Deloitte’s Roadmap: Revenue Recognition
Preface
Preface
We are pleased to present the 2023 edition of
Revenue Recognition. This Roadmap provides Deloitte’s insights into and
interpretations of the accounting guidance in the revenue standard, which was issued
in May 2014 by the FASB as ASU 2014-091 and by the International Accounting Standards Board (IASB®) as IFRS
15.2
Since the original release of the
revenue standard, the FASB and IASB, along with stakeholders from all industries,
have focused on implementation efforts related to the standard’s adoption. In June
2014, a joint FASB/IASB transition resource group (TRG) for revenue recognition was
created to discuss implementation issues related to the revenue standard and help
the boards resolve any such issues that could give rise to diversity in practice.
There have been eight TRG meetings (including two FASB-only TRG meetings), at which
52 staff papers in aggregate were discussed.3 The feedback the FASB received through these meetings resulted in the issuance
of (1) multiple ASUs amending aspects of ASC 606 and related topics in the FASB
Accounting Standards Codification (the “Codification”) and (2) the FASB
staff’s Revenue Recognition Implementation Q&As compiled
from previously issued educational materials.
In addition, the 16 AICPA revenue recognition
industry task forces produced industry-specific interpretive guidance on the revenue
standard. The task forces have developed updates to the AICPA’s industry guides that
address over 130 accounting matters related to revenue recognition, presentation,
and disclosure.
The SEC staff has been active as well. In
addition to monitoring implementation efforts and discussing its expectations for
transparent disclosures, the staff has updated its revenue guidance with the
issuance of SAB
116, which effectively supersedes SAB Topic 13.
The 2023 edition of this Roadmap includes
additional guidance and examples that reflect (1) significant standard-setting and
SEC developments through November 10, 2023, and (2) our own interpretations in light
of those developments. Key changes made to this Roadmap since publication of the
2022 edition are summarized in Appendix F.
We hope that this update will enable
you to navigate some of the more challenging aspects of the revenue standard. This
publication has been developed for readers who have studied every aspect of the
standard, as well as for readers who may be working through the standard to
determine how to account for new revenue streams. That is, it may function as a
quick resource guide for those who have a specific question and are looking for a
clear answer, or it may serve as an all-encompassing guide for those who are still
building up their knowledge base to work through an implementation issue. We expect
additional implementation challenges to arise as (1) business models emerge or
evolve and (2) contracts are created or amended. Accordingly, we will continue to
develop guidance that we believe will help stakeholders with interpreting the
standard.
Be sure to check out On the Radar (also available as a stand-alone publication),
which briefly summarizes emerging issues and trends related
to the accounting and financial reporting topics addressed
in the Roadmap.
We encourage you to use this Roadmap as a guide
throughout your application of the revenue standard and to contact us with any
questions or suggestions for future improvements. However, the Roadmap is not a
substitute for consulting with Deloitte professionals on complex accounting
questions and transactions. We look forward to helping you address whatever
implementation questions you have.
Footnotes
1
For a list of the titles of standards and other literature
referred to in this publication, see Appendix D. For a list of
abbreviations used in this publication, see Appendix E.
2
As used in this publication, references to the revenue
standard may denote the guidance, as originally issued or amended, in (1)
ASU 2014-09 (or IFRS 15) broadly or (2) ASC 606 (or IFRS 15) on revenue from
contracts with customers specifically. In addition to the guidance in ASC
606 on revenue from contracts with customers, the guidance in ASU 2014-09,
as originally issued or amended, includes (1) the cost guidance in ASC
340-40 and (2) the guidance in ASC 610-20 on gains and losses on transfers
of nonfinancial and in-substance nonfinancial assets to noncustomers. IFRS
15, as originally issued or amended, includes the guidance on revenue from
contracts with customers and the related cost guidance but does not include
guidance similar to that in ASC 610-20 under U.S. GAAP.
3
In total, the FASB issued 60 TRG Agenda Papers consisting of
52 staff papers, 6 meeting summaries, and 2 research updates.
Videos in This Roadmap
Trending
Topics
Guarantees
Identifying
Performance Obligations
Consideration
Payable to a Customer
Allocating
Variable Consideration
Principal-Versus-Agent Analysis
Incremental
Costs of Obtaining a Contract
Disaggregation
of Revenue Disclosures
On the Radar
On the Radar
The core principle of the revenue standard
is to depict the transfer of promised goods or services to
customers in an amount that reflects the consideration to
which an entity expects to be entitled in exchange for those
goods and services. Significant judgments frequently need to
be made when an entity evaluates the appropriate recognition
of revenue from contracts with customers. These judgments
are often required throughout the revenue standard’s
five-step process that an entity applies to determine when,
and how much, revenue should be recognized.
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Application of the five steps illustrated above requires a critical assessment of the
specific facts and circumstances of an entity’s arrangement with its customer. This
Roadmap addresses each of these steps in detail and provides interpretive guidance
on how to address the myriad complexities that may exist in revenue arrangements.
Some of the more challenging and judgmental aspects of applying the revenue standard
are highlighted below.
Entities often have
difficulty determining the appropriate judgments to
apply in the identification of performance obligations
and the assessment of whether an entity is a principal
or an agent, as described below. Not surprisingly, these
are two topics of the revenue standard on which entities
commonly seek the SEC staff’s views in prefiling
submissions. In addition, these topics are frequently
discussed in SEC staff speeches at the annual AICPA
& CIMA Conference on Current SEC and PCAOB
Developments.
Identifying Performance Obligations
A performance obligation is the unit of account for which revenue is recognized,
and the identification of performance obligations affects the revenue
recognition timing. A performance obligation is a promise that an entity makes
to transfer to its customer a “distinct” good or service. Contracts with
customers often include multiple promises, and it can be difficult for an entity
to (1) identify the activities it is undertaking that qualify as promises to
provide goods or services and (2) determine which promises are distinct. An
entity should answer two questions to evaluate whether a promised good or
service is distinct and, thus, a separate performance obligation:
-
Can the customer benefit from the good or service on its own or with other readily available resources (i.e., is the good or service capable of being distinct)?
-
Is the entity’s promise to transfer the good or service separately identifiable from other promises in the contract (i.e., is the good or service distinct within the context of the contract)?
Only when the answer to each question above is yes for a promised good or service
(or bundle of goods or services) is the promised good or service (or bundle of
goods or services) distinct and, therefore, a performance obligation. If the two
revenue recognition criteria for identifying a distinct good or service are not
met, an entity must combine goods or services until it identifies a bundle that
is distinct.
