8.9 Other Considerations in Step 5
8.9.1 Transfer of Control in Licensing Arrangements
The FASB and IASB acknowledged that because of the intangible nature of licenses, license
arrangements create unique challenges in the application of the revenue framework. For that reason,
the boards provided within their implementation guidance some additional guidance on assessing
license arrangements.
The application of the control-based model in the delivery of licenses requires a comprehensive
understanding of the entity’s arrangement with a customer and an understanding of the type of
intellectual property (IP) that is subject to the license agreement. A contract that includes a right to
use software can be viewed as a contract for a good or a service. For example, software that relies
on an entity’s IP and is delivered only through a hosting arrangement (i.e., the customer cannot take
possession of the software) is a service, whereas a software arrangement that is provided through an
access code or key is more like the transfer of a good. In light of these unique characteristics, the boards
established the additional implementation guidance to assist in the assessment of how and when the
entity transfers control of its IP through a license to the customer since that control is transferred over
time in some cases and at a point in time in other cases.
In determining whether the transfer of a license occurs over time or at a point in time, an entity should
consider the indicators of the transfer of control to determine the point in time at which a license is
transferred to the customer. ASC 606-10-55-58C states that revenue from a license of IP cannot be
recognized before both of the following:
- An entity provides (or otherwise makes available) a copy of the intellectual property to the customer.
- The beginning of the period during which the customer is able to use and benefit from its right to access or its right to use the intellectual property. That is, an entity would not recognize revenue before the beginning of the license period even if the entity provides (or otherwise makes available) a copy of the intellectual property before the start of the license period or the customer has a copy of the intellectual property from another transaction. For example, an entity would recognize revenue from a license renewal no earlier than the beginning of the renewal period.
Section 12.5 further
explores transfer of control related to licensing arrangements.
8.9.2 Partially Satisfied Performance Obligations Before the Identification of a Contract
Entities sometimes begin activities on a specific anticipated
contract with their customer before (1) the parties have agreed to all of the
contract terms or (2) the contract meets the criteria in step 1 (see Chapter 4) of the revenue
standard. The FASB and IASB staffs refer to the date on which the contract meets
the step 1 criteria as the “contract establishment date” (CED) and refer to
activities performed before the CED as “pre-CED activities.”
Sometimes, pre-CED activities result in the transfer of a good or service to an
entity’s customer on the date the contract meets the criteria in ASC 606-10-25-1
(e.g., when the customer takes control of the partially completed asset) such
that a performance obligation meeting the criteria in ASC 606-10-25-27 for
recognition of revenue over time is partially satisfied.
Stakeholders have identified two issues with respect to pre-CED
activities:
-
How to recognize revenue from pre-CED activities.
-
How to account for certain fulfillment costs incurred before the CED.
Once the criteria in step 1 have been met, entities should
recognize revenue for pre-CED activities on a cumulative catch-up basis (i.e.,
record revenue as of the CED for all satisfied or partially satisfied
performance obligations) rather than prospectively because cumulative catch-up
is more consistent with the revenue standard’s core principle. On that date, the
entity should recognize revenue on a cumulative catch-up basis that reflects the
entity’s progress toward complete satisfaction of the performance obligation. In
calculating the required cumulative catch-up adjustment, the entity should
consider the requirements in ASC 606-10-25-23 through 25-37 with respect to
determining when a performance obligation is satisfied to determine the goods or
services that the customer controls on the date the criteria in ASC 606-10-25-1
are met.
Similarly, certain fulfillment costs incurred before the CED are capitalized as
costs of fulfilling an anticipated contract. If other Codification topics are
applicable to pre-CED fulfillment costs, an entity should apply the guidance in
those other Codification topics. If it is determined that other Codification
topics are not applicable, an entity should capitalize such costs as costs of
fulfilling an anticipated contract, subject to the criteria in ASC 340-40-25-5.
