historical evidence of product returns or
other available market evidence.
55-228 The cash selling price of the product is $100, which represents the amount that the customer would
pay upon delivery for the same product sold under otherwise identical terms and conditions as at contract
inception. The entity’s cost of the product is $80.
55-229 The entity does not
recognize revenue when control of the product transfers
to the customer. This is because the existence of the
right of return and the lack of relevant historical
evidence means that the entity cannot conclude that it
is probable that a significant reversal in the amount of
cumulative revenue recognized will not occur in
accordance with paragraphs 606-10-32-11 through 32-13.
Consequently, revenue is recognized after three months
when the right of return lapses.
55-230 The contract includes a significant financing component, in accordance with paragraphs 606-10-32-15
through 32-17. This is evident from the difference between the amount of promised consideration of $121 and
the cash selling price of $100 at the date that the goods are transferred to the customer.
55-231 The contract includes an implicit interest rate of 10 percent (that is, the interest rate that over 24
months discounts the promised consideration of $121 to the cash selling price of $100). The entity evaluates
the rate and concludes that it is commensurate with the rate that would be reflected in a separate financing
transaction between the entity and its customer at contract inception. The following journal entries illustrate
how the entity accounts for this contract in accordance with paragraphs 606-10-55-22 through 55-29:
- When the product is transferred to the customer, in accordance with paragraph 606-10-55-23.
- During the three-month right of return period, no interest is recognized in accordance with paragraph 606-10-32-20 because no contract asset or receivable has been recognized.
- When the right of return lapses (the product is not returned).
Pending Content (Transition
Guidance: ASC 326-10-65-1)
55-231 The contract
includes an implicit interest rate of 10 percent
(that is, the interest rate that over 24 months
discounts the promised consideration of $121 to
the cash selling price of $100). The entity
evaluates the rate and concludes that it is
commensurate with the rate that would be reflected
in a separate financing transaction between the
entity and its customer at contract inception. The
following journal entries illustrate how the
entity accounts for this contract in accordance
with paragraphs 606-10-55-22 through 55-29:
- When the product is
transferred to the customer, in accordance with
paragraph 606-10-55-23.
- During the three-month right of return period, no interest is recognized in accordance with paragraph 606-10-32-20 because no contract asset or receivable has been recognized.
- When the right of return
lapses (the product is not returned).
55-232 Until the entity receives the cash payment from the customer, interest income would be recognized
consistently with the subsequent measurement guidance in Subtopic 835-30 on imputation of interest. The
entity would accrete the receivable up to $121 from the time the right of return lapses until customer payment.
6.4.8 Reassessment of Significant Financing Component
ASC 606-10-32-19 (reproduced in Section 6.4.4) states, in part, that “[a]fter contract inception, an
entity shall not update the discount rate for changes in interest rates or other
circumstances (such as a change in the assessment of the customer’s credit
risk).” An entity is thus not required to update the discount rate used to
measure a significant financing component as it would otherwise be required to
reassess and remeasure, for example, variable consideration (see Section 6.3.6). Paragraph
BC243 of ASU 2014-09 indicates that as much as for any other reason, the FASB
and IASB deemed reassessment of the discount rate inappropriate because of the
impracticality of updating it in each subsequent reporting period for changes in
facts and circumstances.
Connecting the Dots
The boards’ decision with respect to reassessing the discount rate reflects a
conscious and substantial form of relief to preparers. In a manner
consistent with the boards’ decision to establish stand-alone selling
prices in step 4 as of contract inception (see Chapter 7), the boards decided that
the determination of the discount rate and stand-alone selling prices
should not be adjusted even if facts and circumstances change over the
course of the entity’s performance under the contract (e.g., when, over
the term of a 5- or 10-year contract, it is likely that the discount
rate or the stand-alone selling prices of individual goods or services
will economically shift). This relief may pose challenges when the
timing of delivery of the goods and services shifts after contract
inception. The complexity is exacerbated when variable consideration is
reassessed and the reassessment results in an updated estimate that
needs to be reallocated to individual performance obligations. Unlike
the static discount rate and stand-alone selling price estimates,
estimates of variable consideration need to be reassessed and updated as
uncertainties become known. In addition, the timing of delivery of goods
and services may change from estimates made at contract inception and
directly contributes to when revenue and the impact of financing are
recognized. As a result, when a contract includes multiple performance
obligations that are expected to be satisfied over a longer period and
also contains a significant financing component and variable
consideration, the recognition of revenue for those separate performance
obligations may become complex and challenging.
Footnotes
6.5 Noncash Consideration
ASC 606-10
32-21 To determine the transaction price for contracts in which a customer promises consideration in a form
other than cash, an entity shall measure the estimated fair value of the noncash consideration at contract
inception (that is, the date at which the criteria in paragraph 606-10-25-1 are met).
32-22 If an entity cannot
reasonably estimate the fair value of the noncash
consideration, the entity shall measure the consideration
indirectly by reference to the standalone selling price of
the goods or services promised to the customer (or class of
customer) in exchange for the consideration.
32-23 The fair value of the noncash consideration may vary after contract inception because of the form of
the consideration (for example, a change in the price of a share to which an entity is entitled to receive from a
customer). Changes in the fair value of noncash consideration after contract inception that are due to the form
of the consideration are not included in the transaction price. If the fair value of the noncash consideration
promised by a customer varies for reasons other than the form of the consideration (for example, the exercise
price of a share option changes because of the entity’s performance), an entity shall apply the guidance on
variable consideration in paragraphs 606-10-32-5 through 32-14. If the fair value of the noncash consideration
varies because of the form of the consideration and for reasons other than the form of the consideration, an
entity shall apply the guidance in paragraphs 606-10-32-5 through 32-14 on variable consideration only to the
variability resulting from reasons other than the form of the consideration.
32-24 If a customer contributes goods or services (for example, materials, equipment, or labor) to facilitate
an entity’s fulfillment of the contract, the entity shall assess whether it obtains control of those contributed
goods or services. If so, the entity shall account for the contributed goods or services as noncash consideration
received from the customer.
When providing goods or services, an entity may receive noncash consideration
from its customers (e.g., goods, services, shares of stock). Step 3 requires
entities to include the fair value of the noncash consideration in the transaction
price. Paragraph BC248 of ASU 2014-09 states the FASB’s and IASB’s rationale for
this requirement: “When an entity receives cash from a customer in exchange for a
good or service, the transaction price and, therefore, the amount of revenue should
be the amount of cash received (that is, the value of the inbound asset). To be
consistent with that approach, the Boards decided that an entity should measure
noncash consideration at fair value.” Further, in issuing ASU 2014-09 and IFRS 15, the boards included
guidance stating that changes in the fair value of noncash consideration for reasons
other than its form would be subject to the variable consideration constraint in ASC
606-10-32-11 through 32-13 (paragraphs 56 through 58 of IFRS 15).
During the FASB’s outreach on issues related to the implementation of ASU 2014-09, stakeholders
indicated that they were unclear about the measurement date in the determination of the fair value of
noncash consideration received in a contract with a customer. Further, they questioned the applicability
of the variable consideration constraint when changes in the fair value of the noncash consideration
are due both to (1) its form (e.g., stock price changes attributable to market conditions) and (2) reasons
other than its form (e.g., additional shares of stock that may become due on the basis of a contingent
event).
In response, the FASB issued ASU 2016-12, which defines the
measurement date for noncash consideration as the “contract inception” date and
clarifies that this is the date on which the criteria in step 1 are met (i.e., the
criteria in ASC 606-10-25-1, as discussed in Chapter 4).6 In addition, the transaction price does not include any changes in the fair
value of the noncash consideration after the contract inception date that are due to
its form. Further, ASU 2016-12 states that if changes in noncash consideration are
due both to its form and to reasons other than its form, only variability resulting
from changes in fair value that are due to reasons other than the consideration’s
form is included in the transaction price as variable consideration (and thus also
subject to the variable consideration constraint).
Lastly, some stakeholders asked the FASB to clarify how the fair value of
noncash consideration should be measured on the contract inception date. As noted in
paragraph BC39 of ASU 2016-12, the FASB elected not to clarify the measurement
process because it believes that “the concept of fair value exists in other parts of
[ASC] 606,” and an entity will need to use judgment in determining fair value.
ASC 606-10-32-21 requires an entity to measure the fair value of
noncash consideration at contract inception. In terms of the sequence of steps used
to determine the fair value of noncash consideration, ASC 606-10-32-21 and 32-22
require an entity to first look to measure the estimated fair value of the noncash
consideration and then consider the stand-alone selling price of the goods or
services promised to the customer only when the entity is unable to reasonably
estimate the fair value of the noncash consideration.
The Codification example below and Example 6-15 illustrate the application of the
revenue standard’s guidance on noncash consideration in two different contractual
scenarios.
ASC 606-10
Example 31 — Entitlement to Noncash Consideration
55-248 An entity enters into a contract with a customer to provide a weekly service for one year. The contract
is signed on January 1, 20X1, and work begins immediately. The entity concludes that the service is a single
performance obligation in accordance with paragraph 606-10-25-14(b). This is because the entity is providing
a series of distinct services that are substantially the same and have the same pattern of transfer (the services
transfer to the customer over time and use the same method to measure progress — that is, a time-based
measure of progress).
55-249 In exchange for the service, the customer promises 100 shares of its common stock per week of
service (a total of 5,200 shares for the contract). The terms in the contract require that the shares must be paid
upon the successful completion of each week of service.
55-250 To determine the transaction price (and the amount of revenue to be recognized), the entity measures
the estimated fair value of 5,200 shares at contract inception (that is, on January 1, 20X1). The entity measures
its progress toward complete satisfaction of the performance obligation and recognizes revenue as each
week of service is complete. The entity does not reflect any changes in the fair value of the 5,200 shares
after contract inception in the transaction price. However, the entity assesses any related contract asset or
receivable for impairment. Upon receipt of the noncash consideration, the entity would apply the guidance
related to the form of the noncash consideration to determine whether and how any changes in fair value that
occurred after contract inception should be recognized.
Example 6-15
As part of Entity X’s revenue contract with
Customer Y for the delivery of goods, X is entitled to
receive 500 shares of Y’s common stock when all of the goods
are provided to Y. In addition, if X delivers all goods
within 90 days, it will receive an additional 100 shares of
Y’s common stock. The changes in the fair value of the
noncash consideration may vary between the contract
inception date and the delivery of goods as a result of (1)
the form of the common stock (i.e., because of changes in
the market value) and (2) reasons other than its form (i.e.,
the quantity of shares that X will receive may vary if
delivery occurs in 90 days).
ASU 2016-12 clarifies that the transaction
price would include as variable consideration (subject to
the variable consideration constraint) only changes in fair
value that are due to reasons other than the consideration’s
form (in this example, the quantity of shares to be received
by the entity). Consequently, in this example, increases or
decreases in the market value of the common stock would not
be recorded as adjustments to the transaction price (i.e.,
revenue).
For illustrative purposes, assume the
following:
-
At contract inception, the fair value of the 500 shares of Y’s common stock is $10 per share.
-
Entity X determines that the probability of delivering all goods within 90 days is 15 percent and that the most likely amount method better predicts the amount of variable consideration to which it will be entitled.
Entity X determines at contract inception
that the transaction price is $5,000 (500 shares × $10 per
share) and recognizes revenue as the goods are provided.
After 60 days, X determines that there is a
90 percent probability that all goods will be delivered
within the remaining 30 days of the contract. After 60 days,
the fair value of Y’s common stock is $12 per share. On the
basis of the fair value of Y’s common stock at contract
inception, X now determines that the transaction price is
$6,000 (600 shares × $10 per share). The change in the
transaction price is due to a change in the estimate of
variable consideration under the most likely amount method.
That is, the variability in the transaction price results
from “reasons other than the form of the
consideration.”7 The change in the
transaction price ignores any change in the fair value of
Y’s common stock (the form of the consideration) since
contract inception. Accordingly, in this example, the $2
increase in the fair value of the common stock would be
accounted for under other applicable GAAP.
Connecting the Dots
The example above illustrates variability in noncash
consideration that is due to both (1) its form (i.e., changes in the market
price of the common stock) and (2) drivers other than its form (i.e., the
occurrence or nonoccurrence of an event). This example makes it easier to
see how the measurement guidance in ASU 2016-12 after contract inception
would come into play. In short, variability in item (2) would be
subsequently reassessed and remeasured, but variability in item (1) would
not be. In paragraph BC39 of ASU 2016-12, the FASB acknowledges that for
item (1), the entity would thus be required to assess whether there is an
embedded derivative that should also be bifurcated and measured at fair
value in accordance with ASC 815-15. The FASB reasons in paragraph BC39 that
contracts with noncash consideration are most commonly for payment in the
form of shares of a nonpublic entity. Such shares would most likely not meet
all of the criteria in ASC 815-15 to be bifurcated as an embedded derivative
because they are not readily convertible to cash.
6.5.1 Noncash Consideration in the Form of Internet Advertisement Space in the Advertisement Technology Industry
Noncash consideration may sometimes be used in the advertisement
technology industry — specifically, an entity may be paid in the form of
Internet advertising space (commonly referred to as “impressions”). In addition,
the total number of impressions received by the entity may vary depending on the
number of impressions generated by the customer. In such situations, the noncash
consideration would also represent a form of variable consideration.
Unlike some other forms of noncash consideration, impressions
generated in the advertisement technology industry do not represent assets that
are transferred to the entity at contract inception. Rather, the impressions
will be generated in the future and therefore will become assets of the entity
when the impressions are generated and control of the impressions is transferred
to the entity. Consequently, the entity does not have control of the impressions
at contract inception.