Answering the first question can be straightforward but is not always so. If an
entity typically sells a good or service on its own, or if the good or service
can be used with another good or service that the entity (or another vendor)
sells separately, the answer to the first question is likely to be yes. The key
is whether a customer can generate some economic benefits from the good or
service on its own or with other readily available resources.
Answering the second question is often more challenging. For an entity to assess
whether its promise to transfer a good or service is separately identifiable
from other goods or services in a contract, the entity should evaluate whether
the nature of the promise is to transfer each of those goods or services
individually or, instead, to transfer a combined item or items to which the
promised goods or services are inputs.
Broadly speaking, if multiple promised goods or services represent inputs to a
combined output, the combined output would typically be greater than (or
substantively different from) the sum of those inputs.
Assessing Whether an Entity Is a Principal or an Agent
It is not uncommon for more than one party to be involved in providing goods or
services to a customer. Whenever another party is involved, an entity must
evaluate whether its promise is to provide the goods or services itself as a
principal or to arrange for another party to provide the goods or services to a
customer. Such a determination significantly affects the amount of revenue an
entity records. This is because a principal records as revenue the gross amount
of consideration from the customer (with a corresponding cost for the amount
paid to the other party involved in providing goods or services to the customer)
while an agent records the net amount retained from the transaction.
The unit of account for performing the principal-versus-agent
assessment is called the “specified” good or service, which is the good or
service that an entity determines to be distinct by using the same criteria that
apply to the identification of performance obligations. The underlying principle
in determining whether an entity is a principal or an agent is to evaluate
whether the entity controls the specified good or service (i.e., an asset)
before transferring it to the customer. ASC 606-10-25-25 states, in part, that
“[c]ontrol of an asset refers to the ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset.” Determining
whether the entity controls the specified good or service before transferring it
to the customer — and, therefore, is the principal in the arrangement — may be
clear in some circumstances but may require significant judgment in others.
These indicators are intended to support a conclusion that the entity does or
does not control the specified good or service before transferring it to the
customer and should not be used as a checklist that overrides the underlying
principle of control.
The framework for evaluating whether an entity is a principal or an agent is also
relevant to the determination of the party to which control of a specified good
or service is transferred (i.e., which party is the entity’s customer). This
evaluation is particularly relevant when an intermediary (e.g., a distributor or
reseller) is involved in reselling the entity’s goods or services to an end
customer. If an entity determines that control of a specified good or service is
transferred to an intermediary, the intermediary is the entity’s customer, and
the entity records revenue based on the amount that it expects the intermediary
to pay. However, if the entity concludes that the intermediary does not obtain
control of the specified good or service before the good or service is
transferred to the end customer, the amount of revenue that the entity records
is based on the consideration (if known) that the entity expects the end
customer to pay.
Variable Consideration
Many revenue contracts include variable consideration, including
price concessions, rebates, incentives, royalties, and performance-based bonuses
or penalties. Generally, the revenue standard requires an entity to estimate
variable consideration, with recognition subject to a constraint such that it is
probable that a significant reversal of cumulative revenue recognized will not
occur. There are a few exceptions to the requirement to estimate variable
consideration, including sales- or usage-based royalties associated with a
license of intellectual property (IP) that is the predominant item. In addition,
entities must carefully evaluate whether variable consideration should be
allocated to one or more, but not all, performance obligations in a contract (or
one or more, but not all, distinct goods or services that are part of a series
of distinct goods or services that represent a single performance obligation).
For example, some usage-based fees may be allocated to a distinct day of service
that is part of a series of services.
Licensing
The revenue standard includes specific guidance on the licensing of an entity’s
IP. For example, revenue associated with the license of functional IP (e.g.,
software, film, music, drug compound/formula) is typically recognized at a point
in time (unless combined as a single performance obligation with a service that
is recognized over time) while revenue associated with a license of symbolic IP
(e.g., franchise, trade or brand name, logo) is typically recognized over time.
Accordingly, entities may need to apply different revenue recognition methods
for different types of licenses. However, the general framework used to account
for licensing of IP is essentially the same as the framework used to account for
the sale of other goods or services (i.e., the five-step model described above).
As noted above, one exception to the general framework is the accounting for
sales- or usage-based royalties associated with licensing of IP that is the
predominant item.
Licensing of IP can take many forms, and the economics and substance of such
transactions can often be difficult to identify. This is because (1) a license
is defined by the contractual rights conveyed to a customer and (2) the
accounting for such rights is highly dependent on how those rights are defined
and what, if any, additional promised goods or services are required to be
provided along with such rights. Therefore, an entity may find that no two
contracts are the same and that new judgments must be made with each
arrangement. As more and more entities expand their product offerings to include
technology-related products or services, assessing the appropriate revenue
recognition for licensing of IP continues to be a topic of focus for many
entities.
Financial Statement Disclosures
The revenue standard requires entities to disclose both
quantitative and qualitative information that enables users of financial
statements to understand the nature, amount, timing, and uncertainty of revenue
and cash flows arising from contracts with customers.
The illustration below gives an overview of the annual revenue disclosure
requirements for public entities. Nonpublic entities can elect not to provide
certain disclosures, and the disclosure requirements for interim periods are
significantly reduced in scope from the illustration below.
Annual Disclosures
SEC Comment Letters
Revenue remains a hot topic of SEC comment letters. Key themes of SEC comment
letters related to revenue recognition include the following:
Theme
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Example(s)
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Significant judgments
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Disclosures of performance obligations
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Contract costs
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Disclosures of disaggregation of revenue
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Disclosures of contract balances
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How contract balances are derived.
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Disclosures of remaining performance obligations
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When an entity expects to recognize
revenue.
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The SEC also continues to focus on non-GAAP metrics,
including adjustments that change the accounting
policy or the method of recognition of an accounting
measure that may be misleading and, therefore,
impermissible. For example, a non-GAAP performance
measure that reflects revenue recognized over the
service period under GAAP on an accelerated basis as
if the registrant earned revenue when it billed its
customers is likely to be prohibited because it is
an individually tailored accounting principle and
does not reflect the registrant’s required GAAP
recognition method. However, in certain
circumstances, the SEC may not object when a
registrant presents the amount of revenue billed to
a customer — that is, “billings” or “bookings” (with
appropriate characterization) as an operational
metric — because such measures are not considered
non-GAAP measures. For more information, see
Deloitte’s Roadmap Non-GAAP Financial Measures and
Metrics.