Once the criteria in step 1 have been met, the portion of the asset related to
progress made to date should be expensed immediately. The remaining asset should
be amortized over the period in which the related goods or services are
transferred to the customer.
Costs that do not satisfy the criteria in other Codification topics or in ASC
340-40-25-5 for recognition as an asset (e.g., general and administrative costs
that are not explicitly chargeable to the customer under the contract) should be
expensed as incurred in accordance with ASC 340-40-25-8.
The above issues are addressed in Implementation Q&As 53 and 76 (compiled from previously
issued TRG Agenda Papers 33 and 34). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
Example 8-19
In this example, assume that the
criteria for recognizing revenue over time are met. In
practice, whether those criteria are met will depend on
a careful evaluation of the facts and circumstances.
An entity is constructing a piece of
specialized equipment to an individual customer’s
specifications. Because of a delay in obtaining the
customer’s approval for the contract, the entity
commences work on constructing the equipment before the
contract is signed. Consequently, the costs that meet
the criteria in ASC 340-40-25-5 that the entity incurs
in performing this work are initially capitalized.
Subsequently, the contract is approved, and the terms of
the contract are such that the criteria for recognition
of revenue over time are met. On the date the contract
is signed and the criteria in ASC 606-10-25-1 are met, a
cumulative catch-up of revenue (and expensing of
capitalized costs), reflecting progress made to date,
should be recognized for the partially constructed
equipment.
Example 8-20
In this example, assume that the
criteria for recognizing revenue over time are met. In
practice, whether those criteria are met will depend on
a careful evaluation of the facts and circumstances.
An entity is constructing an apartment
block, in a foreign jurisdiction, consisting of 10
apartments. In the period before commencing
construction, the entity has signed contracts (meeting
the criteria in ASC 606-10-25-1) with customers for six
of the apartments in the apartment block but not for the
remaining four. The entity uses standard contract terms
for each apartment, such that the entity (1) is
contractually restricted from readily directing the
apartment for another use during its construction and
(2) has an enforceable right to payment for performance
completed to date.
For the six apartments for which
contracts have been signed with customers, the
construction of each apartment represents the transfer
of a performance obligation over time because the
criteria in ASC 606-10-25-27(c) are met. Accordingly,
revenue is recognized as those six apartments are
constructed, reflecting progress made to date, and the
costs incurred in relation to those six apartments are
expensed to the extent that they are related to progress
made to date.
For the four apartments for which
contracts have not yet been signed with customers, costs
that meet the criteria in ASC 340-40-25-5 are initially
capitalized. Subsequently, on the date a contract is
signed with a customer for one of those four apartments
and the criteria in ASC 606-10-25-1 are met, a
cumulative catch-up of revenue (and expensing of related
capitalized costs) should be recognized for that
apartment.
There may be instances in which an entity has transferred goods
or services to the customer but has not met the requirements of step 1 in ASC
606-10-25-1 (i.e., one of the five required criteria is not met). For example,
the entity may not have met the criterion stating that “[i]t is probable that
the entity will collect substantially all of the consideration to which it will
be entitled in exchange for the goods or services that will be transferred to
the customer.” In these instances, the entity would generally not record a
receivable (or a related contract liability) to reflect its right to payment for
performance completed before meeting the step 1 criteria.
ASC 606-10-45-4 states, in part, the following (pending content
effective later than the effective date of ASC 606 {in braces}):
A receivable is an entity’s right to consideration that
is unconditional. A right to consideration is unconditional if only the
passage of time is required before payment of that consideration is due.
. . . An entity shall account for a receivable in accordance with Topic
310 {and Subtopic 326-20}.
Refer to Chapter
4 (step 1) for considerations related to whether an entity can
account for a receivable before the contract existence criteria are met.