The entity should not recognize the fair value of the impressions promised by the
customer until control of the impressions is transferred to the entity. This
determination is consistent with the guidance in ASC 606-10-32-24, which
requires an entity to account for contributed goods or services as noncash
consideration if the entity obtains control of those contributed goods or
services. Although ASC 606-10-32-24 focuses on the evaluation of whether an
entity should account for goods or services contributed by a customer as noncash
consideration received from the customer, it also helps an entity understand
when noncash consideration should be recognized. That is, the guidance in ASC
606-10-32-24 indicates that noncash consideration should be recognized only when
control of the consideration is transferred to the entity.
Example 6-16
Company A enters into an arrangement
with Company B in which A will provide a service to B
ratably over a four-month period in exchange for cash of
$1 million (payable in equal increments of $250,000 at
the beginning of each month) and Internet advertising
space (i.e., “impressions”) on B’s Web platform. In the
arrangement, B does not promise a specified number or
amount of impressions but promises a specified
percentage of impressions generated on B’s Web platform;
therefore, the number of users who will view A’s
advertisement on B’s Web platform is unknown.
Company A should treat the impressions as variable
consideration and estimate the fair value of the
impressions expected to be generated and transferred by
B at contract inception. In this case, A estimates that
it will receive 20 million impressions at a fair value
of $10 cost per mille (CPM) — that is, $10 cost per
1,000 impressions — for a total fair value of $200,000.
However, because control of the impressions has not been
transferred to A at contract inception, A would not
record an asset for the estimated fair value of the
impressions to be received.
At the end of the first month of the
service contract, B has generated 8 million impressions
and transferred them to A. On the basis of the fair
value of $10 CPM estimated at contract inception, A has
received from B noncash consideration totaling $80,000,
or 8 million impressions × ($10 ÷ 1,000 impressions).
However, since A has performed only 25 percent of its
promised service to B (one month’s service to date under
the four-month service contract), only $300,000 of
revenue has been earned ($1.2 million × 25%). Therefore,
A should record revenue of $300,000 and a contract
liability of $30,000 for the impressions received that
have not yet been earned, which is calculated as
$330,000 consideration received ($250,000 cash and
$80,000 noncash) less $300,000 recognized as revenue.
If, instead, A received 3 million impressions for
noncash consideration of $30,000, or 3 million
impressions × ($10 ÷ 1,000 impressions), A should record
a contract asset of $20,000, or $280,000 consideration
received ($250,000 cash and $30,000 noncash) compared
with $300,000 recognized as revenue.
Note that this example represents a simple fact pattern
and does not contemplate changes or updates to the
number of impressions that A would be granted under the
arrangement.
6.5.2 Accounting for Barter Credits
The example below illustrates how an entity would account
for radio and television advertising barter credits.
Example 6-17
Company C, a retailer, enters into a
transaction in which it transfers consumer product
inventory to a barter company in exchange for radio and
television advertising airtime barter credits. The radio
and television advertising airtime is provided to the
barter company by Company A, a broadcasting company. The
airtime is available at certain times in certain markets
for the next 24 months through a media outlet.
In the manner described in Section 3.2.5, C should
first consider whether the barter credit transaction is
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.
As described above, C is a retailer and
is not in the same line of business as the barter
company or A, a broadcasting company. Therefore, the
barter credit transaction is not subject to the scope
exception in ASC 606-10-15-2(e). That is, the barter
credit transaction is not a nonmonetary exchange that
facilitates a sale to another party. Accordingly, C
should consider whether the nonmonetary exchange
represents a contract with a customer.8 Company C’s conclusion will depend on the facts
and circumstances of the specific arrangement, including
the terms of the parties’ contract.
If C concludes that the nonmonetary
exchange represents a contract with a customer, C should
account for the consideration (i.e., radio and
television advertising airtime barter credits) it
receives from the customer in exchange for the goods
(i.e., consumer product inventory) it provides to the
customer as noncash consideration. Under ASC
606-10-32-21, an entity is required to measure the
estimated fair value of noncash consideration at
contract inception when determining the amount of
noncash consideration to include in the transaction
price. Therefore, C should determine at contract
inception the estimated fair value of the radio and
television advertising airtime barter credits it
receives from the customer. Since C does not receive any
other consideration in the barter credit transaction,
the estimated fair value of the radio and television
advertising airtime barter credits at contract inception
represents the transaction price of C’s contract to
provide the consumer product inventory to the customer.
When the fair value of the noncash consideration cannot
be reasonably estimated, the noncash consideration is
measured indirectly by reference to the stand-alone
selling price of the goods or services promised to the
customer (or class of customer) in exchange for the
noncash consideration.
Connecting the Dots
Arrangements between media producers and broadcasters
often include a requirement that the broadcaster air certain advertising
spots for the media producer during the broadcast of the media
producer’s content. For example, assume that a media producer enters
into an agreement to license one season of a syndicated television
sitcom (10 episodes, each with 22 minutes of content) to a broadcast
network in exchange for $5 million in cash. The arrangement stipulates
that each time one of the sitcom episodes airs in a 30-minute time slot
on the network, the media producer is allowed to sell, and have aired,
advertising spots (i.e., commercials) for 4 of the 8 available minutes
of airtime while the broadcast network will provide the advertising
spots for the remaining 4 minutes.
Industry stakeholders have considered whether the
agreement to allow the media producer to sell advertising spots that
will air during the broadcast of the syndicated sitcom represents
noncash consideration in exchange for licensing the syndicated sitcom to
the broadcast network. This issue was ultimately brought to the
attention of the FASB and SEC staffs by industry stakeholders and public
accounting firms.
The FASB staff generally preferred a view that the
future advertising spots provided by the broadcast network to the media
producer are not a form of noncash consideration that the media entity
receives in exchange for a license to the media content. The FASB staff
indicated that it gave particular weight to an understanding that the
value of the future advertising spots is inextricably linked to the
value of the licensed content; the more valuable or popular the
syndicated sitcom is, the more valuable the future advertising spots
are. Accordingly, the FASB staff noted that in these particular unique
circumstances, the arrangements could be viewed as either of the
following:
-
Two arrangements: one for the license of IP (i.e., the syndicated sitcom) and another for the sale of future advertising spots.
-
A profit-sharing arrangement that includes fixed consideration and variable consideration in the form of a sales- or usage-based royalty.
The FASB staff noted that either approach would result
in similar reporting outcomes. That is, revenue would be recognized (1)
as fixed consideration upon the transfer of the license of IP and (2) as
variable consideration as the media producer sells future advertising
spots and such spots are aired.
The FASB staff also noted that it could not object to a
view that the future advertising spots provided by the broadcast network
to the media producer represent noncash consideration in accordance with
ASC 606-10-32-21. However, the FASB staff noted the difficulties
associated with applying the noncash consideration measurement guidance
in ASC 606-10-32-21 through 32-24 to advertising space if such was
concluded to be noncash consideration.
The SEC staff noted that preparers should provide
sufficient detailed disclosures to enable financial statement users to
understand the entity’s evaluation of the nature, substance, and
economics of these arrangements.
As noted in Example 6-17, an entity is required to measure the fair value of
noncash consideration at contract inception. However, if an entity cannot
reasonably estimate the fair value of the noncash consideration to be received
in the form of barter credits, it might be appropriate for the entity to measure
the consideration indirectly by reference to the stand-alone selling price of
the consumer product inventory promised to the customer in exchange for this
noncash consideration.
Further, an entity should carefully consider the particular good or service being
promised to the customer in exchange for the noncash consideration and whether
its stand-alone selling price may in fact differ from its normal retail price.
Sometimes, a good or service is exchanged in a barter transaction precisely
because the entity has encountered difficulties in selling it at a normal retail
price and through normal sales channels. For example, an entity may be willing
to exchange excess inventory that it is unable to sell through normal retail
channels for barter credits. In this case, it may not be appropriate to conclude
that the retail price of the promised good is an appropriate measure of the fair
value of the noncash consideration.
Footnotes
6
ASU 2016-12 and the FASB’s updates to the guidance on
noncash consideration reflect a difference between ASC 606 and IFRS 15. The
IASB decided not to make the changes in ASU 2016-12 to IFRS 15. As a result,
IFRS 15 does not require the measurement of noncash consideration as of the
inception date. See Appendix
A for a summary of differences between U.S. GAAP and IFRS
Accounting Standards on revenue-related topics.
7
Quoted from ASU 2016-12.
8
A customer is defined in the ASC
606 glossary 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.”
6.6 Consideration Payable to a Customer
If an entity makes (or promises to make) a cash payment to a
customer in (or related to) a contract with that customer to subsequently receive
the return of that cash through purchases of its goods or services by the customer,
the economics of the transaction do not justify the entity’s recognition of revenue
without consideration of the amounts it paid to the customer. As a result, ASC 606
generally precludes the “grossing up” of revenue for the amounts paid to the
customer. This ensures that payments made to a customer are appropriately reflected
as a reduction of revenue such that revenue is presented on a “net basis” to more
appropriately reflect the economics of the arrangements.
ASC 606-10
32-25 Consideration payable to a
customer includes:
- Cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase the entity’s goods or services from the customer)
- Credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that purchase the entity’s goods or services from the customer)
- Equity instruments (liability or equity classified) granted in conjunction with selling goods or services (for example, shares, share options, or other equity instruments).
An entity shall account for consideration
payable to a customer as a reduction of the transaction
price and, therefore, of revenue unless the payment to the
customer is in exchange for a distinct good or service (as
described in paragraphs 606-10-25-18 through 25-22) that the
customer transfers to the entity. If the consideration
payable to a customer includes a variable amount, an entity
shall estimate the transaction price (including assessing
whether the estimate of variable consideration is
constrained) in accordance with paragraphs 606-10-32-5
through 32-13.
32-25A
Equity instruments granted by an entity in conjunction with
selling goods or services shall be measured and classified
under Topic 718 on stock compensation. The equity instrument
shall be measured at the grant date in accordance with Topic
718 (for both equity-classified and liability-classified
share-based payment awards). Changes in the measurement of
the equity instrument (through the application of Topic 718)
after the grant date that are due to the form of the
consideration shall not be included in the transaction
price. Any changes due to the form of the consideration
shall be reflected elsewhere in the grantor’s income
statement. See paragraphs 606-10-55-88A through 55-88B for
implementation guidance on equity instruments granted as
consideration payable to a customer.
32-26 If consideration payable to a
customer is a payment for a distinct good or service from
the customer, then an entity shall account for the purchase
of the good or service in the same way that it accounts for
other purchases from suppliers. If the amount of
consideration payable to the customer exceeds the fair value
of the distinct good or service that the entity receives
from the customer, then the entity shall account for such an
excess as a reduction of the transaction price. If the
entity cannot reasonably estimate the fair value of the good
or service received from the customer, it shall account for
all of the consideration payable to the customer as a
reduction of the transaction price.
32-27 Accordingly, if consideration
payable to a customer is accounted for as a reduction of the
transaction price, an entity shall recognize the reduction
of revenue when (or as) the later of either of the following
events occurs:
-
The entity recognizes revenue for the transfer of the related goods or services to the customer.
-
The entity pays or promises to pay the consideration (even if the payment is conditional on a future event). That promise might be implied by the entity’s customary business practices.
Connecting the Dots
In June 2018, the FASB issued ASU 2018-07 to
improve the accounting for nonemployee share-based payments. The ASU amends
ASC 606-10-32-25 by expanding the scope of the guidance in that paragraph on
consideration payable to a customer to include equity instruments granted in
conjunction with the sale of goods or services. In addition, if share-based
payments are granted to a customer as payment for a distinct good or service
from the customer, an entity should apply the guidance in ASC 718.
In November 2019, the FASB issued ASU 2019-08 on
share-based consideration payable to a customer, which clarifies the
accounting for share-based payments issued as consideration payable to a
customer in accordance with ASC 606 (i.e., share-based consideration payable
to a customer that is not in exchange for distinct goods or services). ASU
2019-08 requires that entities measure and classify share-based sales
incentives by applying the guidance in ASC 718. Accordingly, under the ASU,
entities should measure share-based sales incentives by using a
fair-value-based measure on the grant date, which would be the date on which
the grantor (the entity) and the grantee (the customer) reach a mutual
understanding of the key terms and conditions of the share-based sales
incentive. The resulting measurement of the share-based sales incentive
should be reflected as a reduction of revenue in accordance with the
guidance in ASC 606 on consideration payable to a customer. After initial
recognition, the measurement and classification of the share-based sales
incentive continues to be subject to ASC 718 unless (1) the award is
subsequently modified when vested and (2) the grantee is no longer a
customer. The amendments in the ASU apply to share-based sales incentives
issued to customers under ASC 606 that are not in exchange for distinct
goods or services.
For more information about the accounting for share-based payments granted to
a customer as payment for a distinct good or service from the customer, see
Chapter 9 of Deloitte’s Roadmap
Share-Based Payment Awards.
For more information about share-based sales incentives, see Chapter 14 of that Roadmap.
The FASB and IASB acknowledge in paragraph BC255 of ASU 2014-09 that
consideration in a contract with a customer may be payable by an entity to its
customer in various forms (e.g., a cash discount, or a payment in exchange for good
or services). Accordingly, an entity should consider the following thought process
in determining how to account for consideration payable to its customer:
6.6.1 Scope of the Guidance on Consideration Payable to a Customer
6.6.1.1 Identifying Customers Within the Scope of the Requirements Related to Consideration Payable to a Customer
As noted above, ASC 606-10-32-25 through 32-27 establish
requirements related to consideration payable to a customer. ASC
606-10-32-25 states that those requirements apply to (1) an entity’s
customer (defined in the ASC 606 glossary 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”) and (2) other
parties that purchase the entity’s goods or services from the customer
(commonly referred to as other parties “in the distribution chain,” such as
a reseller).