Accounting Standards Update on Revenue Contracts Acquired in Business Combinations
In October 2021, the FASB issued ASU 2021-08, which amends the
guidance in ASC 805 to address the recognition and measurement of revenue
contracts with customers acquired in a business combination. The ASU requires an
entity to apply the revenue standard when recognizing and measuring contract
assets and contract liabilities arising from those contracts. By contrast, fair
value is the measurement model that is applied to most assets and liabilities
(e.g., customer relationship intangibles) acquired in a business
combination.
Postimplementation Review
After the FASB issues a major new accounting standard, it
performs a postimplementation review (PIR) process to evaluate whether the
standard is achieving its objective by providing users of financial statements
with relevant information that justifies the costs of providing it. This process
enables the Board to solicit and consider stakeholder input and FASB staff
research. At its July 28, 2021, and September 21, 2022, meetings, the FASB
discussed feedback received to date on the revenue standard as well as the
results of research performed on certain revenue topics, including disclosures,
short-cycle manufacturing, principal-versus-agent considerations, licensing, and
variable consideration. In the handouts prepared for the Board’s July 2021 and September 2022 meetings, the FASB staff
noted that stakeholder feedback on the revenue standard was positive overall,
particularly from users of financial statements since the standard results in
more useful and transparent information, improved disclosures, and comparability
across entities and industries. The staff further observed that while many
preparers noted significant one-time costs associated with implementation of the
standard, they also highlighted that the standard has been beneficial in the
long run.
On November 10, 2023, the FASB hosted a public roundtable on the
PIR of ASC 606. During this meeting, participants discussed the benefits and
costs of the revenue standard, implementation challenges, improvements to the
standard-setting process, and assessment of the PIR process.
The FASB staff will continue to monitor implementation of the
revenue standard and provide updates to the Board on any emerging issues
identified. As the PIR of the revenue standard progresses, the Board and its
staff may identify areas of improvement that could result in future standard
setting.
This Roadmap comprehensively discusses the key accounting
and financial reporting considerations related to the
recognition of revenue from contracts with customers
under ASC 606.
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Chapter 1 — Overview
Chapter 1 — Overview
1.1 Background
In May 2014, the FASB and IASB issued their final standard on
revenue from contracts with customers. The standard, issued as ASU 2014-09 by the FASB
and as IFRS 15 by the IASB, outlines a single comprehensive model for
entities to use in accounting for revenue from contracts with customers and
supersedes most legacy revenue recognition guidance, including industry-specific
guidance.
The goals of the revenue recognition project were to clarify and
converge the revenue recognition principles under U.S. GAAP and IFRS Accounting
Standards and to develop guidance that would streamline and enhance revenue
recognition requirements while also providing “a more robust framework for
addressing revenue issues.”1 The boards believe that the standard will improve the consistency of
requirements, comparability of revenue recognition practices, and usefulness of
disclosures.
The timeline below provides an overview of the key events in the development of the
final revenue recognition standard.
1.1.1 Revenue Project — Timeline
2
For public business entities, the revenue
standard became effective for annual reporting periods
(including interim reporting periods within those periods)
beginning after December 15, 2017. As a result,
calendar-year-end companies were required to apply the revenue
standard in 2018.
3
For entities that are not public business
entities, the revenue standard became effective for annual
reporting periods beginning after December 15, 2018, and for
interim reporting periods within annual reporting periods
beginning after December 15, 2019. However, in June 2020, the
FASB issued ASU 2020-05, which permitted those nonpublic
entities that had not yet issued their financial statements or
made financial statements available for issuance as of June 3,
2020, to adopt the revenue standard for annual reporting periods
beginning after December 15, 2019, and for interim reporting
periods within annual reporting periods beginning after December
15, 2020.
The boards’ 2008 discussion paper on revenue recognition represented a
significant milestone in the project. The project picked up momentum with the
issuance of the June 2010 ED, for which the boards received nearly 1,000 comment
letters. Then, in November 2011, the boards issued their revised ED after
conducting extensive outreach and redeliberating almost every aspect of the
original proposal. After further outreach and deliberations, the boards modified
the proposal and issued the final standard in May 2014.
The following month, a joint FASB/IASB TRG was created to
research standard-related implementation issues and help the boards resolve
questions that could give rise to diversity in practice. Throughout the
remainder of 2014 and 2015, the full TRG met and discussed topics that
preparers, auditors, and industries had elevated to the TRG’s attention. In
addition, the FASB-only version of the TRG met in April 2016 and November 2016.
With the help of input from the TRG, the boards issued additional revenue
guidance and interpretations (see Chapter 18 for more information). Both the
FASB and the IASB have indicated that no future TRG meetings are scheduled and
that the TRG will not meet unless additional significant, pervasive issues are
identified. However, the FASB has indicated that stakeholders may submit
inquiries through its technical inquiry process.4
In January 2016, the IASB issued an announcement that it had
completed its decision-making process related to clarifying the revenue standard
and that it did not plan to schedule any additional TRG meetings for IFRS
constituents. However, the FASB continued to address implementation issues. As
noted above, two FASB-only TRG meetings were held, one in April 2016 and the
other in November 2016. At the November 2016 FASB-only TRG meeting, the FASB
announced that no additional TRG meetings were scheduled. However, the FASB
encouraged stakeholders to continue submitting implementation questions either
directly to the TRG or through the FASB’s technical inquiry process. While it
acknowledged that it would be open to scheduling future TRG meetings to discuss
implementation issues that are significant and far-reaching, the FASB noted that
it would be judicious in selecting topics, partly because the Board did not want
to disrupt the implementation activities of entities that were adopting the
standard as of January 1, 2017. As of the issuance date of this publication,
there have been no additional TRG meetings since November 2016.
In August 2017, the SEC issued SAB
116, which effectively rescinded the SEC’s legacy revenue
recognition guidance in SAB Topic 13, Securities Exchange Act Release No. 23507,
and Accounting and Auditing Enforcement Release No. 108. As part of this update,
the SEC’s legacy guidance on bill-and-hold arrangements is no longer applicable
upon the adoption of ASC 606 (i.e., entities should look to the guidance in the
revenue standard to determine the appropriate accounting for bill-and-hold
arrangements). Refer to Section 8.6.9 for additional information on bill-and-hold
arrangements. In addition, SAB 116 notes that SAB Topic 8 will no longer be
applicable for retail companies. Further, SAB 116 modified the miscellaneous
disclosure guidance in SAB Topic 11.A. For additional information about SAB 116
and other relevant SEC activities, refer to Chapter 18.