8.9.3 Trial Periods
In a manner consistent with the discussion in Section 4.3.1 on free trial
periods, entities may need to consider the effect of trial periods on contracts
with customers. An entity must evaluate whether a contract exists during a trial
period and, if so, the appropriate timing of revenue recognition during the
trial period. Factors to consider include whether the trial period is risk-free,
whether the customer has an obligation to make further purchases beyond the
trial period, and whether the goods or services transferred during the trial
period are, in fact, performance obligations. This determination may require an
entity to use judgment on the basis of the specific facts and circumstances of
the arrangement.
Two types of trial periods that an entity may participate in to
solicit customers are (1) “risk-free” trials (i.e., the customer is not
committed to a contract until some of the goods or services are delivered) and
(2) the delivery of “free” goods or services upon execution of a contract (i.e.,
a contract under the revenue standard exists when the free goods or services are
delivered). As noted above, it is essential to evaluate whether a contract with
a customer exists under the revenue standard to determine whether the goods or
services provided during the trial period are performance obligations to which
revenue should be allocated and recognized when control transfers. In addition,
consideration should be given to whether the entity’s performance obligation to
transfer the goods or services during the trial period is satisfied at a point
in time or over time (i.e., partly during the trial period and partly during the
contractual period). Such factors are likely to affect the determination of
whether and, if so, when revenue is recognized for the goods or services
provided during the trial period.
The two examples below illustrate the accounting for free goods
or services.
Example 8-21
Risk-Free
Magazines
Entity A sells sports magazines that
customers are able to purchase on an annual subscription
basis. Entity A’s marketing program includes a risk-free
offer that allows a subscriber to receive a predefined
number of magazine issues on a trial basis (but A is not
obligated to provide any free magazines). For example, A
will deliver up to 3 magazines on a trial basis, and
upon the customer’s decision to accept the subscription
offer, $12 is due and payable to A. Regardless of when
the customer accepts the subscription offer during the
trial period, A will deliver a total of 15 magazines
(which includes the 3 “risk-free” magazines) in exchange
for a nonrefundable fee of $12.
Assume that after A has delivered the
first 2 trial-period magazines, the customer accepts the
subscription offer and pays A a nonrefundable price of
$12. Each magazine is determined to be a distinct
performance obligation that is satisfied at a point in
time.
The parties are not committed to perform
their respective obligations until the customer accepts
the subscription offer. That is, no contract exists.
Once the customer accepts the offer (after 2 free
magazines are delivered), A has a contract to deliver 13
additional magazines to the customer (the first 2 free
magazines are a marketing offer rather than a promised
good or service). Entity A would allocate the $12
transaction price to the 13 magazines (92¢ each) and
recognize revenue as each magazine is transferred to the
customer.
Example 8-22
Bonus
Magazines
Entity A offers a marketing program that
advertises that bonus magazines will be added to a
subscription term. For example, upon a customer’s
acceptance of an offer for an annual magazine
subscription, A will supply three bonus months that
result in a total of 15 magazines. Accordingly, if a
customer accepts a subscription offer, the customer will
receive 15 magazines for an annual nonrefundable
subscription price of $12.
Once the customer accepts the
subscription offer, the nature of the promise is to
transfer 15 magazines to the customer for $12. Entity A
would allocate the transaction price to each of the 15
magazines (80¢ per magazine) and recognize revenue as
each magazine is transferred to the customer.
8.9.4 Up-Front Fees
Arrangements may include up-front fees (e.g., activation fees or nonrefundable deposits) before any
goods or services are transferred to the customer. Entities must determine whether any goods or
services are transferred in exchange for the up-front fee, or whether the transfer of goods or services
has not yet commenced.
When up-front fees are included in an arrangement, an entity must first identify
the performance obligations (see Section 5.6 for additional discussion about determining the nature
of a promise and identifying performance obligations). Any up-front payment
becomes a portion of the overall transaction price (see Chapter 6 for further discussion about
determining the transaction price).
When an entity enters into a contract with a customer, it
sometimes receives some or all of the consideration up front, before
transferring the promised goods or services to the customer (i.e., before
satisfying the performance obligation). In these circumstances, the up-front fee
cannot be recognized as revenue immediately when it is received.