The requirements should be applied
more broadly to include parties outside the
distribution chain depending on the facts and
circumstances. ASC 606-10-32-25 is clear that the
requirements of ASC 606-10-32-25 through 32-27 apply
to parties in the distribution chain. In addition,
depending on the circumstances, an entity might
identify a customer beyond the distribution chain.
In some instances, an agent that arranges for a
supplier (the principal) to supply goods to a third
party (the end customer) might regard both the
principal and the end customer as its customers. In
this circumstance, any incentive payment to the end
customer should be treated as consideration payable
to a customer.
In addition, regardless of whether the end customer
is the agent’s customer, if the agent has an
agreement with the principal to provide
consideration to the end customer (e.g., to
incentivize the end customer to purchase the
principal’s goods or services), the entity acting as
an agent should treat the consideration payable to
the end customer as consideration payable to a
customer (i.e., a reduction of revenue rather than
an amount recognized as an expense) in accordance
with ASC 606-10-32-25 through 32-27.
|
The above issue is addressed in Implementation Q&A 26 (compiled from previously
issued TRG Agenda Papers 19, 25, 28, 34, 37, and 44). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
An agent’s agreement with the principal to provide
consideration to the end customer may not have to be explicit. That is,
contractual linkage is not necessarily required for the incentive payment to
be treated as consideration payable to a customer. Depending on the facts
and circumstances, an incentive payment could be implicitly agreed to (i.e.,
the principal may have a reasonable expectation that the incentive payment
will be provided to its customers) and could represent consideration payable
to a customer. Significant judgment may be required to determine whether an
implicit agreement to provide an incentive to the principal’s customer
results in consideration payable to a customer, and any information that is
reasonably available to the principal’s customer should be considered.
Example 6-18
Entity AR is a platform company that provides a
marketplace for merchants to sell certain used
products to consumers. Entity AR derives revenue
from the merchants’ use of the platform by
collecting a fee (fixed percentage) for each
transaction a merchant has with a consumer. Entity
AR concludes that the merchants are its customers
but consumers are not its customers. Entity AR’s
sole performance obligation is to provide a platform
to connect merchants with consumers. That is, AR
considers itself to be acting as an agent when the
merchants sell products directly to consumers.
Entity AR regularly offers credits (i.e., discounts)
on all products purchased by consumers through the
platform to encourage consumer use of the platform
and to attract new consumers. However, AR is not
obligated to provide discounts under its agreements
with the merchants, and the discounts do not affect
the consideration the merchants receive from sales
of their products. Nevertheless, the merchants are
aware of the details of AR’s offerings because AR
routinely mentions the incentives in advertising
campaigns and on its own Web site.
Although AR is not contractually required to provide
credits to consumers, the merchants (i.e., AR’s
customers) are aware of the offerings and have a
reasonable expectation of benefiting from them.
Further, although AR also benefits from the
offerings through increased use of the platform,
that benefit is not a good or service that is
distinct from the platform services provided to the
merchants that benefit from the offerings through
increased sales on the platform.
Entity AR therefore concludes that the credits should
be accounted for as consideration payable to a
customer and records such amounts as a reduction of
revenue.
Example 6-19
Assume the same facts as in the example above, except
for the following:
-
Entity AR does not regularly offer credits to consumers. Rather, AR occasionally offers ad hoc credits as a short-term marketing strategy to penetrate certain markets via e-mail campaigns.
-
The details of the offerings are not available to the merchants even after they are provided to consumers.
Because the merchants are unaware of the ad hoc
credits, new or existing merchants do not have a
reasonable expectation of benefiting from the
credits provided to consumers. Therefore, AR may
conclude that the credits are not paid on behalf of
its customers. That is, AR may conclude that the
credits are not consideration payable to a customer
and instead can be separately accounted for as sales
and marketing expenses when incurred. However,
before making this determination, AR should
carefully consider any information about the
offerings that is reasonably available to the
merchants. If information about the offerings is
reasonably available to the merchants, the credits
may need to be accounted for as consideration
payable to a customer.
Connecting the Dots
At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB
Developments, OCA Senior Associate Chief Accountant Jonathan Wiggins
discussed a scenario in which an entity that operates a marketplace
platform and is acting as an agent must determine which party or
parties are the entity’s customers. This assessment is particularly
important when the entity offers incentives to one or more parties
involved in the arrangement. Mr. Wiggins referred to isolated fact
patterns in which platform entities have concluded that they are
seller agents and were able to support the presentation of certain
incentives paid to the end user as a marketing expense rather than
as a reduction of revenue. He cautioned that an entity’s specific
facts and circumstances may not support this accounting and
financial reporting conclusion and that the SEC staff has objected
to recognizing incentives as a marketing expense in certain
circumstances. In addition, he advised that an entity acting as a
seller agent should consider whether it has multiple customers,
including whether it receives consideration from both the seller and
the end user. Mr. Wiggins noted that even if the entity concludes
that it has only one customer (i.e., the seller), the entity should
consider whether it has made an implicit or explicit promise to
provide incentives to the end user on the seller’s behalf. Further,
the entity should consider whether incentives are an in-substance
price concession because the seller has a valid expectation that the
entity will provide the incentives to the end user buying the good
or service.
In considering the SEC staff’s views, we believe that determining
whether there is an implicit promise to provide incentives to the
end users on the seller’s behalf and whether the seller has a valid
expectation that the entity (i.e., the entity acting as a seller
agent) will provide incentives to the end users requires an
understanding of the entity’s facts and circumstances. The entity
should analyze all communications with the seller and the type of
information that the seller might have about the entity’s incentive
program. If information about the incentives is reasonably available
to the seller, those incentives may be deemed to be consideration
payable to a customer (i.e., incentives paid on the seller’s
behalf).
6.6.1.2 Identifying Payments Within the Scope of the Requirements Related to Consideration Payable to a Customer
In accordance with ASC 606-10-32-25, consideration payable
to a customer includes the following:
- Cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase the entity’s goods or services from the customer)
- Credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that purchase the entity’s goods or services from the customer)
- Equity instruments (liability or equity classified) granted in conjunction with selling goods or services (for example, shares, share options, or other equity instruments).
An entity should account for consideration payable to a customer as a
reduction of the transaction price and, therefore, of revenue unless the
payment to the customer is in exchange for a distinct good or service
(typically resulting in the recognition of an asset or expense).
An entity should assess the following payments to customers
under ASC 606-10-32-25 to determine whether they are in exchange for a
distinct good or service:
-
Payments to customers that result from a contractual obligation (either implicitly or explicitly).
-
Payments made on behalf of customers that are considered in-substance price concessions because the customer has a reasonable expectation of such payments (either implicitly or explicitly; see further discussion in Section 6.6.1.1).
-
Purchases made on behalf of customers in lieu of making cash payments to those customers.
-
Payments to customers that can be economically linked to revenue contracts with those customers.
While an entity is not required to separately assess and
document each payment made to a customer, an entity should not disregard
payments that extend beyond the context of a specific revenue contract with
a customer. Rather, an entity should use reasonable judgment when
determining how broadly to apply the guidance on consideration payable to a
customer to determine whether the consideration provided to the customer is
in exchange for a distinct good or service (and is therefore an asset or
expense) or is not in exchange for a distinct good or service (and is
therefore a reduction of revenue).
The above issue is addressed in Implementation Q&A 25 (compiled from previously
issued TRG Agenda Papers 19, 25, 28, 34, 37, and 44). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
Payments made to third parties on behalf of customers can come in many forms
and may not necessarily be incentives paid to a customer’s customer to be
deemed consideration payable to a customer. For example, an entity might pay
a fee to a financing company that enables the entity’s customer to obtain a
favorable borrowing rate for a loan the customer uses to pay for the
entity’s product. In this example, the payment to the financing company
would be linked to the revenue contract with that customer and is being made
on behalf of (and for the benefit of) that customer. Therefore, the fee paid
would be deemed consideration payable to a customer and should be recorded
as a reduction of revenue.
In determining whether a payment made to a third party is on behalf of a
customer, the entity making the payment should consider whether it receives
a distinct good or service from the third party. In the above example, the
entity does not receive a distinct good or service because (1) the customer
is the party that obtains the favorable financing from the third party
(i.e., the entity is not the party that receives a good or service from the
third party for making the payment) and (2) the benefit the entity receives
from making the payment is not distinct from the product sold in its revenue
contract with the customer.
Further, in determining whether a payment made to a third party is on behalf
of a customer, the entity making the payment might consider whether it is
acting as a principal or as an agent when the customer receives the good or
service provided by the third party. For example, if an entity (1) sells a
service to a customer, (2) pays a third party for a distinct good that is
provided to the customer for free, and (3) is the principal in providing
that good to the customer because it obtains control over that good before
the good is transferred to the customer, the entity may determine that the
payment made to the third party should be reflected as cost of sales. In
this circumstance, the good provided to the customer may be considered a
separate performance obligation in the entity’s revenue contract with the
customer. By contrast, if the entity is an agent in facilitating the
provision of the good to the customer, the payment made to the third party
could be deemed consideration payable to a customer because the payment is
being made on behalf of the customer.
Example 6-20
Natural Gas Inc. (the “Company”) is
a supplier of renewable natural gas for commercial
vehicle operators, which are the Company’s
customers. To increase its sales of renewable
natural gas, the Company offers an incentive to its
customers to use natural gas–powered vehicles
(rather than diesel-powered vehicles). To offer the
incentive to its customers, the Company partners
with Car Rental Inc., an unrelated third-party
commercial vehicle lessor.
The Company’s incentive program for
its customers is structured as follows:
-
The customer enters into a three-year lease agreement for a natural gas–powered vehicle with Car Rental Inc. The terms of the lease agreement stipulate that the customer is to make lease payments to Car Rental Inc. that are equal to the market rate for a leased diesel-powered vehicle, which is less than the market rate for the leased natural gas–powered vehicle. At the direction of the customer, the Company makes cash payments directly to Car Rental Inc. to cover the difference between the market rate for a leased diesel-powered vehicle and the market rate for the leased natural gas–powered vehicle.
-
If the customer leases a natural gas–powered vehicle, the customer executes a separate natural gas supply contract with the Company in exchange for the Company’s cash payments to Car Rental Inc. that commits the customer to purchase a minimum volume of natural gas from the Company. The Company’s incremental cash payments to Car Rental Inc. are required on the basis of the Company’s contract with the customer. The Company’s customer billings for the natural gas have sufficient margins to cover the Company’s incremental cash payments to Car Rental Inc.
-
The Company is named as a secondary lienholder of the leased natural gas–powered vehicle (subordinate to Car Rental Inc.). However, the Company does not take possession of the leased asset (the natural gas–powered vehicle) at any time, does not operate the natural gas–powered vehicle at any time, and does not control the natural gas–powered vehicle with respect to its use. In the event that the customer defaults under its lease agreement with Car Rental Inc., the Company is not obligated to make lease payments for the natural gas–powered vehicle.
The Company’s cash payments to Car
Rental Inc. should be accounted for as consideration
payable to a customer in accordance with ASC
606-10-32-25 through 32-27 even though Car Rental
Inc. is not the Company’s customer, the customer’s
customer, or another party in the distribution
channel for the Company’s natural gas.
As stated in Section
6.6.1.1, the requirements related to
consideration payable to a customer should be
applied more broadly to include parties outside the
distribution chain depending on the facts and
circumstances. While the Company’s cash payments are
not to its customer’s customer, the cash payments to
Car Rental Inc. are required on the basis of the
Company’s contract with the customer. Accordingly,
the Company should account for the cash payments to
Car Rental Inc. as consideration payable to a
customer. Since the Company could have made the cash
payments directly to the customer, which then could
have paid Car Rental Inc. for the lease payments in
their entirety, we believe that there is no
difference in the substance of the arrangement.
Further, the Company does not
receive a distinct good or service in exchange for
the cash payments to Car Rental Inc. Therefore, in
accordance with ASC 606-10-32-25 through 32-27, the
consideration payable to the customer should be
recognized as a reduction of the transaction price
when or as the related goods or services are
transferred to the customer.
6.6.1.3 Accounting for an Entity’s Participation in Its Customer’s Third-Party Financing
In certain revenue transactions, an entity may participate
in a customer’s third-party financing by (1) providing financial guarantees
or indemnifications to the financing party or (2) buying down interest rate
points payable to the financing party to give the customer a sales
incentive. These types of arrangements may be structured in any of various
forms, such as one in which the customer obtains third-party financing to do
either of the following:
-
Pay for a product up front when the product is delivered.
-
Make payments to the entity over time rather than pay any up-front consideration to the entity.
Depending on the facts and circumstances of the particular
arrangement, an entity’s participation in its customer’s third-party
financing may (1) affect the entity’s assessment that collectibility of
substantially all of the consideration to which the entity will be entitled
for goods or services transferred to the customer is probable, (2) affect
the entity’s determination of the transaction price of the entity’s contract
with the customer, or (3) result in a guarantee within the scope of ASC
460.
When an entity’s customer has obtained third-party financing
and the entity participates in the financing, the entity should first
evaluate whether its participation in the financing results in a guarantee
within the scope of ASC 460.