Footnotes
1
Quoted from ASU 2014-09.
2
For public business entities, the revenue
standard became effective for annual reporting periods
(including interim reporting periods within those periods)
beginning after December 15, 2017. As a result,
calendar-year-end companies were required to apply the revenue
standard in 2018.
3
For entities that are not public business
entities, the revenue standard became effective for annual
reporting periods beginning after December 15, 2018, and for
interim reporting periods within annual reporting periods
beginning after December 15, 2019. However, in June 2020, the
FASB issued ASU 2020-05, which permitted those nonpublic
entities that had not yet issued their financial statements or
made financial statements available for issuance as of June 3,
2020, to adopt the revenue standard for annual reporting periods
beginning after December 15, 2019, and for interim reporting
periods within annual reporting periods beginning after December
15, 2020.
1.2 Key Provisions of the Revenue Standard
The core principle and application of the standard’s revenue model can be
depicted as follows:
The core principle was established by the FASB and IASB and is the underpinning of the entire revenue
framework. In this principle, the boards identified and answered the two most fundamental questions
concerning revenue:
- When?
- That is, when may an entity recognize revenue?
- Answer — When the entity satisfies its obligations under a contract by transferring goods or services to its customer. That is, when the entity performs, it should recognize revenue.
- How much?
- That is, how much revenue may an entity recognize?
- Answer — The amount to which the entity expects to be entitled to under the contract (i.e., an expected amount, so estimates may be 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 Chapters 4 and 6 for further discussion).
The core principle is supported by five steps (following a scope decision) in
the standard’s revenue framework, which are outlined in the following chart:
1.3 Scope (Chapter 3 of the Roadmap)
The standard’s revenue guidance applies to all contracts
with customers as defined
by the standard (see Chapter 2 for
definitions of terms included in the standard’s
glossary) except those that are within the scope
of other topics in the Codification. The guidance
does not apply to contracts within the scope of
ASC 842 (leases) and ASC 944 (financial services —
insurance); contractual rights or obligations
within the scope of ASC 310, ASC 320, ASC 321, ASC
323, ASC 325, ASC 405, ASC 470, ASC 815, ASC 825,
and ASC 860 (primarily various types of financial
instruments); contracts within the scope of ASC
460 (guarantees other than product or service
warranties); and ASC 845 (nonmonetary exchanges
between entities in the same line of business to
facilitate a sale to another party).
Certain provisions of the standard’s revenue guidance also apply to transfers of
nonfinancial assets, including in-substance
nonfinancial assets that are not an output of an
entity’s ordinary activities (e.g., sales to
noncustomers of (1) property, plant, and
equipment; (2) real estate; or (3) intangible
assets). Such provisions include guidance on
recognition (including determining the existence
of a contract and control principles) and
measurement. See Chapter 17.
1.4 Step 1: Identify the Contract With the Customer (Chapter 4 of the Roadmap)
Step 1 requires an entity to identify the contract with the customer. A contract does not have to be
written to meet the criteria for revenue recognition; however, it does need to create enforceable rights
and obligations.
A contract can be written, verbal, or implied; however, the guidance applies to
a contract only if all of the following criteria are met:
-
“The parties to the contract have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations.”
-
“The entity can identify each party’s rights regarding the goods or services to be transferred.”
-
“The entity can identify the payment terms for the goods or services to be transferred.”
-
“The contract has commercial substance (that is, the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract).”
-
“It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.”
Stakeholders should be aware that under U.S. GAAP, the “probable” threshold for
collectibility as used in the criterion above for identifying the contract with the
customer is defined differently from how it is defined under IFRS Accounting
Standards. In U.S. GAAP, ASC 450-20 (formerly FASB Statement 5) states that the term
“probable” refers to a “future event or events [that] are likely to occur.” In IFRS
Accounting Standards, “probable” means “more likely than not.” Because “more likely
than not” under U.S. GAAP is a lower threshold than “probable,” an entity may
encounter differences between U.S. GAAP and IFRS Accounting Standards in determining
whether a contract exists. For more discussion on differences between U.S. GAAP and
IFRS Accounting Standards, refer to Appendix A.
If a contract does not meet these criteria at contract inception, an entity must continue to reassess
the criteria to determine whether they are subsequently met. If the above criteria are not met in a
contract with a customer, the entity is precluded from recognizing revenue under the contract until the
consideration received is nonrefundable and one or more of the following events have occurred:
- All of the performance obligations in the contract have been satisfied, and substantially all of the promised consideration has been received.
- The contract has been terminated or canceled.
- The entity (1) has transferred control of the goods or services to which the consideration that has been received is related, (2) has stopped transferring goods or services, and (3) has no obligation to transfer additional goods or services.
If none of the events above have occurred, any consideration received would be recognized as a liability.
1.5 Step 2: Identify the Performance Obligations in the Contract (Chapter 5 of the Roadmap)
Step 2 requires an entity to
identify the distinct goods or services promised in the contract. Distinct
goods and services should be accounted for as separate units of account (this
process is sometimes called “unbundling”). These distinct goods or services are
referred to as “performance obligations.”
The guidance requires an entity to evaluate the promised “goods or services” in
a contract to determine each performance obligation (i.e., the unit of account). A
performance obligation is a promise to transfer either of the following to a
customer:
-
“A good or service (or a bundle of goods or services) that is distinct.”
-
“A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.”
The guidance addresses the identification of distinct performance obligations in
contracts involving the following:
-
Warranties (see Section 5.5).
-
Customer options to acquire additional free or discounted goods or services (see Chapter 11).
-
Nonrefundable up-front fees (see Section 5.6).
The decision tree below illustrates the process for identifying performance
obligations in a contract.
A promised good or service is distinct (and therefore a performance obligation) if both of the following
criteria are met:
- Capable of being distinct — “The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.”
- Distinct within the context of the contract — “The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.”
The standard defines a readily available resource as “a good or service that is
sold separately (by the entity or another entity) or a resource that the customer
has already obtained from the entity.” If an entity regularly sells a good or
service on a stand-alone basis, the customer can benefit from that good or service
on its own and, therefore, the first criterion above is met.