Under ASC 606, the timing of recognition of revenue is not based
on cash receipt or payment schedules. Instead, an entity recognizes revenue when
(or as) it satisfies a performance obligation by transferring control of a
promised good or service to a customer.
When an entity receives consideration before the related
performance obligation is satisfied, the entity should not recognize the advance
payment as revenue until that obligation is satisfied. However, the entity
should recognize the consideration received as a contract liability (i.e.,
deferred revenue) in its statement of financial position and evaluate such
payment for the potential existence of a significant financing component (see
Section
6.4).
This treatment is required even if the consideration received up
front is nonrefundable since the goods or services may not have been transferred
to the customer. Specifically, ASC 606-10- 55-51 states, in part:
In many cases, even though a nonrefundable upfront fee
relates to an activity that the entity is required to undertake at or near
contract inception to fulfill the contract, that activity does not result in
the transfer of a promised good or service to the customer . . . . Instead,
the upfront fee is an advance payment for future goods or services and,
therefore, would be recognized as revenue when those future goods or
services are provided.
Further, ASC 606-10-55-53 states, in part:
An entity may charge a nonrefundable fee in part as compensation for costs
incurred in setting up a contract (or other administrative tasks as
described in paragraph 606-10-25-17). If those setup activities do not
satisfy a performance obligation, the entity should disregard those
activities (and related costs) when measuring progress in accordance with
paragraph 606-10-55-21. That is because the costs of setup activities do not
depict the transfer of services to the customer.
The example below illustrates how to determine whether a
nonrefundable initiation fee in a club membership contract should be recognized
upon receipt.
Example 8-23
An entity operates a fitness club. The
key terms of its contractual arrangements with customers
are as follows:
-
Customers have to pay an initiation fee of $100 upon entering into the contract.
-
Each contract has a term of one year. During the contractual period, customers are required to pay a monthly fee of $100 (irrespective of their usage of the club during that month).
-
The initiation fee is not refundable, even if the customer never uses the club during the one-year contract period.
The entity should not recognize the initiation fee as revenue
upon receipt even though it is nonrefundable. Under ASC
606, an entity should recognize revenue when (or as) it
satisfies a performance obligation by transferring a
promised good or service to a customer.
In this example, customers pay the
initiation fee and monthly fees to use the facilities
provided by the fitness club. The performance obligation
is therefore to provide fitness club facilities for
customers’ use. Hence, the initiation fee is just part
of the consideration paid by customers to use the
facilities in the future. Because no performance
obligation has been satisfied upon payment of that fee,
revenue should not be recognized immediately in profit
or loss when that consideration is received.
Instead, the initiation fee should be
recognized as a liability. Such consideration would be
included in the transaction price and recognized as
revenue when (or as) the entity satisfies the associated
performance obligations, which may include a material
right.
8.9.5 Recognizing Revenue Related to Commissions Earned by a Sales Agent
An entity may earn revenue in the form of a sales commission;
the treatment of sales commissions (i.e., the timing of recognizing the revenue
related to the sales commission) may vary depending on the terms of the
arrangement. In some cases in which an entity acts as an agent, it is providing
a service over time; however, in other instances, an agent only provides its
service at a point in time. See Chapter 10 for further discussion of principal-versus-agent
considerations.
The timing of recognition of a sales agent’s commission revenue
depends on the nature of (1) the agreement between the sales agent and its
customer (the principal) and (2) the promise to the customer. Revenue will be
recognized at a point in time unless the criteria in ASC 606-10-25-27 are met.
Accordingly, it is appropriate to focus on ASC 606-10-25-27(a) and (c):
-
Does the principal simultaneously receive and consume the benefits provided by the sales agent’s performance as the sales agent performs?
-
Does the sales agent have an enforceable right to payment for performance completed to date?
In accordance with ASC 606-10-55-6, when the first of these
criteria is assessed, it will be appropriate to consider whether another entity
would need to substantially reperform the work that the sales agent has
completed to date if that other entity were to fulfill the remaining performance
obligation to the principal.