If the entity’s participation in the financing is not a
guarantee within the scope of ASC 460, the entity should still consider
whether the nature of the arrangement may affect the assessment of
collectibility or increase the probability that the entity will offer a
price concession to the customer. That is, through the entity’s
participation in the third-party financing, the entity may inherently be
more likely to accept an amount that is less than what it is entitled to
under the contract. Specifically, under the revenue recognition framework of
ASC 606, the entity will need to evaluate whether (1) its participation in
the financing affects its assessment that collectibility of substantially
all of the consideration to which the entity will be entitled for goods or
services transferred to the customer is probable (step 1) or (2) any
potential price concessions represent variable consideration that should be
included in the determination of the transaction price (step 3). See
Sections 4.3.5 through
4.3.5.5 for further discussion of collectibility concepts,
including those related to price concessions.
In addition, under the revenue recognition framework of ASC
606, the entity should consider whether the nature of the arrangement
includes consideration payable to a customer that would be accounted for as
a reduction in the transaction price (step 3). If the payments the entity
made to the financing party are contractually or economically linked to the
entity’s revenue contract with the customer, the entity should account for
those payments as consideration payable to a customer, as discussed in
Section 6.6.1.2.
6.6.2 Applying the Guidance on Consideration Payable to a Customer
In most circumstances, application of the guidance on consideration payable to a
customer is straightforward because an entity pays a customer a fixed cash
amount at the inception of a new contract without receiving any goods or
services in return. In these situations, it is clear that the requirements of
ASC 606-10-32-25 through 32-27 related to consideration payable to a customer
need to be applied. However, application of this guidance can prove to be
challenging in other scenarios, such as those in which (1) other third parties
are involved or (2) purchases or payments are made on a customer’s behalf rather
than directly to the customer. An entity may have to make critical judgments in
applying the guidance, including those related to (1) determining whether a
“distinct” good or service is received from a customer in exchange for a
payment, (2) applying the guidance on variable consideration, (3) determining
the transaction price when a customer supplies goods or services to the entity,
and (4) presentation matters when amounts paid (or payable) to a customer could
exceed the consideration to which the entity expects to be entitled from the
customer.
When applying the guidance on consideration payable to a customer, an entity may
also have to use judgment to identify the related revenue so that it can
appropriately determine what revenue (or portion of revenue) needs to be
reduced. That is, judgment may be required in the determination of whether
consideration payable to a customer is related to one or more of the following
types of revenue:
-
Revenue previously recognized.
-
Revenue associated with performance obligations in a current or new contract.
-
Revenue from a potential future contract.
See Section 6.6.3 for additional
considerations related to up-front payments made to customers.
The following example in ASC 606 illustrates how an entity would
account for consideration payable to a customer:
ASC 606-10
Example 32 — Consideration Payable to a
Customer
55-252 An entity that
manufactures consumer goods enters into a one-year
contract to sell goods to a customer that is a large
global chain of retail stores. The customer commits to
buy at least $15 million of products during the year.
The contract also requires the entity to make a
nonrefundable payment of $1.5 million to the customer at
the inception of the contract. The $1.5 million payment
will compensate the customer for the changes it needs to
make to its shelving to accommodate the entity’s
products.
55-253 The entity considers
the guidance in paragraphs 606-10-32-25 through 32-27
and concludes that the payment to the customer is not in
exchange for a distinct good or service that transfers
to the entity. This is because the entity does not
obtain control of any rights to the customer’s shelves.
Consequently, the entity determines that, in accordance
with paragraph 606-10-32-25, the $1.5 million payment is
a reduction of the transaction price.
55-254 The entity applies the
guidance in paragraph 606-10-32-27 and concludes that
the consideration payable is accounted for as a
reduction in the transaction price when the entity
recognizes revenue for the transfer of the goods.
Consequently, as the entity transfers goods to the
customer, the entity reduces the transaction price for
each good by 10 percent ($1.5 million ÷ $15 million).
Therefore, in the first month in which the entity
transfers goods to the customer, the entity recognizes
revenue of $1.8 million ($2.0 million invoiced amount –
$0.2 million of consideration payable to the
customer).
6.6.2.1 Meaning of “Distinct” Goods or Services
In accordance with ASC 606-10-32-25, consideration payable
to a customer should generally be accounted for as a reduction of the
transaction price (and, therefore, of revenue). However, ASC 606-10-32-26
provides that if the payment to the customer is in exchange for a distinct
good or service that the customer transfers to the entity, the entity should
“account for the purchase of the good or service in the same way that it
accounts for other purchases from suppliers.”
ASC 606-10-32-25 refers to ASC 606-10-25-18 through 25-22 for guidance on the
identification of distinct goods or services. Specifically, in the context
of consideration payable to a customer, application of ASC 606-10-25-19
would lead to a determination that goods or services are distinct if both of
the following criteria are met:
-
The entity can benefit from the good or service supplied by the customer (either on its own or together with other resources that are readily available to the entity).
-
The customer’s promise to transfer the good or service to the entity is separately identifiable from other promises in the entity’s revenue contract with the customer (i.e., the customer’s promise to transfer the good or service to the entity is distinct within the context of the contract, and the benefit to be received by the entity is separable from the sale of goods or services by the entity to the customer).
See Chapter
5 for further discussion of identifying distinct goods or
services in a contract with a customer.
Paragraph BC256 of ASU 2014-09 explains that the principle for assessing
whether a good or service is distinct is similar to the concept of an
“identifiable benefit” previously applied under U.S. GAAP. As stated in
paragraph BC256, an identifiable benefit “was described as a good or service
that is ‘sufficiently separable from the [customer’s] purchase of the
vendor’s products such that the vendor could have entered into an exchange
transaction with a party other than a purchaser of its products or services
in order to receive that benefit.’”
Note that when an entity concludes that the consideration
payable to a customer is for distinct goods or services that the entity
receives, the entity is also required to assess whether it can reasonably
estimate the fair value of those distinct goods or services (see Section 6.6.2.3).
6.6.2.2 Consideration Payable to a Customer and Variable Consideration
The revenue standard requires an entity to recognize
consideration payable to a customer as a reduction of revenue at the later
of when the entity (1) recognizes revenue for the transfer of the related
goods or services or (2) pays or promises to pay such consideration.
However, under the revenue standard, an entity also has to take into account
variable consideration when determining the transaction price.
For example, if an entity anticipates that it may provide a
coupon to the customer when entering into the contract, or if, given the
facts and circumstances, an entity can conclude that the customer has a
valid expectation that it will receive a price concession in the form of a
coupon, the coupon represents variable consideration that the entity should
estimate at contract inception.9 The entity’s anticipation or the customer’s expectation of a price
concession does not need to be explicit and instead may be determined on the
basis of the entity’s history of granting price reductions through coupons
(i.e., on the basis of the entity’s customary business practices even though
the coupon is not explicitly stated in the contract). Accordingly, the
entity should apply the guidance on estimating variable consideration in ASC
606-10-32-5 and should reduce the transaction price before the payment is
communicated to the customer (i.e., at contract inception, when the
transaction price is estimated).
Because an entity needs to take into account the variable
consideration guidance in determining when to recognize price concessions
such as coupons provided to a customer, it is expected that the “later of”
guidance in ASC 606-10-32-27 on consideration payable to a customer under
the revenue standard will be applied in limited circumstances.
The above issue is addressed in Implementation Q&A 29 (compiled from previously
issued TRG Agenda Papers 19, 25, 28, 34, 37, and 44). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
6.6.2.3 Determining the Transaction Price — Consideration of Goods or Services Supplied to the Entity by the Customer
When an entity enters into an agreement to sell products to
a customer, the transaction with the customer may also involve the
customer’s supplying goods or services to the entity. The contract may be
structured in such a way that the consideration payable by the entity to the
customer for those goods or services is separately identified.
Alternatively, the contract may be structured in such a way that it includes
a single amount payable by the customer to the entity that reflects the net
of the value of the goods or services provided by the entity to the customer
and by the customer to the entity. When the fair value of the goods or
services can be reasonably estimated, the accounting outcome should be the
same in either circumstance.
The goods or services supplied by the customer should be
accounted for separately if both of the following conditions are met:
-
Those goods or services are “distinct” (see Section 6.6.2.1).
-
The entity can reasonably estimate the fair value of the goods or services that it will receive (which may not correspond to any amount specified in the contract for those goods or services).
If both of these conditions are met, the fair value of the
goods or services received from the customer should be accounted for in the
same way the entity accounts for other purchases from suppliers (e.g., as an
expense or asset). If any consideration payable to the customer with respect
to those goods or services exceeds their fair value, the excess should be
accounted for as a reduction of the transaction price.
If either or both of these conditions are not met, any
consideration payable to the customer with respect to those goods or
services should be accounted for as a reduction of the transaction
price.
The examples below illustrate the application of this
guidance.
Example 6-21
An entity sells goods to a customer
for $10,000 and, as part of the same arrangement,
pays that customer $1,000 in exchange for a service.
If the service is determined to be distinct and its
fair value can be reasonably estimated (as being,
for example, $600), a portion of the contractually
stated amount will be recognized as a reduction of
the transaction price for the sale of goods to
$9,600 ($10,000 minus the $400 payment made to the
customer in excess of the fair value of the service
received).
Example 6-22
An entity sells goods to a customer
for $10,000 and, as part of the same arrangement,
pays that customer $1,000 in exchange for a service.
If the service is not determined to be distinct or
its fair value cannot be reasonably estimated, the
transaction price for the sale of goods will be
reduced to $9,000 ($10,000 minus the full amount
payable to the customer).
The requirements above apply irrespective of whether the
consideration related to the goods or services supplied by the customer is
separately identified in the contract. If the contract is net settled (i.e.,
the customer is required to pay cash and provide distinct goods or services
as payment for the goods or services provided by the entity to the customer,
and the entity does not make a cash payment to the customer for the distinct
goods or services provided by the customer), the noncash consideration
guidance would apply (see Section
6.5).
6.6.2.4 Impact of Negative Revenue on Presentation of Consideration Payable to a Customer
In certain arrangements, amounts paid (or payable) to a
customer could exceed the consideration to which the entity expects to be
entitled from the customer. In these situations, recognition of payments to
the customer as a reduction of revenue could result in “negative revenue.”
Legacy revenue guidance in ASC 605-50 included explicit guidance on how to
account for payments to customers that result in negative revenue. In these
cases, ASC 605-50-45-9 required an entity to reclassify the cumulative
shortfall (i.e., the amount of the payment to a customer in excess of the
entity’s cumulative revenue from the customer) from a reduction of revenue
to an expense unless certain conditions exist.
ASC 606 does not specifically address situations in which
the entity could potentially recognize negative revenue if it accounts for
consideration payable to a customer as a reduction of revenue.
The absence of explicit guidance in ASC 606 was acknowledged
in TRG Agenda Paper 19, which was prepared by the FASB and
IASB staffs for the TRG’s January 2015 meeting. Specifically, those staffs
acknowledged in paragraph 27 of TRG Agenda Paper 19 that ASC 606 “does not
currently address the accounting for ‘negative revenue.’ ” Although negative
revenue was included as an issue for discussion in TRG Agenda Paper 19, the
TRG did not reach a consensus on whether and, if so, when negative revenue
should be reclassified as an expense.
In the absence of explicit guidance in ASC 606, we believe
it would be acceptable for entities to consider the legacy guidance in ASC
605-50 by analogy and reclassify negative revenue as an expense if certain
conditions are met. Specifically, the legacy guidance in ASC 605-50-45-9
stated:
A vendor may remit or be obligated to remit cash
consideration at the inception of the overall relationship with a
customer before the customer orders, commits to order, or purchases
any vendor products or services. Under the guidance in the preceding
two paragraphs, any resulting negative revenue may be
recharacterized as an expense if, at the time the consideration is
recognized in the income statement, it exceeds cumulative revenue
from the customer. However, recharacterization as an expense would
not be appropriate if a supply arrangement exists and either of the
following circumstances also exists:
-
The arrangement provides the vendor with the right to be the provider of a certain type or class of products or services for a specified period of time and it is probable that the customer will order the vendor’s products or services.
-
The arrangement requires the customer to order a minimum amount of vendor products or services in the future, except to the extent that the consideration given exceeds probable future revenue from the customer under the arrangement.
Example 6-23
On January 1, 20X1, Company A enters
into a master supply agreement with Customer X to
sell X an undefined quantity of widgets over a
five-year period. A sale of widgets is initiated
each time X issues a purchase order to A, at which
point A is legally obligated to supply X with the
quantity of widgets specified in the purchase order.
Company A expects that it is
probable that X will purchase a total of 1,000
widgets per year (i.e., 5,000 widgets over the term
of the master supply agreement). The price of each
widget is $5.
As an incentive for X to enter into
the master supply agreement, A agrees to pay X
$30,000 upon receipt of the first purchase order. On
January 15, 20X1, X issues its first purchase order
to A for 200 widgets. Customer X pays A $1,000 for
the 200 widgets and receives the $30,000 payment
from A. Company A determines that at least some of
the $30,000 payment meets the definition of an asset
(see Section 6.6.3
for considerations related to whether an up-front
payment meets the definition of an asset). In
addition, A determines that the $30,000 is not in
exchange for a distinct good or service.
To determine the amount of negative
revenue, A compares the $30,000 payment to X with
the total purchases that A believes it is probable
that X will make over the term of the master supply
agreement (i.e., $25,000 for 5,000 widgets). Because
the consideration payable to X ($30,000) exceeds the
total expected purchases from X ($25,000), it would
be acceptable for A to reclassify the cumulative
shortfall ($5,000) as an expense.
6.6.2.5 Retail Industry Considerations
Transactions that involve payments by an entity to a customer frequently
arise in the retail industry. One transaction of this nature is illustrated
in Example 32 of the revenue standard (ASC 606-10-55-252 through 55-254
above), in which an entity makes a payment to a customer to compensate it
for changes it needs to make to its shelving to accommodate the entity’s
products. In this example, the entity concludes that the payment to the
customer should be accounted for as a reduction of the transaction price
because the payment is not in exchange for a distinct good or service the
entity receives.