The objective of the second criterion above is to determine whether the nature
of the promise is to transfer each good or service individually or, instead, to
transfer a combined item or items to which the promised goods or services are
inputs. The guidance provides the following indicators that two or more promises are
not separately identifiable:
-
“The entity provides a significant service of integrating goods or services with other goods or services promised in the contract . . . . In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer.”
-
“One or more of the goods or services significantly modifies or customizes, or are significantly modified or customized by, one or more of the other goods or services promised in the contract.”
-
“The goods or services are highly interdependent or highly interrelated. In other words, each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, in some cases, two or more 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.”
Entities may need to use significant judgment when determining whether the goods
or services in a contract are significantly integrated, are highly interdependent or
highly interrelated, or significantly modify or customize one another.
1.6 Step 3: Determine the Transaction Price (Chapter 6 of the Roadmap)
Step 3 requires an entity to determine the transaction price for the contract, which is the amount of
consideration to which the entity expects to be entitled in exchange for the
promised goods or services in the contract. The transaction price can be a fixed
amount or can vary because of “discounts, rebates, refunds, credits, price
concessions, incentives, performance bonuses, penalties, or other similar items.” An
entity must consider the following when determining the transaction price:
-
Variable consideration (see Section 6.3) — When the transaction price includes a variable amount, an entity is generally required to estimate the variable consideration by using either an “expected value” (probability-weighted) approach or a “most likely amount” approach, whichever is more predictive of the amount to which the entity will be entitled (subject to the “constraint” discussed below). However, estimation may not be required in all circumstances. For example, variable consideration may not require estimation if it could be allocated entirely to a distinct good or service when certain criteria are met (see Section 1.7).
-
Significant financing components (see Section 6.4) — Adjustments for the time value of money are required if the contract includes a “significant financing component” (as defined by the guidance).
-
Noncash consideration (see Section 6.5) — To the extent that a contract includes noncash consideration, an entity is required to measure that consideration at fair value at contract inception.
-
Consideration payable to a customer (see Section 6.6) — The revenue standard requires consideration payable to the customer to be reflected as an adjustment to the transaction price unless the consideration is payment for a distinct good or service (as defined by the standard).
Some or all of an estimate of variable consideration is only
included in the transaction price to the “extent that it is probable[5] 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” (this concept is commonly referred to as the “constraint”).
The guidance requires entities to perform a qualitative assessment that takes into
account both the likelihood and the magnitude of a potential revenue reversal and
provides factors that could indicate that an estimate of variable consideration is
subject to significant reversal (e.g., susceptibility to factors outside the
entity’s influence, a long period before uncertainty is resolved, limited experience
with similar types of contracts, practices of providing concessions, or a broad
range of possible consideration amounts). This estimate would be updated in each
reporting period to reflect changes in facts and circumstances. In addition, the
constraint does not apply to sales- or usage-based royalties derived from the
licensing of intellectual property (IP); rather, consideration from such royalties
is only recognized as revenue at the later of when the performance obligation is
satisfied or when the uncertainty is resolved (e.g., when subsequent sales or usage
occurs). See Section
12.7 for further discussion of the sales- or usage-based royalty
exception for licenses of IP.
Entities will need to exercise significant judgment when determining
the amount of variable consideration to include in the transaction price.
Consequently, they could find it challenging to consistently apply the standard’s
requirements throughout their organizations.
Footnotes
[5]
In IFRS 15, the IASB uses the term “highly probable,” which
has the same meaning as the FASB’s “probable” as defined in ASC 450.
1.7 Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract (Chapter 7 of the Roadmap)
Step 4 requires an entity to allocate the transaction price determined in step 3 to the performance
obligations identified in step 2 by using the following approaches:
- Allocating the transaction price to the performance obligations on the basis of the stand-alone selling price (see Section 7.2).
- Allocating a discount to one or more, but not all, of the performance obligations in the contract (see Section 7.4).
- Allocating variable consideration to one or more, but not all, of the distinct goods or services in the contract (see Section 7.5).
- Allocating changes in the transaction price to the performance obligations in the contract (see Section 7.6).
Under the guidance, when a contract contains more than one performance
obligation, an entity would generally allocate the transaction price
to each performance obligation on a relative stand-alone selling
price basis. The guidance states that the “best evidence of a
standalone selling price is the observable price of a good or
service when the entity sells that good or service separately in
similar circumstances and to similar customers.” If the good or
service is not sold separately, an entity must estimate the
stand-alone selling price by using an approach that maximizes the
use of observable inputs. Acceptable estimation methods include, but
are not limited to, (1) adjusted market assessment, (2) expected
cost plus a margin, and (3) a residual approach (when the
stand-alone selling price is not directly observable and is either
highly variable or uncertain). An entity would determine the
stand-alone selling price for a good or service at contract
inception and would not reassess or update its determination of the
stand-alone selling price thereafter unless the contract is
modified.
The guidance indicates that if certain conditions are met, there are limited
exceptions to this general allocation requirement. When those conditions are met, a
discount or variable consideration must be allocated to one or more, but not all, of
the performance obligations in a contract.
Changes in the transaction price (e.g., changes in an estimate of variable consideration) after contract
inception would be allocated to all performance obligations in the contract on the same basis (unless
the terms of the contract meet certain criteria that allow for allocation of variable
consideration to one or more, but not all, of the performance obligations).
The guidance allows entities to use a residual approach in allocating contract
consideration, but only when the stand-alone selling price of a good
or service is not directly observable and is either “highly variable
or uncertain.” An entity will need to use judgment in determining
whether these criteria are met.
1.8 Step 5: Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation (Chapter 8 of the Roadmap)
Step 5 specifies how an entity should determine when to recognize revenue in relation to a
performance obligation and requires consideration of the following:
- Recognition of revenue when (or as) control of the good or service is passed to the customer (see Sections 8.1 and 8.2).
- Criteria for satisfying performance obligations and recognizing revenue over time (see Section 8.4).
- Measurement of progress in satisfying performance obligations to determine the pattern of when to recognize revenue over time (see Section 8.5).
- Indicators of when performance obligations are satisfied and when to recognize revenue at a point in time (see Section 8.6).
Under the guidance, a performance obligation is satisfied (and the related
revenue recognized) when “control” of the underlying goods or services (the
“assets”) related to the performance obligation is transferred to the customer. The
guidance defines “control” as “the ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset.” An entity must first
determine whether control of a good or service is transferred over time. If so, the
related revenue is recognized over time as the good or service is transferred to the
customer. If not, control of the good or service is transferred at a point in
time.