Often, the only promise that a sales agent makes to the
principal is to arrange a sale, and the sales agent is only paid commission if
it achieves a sale. In these circumstances, the criterion in 606-10-25-27(a)
will typically not be met. That is, as the agent works toward achieving a sale
(e.g., by meeting with the principal’s potential customer), the work performed
is not consumed by the principal (i.e., the agent’s customer) until a sale is
achieved. Further, if another entity were to take over from the sales agent,
typically that other entity would need to substantially reperform the work that
the sales agent has completed to date (e.g., reestablish contact and build a
relationship with the principal’s potential customer). Thus, the conditions for
recognizing revenue over time are not met, and control of the “good or service”
is not considered to be transferred. In these instances, the point in time at
which revenue should be recognized will depend on the nature of the sales
agent’s promise to its customer, the principal. The agent may perform activities
before a sale, but these activities are often performed on the agent’s own
behalf to fulfill the promise made to the customer, which is to complete the
sale. Although there may be some limited benefit to the customer as a result of
the sales agent’s presale activities, that benefit is significantly limited
unless a sale transaction is ultimately completed.
This conclusion is consistent with Example 45 of the revenue
standard (ASC 606-10-55-317 through 319), which concludes that “[w]hen the
entity satisfies its promise to arrange for the goods to be provided by the
supplier to the customer (which, in this example, is when goods are purchased by
the customer), the entity recognizes revenue in the amount of the commission to
which it is entitled.” The use of the word “when” suggests that this is at a
point in time, whereas the use of the word “as” would have implied that the
entity is delivering, and the customer is receiving, a good or service over
time.
In some instances, a sales agent may receive nonrefundable
consideration at the outset of an arrangement, which may indicate that the
customer is receiving a benefit from the activities performed before the sale.
That is, the agent in these circumstances may be delivering an additional
service during the contractual period (e.g., a listing service). However, the
mere existence of such an up-front payment does not in itself indicate that a
good or service has been transferred before the ultimate sale. In all cases,
careful consideration of the contractual arrangement is required, and revenue
should be recognized over time only if the contract meets one of the criteria in
ASC 606-10-25-27.
Example 8-24
Revenue Recognized
Upon Completion of the Sale
A sales agent enters into an arrangement
with a seller in which it promises to arrange for buyers
to purchase the seller’s products. The agent performs
various tasks to locate a buyer, including listing the
products on its Web site. Once a buyer is located, the
agent facilitates the purchase of the product on its Web
site. The agent receives a commission equal to 10
percent of the sales price of the product when a sale is
completed. The seller also pays the agent a small
up-front fee to help cover costs incurred by the agent
before the sale. The up-front fee is nonrefundable
(i.e., the sales agent retains the fee even if the
product is not sold). The up-front fee is expected to
represent approximately 5 percent of the contract
consideration received by the agent, and the commission
represents the remaining 95 percent.
In this example, the promise to the
customer is to arrange for the sale; therefore, the
performance obligation is satisfied at the time of the
sale. The agent should recognize the up-front fee and
commission at the point in time when the sale is
completed (as discussed above, the point in time at
which revenue should be recognized will depend on the
nature of the promise to the customer). The listing
service in this example is an activity that the agent
performs to satisfy its promise (i.e., to achieve the
sale), but it does not transfer a good or service to the
customer.
Example 8-25
Revenue Recognized
Over Time
A sales agent enters into an arrangement
with a seller in which it promises to list the seller’s
products on its Web site for a specified period in a
manner similar to that of an online classified ad. If a
buyer decides to purchase the seller’s product, the
buyer separately contacts the seller to complete the
transaction. The agent receives a fee from the seller
for the listing service. This fee is nonrefundable even
if the product is not sold. If the product is sold, the
agent also receives a commission equal to 1 percent of
the sales price of the product. The listing fee is
expected to represent approximately 80 percent of the
contract consideration received by the agent, and the
commission represents the remaining 20 percent.