The example below illustrates how an entity in an arrangement involving the
payment of “slotting fees,” which are common in the retail industry, should
determine whether the services supplied by the customer in exchange for the
slotting fees are distinct from the goods sold to the customer.
Example 6-24
Entity X contracts to sell products to Entity Y, a
retailer. As part of the contract, Y promises to
display the products in a prime location within its
store to encourage sales of those products to the
end customer in exchange for a payment from X
(payments for such services are commonly referred to
as slotting fees).
To determine the appropriate accounting, X considers
whether the services provided by Y are “distinct.”
Entity X concludes that its only substantive benefit
from those services will be through additional sales
in Y’s store and that it would not enter into an
exchange transaction with a party other than a
purchaser of its products to receive that benefit
(i.e., it would not pay for the services if Y were
not also purchasing goods from X). Consequently,
although X believes that it receives benefit from
the services provided by Y, it concludes that the
benefit received and its own sales of goods to Y are
highly interrelated. Therefore, it concludes that
the services provided by Y are not sufficiently
separable from Y’s purchases of X’s products to be
regarded as distinct.
Accordingly, any payments made, or discounts
provided, to Y in exchange for such slotting
services should be accounted for as a reduction of
the transaction price recognized by X in accordance
with ASC 606-10-32-25 and ASC 606-10-32-27 (see
Section
6.6.2.3).
Connecting the Dots
In the retail industry, it is common for a wholesaler to pay a
retailer (the wholesaler’s customer) (1) fees to have the products
allocated to attractive or advantageous spaces in the retailer’s
premises for a defined period (i.e., slotting fees) and (2) fees to
be included in the retailer’s list of authorized suppliers (i.e.,
listing fees). ASC 606-10-32-25 requires an entity to account for
consideration paid to a customer as a reduction of the transaction
price “unless the payment to the customer is in exchange for a
distinct good or service.” Given that guidance, stakeholders have
asked whether the wholesaler in an arrangement involving slotting or
listing fees receives a distinct good or service from the retailer
in return for the payment of these fees.
Our view is that slotting and listing fees cannot be separated from
the sale of the products to the retailer (since the fees are
generally not paid when no products are sold) and thus have no value
to the wholesaler unless these payments are linked to the products
sold. Therefore, these slotting and listing fees are not capable of
being distinct.
6.6.2.5.1 Consideration Payable to a Customer for Advertising in the Retail Industry
The types of advertising arrangements in the retail industry vary
significantly. For example, a supplier could pay a retailer to provide
advertising in an in-store circular or on a third-party search engine.
In addition, to reach the right consumers and optimize sales, suppliers
are increasingly using retail media networks (RMNs), collections of
digital channels that allow retailers and product suppliers to use
consumer data to create targeted, more effective advertising programs
and platforms.
Because a retailer’s provision of advertising services to a supplier can
involve contracts that are highly complex, multiparty, or both, an
entity may need to use significant judgment to determine the appropriate
accounting treatment. Such arrangements include those in which a
retailer (i.e., customer) provides goods or services to a supplier
(i.e., vendor); thus, it is important for an entity to carefully analyze
the nature of the arrangement to determine whether the goods or services
(i.e., advertising services) provided by a retailer are distinct from
the retailer’s purchase of products from the supplier. A key part of
that analysis is the determination of whether the supplier would
purchase the advertising from the retailer if it was not also selling
its products to the retailer.
The accounting judgments and considerations are similar from the
supplier’s standpoint. That is, the supplier likewise needs to determine
whether the advertising services acquired from the retailer are distinct
from the products sold to the retailer.
If the advertising services are distinct, the purchase or sale of the
advertising services will typically be accounted for as a separate
transaction (i.e., as revenue or income by the retailer or an expense by
the supplier). However, if the advertising services are not distinct,
any consideration exchanged between the parties will typically be
accounted for as a reduction of (1) the cost of products purchased by
the retailer and (2) revenue by the supplier.
While such arrangements are often between retailers and suppliers in the
retail industry, similar arrangements may also exist in other
industries, such as travel and hospitality. The accounting concepts
discussed below apply to similar contracts and analogous fact patterns
regardless of industry.
It is important for an entity to carefully evaluate the nature and type
of advertising promised in the contract when determining whether it is
distinct from the products sold to the retailer. The evaluation of
whether the products and advertising are distinct is based on the
criteria in ASC 606-10-25-19 through 25-21, which are considered by both
the retailer and the supplier.
6.6.2.5.1.1 Retailer’s Accounting
Because the retailer typically (1) receives or is entitled to receive
cash in exchange for the advertising services provided to the
supplier and (2) pays or is obligated to pay cash for products
purchased from the supplier, the retailer should consider the
guidance in ASC 705-20. This guidance requires an entity to account
for any consideration received from the supplier as a reduction of
the cost of products purchased from the supplier unless the supplier
receives a distinct good or service.10 If the supplier receives a distinct advertising service, the
retailer will generally account for the sale of advertising services
as revenue from a contract with a customer (provided that the
advertising services are outputs of the retailer’s ordinary
activities), but the amount recorded as revenue cannot exceed the
stand-alone selling price of the advertising services. ASC
705-20-25-2 addresses this point:
If the consideration from a vendor is in exchange for a
distinct good or service (see paragraphs 606-10-25-19
through 25-22) that an entity transfers to the vendor, then
the entity shall account for the sale of the good or service
in the same way that it accounts for other sales to
customers in accordance with Topic 606 on revenue from
contracts with customers. If the amount of consideration
from the vendor exceeds the standalone selling price of the
distinct good or service that the entity transfers to the
vendor, then the entity shall account for such excess as a
reduction of the purchase price of any goods or services
acquired from the vendor. If the standalone selling price is
not directly observable, the entity shall estimate it in
accordance with paragraphs 606-10-32-33 through 32-35.
For more information about determining whether the
advertising services provided by the retailer are distinct from the
products the retailer purchases from the supplier, see Section
6.6.2.5.1.3.
While the language in ASC 705-20 on consideration
received from a vendor differs from that in the legacy GAAP in ASC
605-50, the guidance in the two Codification subtopics is similar.
Under ASC 605-50-45-12 through 45-14 (superseded by ASU 2014-09),
cash received by a customer from a vendor was presumed to be a
reduction of the cost of products the customer purchased unless it
was payment for an “identifiable benefit.” That is, the goods or
services received by the supplier “must be sufficiently separable
from the customer’s purchase of the vendor’s products such that the
customer would have entered into an exchange transaction with a
party other than the vendor in order to provide that benefit, and
the customer can reasonably estimate the fair value of the benefit
provided.” See Section 6.6.2.5.1.2 for more information.
A retailer will sometimes partner with a third-party advertising
company to provide the advertising services to the supplier. In
these circumstances, the retailer will need to consider the
principal-versus-agent guidance in ASC 606. Under ASC 606-10-55-36
through 55-40, the retailer is the principal for the advertising
services if it controls the advertising services before they are
transferred to the supplier. Typically, the principal is the party
that is primarily responsible for fulfilling the advertising
services. If the retailer is the principal, it will recognize the
gross amount paid by the supplier as revenue and a corresponding
cost for the goods or services received from the third-party
advertising company. However, if the retailer is an agent because it
does not control the advertising services before they are
transferred to the supplier, it will recognize the net amount it
retains (i.e., the amount paid by the supplier less the amount paid
to the third-party advertising company) for arranging for the
third-party advertising company to provide advertising services to
the supplier. For more information about principal-versus-agent
considerations, see Chapter
10.
6.6.2.5.1.2 Supplier’s Accounting
The accounting framework for the supplier is largely
symmetrical to that of the retailer. Specifically, any consideration
paid or payable by the supplier should be accounted for as a
reduction of the transaction price (i.e., revenue) for product sales
unless the supplier receives a distinct good or service. However,
unlike the retailer, the supplier must also be able to reasonably
estimate the fair value of the good or service received from the
retailer so that it can account for the distinct good or service
separately (see ASC 606-10-32-25 and ASC 606-10-32-36, which are
reproduced in Section 6.6).
The example below illustrates a supplier’s accounting for an
arrangement involving consideration payable to a customer (a
retailer) in exchange for advertising in an in-store circular.
Example 6-25
Entity F contracts to sell
products to Entity G, a retailer. As part of the
contract, G agrees to include F’s products in G’s
weekly in-store advertising circular in exchange
for cash consideration.
To determine the appropriate
accounting, F considers whether the in-store
advertising services provided by G are “distinct.”
Entity F concludes that its only substantive
benefit from those services will be through
additional sales in G’s store and that it would
not pay for the services if G were not also
purchasing goods from F. Consequently, although F
believes that it receives benefit from the
services supplied by G (thus meeting the criterion
in ASC 606-10-25-19(a)), it concludes that the
benefit received and its own sales of goods to F
are highly interrelated; the service received is
not distinct in the context of the contract (thus
failing the criterion in ASC 606-10-25-19(b)).
Accordingly, any payments made, or discounts
provided, to G in exchange for the inclusion of
F’s products in G’s weekly in-store advertising
circular would be considered a reduction of the
transaction price recognized by F in accordance
with ASC 606-10-32-25 and ASC 606-10-32-27 (see
Section 6.6.2.3).
The example below illustrates a supplier’s accounting for an
arrangement involving consideration payable to a customer (a
retailer) in exchange for broadly distributed advertising.
Example 6-26
Entity J contracts to sell a particular product
to Entity K, a retailer, and also sells that
product through other retailers and directly to
the public via its Web site. As part of the
contract, K agrees to advertise the sale of J’s
product in a national newspaper and on national
television and radio in exchange for cash
consideration.
To determine the appropriate accounting, J
considers whether the advertising services
provided by K are “distinct.” Entity J concludes
that (1) it will benefit from the advertising
undertaken by K through increased sales in all
retail stores that sell the product (not just in
K’s store) and via its Web site and (2) it would
enter into an exchange transaction with a party
other than a purchaser of its product to receive
that benefit (e.g., it could purchase advertising
services directly from the third-party media
outlets). Entity J concludes that the services
provided by K are sufficiently separable from K’s
purchase of J’s product and are therefore
distinct.
Accordingly, J should assess whether it can
reasonably estimate the fair value of the
advertising services that it will receive (which
may not correspond to any amount specified in the
contract for those services). If that fair value
can be reasonably estimated, J should record the
lesser of the fair value of those services or the
consideration paid to the customer as an expense
when the advertising services are received.
If the fair value cannot be reasonably
estimated, any consideration payable by J to K
with respect to services should be accounted for
as a reduction in the transaction price for the
sale of goods to K. In addition, if the fair value
can be reasonably estimated, any amount of
consideration paid to K that exceeds the fair
value of the advertising services received should
be accounted for as a reduction of the transaction
price for the sale of goods to K.
The guidance in ASC 606 on consideration payable to a customer is
similar to legacy GAAP in ASC 605-50 in that ASC 605-50-45-2
included a presumption that any consideration paid by a vendor to a
customer would be recorded as reduction of revenue unless the vendor
(1) “receives, or will receive, an identifiable benefit (goods or
services)” from the customer and (2) “can reasonably estimate the
fair value of the benefit identified.” ASC 605-50-45-2 (superseded
by ASU 2014-09) stated, in part, the following regarding the
determination of whether an identified benefit can be accounted for separately:
In order to meet this condition, the identified benefit must
be sufficiently separable from the recipient’s purchase of
the vendor’s products such that the vendor could have
entered into an exchange transaction with a party other than
a purchaser of its products or services in order to receive
that benefit.
While the wording in ASC 606 differs from that in
the legacy guidance, the application of the current guidance appears
to be similar to how the legacy guidance was applied. The FASB
addresses this matter in paragraph BC256 of ASU
2014-09, which states, in part:
Previous guidance in U.S. GAAP on the
consideration that a vendor gives to a customer used the
term identifiable benefit, which was described as a good or
service that is “sufficiently separable from the recipient’s
purchase of the vendor’s products such that the vendor could
have entered into an exchange transaction with a party other
than a purchaser of its products or services in order to
receive that benefit.” The Boards concluded that the
principle in Topic 606 for assessing whether a good or
service is distinct is similar to the previous guidance in
U.S. GAAP.
In short, consideration payable to a customer (e.g., cash
consideration a supplier pays a retailer) should be accounted for as
a reduction of the transaction price (i.e., revenue) when
recognized, unless those payments are for distinct goods or services
(i.e., there is a separately identifiable benefit derived from the
goods or services) and the fair value can be reasonably
estimated.
6.6.2.5.1.3 Distinct Goods or Services
In determining whether the goods or services provided to the supplier
are distinct, an entity should consider the guidance in ASC
606-10-25-18 through 25-22. The application of ASC 606-10-25-19
would lead to a determination that goods or services are distinct if
both of the following criteria are met:
- The supplier can benefit from the advertising provided by the retailer (either on its own or with other readily available resources) in such a way that the advertising is capable of being distinct.
- The retailer’s promise to provide the advertising services to the supplier is separately identifiable from the promised goods or services in the supplier’s revenue contract with the retailer (i.e., the retailer’s promise to provide the advertising services to the supplier is distinct within the context of the contract, and the benefit to be received by the supplier is sufficiently separable from the promised goods or services in the supplier’s revenue contract with the retailer).
When a retailer provides advertising to its supplier, the first
criterion will typically be met. That is, advertising will typically
be capable of being distinct because advertising companies often
sell advertising on a stand-alone basis and the supplier can derive
some economic benefit from the advertising on its own (e.g., brand
awareness) even if the supplier is not selling goods to the retailer
providing the advertising.