Control of a good or service (and therefore satisfaction of the related performance obligation) is
transferred over time when at least one of the following criteria is met:
- “The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.”
- “The entity’s performance creates or enhances an asset . . . that the customer controls as the asset is created or enhanced.”
- “The entity’s performance does not create an asset with an alternative use to the entity . . . and the entity has an enforceable right to payment for performance completed to date.”
If a performance obligation is satisfied over time, an entity recognizes revenue
by measuring progress toward satisfying the performance obligation in a manner that
faithfully depicts the transfer of goods or services to the customer. The revenue
standard provides specific guidance on measuring progress toward completion,
including the use and application of output and input methods.
The guidance notes that in certain circumstances, an entity may not be able to
reasonably measure progress toward complete satisfaction of a performance
obligation. In such circumstances, the entity would be required to recognize revenue
to the extent of costs incurred (i.e., at a zero profit margin) if the entity
expects to recover such costs. The guidance does not permit entities to use a
completed-contract method.
If a performance obligation is not satisfied over time, it is deemed satisfied
at a point in time. Under the guidance, entities would consider the following
indicators in evaluating the point at which control of an asset has been transferred
to a customer:
-
“The entity has a present right to payment for the asset.”
-
“The customer has legal title to the asset.”
-
“The entity has transferred physical possession of the asset.”
-
“The customer has the significant risks and rewards of ownership of the asset.”
-
“The customer has accepted the asset.”
In addition, the implementation guidance includes further discussion on the following topics related to
when control of an asset has been transferred to a customer:
- Customer acceptance terms (Section 8.6.7) — Control has been transferred to the entity’s customer if the entity can objectively determine that the good or service meets agreed-upon specifications. If the entity is unable to make that objective determination, the entity must receive the customer’s acceptance before concluding that control has been transferred.
- Consignment arrangements (Section 8.6.8) — Control typically passes to another party (a dealer or distributor) when (1) that party sells the product to a customer of its own or (2) a specified period expires.
- Bill-and-hold arrangements (Section 8.6.9) — The entity should evaluate whether control has passed to its customer (the revenue standard provides specific criteria that need to be met for the entity to conclude that control has been transferred to the customer). Further, the entity is required to consider whether there are additional performance obligations after control is transferred to the customer (e.g., an obligation to provide custodial services); if such performance obligations exist, the entity would allocate a portion of the transaction price to those performance obligations.
- Repurchase agreements (Section 8.7) — If the entity has an obligation (forward) or right (call option) to repurchase the asset (or in some instances when the customer has rights to put the asset back to the entity), the customer does not obtain control, and the transaction is accounted for as a lease (ASC 842) or a financing arrangement.
1.9 Beyond the Core Model
The revenue standard also affects other related accounting topics and contains
disclosure requirements, as discussed in Sections 1.9.1 and 1.9.2.
1.9.1 Other Related Accounting Topics
Additional accounting topics affected by the revenue standard are summarized in
the table below.
Topic | Roadmap Chapter |
---|---|
Combination of contracts There are certain circumstances in which multiple legal-form contracts would be
accounted for as though they were one contract for
accounting purposes. The revenue standard provides
guidance on when contracts should be combined. | |
Rights of return The obligation of a seller to “stand ready” to accept a return is not a performance
obligation. However, when a seller stands ready to accept a return, it does not recognize
revenue for goods expected to be returned. Rather, it recognizes a refund liability for
consideration paid by a buyer to which the seller does not expect to be entitled, together
with a corresponding asset to recover the product from the buyer. | |
Customers’ unexercised rights An entity recognizes “breakage” (i.e., a customer’s unexercised rights) in a manner
consistent with the pattern of rights exercised by the customer if the entity expects
to be entitled to a breakage amount; otherwise, the entity defers recognition until the
probability that the customer will exercise its rights is remote. | |
Contract modifications The revenue standard provides a general framework of accounting for contract
modifications, including guidance on when modifications
are accounted for as a separate contract and how changes
should be recorded. | |
Principal-versus-agent considerations The revenue standard includes control-based guidance on determining whether the
promise an entity has made to a customer is to provide
the good or service or to arrange for another party to
fulfill the promise. | |
Licensing The revenue standard’s guidance on licensing distinguishes between two types of
licenses (right to use and right to access). The timing
of revenue recognition is different for each. | |
Costs of obtaining or fulfilling a contract The revenue standard includes guidance on how to account for costs related to a
contract, distinguishing between costs of obtaining a
contract and costs of fulfilling a contract. For
situations in which the application of this guidance
results in the capitalization of costs, the revenue
standard provides additional guidance on (1) determining
an appropriate amortization period and (2) impairment
considerations. | |
Presentation The revenue standard includes guidance on the presentation of contract assets,
contract liabilities, and receivables arising from
contracts with customers. | |
Nonpublic-entity requirements The revenue standard provides nonpublic entities with disclosure practical
expedients. | |
Nonfinancial assets ASU 2014-09 (as amended by ASU 2017-05) provides guidance on the recognition and
measurement of transfers of nonfinancial assets to
parties that are not customers (codified in ASC
610-20). |
1.9.2 Required Disclosures (Chapter 15 of the Roadmap)
The revenue standard requires entities to disclose both quantitative and
qualitative information that enables “users of financial statements to
understand the nature, amount, timing, and uncertainty of revenue and cash flows
arising from contracts with customers.” The standard’s disclosure requirements
include the following (there are certain exceptions for nonpublic entities; see
Chapter 16 for a summary of these
exceptions):
-
Presentation or disclosure of revenue from contracts with customers and any impairment losses recognized separately from other sources of revenue or impairment losses from other contracts (e.g., leases).
-
A disaggregation of revenue to “depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors” (the standard also provides implementation guidance).
-
Information about (1) contract assets and contract liabilities (including changes in those balances), (2) the amount of revenue recognized in the current period that was previously recognized as a contract liability, and (3) the amount of revenue recognized in the current period that is related to performance obligations satisfied in prior periods.
-
Information about performance obligations (e.g., types of goods or services, significant payment terms, typical timing of satisfying obligations, and other provisions).
-
Information about an entity’s transaction price allocated to the remaining performance obligations, including (in certain circumstances) a quantitative disclosure of the “aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied)” and when the entity expects to recognize that amount as revenue.
-
A description of the significant judgments, and changes in those judgments, that affect the amount and timing of revenue recognition (including information about the timing of satisfaction of performance obligations, the determination of the transaction price, and the allocation of the transaction price to performance obligations).