In this example, the promise to the
customer is the listing service. This performance
obligation is satisfied over time as the customer
receives the benefit of the listing (the customer
simultaneously receives and consumes the benefit).
Therefore, the agent should recognize the contract
consideration over the listing period. The significant
up-front payment is one indicator that the promise to
the customer in this example is the listing service (as
opposed to a promise to arrange for a sale, as in the
example above). The commission represents variable
consideration that the agent should estimate (unless the
variable consideration meets the criteria in ASC
606-10-32-40 to be allocated to the period in which the
product sale occurs) and include in the transaction
price, subject to the constraint.
Example 8-26
Two Separate
Performance Obligations
A sales agent manages a Web site that
(1) lists independent sellers’ products and (2) posts
advertisements of independent sellers’ products.
Advertisements are purchased by some of the sales
agent’s customers on a stand-alone basis (i.e., they are
purchased by customers that do not have any products
listed on the Web site) and by other customers of the
sales agent that are also contracting to have their
products listed for sale on the Web site.
The sales agent enters into an
arrangement with a seller in which it promises to
arrange for buyers to purchase the seller’s products.
The products are listed on the agent’s Web site, and
potential buyers are able to search for and view the
products. In addition, the agent agrees to advertise the
product on its Web site for a fixed price per day based
on the length or content of the advertisement (e.g.,
number of words, pictures). The seller also purchases
optional “upgrade” features for an additional fee, such
as premium placement of the advertisement. The seller
determines the number of days to run the advertisement
and the content of the advertisement. The fees for the
advertisement are nonrefundable even if the product is
not sold. Once a buyer is located, the agent facilitates
the purchase of the product on its Web site. The agent
receives a commission equal to 5 percent of the sales
price of the product when a sale is completed. The
nonrefundable fee for the advertisement is expected to
represent approximately 50 percent of the contract
consideration received by the agent, and the commission
represents the remaining 50 percent.
In this example, there are two distinct
promises to the customer: the advertisement and the
promise to arrange for the sale. The promises are
distinct because the purchase of the advertisement is
optional and the seller could sell its product on the
Web site without the advertisement. The agent also sells
advertisements separately to other customers. The
advertising service is satisfied over time because the
customer simultaneously receives and consumes the
benefit over the period the advertisement is run. The
promise to arrange for the sale is satisfied at the time
of sale. The agent should estimate the total
consideration, including the variable consideration
(subject to the constraint) and allocate the
consideration to the two performance obligations on the
basis of stand-alone selling prices. Alternatively, if
both the contract price for the advertisement and the
price for arranging the sale reflect their respective
stand-alone selling prices, the entity may not need to
estimate the variable consideration.
If the promises were not considered
distinct, the combined performance obligation may be
satisfied over time (for the same reasons the
advertising service is satisfied over time when it is
distinct). The agent would determine the estimated
transaction price, including variable consideration
subject to the constraint (unless the variable
consideration meets the criteria in ASC 606-10-32-40 to
be allocated to the period in which the product sale
occurs), and recognize revenue by using an appropriate
measure of progress.
8.9.6 Government Vaccine Stockpile Programs
In August 2017, the SEC issued an interpretive
release (the “2017 release”) updating the Commission’s
previous guidance on accounting for sales of vaccines and bioterror
countermeasures to the federal government for placement into stockpiles related
to the Vaccines for Children Program or the Strategic National Stockpile. The
update was aimed at conforming the SEC’s guidance with ASC 606.
Under the guidance in the 2017 release, vaccine manufacturers should recognize
revenue when vaccines are placed into U.S. government stockpile programs because
control of the vaccines has been transferred to the customer. However, these
entities also need to evaluate whether storage, maintenance, or other promised
goods or services associated with vaccine stockpiles are separate performance
obligations. The guidance in the 2017 release applies only to the stockpile
programs discussed in that release and is not applicable to any other
transactions.