However, the assessment of whether advertising is distinct in the
context of the contract will often be more challenging
because an entity will frequently need to use significant judgment
to determine whether the advertising is distinct in the context
of the contract. One of the factors for determining whether
goods or services are distinct in the context of the contract is
whether they are “highly interdependent or highly interrelated” in
accordance with ASC 606-10-25-21(c). In making this determination,
an entity must evaluate whether the goods or services “are
significantly affected” by each other because “the entity would not
be able to fulfill its promise by transferring each of the goods or
services independently.” That is, the entity must consider whether
the advertising services received by the supplier and the products
purchased by the retailer are significantly affected by each other
in such a way that the retailer would not be able to fulfill its
promise to provide advertising services independently from its
purchase of products from the supplier. We believe that this factor
is similar to the determination under legacy guidance of whether the
identified benefit the supplier derives from the advertising is
sufficiently separable from the supplier’s sale of products to the
retailer.
In the evaluation of whether the advertising is providing the
supplier with a separate identifiable benefit, it may be helpful for
an entity to answer the following questions:
- Would the supplier purchase the advertising from the retailer if the supplier was not also selling its products to the retailer?
- Could the supplier purchase the same advertising from a party other than a purchaser of its products to receive the same benefit? Alternatively, is the expected benefit the supplier obtains from the retailer tied to the sale of additional products to the retailer in such a way that the advertising and the retailer’s purchase of goods from the supplier are highly interdependent and interrelated?
If the answer to at least one of these first two questions is no, it
may be difficult to demonstrate that the supplier is receiving a
distinct good or service (i.e., a separate identifiable benefit)
from the retailer. Generally, we do not believe that the supplier
would be obtaining a separate identifiable benefit from the retailer
if the predominant benefit expected to be received is the sale of
additional products to the retailer.
When a supplier sells products to a retailer that (1) sells the
products on its online platform and (2) advertises the supplier’s
products on that platform, the following additional considerations
may be helpful:
- Use of third-party platforms — Advertising campaigns that include third-party platforms (e.g., third-party search engines, social media, demand-side platforms, news publishers, digital billboards) may provide a distinct benefit to the supplier because the advertising reaches potential consumers outside the retailer’s platform and may lead to additional sales for the supplier through other sales channels. Conversely, campaigns that provide advertising only on the retailer’s platforms may not provide a distinct benefit to the supplier because the advertising will only reach potential consumers on the retailer’s platform and may only lead to additional sales for the supplier through the retailer’s platform.
- Other nonsupplier customers purchasing the same advertising services — If a retailer sells advertising services to third parties that are not suppliers, the retailer may be more easily able to demonstrate that the advertising provided to the supplier is distinct because the retailer has evidence of selling advertising on a stand-alone basis in such situations. Such evidence suggests that those customers of the retailer’s advertising services believe that the advertising will provide a benefit that is separate from sales of products to the retailer.
- Other users of the retailer’s platform that are not customers of the retailer — When a retailer has a platform that is used for reasons other than purchasing goods on the platform (i.e., users of the retailer’s platform are not just consumers of the products sold on the retailer’s platform), it may be easier to demonstrate that advertising on the retailer’s platform provides a distinct benefit to the supplier. For example, if a retailer’s platform is used for product research, advertising on the retailer’s platform might provide a distinct benefit to a supplier because the advertising may be expected to reach an audience that is not necessarily expected to complete a purchase of the supplier’s product through the retailer that is providing the advertising. Rather, the advertising may be expected to provide broad brand or product awareness that results in a benefit to the supplier that is distinct from sales of products to the retailer.
If the payments are not for a distinct good or service, the cash
consideration received by the retailer from the supplier for
advertising services should be accounted for as a reduction of the
cost of the vendor’s products. Similarly, the cash consideration
paid by the supplier to the retailer should be accounted for as a
reduction of revenue.
Connecting the Dots
Advertising contracts can take many forms, and retailers and
suppliers often have numerous arrangements for product
purchases and advertising. It is, therefore, important for
an entity to consider and understand the substance of such
contracts and arrangements to ensure that it appropriately
reflects the economics of the arrangements when determining
how to account for them. We believe that an entity should
apply the above framework and considerations irrespective of
the number of contracts between the retailer and the
supplier or when the contracts were entered into.
The examples below illustrate different fact patterns related to
online advertising provided on a retailer’s platform to its
supplier.
Example 6-27
Retailer A is a large retailer that offers a
diverse product line in its brick-and-mortar
stores as well as on multiple e-commerce
platforms. Retailer A has a wide consumer base
and, via its online platforms, in-store sales,
loyalty programs, and co-branded credit cards, has
obtained a rich set of consumer data (online and
offline) such as age, gender, geographic location,
income level, family structure, past purchases,
purchasing patterns, and preferences. Retailer A’s
online platforms are used only for product
purchases, and consumers who initially evaluate a
product on its platform typically complete the
purchase on the platform. Using its consumer data,
A has established a company owned and operated
advertising agency in which it partners with
suppliers to sell online advertisement space and
create targeted advertisements. The targeted
advertisements are only for products sold by A,
and these advertisements direct consumers to A’s
online sales platform. Retailer A has a history of
offering advertising services on a stand-alone
basis, and A’s competitors have similar
advertising offerings that are sold on a
stand-alone basis; however, A only provides
advertising services to its suppliers and no other
third party purchases advertisement space on A’s
platform.
Retailer A has a merchandising relationship
with Supplier B in which A contracts to purchase
merchandise from B to sell in its stores and
online. Supplier B’s customer is A, not the end
consumers that purchase products from A’s stores
and online platforms. In addition to the
merchandising contract, B enters into an
advertising contract with A to purchase targeted
advertising space on A’s digital properties. When
a consumer clicks on an advertisement for B’s
product, that consumer will be directed to a Web
page on A’s e-commerce platform to purchase B’s
product. Retailer A charges B an advertising fee
for these services on the basis of the number of
clicks per impression (i.e., cost per click or
CPC).
Retailer A’s Accounting for the Advertising
Agreement
To determine the appropriate accounting, A must
consider whether the advertising services it
provides to B are distinct from A’s purchases of
B’s products.
Retailer A concludes that the advertising
services are capable of being distinct because B
can derive economic benefit from the advertising
services on a stand-alone basis. Further, similar
advertising services are offered by other
third-party retailers (i.e., A’s competitors),
suggesting that the advertising services are
readily available in the marketplace.
However, A concludes that the advertising
services are not distinct within the context of
the contract (i.e., are not separately
identifiable) because the benefit received from
the advertising is highly interdependent and
highly interrelated with A’s purchase of B’s
products. That is, because the advertisements are
only on A’s platform and direct consumers to
purchase B’s products on A’s platform, the
advertising services received by B and the
products purchased by A are significantly affected
by each other in such a way that A would not be
able to fulfill its promise to provide advertising
services independently from its purchase of
products from B. Because the value B derives from
A’s advertising services is intrinsically linked
to A’s purchase of B’s products (i.e., the
predominant benefit expected to be received by B
is the sale of additional products to A), the
purchase of the advertising services is not
sufficiently separable from the purchase of B’s
products.
The following factors further support the
conclusion that the advertising services are not
separately identifiable:
- Supplier B could not purchase the advertising from A without also selling its products to A. That is, A would not enter into a contract to provide its targeted advertising services with a counterparty that was not also a supplier.
- Supplier B could not purchase the same advertising from a party other than A to receive the same benefit, as demonstrated by the fact that no other third party purchases advertisement space on A’s platform.
- Retailer A’s advertising services do not include placement on any third-party platforms, suggesting that the only substantive benefit that B will obtain from the advertising services will be through additional sales of B’s products on A’s e-commerce platform.
- No other nonsupplier customers are purchasing the same advertising services, because A only provides advertising services on its online platform to its suppliers.
- Retailer A’s platform is used by consumers only for purchasing products and does not have a large viewer base of users who do not purchase products from A.
On the basis of the above analysis, A concludes
that the advertising services provided through the
advertising contract are not distinct (i.e., not
sufficiently separable) from its purchases of B’s
products. Accordingly, the fees paid by B for the
advertising services should be accounted for as a
reduction of the cost of products purchased by A
from B.
Supplier B’s Accounting for the Advertising
Agreement
In a manner similar to the accounting analysis
performed by A, B must also consider whether the
advertising services provided by A are distinct.
We would expect B to reach the same conclusion as
A and, thus, to conclude that the advertising
services are not distinct (i.e., not sufficiently
separable) from A’s purchases of B’s products.
Accordingly, the fees paid by B for the
advertising services contract should be accounted
for as a reduction of revenue for the sale of
products to A.
Example 6-28
Assume the same facts as in the example above
except for the following:
- In addition to product purchases, Retailer A’s platforms are used for product reviews and product research. Because A tracks consumer behavior, it can demonstrate that consumers use its platform for product research and often purchase products off the platform (i.e., from A’s suppliers directly or other third-party competitors that sell the same products as A) after initially evaluating products on the platform.
- Retailer A’s owned and operated advertising agency partners with both suppliers and nonsuppliers to sell advertisement space and create targeted advertisements. Retailer A has a history of selling advertising services to third parties that are not also A’s suppliers.
- Other third-party advertising companies purchase advertisement space on A’s platform for their advertising customers, who may not be suppliers of A. Third-party advertising companies and A’s suppliers pay the same rates for advertising space.
- By leveraging its consumer data, A manages B’s advertising campaign and purchases targeted advertising space on A’s digital properties and on other third-party platforms (e.g., third-party search engines, social media, publishers). The advertising budget is established at contract inception, and A has discretion regarding where to place B’s advertisements (e.g., on site or off site) as long as the campaign objectives are met. Retailer A charges B an advertising fee for these services on the basis of the number of impressions purchased (i.e., cost per mille or CPM).
Retailer A’s Accounting for the Advertising
Agreement
To determine the appropriate accounting, A must
consider whether the advertising services it
provides to B are distinct from A’s purchases of
B’s products.
Retailer A concludes that the advertising
services are capable of being distinct because (1)
B can derive economic benefit from the advertising
services on a stand-alone basis, (2) A has a
history of selling advertising services on a
stand-alone basis to third parties that are not
also A’s suppliers, (3) other third-party
advertising companies purchase advertisement space
on A’s platform for their advertising customers
(who may not be suppliers of A), and (4) similar
advertising services are offered by other
third-party retailers (i.e., A’s competitors).
These factors suggest that the advertising
services are readily available in the
marketplace.
In addition, A concludes that the advertising
services are distinct within the context of the
contract (i.e., are separately identifiable)
because the benefit received from the advertising
is not highly interdependent or highly
interrelated with A’s purchase of B’s products.
Because of the nature and type of A’s advertising
services (i.e., on-site and off-site), the
advertising services received by B and the
products purchased by A are not significantly
affected by each other and A is able to fulfill
its promise to provide advertising services
independently from its purchase of products from
B. Because B is expected to receive a distinct
benefit from increased sales across multiple
platforms and different retailers (i.e., the
predominant benefit expected to be received by B
is not just the sale of additional products to A),
the distinct benefit is incremental to the benefit
received from A’s product purchases from B and is
sufficiently separable from the purchase of B’s
products. The following factors further support
the conclusion that the advertising services are
separately identifiable:
- Supplier B could purchase the advertising from A without also selling its products to A. Retailer A enters into contracts to provide its targeted advertising services with counterparties that are also not its suppliers.
- Supplier B could purchase the same advertising from a party other than A to receive the same benefit because other third-party advertising companies purchase advertisement space on A’s platform for their advertising customers, who may not be suppliers of A.
- Other nonsupplier customers are purchasing the same advertising services because A provides advertising services on its online platform to nonsuppliers.
- Retailer A’s platform is not just used by consumers for purchasing products and has a large viewer base of users who do not purchase products from A. The nature of A’s platform is such that consumers use the information on A’s Web site to research products. As a result, a consumer may purchase products off platform after initially evaluating products on A’s platform. Accordingly, B is expected to derive broad brand and product awareness from A’s advertising that is expected to generate additional sales of B’s products to parties other than A.
On the basis of the above analysis, we believe
that it is reasonable for A to conclude that the
advertising services provided through the
advertising contract are distinct (i.e.,
sufficiently separable) from its purchases of B’s
products. Accordingly, the fees paid by B for the
advertising services should be accounted for
separately as revenue or income. However, if the
amount of consideration paid by B exceeds the
stand-alone selling price of the distinct
advertising services, the consideration received
in excess of the stand-alone selling price should
be accounted for as a reduction of the purchase
price of the products acquired from B.
Supplier B’s Accounting for the Advertising
Agreement
In a manner similar to the accounting analysis
performed by A, B must also consider whether the
advertising services provided by A are distinct.
We would expect B to reach the same conclusion as
A and, thus, to conclude that the advertising
services are distinct (i.e., sufficiently
separable) from A’s purchases of B’s products.
However, B must also assess whether it can
reasonably estimate the fair value of the
advertising services that it will receive (which
may not correspond to the fee specified in the
contract for those services). If that fair value
can be reasonably estimated, (1) B should record
the lesser of the fair value of those services or
the consideration paid to A as an expense when the
advertising services are received and (2) any
amount of consideration paid to A that exceeds the
fair value of the advertising services received
should be accounted for as a reduction of revenue
for the sale of products to A. If, instead, the
fair value cannot be reasonably estimated, any
consideration paid to A for the advertising
services should be entirely accounted for as a
reduction of revenue.
Connecting the Dots
In the above examples, the retailer is internally operating
its advertising agency services. If a retailer uses a third
party to operate all or a portion of its advertising
services, as noted earlier, the retailer must assess whether
it is the principal or agent for the underlying advertising
services. For more information about principal-versus-agent
considerations, see Chapter 10.