-
Information about an entity’s accounting for costs to obtain or fulfill a contract (including account balances and amortization methods).
-
Information about policy decisions (i.e., whether the entity used the practical expedients for significant financing components and contract costs allowed by the guidance).
The guidance requires entities, on an interim basis, to disclose information
required under ASC 270 as well as to provide the disclosures (described above)
about (1) the disaggregation of revenue, (2) contract asset and contract
liability balances and significant changes in those balances since the previous
period-end, and (3) the transaction price allocated to the remaining performance
obligations.
IFRS 15 only requires entities to disclose the disaggregation of revenue in
addition to the information required under IAS 34 for interim periods. For a
summary of differences between U.S. GAAP and IFRS Accounting Standards, refer to
Appendix A.
Chapter 2 — Symbols and Defined Terms
Chapter 2 — Defined Terms
This chapter discusses the symbols used in this publication and the definition of various terms used in
ASC 606.
2.1 Glossary Terms
ASC 606 contains a glossary of terms used in the revenue standard.
Several of these glossary terms are also used in other topics of U.S. GAAP (e.g.,
“public business entity” and “probable”). However, most of them are specific to ASC
606 (e.g., “contract asset” and “contract liability”).
Although there are not many terms in the standard’s glossary, a
significant number of them play a critical role in establishing the scope of the
guidance (e.g., “contract” and “customer,” as discussed in Chapter 3), establishing presentation of financial
statement line items (e.g., “contract asset” and “contract liability,” as discussed
in Chapter 14), and creating a
new definition of the unit of account for revenue (e.g., “performance obligation,”
as discussed in Chapter 5).
Also, as noted in the discussion of collectibility in Chapter 4, the definition of “probable” under U.S.
GAAP differs from that under IFRS Accounting Standards.
The terms and definitions below are reproduced from the ASC 606
glossary.
ASC 606-10 — Glossary
Contract
An agreement between two or more parties
that creates enforceable rights and obligations.
Contract Asset
An entity’s right to consideration in
exchange for goods or services that the entity has
transferred to a customer when that right is conditioned on
something other than the passage of time (for example, the
entity’s future performance).
Contract
Liability
An entity’s obligation to transfer goods or
services to a customer for which the entity has received
consideration (or the amount is due) from the customer.
Customer
A party that has contracted with an entity
to obtain goods or services that are an output of the
entity’s ordinary activities in exchange for
consideration.
Lease
A contract, or part of a contract, that
conveys the right to control the use of identified property,
plant, or equipment (an identified asset) for a period of
time in exchange for consideration.
Not-for-Profit
Entity
An entity that possesses the following
characteristics, in varying degrees, that distinguish it
from a business entity:
-
Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
-
Operating purposes other than to provide goods or services at a profit
-
Absence of ownership interests like those of business entities.
Entities that clearly fall outside this
definition include the following:
-
All investor-owned entities
-
Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
Performance
Obligation
A promise in a contract with a customer to
transfer to the customer either:
-
A good or service (or a bundle of goods or services) that is distinct
-
A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
Probable
The future event or events are likely to
occur.
Public Business
Entity
A public business entity is a business
entity meeting any one of the criteria below. Neither a
not-for-profit entity nor an employee benefit plan is a
business entity.
-
It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
-
It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
-
It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
-
It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
-
It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.
An entity may meet the definition of a
public business entity solely because its financial
statements or financial information is included in another
entity’s filing with the SEC. In that case, the entity is
only a public business entity for purposes of financial
statements that are filed or furnished with the SEC.
Revenue
Inflows or other enhancements of assets of
an entity or settlements of its liabilities (or a
combination of both) from delivering or producing goods,
rendering services, or other activities that constitute the
entity’s ongoing major or central operations.
Security
A share, participation, or other interest in
property or in an entity of the issuer or an obligation of
the issuer that has all of the following characteristics:
-
It is either represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer.
-
It is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.
-
It either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations.
Standalone Selling
Price
The price at which an entity would sell a
promised good or service separately to a customer.
Transaction
Price
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.
2.2 “Criteria” Versus “Factors” and “Indicators”
Various guidance throughout the revenue standard lists “criteria,”
“factors,” or “indicators.” Criteria are distinguishable from factors and
indicators.
Criteria are specific requirements that must be met for an entity to
make a determination. That is, criteria are determinative or are requirements in a
particular assessment. For example, as discussed in step 1 (Chapter 4), ASC 606-10-25-1 lists five criteria that
must all be met for an entity to conclude that a contract with a customer exists.
Similarly, as discussed in step 2 (Chapter 5),
ASC 606-10-25-19 lists two criteria that must be met for an entity to determine that
a good or service promised to a customer is distinct and therefore a performance
obligation. In that assessment, if one or both of those criteria are not met, the
promise is not distinct and is therefore not a separate performance obligation.
In contrast, factors and indicators are considerations that may
support a conclusion but are not determinative. For example, the guidance on
constraining estimates of variable consideration lists factors in ASC 606-10-32-12
“that could increase the likelihood or the magnitude of a revenue reversal”; and the
guidance on principal-versus-agent considerations lists indicators in ASC
606-10-55-39 that the entity is a principal. The indicators in ASC 606-10-55-39 are
intended to support an entity’s conclusion that the entity either does or does not
obtain control of a specified good or service before it is transferred to a
customer. For more information about constraints on variable consideration and
principal-versus-agent considerations, see Chapters
6 and 10.
Chapter 3 — Objective and Scope
Chapter 3 — Objective and Scope
3.1 Objective
ASC 606-10
General
10-1 The
objective of the guidance in this Topic is to establish the
principles that an entity shall apply to report useful
information to users of financial statements about the
nature, amount, timing, and uncertainty of revenue and cash
flows arising from a contract with a customer.
In the revenue recognition project, the FASB, together with the IASB, set key
objectives to guide its development of the new guidance. ASU 2014-09, which
created ASC 606, outlines those key objectives in its Summary as follows:
-
Remove inconsistencies and weaknesses in revenue requirements.
-
Provide a more robust framework for addressing revenue issues.
-
Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.
-
Provide more useful information to users of financial statements through improved disclosure requirements.
-
Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The objectives listed above could be further summarized as follows:
- Establish a comprehensive framework — Create a new comprehensive framework for assessing all revenue transactions (across entities, industries, jurisdictions, and capital markets) to eliminate inconsistencies and fill gaps in legacy U.S. GAAP.