In addition, entities will need to carefully evaluate all
relevant facts and circumstances when determining the
appropriate accounting treatment for advertising
arrangements. Further, a contract to provide advertising
services to a supplier may include various advertising
services, some of which could be distinct while others might
not. It is important to carefully analyze the nature of the
promised services to determine the appropriate
accounting.
6.6.3 Accounting for Up-Front Payments to Customers
In developing the revenue standard, the FASB and IASB did not
broadly reconsider the accounting for up-front payments made to customers. While
the revenue standard provides explicit guidance on accounting for payments made
to customers, such guidance does not distinguish the accounting for payments
made to customers at the inception of the contract (i.e., up-front payments)
from the accounting for payments made to customers during the contract
period.
The revenue standard specifies that if consideration paid to a
customer is not in exchange for a distinct good or service, the consideration
paid should be reflected as a reduction of the transaction price that is
allocated to the performance obligations in the contract. If an up-front payment
is made as part of an enforceable contract with a customer (i.e., a contract
that meets all of the criteria in ASC 606-10-25-1, as discussed in Section 4.3), treating
that payment as a reduction of the transaction price would result in the
recording of an asset for the up-front payment made, which would then be
recognized as a reduction of revenue as the promised goods or services are
transferred to the customer. The recording of an asset and subsequent
amortization is predicated on the fact that the asset represents an advance of
funds to the customer, which the entity recovers as goods or services are
transferred to the customer.
However, the revenue standard is less clear on the accounting
for up-front payments when either (1) a revenue contract does not yet exist
(i.e., an entity makes a payment to incentivize the customer to enter into a
revenue contract with the entity) or (2) an up-front payment is related to goods
or services to be transferred under a current contract and anticipated future
contracts.
Connecting the Dots
Implementation Q&A 43 (compiled from previously
issued TRG Agenda Papers 59 and 60) discusses how an entity should account for an
up-front payment made to a customer when (1) a revenue contract does not
yet exist (i.e., an entity makes a payment to incentivize a customer to
enter into a revenue contract with the entity) or (2) the up-front
payment is related to goods or services to be transferred under a
current contract and anticipated future contracts. That Q&A presents
the following two views on when an up-front payment to a customer should
be recognized as a reduction of revenue:
-
View A — A payment to a customer should be recognized as an asset and amortized as a reduction of revenue as the entity provides the customer with the related goods or services (i.e., the expected total purchases resulting from the up-front payment). Under this approach, the up-front payment may be recognized as a reduction of revenue over a period that is longer than the currently enforceable contract term.
-
View B — Payments to customers should be recognized as a reduction of revenue only over the current contract term. If a contract does not yet exist, the up-front payment should be recognized as a reduction of revenue immediately.
Implementation Q&A 43 indicates that View A would often be appropriate and that if an asset is recorded, it should be an asset as defined in FASB Concepts Statement 6.11 In addition, View B would sometimes be appropriate.
However, as also stated in Implementation Q&A 43,
the selection of either view is not an accounting policy election but
should be made after entities “understand the reasons for the payment,
the rights and obligations resulting from the payment (if any), the
nature of the promise(s) in the contract (if any), and other relevant
facts and circumstances for each arrangement when determining the
appropriate accounting.” Further, while acknowledging that some
diversity in practice may continue under the revenue standard, the FASB
staff emphasized that the standard’s requirement to provide increased
disclosure about judgments made in the determination of the transaction
price should help financial statement users understand an entity’s
accounting for up-front payments to customers.
For additional information and Deloitte’s summary of the
Implementation Q&As, see Appendix
C.
When determining how to account for an up-front payment to a
customer that is not in exchange for a distinct good or service, an entity
should first consider whether the up-front payment meets the definition of an
asset.
Connecting the Dots
In December 2021, the FASB issued FASB Concepts Statement 8, Chapter 4, whose guidance supersedes that in FASB Concepts Statement 6, including guidance on the definition of an asset. Under the legacy guidance of FASB Concepts Statement 6, assets are defined as “probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.” FASB Concepts Statement 8,
Chapter 4, updates this definition by providing that “[a]n asset is a
present right of an entity to an economic benefit,” further noting that
“[a]n asset has the following two essential characteristics:
- It is a present right.
- The right is to an economic benefit.”
Paragraph BC4.9 of FASB Concepts Statement 8, Chapter 4, states:
When
applied as intended, the definitions of assets and liabilities in
Concepts Statement 6 were not fundamentally problematic. However,
those definitions were often misunderstood. As a result, the Board
concluded that improving the definitions in Concepts Statement 6 by
making them clearer and more precise would enhance consistent
application of the definitions in developing standards.
While the Board made clarifications to the definition of an asset, we do not believe that the definition of an asset as updated in FASB Concepts Statement 8, Chapter 4, would result in a change in practice when
entities determine whether up-front payments to customers should be
recognized as assets.
In a speech at the 2016 AICPA Conference on Current SEC and
PCAOB Developments, Ruth Uejio, then professional accounting fellow in the OCA,
provided the following guidance on determining whether an up-front payment
constitutes an asset:
From my perspective, a company must
first determine what the payment was made for. The following are some of the
questions that OCA staff may focus on to understand the nature and substance
of the payment:
-
What are the underlying economic reasons for the transaction? Why is the payment being made?
-
How did the company communicate and describe the nature of the payment to its investors?
-
What do the relevant contracts governing the payment stipulate? Does the payment secure an exclusive relationship between the parties? Does the payment result in the customer committing to make a minimum level of purchases from the vendor?
-
What is the accounting basis for recognizing an asset, or recognizing an upfront payment immediately through earnings?
Once a company has determined the substance
of the payment, I believe a company should account for the payment using an
accounting model that is consistent with the identified substance of the
payment and relevant accounting literature. Additionally, companies should
establish accounting policies that are consistently applied. I’d highlight
that there should be a neutral starting point in the accounting evaluation
for these types of arrangements. I believe that registrants must carefully
evaluate all of the facts and circumstances in arriving at sound judgments,
and should perform the analysis impartially. Additionally, in my view
“matching” is not a determinative factor to support asset
recognition.
To recognize an up-front payment to a customer as an asset, an
entity needs to be assured that it has obtained a present right to an economic
benefit in exchange for providing the customer with the up-front payment. In
evaluating whether an up-front payment to a customer meets the definition of an
asset, an entity should consider the following:
-
Whether the up-front payment is expected to be recovered through the customer’s purchases under the initial contract or an anticipated contract.
-
The entity’s history of renewals with that specific customer or similar classes of customers.
-
The negotiation process for the up-front payment and how the payment is characterized in the contract with the customer.
If the entity determines that the payment meets the definition
of an asset, the payment should be recognized as an asset and subsequently
“amortized” as a reduction of revenue as the related goods or services are
provided to the customer over a period that may continue beyond the current
contract term. If, on the other hand, the payment does not meet the definition
of an asset, it may be more appropriate to recognize the payment as a reduction
of revenue immediately. For example, we believe that for an asset to be
recognized, the payment must be recoverable. In our view, it would be reasonable
for an entity to assess recoverability by performing the same analysis it uses
to evaluate the costs of obtaining or fulfilling a contract under ASC
340-40.
Connecting the Dots
The SEC observer at the November 2016 TRG meeting noted
that an entity will need to use judgment in assessing up-front payments
to customers and emphasized that the entity must appropriately disclose
its conclusions related to the up-front payments in both its financial
statements and MD&A. In addition, the SEC observer noted that the
SEC staff intends to form its views on the topic by analyzing the
guidance in the revenue standard independently of its past decisions
that were based on the legacy guidance in ASC 605.
6.6.4 Warranty Payments Versus Variable Consideration
6.6.4.1 Accounting for Liquidating Damage Obligations as Warranties or Variable Consideration
Some contracts (e.g., service level agreements) provide for liquidating
damages or similar features that specify damages in the event that the
vendor fails to deliver future goods or services or the vendor’s performance
fails to achieve certain specifications.
In general, cash refunds, liquidating damages, fines, penalties, or other
similar features should be evaluated as variable consideration, as
illustrated in Example 20 in ASC 606-10-55-194 through 55-196 (reproduced
below). However, an entity must consider the specific facts and
circumstances in reaching this conclusion.
ASC 606-10
Example 20 — Penalty Gives Rise to
Variable Consideration
55-194 An entity enters into
a contract with a customer to build an asset for $1
million. In addition, the terms of the contract
include a penalty of $100,000 if the construction is
not completed within 3 months of a date specified in
the contract.
55-195 The entity concludes
that the consideration promised in the contract
includes a fixed amount of $900,000 and a variable
amount of $100,000 (arising from the penalty).
55-196 The entity estimates
the variable consideration in accordance with
paragraphs 606-10-32-5 through 32-9 and considers
the guidance in paragraphs 606-10-32-11 through
32-13 on constraining estimates of variable
consideration.
In limited situations, consideration paid to a customer that is required
under a warranty or similar claim may be accounted for in a manner
consistent with the warranty guidance in ASC 606-10-55-30 through 55-35.
Under ASC 606-10-32-25 through 32-27, consideration paid to a customer is a
reduction of the transaction price unless the payment is in exchange for a
distinct good or service. There may be limited situations in which the
consideration paid to a customer is intended to reimburse the cost of
warranty services that the customer has incurred directly and that the
vendor would have otherwise been obligated to provide to the customer. In
these limited instances, it would be appropriate to account for the
reimbursement amount paid to the customer as an in-substance assurance- or
service-type warranty.
Example 6-29
An entity sells a product to its customer. Shortly
after the purchase (within the warranty period), the
product does not perform as intended because of a
malfunctioning part. The customer pays a third-party
contractor $100 to fix the malfunctioning part. In
accordance with the warranty terms of the contract,
the entity reimburses the customer for the cost of
the third-party repairs ($100).
The cash reimbursement amount paid
to the customer is based on the cost of repairing
the product and is in accordance with the standard
warranty terms of the product. The vendor should
account for the repair cost as an assurance-type
warranty cost in accordance with ASC 606-10-55-32.
As a result, the $100 is presented as an expense
rather than a reduction of revenue.
6.6.4.2 Accounting for a Refund of the Purchase Price Following the Customer’s Return of a Defective Item
ASC 606-10-55-30 through 55-35 provide guidance on the accounting for
warranties under which an entity promises to repair or replace defective
items, requiring that the warranty obligation be accounted for either as a
separate performance obligation (for “service-type” warranties) or in
accordance with the guidance on product warranties in ASC 460-10 on
guarantees (for “assurance-type” warranties). The warranties guidance is
discussed in Section 5.5.
Entities will sometimes provide a customer with a full or partial refund with
respect to a defective item. This might be the only option offered to the
customer (i.e., the entity does not offer to repair or replace defective
items); alternatively, the customer may be entitled to choose between
receiving a refund and having the defective item repaired or replaced. A
right to receive such a refund might sometimes be described as a
“warranty.”
The guidance on accounting for warranties in ASC 606-10-55-30 through 55-35
should not be applied to an obligation to provide a full or partial refund
of consideration received for defective products. When amounts are expected
to be refunded to a customer for a defective product, a refund liability
should be recognized in accordance with ASC 606-10-32-10. The amount
expected to be refunded is consideration payable to a customer and therefore
reduces revenue in accordance with ASC 606-10-32-25 through 32-27. Because
the consideration payable to the customer includes a variable amount, the
entity would also need to estimate the transaction price in accordance with
ASC 606-10-32-5 through 32-13.
This accounting appropriately reflects that when a full or partial refund is
offered, the product delivered to the customer and the consideration payable
for that product are both different from what was originally agreed. If no
refund is due (i.e., there is no warranty claim), the entity receives full
payment for a product that meets agreed-upon specifications, whereas in the
case of a full refund, the entity has not delivered a functioning product
and has received no payment. A partial refund reflects that the entity has
accepted a lower price for an imperfect product.
In contrast, in the case of an assurance-type warranty, neither what is
delivered to the customer (a product meeting agreed-upon specifications) nor
the price eventually paid by the customer varies. Instead, the cost to the
entity of delivery varies, and this variability is appropriately reflected
in the warranty costs recognized in accordance with ASC 460-10 (or in the
costs of fulfilling the performance obligation in a service-type
warranty).
When an entity offers customers a choice between receiving a refund and
accepting repair or replacement of defective items, it will be necessary to
estimate the extent to which customers will choose each option and then
account for each obligation accordingly.
An entity will be required to use judgment to determine the appropriate
treatment of any additional amount paid to a customer over and above the
amount originally paid by the customer for the product.
6.6.5 Applying the Guidance on Consideration Received From a Vendor
ASU 2014-09 added ASC 705-20 to provide specific guidance on
consideration received from a vendor.
ASC 705-20
25-1 Consideration from a
vendor includes cash amounts that an entity receives or
expects to receive from a vendor (or from other parties
that sell the goods or services to the vendor).
Consideration from a vendor also includes credit or
other items (for example, a coupon or voucher) that the
entity can apply against amounts owed to the vendor (or
to other parties that sell the goods or services to the
vendor). The entity shall account for consideration from
a vendor as a reduction of the purchase price of the
goods or services acquired from the vendor unless the
consideration from the vendor is one of the
following:
-
In exchange for a distinct good or service (as described in paragraphs 606-10-25-19 through 25-22) that the entity transfers to the vendor
-
A reimbursement of costs incurred by the entity to sell the vendor’s products
-
Consideration for sales incentives offered to customers by manufacturers.
25-2 If the consideration from
a vendor is in exchange for a distinct good or service
(see paragraphs 606-10-25-19 through 25-22) that an
entity transfers to the vendor, then the entity shall
account for the sale of the good or service in the same
way that it accounts for other sales to customers in
accordance with Topic 606 on revenue from contracts with
customers. If the amount of consideration from the
vendor exceeds the standalone selling price of the
distinct good or service that the entity transfers to
the vendor, then the entity shall account for such
excess as a reduction of the purchase price of any goods
or services acquired from the vendor. If the standalone
selling price is not directly observable, the entity
shall estimate it in accordance with paragraphs
606-10-32-33 through 32-35.
25-3 Cash consideration
represents a reimbursement of costs incurred by the
entity to sell the vendor’s products and shall be
characterized as a reduction of that cost when
recognized in the entity’s income statement if the cash
consideration represents a reimbursement of a specific,
incremental, identifiable cost incurred by the entity in
selling the vendor’s products or services. If the amount
of cash consideration paid by the vendor exceeds the
cost being reimbursed, that excess amount shall be
characterized in the entity’s income statement as a
reduction of cost of sales when recognized in the
entity’s income statement.
25-4 Manufacturers often sell
their products to resellers who then sell those products
to consumers or other end users. In some cases,
manufacturers will offer sales discounts and incentives
directly to consumers — for example, rebates or coupons
— in order to stimulate consumer demand for their
products. Because the reseller has direct contact with
the consumer, the reseller may agree to accept, at the
point of sale to the consumer, the manufacturer’s
incentives that are tendered by the consumer (for
example, honoring manufacturer’s coupons as a reduction
to the price paid by consumers and then seeking
reimbursement from the manufacturer). In other
instances, the consumer purchases the product from the
reseller but deals directly with the manufacturer
related to the manufacturer’s incentive or discount (for
example, a mail-in rebate).
The recognition guidance in ASC 705-20-25 on consideration
received from a vendor has certain conceptual similarities to the measurement
guidance in ASC 606-10-32 on consideration payable to a customer.
ASC 606-10-32-25 states, in part, that an “entity shall account
for consideration payable to a customer as a reduction
of the transaction price and, therefore, of revenue
unless the payment to the customer is in exchange for a
distinct good or service (as described in paragraphs 606-10-25-18
through 25-22) that the customer transfers to the entity” (emphasis added).
Under ASC 606-10-32-26, “[i]f consideration payable to a customer is a payment
for a distinct good or service from the customer, then an entity shall account
for the purchase of the good or service in the same way that
it accounts for other purchases from suppliers. If the amount of
consideration payable to the customer exceeds the fair value of the distinct
good or service that the entity receives from the customer, then the entity
shall account for such an excess as a reduction of the transaction price”
(emphasis added).
Similarly, under ASC 705-20-25-1 and 25-2, an entity will need
to determine whether consideration from a vendor is in
exchange for a distinct good or service (as described in ASC
606-10-25-19 through 25-22) that the entity transfers to the vendor. If an
entity concludes that consideration received from a vendor is related to
distinct goods or services provided to the vendor, the entity should account for
the consideration received from the vendor in the same way
that it accounts for other sales (e.g., in accordance with ASC 606 if
distinct goods or services are sold to a customer). If the consideration is not
in exchange for a distinct good or service and is also unrelated to the items
described in ASC 705-20-25-1(b) and (c), the entity should account for
consideration received from a vendor as a reduction of the
purchase price of the goods or services acquired from the vendor. Also
similar to the guidance in ASC 606-10-32-25 and 32-26 is the requirement in ASC
705-20-25-2 that any excess of the consideration received from the vendor over
the stand-alone selling price of the good or service provided to the vendor
should be accounted for as a reduction of the purchase price of any goods or
services purchased from the vendor.12
Connecting the Dots
Under legacy U.S. GAAP (specifically, ASC 605-50),
consideration received from a vendor could be accounted for as revenue
(or other income, as appropriate) only if a separate benefit was
provided to the vendor. For that condition to be met, the identified
benefit provided would need to (1) be sufficiently separable from the
customer’s purchase of the vendor’s products and (2) have a readily
determinable fair value.
ASC 705-20 retains the “separate identified benefit”
concept, although it provides, in a manner consistent with the ASC 606
framework, that for a customer to account for consideration received
from a vendor as revenue, the consideration received must be in exchange
for the transfer of a distinct good or service. However, ASC 705-20 does
not require the distinct good or service to have a readily determinable
fair value. Rather, ASC 705-20-25-2 states, in part, that “[i]f the
standalone selling price is not directly observable, the entity shall
estimate it in accordance with paragraphs 606-10-32-33 through 32-35.”
This provision differs from the guidance in ASC 606 that allows an
entity to separately account for a distinct good or service obtained
from a customer only if the entity can reasonably estimate the fair
value of the good or service. Specifically, ASC 606-10-32-26 states, in
part, that “[i]f the entity cannot reasonably estimate the fair value of
the good or service received from the customer, it shall account for all
of the consideration payable to the customer as a reduction of the
transaction price.” Under ASC 705-20, an entity may separately account
for a good or service provided to a vendor regardless of whether the
entity can reasonably estimate the fair value of the good or
service.
The concepts in Section 6.6.2.1 that address how to
evaluate whether consideration payable to a customer is in exchange for distinct
goods or services purchased from a customer are also applicable to the
determination of whether consideration received from a vendor is in exchange for
distinct goods or services delivered to a vendor.
Notwithstanding the similarities between ASC 705-20 and ASC 606,
determining whether an entity is a customer or a vendor in certain arrangements
may be challenging. As discussed in Section 3.2.8, there are certain
arrangements in which an entity may enter into one or more contracts with
another entity that is both a customer and a vendor. 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. This determination might
not be able to be made 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 example below illustrates an
arrangement in which this issue may arise and discusses how the reporting entity
may determine whether the other entity in the arrangement is predominantly a
customer or predominantly a vendor. This distinction may be important to
determining whether the reporting entity should apply the guidance on
consideration payable to a customer in ASC 606 or the guidance on consideration
received from a vendor in ASC 705-20.
Example 6-30
Entity B offers digital media analytics
products and services that report on digital activity to
identify trends and provide insights to customers.
Entity B purchases data from third-party operators,
which it analyzes, measures, and combines with a wide
variety of other data obtained from various sources for
use in the products and services that it sells to its
customers.
Entity B has entered into an agreement
with Operator C, a telecommunications company, to
purchase C’s data. Operator C’s data will be combined
with data provided from other sources, analyzed, and
used as an input for delivering data subscription
services to B’s customers. Before negotiating the
agreement to purchase C’s data, B entered into an
agreement to provide data subscription services and
several other services to C. Consequently, B has
contracts with C to (1) purchase data from C in exchange
for cash consideration and (2) sell various services to
C in exchange for cash consideration.
Since C could be viewed as both a
customer and a vendor of B, B evaluates whether C is
predominantly a customer or predominantly a vendor in
their arrangement. Entity B’s conclusion may determine
whether (1) the consideration paid to C for C’s data
should be analyzed under ASC 606 (i.e., potentially as a
reduction of the transaction price for the data
subscription services provided to C) or (2) the
consideration received from C for the data subscription
services should be analyzed under ASC 705-20 (i.e.,
potentially as a reduction of the purchase price of the
data provided to B).
To determine whether C is predominantly
a customer or predominantly a vendor in the arrangement,
B considers qualitative and quantitative factors,
including the following:
-
The extent to which the data purchased from C are important to B’s ability to successfully sell its products and services to customers (e.g., whether C’s data represent a significant portion of all of the data analyzed and included in B’s products and services), or the extent to which the services purchased from B are important to C (e.g., whether C attributes significant value to the insights obtained from the data services provided by B).
-
The quantitative significance of B’s past, current, and expected future (1) purchases of data from C and (2) sales of data subscription services to C.
-
The extent to which B (1) sells other products and services to C and (2) purchases other products and services from C.
-
The historical relationship between B and C, as applicable.
-
The pricing of B’s products and services sold to C as compared with the pricing of products and services that B sells to other customers of similar size and nature.
-
The pricing of C’s data purchased by B as compared with the pricing of similar data that B purchases from other vendors.
-
The substance of the contract negotiation process or contractual terms between B and C, which may indicate that (1) B is the customer and C is the vendor or (2) C is the customer and B is the vendor.
-
The payment terms and cash flows between B and C.
-
The significance of other parties involved in the arrangement.
Regardless of whether B concludes that C
is predominantly a customer or predominantly a vendor in
the arrangement, B must evaluate whether its purchase of
C’s data is distinct from the services sold to C in
accordance with ASC 705-20 or ASC 606.
In addition, if the consideration paid
to C is accounted for under ASC 606 and B has concluded
that the consideration payable to C is a payment for a
distinct good or service, B should account for the
purchase of the data in the same way that it accounts
for other purchases from suppliers. However, B must
evaluate whether the consideration paid to C for the
data represents the fair value of the data received. If
the amount of consideration payable to C exceeds the
fair value of the data that B receives from C, B should
account for such an excess as a reduction of the
transaction price. If B cannot reasonably estimate the
fair value of the data received from C, it should
account for all of the consideration payable to C as a
reduction of the transaction price.
If the consideration received from C is
instead accounted for under ASC 705-20 and B has
concluded that the consideration from C is in exchange
for a distinct good or service, B should account for the
sale of the service in the same way that it accounts for
other sales to customers in accordance with ASC 606.
However, B must evaluate whether the services sold to C
were sold at the stand-alone selling price. If the
amount of consideration received from C exceeds the
stand-alone selling price of the services that B
transfers to C, B should account for the excess as a
reduction of the purchase price of the data acquired
from C.
Footnotes
9
While this section discusses coupons, price
concessions that an entity intends to provide may be in other forms,
such as cash payments, rebates, and account credits. These would
also be regarded as forms of variable consideration.
10
ASC 705-20 also contains two other exceptions that are not
addressed in this section, specifically situations in which
(1) the supplier reimburses the retailer for the costs of
selling the supplier’s products and (2) a manufacturer pays
for sales incentives offered to the retailer’s
customers.
11
Since the issuance of the Implementation
Q&As, FASB Concepts Statement 6 has been superseded by FASB Concepts Statement 8, Chapter 4, which updates the definition of
an asset. However, as discussed below, we do not believe that
the definition of an asset as updated would result in a change
in practice.
12
If an entity concludes that the consideration received
from a vendor was not in exchange for a distinct good or service that
the entity transferred to the vendor, the entity will be required under
ASC 705-20-25-1 to (1) determine whether the consideration received was
either a reimbursement of costs incurred by the entity to sell the
vendor’s products or consideration for sales incentives offered to
customers by manufacturers and (2) account for the consideration
received accordingly.
6.7 Sales Taxes and Similar Taxes Collected From Customers
ASC 606-10
32-2A An entity may make an accounting policy election to exclude from the measurement of the transaction
price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific
revenue-producing transaction and collected by the entity from a customer (for example, sales, use, value
added, and some excise taxes). Taxes assessed on an entity’s total gross receipts or imposed during the
inventory procurement process shall be excluded from the scope of the election. An entity that makes this
election shall exclude from the transaction price all taxes in the scope of the election and shall comply with
the applicable accounting policy guidance, including the disclosure requirements in paragraphs 235-10-50-1
through 50-6.
Stakeholders have questioned whether sales taxes and similar taxes (“sales
taxes”) should be excluded from the transaction price when such taxes are collected
on behalf of tax authorities.
Further, the revenue standard’s guidance on assessing whether an entity is a
principal or an agent in a transaction is relevant to the assessment of whether
sales taxes should be presented on a gross or net basis within revenue (see Chapter 10 for further discussion
of the assessment of whether an entity is a principal or an agent). The analysis is
further complicated by the sales tax in each tax jurisdiction (which would include
all taxation levels in both domestic and foreign governmental jurisdictions),
especially for entities that operate in a significant number of jurisdictions.
The FASB decided to provide in ASU 2016-12 a practical expedient
(codified in ASC 606-10-32-2A) that permits entities to exclude from the transaction
price all sales taxes that are assessed by a governmental authority and that are
“imposed on and concurrent with a specific revenue-producing transaction and
collected by the entity from a customer (for example, sales, use, value added, and
some excise taxes).” However, such an accounting policy election does not apply to
taxes assessed on “an entity’s total gross receipts or imposed during the inventory
procurement process.” An entity that elects to exclude sales taxes is required to
provide the accounting policy disclosures in ASC 235-10-50-1 through 50-6.
An entity that does not elect to present all sales taxes on a net basis would be
required to determine, for every tax jurisdiction, whether it is a principal or an
agent in the sales tax transaction and would present sales taxes on a gross basis if
it is a principal in the jurisdiction and on a net basis if it is an agent. Making
this determination requires an understanding of which entity (the customer or the
vendor) has incurred the tax obligation (i.e., identification of the party on which
the taxes are assessed). In some jurisdictions, it may be clear that the taxes are
assessed on the customer. Therefore, the vendor might be acting as an agent and
collecting and remitting taxes on behalf of the customer or the government. The
vendor might have the obligation to remit taxes (i.e., have a sales tax liability
for amounts collected, or for amounts whose collection was required); however, a
remittance obligation by itself does not mean that the vendor is primarily
responsible for the taxes. By contrast, in other jurisdictions, sales taxes (or
similar taxes) may be assessed on and payable by the vendor regardless of whether
the taxes are included in the amounts collected from customers. In these instances,
the vendor may be the entity that legally incurred the taxes and is obligated to pay
the government (i.e., the vendor may be primarily responsible for paying the taxes).
Therefore, the vendor would be the principal in the tax transaction and would
present the taxes on a gross basis as revenue.