- Enhance revenue disclosures — Improve disclosures by requiring entities to provide more information about revenue, a key financial metric.
The objective of the revenue standard as stated in ASC 606 — “to establish the
principles that an entity shall apply to report useful information to users of
financial statements about the nature, amount, timing, and uncertainty of revenue
and cash flows arising from a contract with a customer” — lays the groundwork for
the overall framework and the detailed recognition, measurement, presentation, and
disclosure principles outlined in the remainder of the standard. The Board believed
that this comprehensive framework would eliminate the need to address revenue topics
in a piecemeal manner through the EITF’s projects or the AICPA’s industry guides.
While it would still be necessary for the EITF and AICPA to work through new and
emerging revenue issues, those groups would all be using the same comprehensive
framework when analyzing revenue questions.
3.1.1 Meeting the Objective
After establishing the objective of the revenue standard, the FASB and IASB
created a core principle that establishes this comprehensive framework and
governs the entire guidance. The core principle is expressed in ASC 606-10-10-2
as follows:
ASC 606-10
Meeting the Objective
10-2 To meet the objective in paragraph 606-10-10-1, the core principle of the guidance in this Topic is that
an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an
amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods
or services.
Many do not focus on this core principle and rush directly into the detailed requirements of the
standard. However, the manner in which the boards developed the core principle and the specific words
they used to articulate it were intentional. At its core, this main principle outlines the answers to the
following key questions that always arise when a revenue transaction is evaluated:
- When (i.e., recognition) — When is it appropriate to recognize revenue?
- How much (i.e., measurement) — What specific amount of revenue should an entity recognize?
The core principle’s answers to these questions are discussed below.
3.1.1.1 When to Recognize Revenue
In accordance with the core principle of the revenue standard, revenue is
recognized when the entity transfers promised goods or services to the
customer.
Specifically, the boards intended to depict performance through the recognition
of revenue. That is, when the entity performs by delivering goods or
services, it should recognize revenue because doing so demonstrates to a
financial statement user that the performance has taken place.
In developing the revenue standard, the boards believed that
it is important to demonstrate to financial statement users when the entity
performs; accordingly, that depiction is the recognition of revenue.
Uncertainties about whether and, if so, how much revenue should be
recognized would be dealt with separately in the measurement of revenue.
3.1.1.2 How Much Revenue to Recognize
Under the core principle, revenue is recognized in an amount that reflects the consideration to which
the entity expects to be entitled in exchange for the promised goods or services.
The measurement concept within the core principle was fiercely debated and
changed over time. In the end, the wording “expects to be entitled,” which
was introduced in the boards’ 2011 revised exposure draft (ED) and
represented a change from their 2010 ED, was deliberate and intended to
reflect a measure of revenue that did not include variability attributable
to customer credit risk. At the time the boards were developing the revenue
standard, they were also debating financial instruments and the impairment
model for those financial instruments. As a result, there were many debates
about whether the measurement of revenue should reflect the risk that the
customer cannot or will not pay the amounts as they become due. The final
decisions of the boards distinguished customer credit risk from other
sources of variability in a revenue contract. Accordingly, the phrase
“expects to be entitled” was intentional — specifically, the phrase “be
entitled” is intentionally different from the word “collect” or the word
“receive” since each of those words would imply that the amount estimated
encompasses all risks, including the risk that the customer cannot or will
not pay. Therefore, unlike a fair value measurement model, the allocated
transaction price approach under the revenue standard generally does not
reflect any adjustments for amounts that the entity might not be able to
collect from the customer (i.e., customer credit risk). However, the
transaction price is inclusive of all other uncertainties. The boards
outlined this allocated transaction price approach in paragraph BC181 of
ASU 2014-09.
In addition, the amount to which an entity expects to be entitled is not always
the price stated in the contract or the invoiced amount, either of which may
be expected on the basis of a common interpretation of the word “entitled.”
For purposes of ASC 606, the term “entitled” is aligned with the
determination of the “accounting” contract (as opposed to the “legal”
contract). Therefore, “entitlement” is influenced by the entity’s past
practices, which affect the enforceable rights and obligations in the
accounting contract. As a result, under ASC 606, the amount to which an
entity expects to be entitled is inclusive of any price concessions that the
entity explicitly or implicitly provides. That is, if the entity will accept
an amount of consideration that is less than the contractually stated or
invoiced price, that amount is a price concession and is treated as variable
consideration. See Chapter
6 for further discussion of the determination of the transaction
price and Chapter 12
for discussion of an exception to the general rule on estimating variable
consideration for sales- or usage-based royalties.
One exception to this “entitlement” notion within measurement is when a
significant financing component is identified in a contract because, for
example, a customer pays in arrears. In that case, customer credit risk will
be reflected in the amount of revenue recognized. This is because an entity
will take customer credit risk into account in determining the appropriate
discount rate (see Section
6.4.4).
In addition, as noted in paragraphs BC260 and BC261 of ASU 2014-09, the FASB and IASB decided that
revenue should be measured at the amount to which an entity expects to be entitled in response to
comments from users of financial statements that “they would prefer revenue to be measured at the
‘gross’ amount so that revenue growth and receivables management (or bad debts) could be analyzed
separately.”
3.1.2 Applying the Standard
After establishing the core principle, the FASB and IASB agreed on the following five steps (as outlined in
Chapter 1) to apply that principle:
The introduction to the standard describes the five steps to be applied. However, those five steps do not
appear sequentially in either the body of the standard or the implementation guidance.
In a manner consistent with the structure of the Codification,
the requirements of ASC 606 adhere to the framework of recognition, measurement,
presentation, and disclosure. As a result, the steps are presented as follows:
- Recognition — Step 1 (identify the contract), step 2 (identify the performance obligations), and step 5 (recognize revenue when [or as] the entity satisfies a performance obligation).
- Measurement — Step 3 (determine the transaction price) and step 4 (allocate the transaction price to the performance obligations in the contract).
An entity should consider all five steps for every contract with
a customer unless a step is clearly inapplicable. After considering the specific
facts and circumstances of a particular contract and understanding the framework
and the five steps, an entity may find that one of the steps is not relevant.
For example, when an entity determines in step 2 that a contract contains only a
single performance obligation, step 4 (allocation of the transaction price) will
often not be applicable. In such a case, the entity can, in effect, jump from
step 3 to step 5.
An entity would generally be expected to apply the five steps in
sequential order. However, the entity may sometimes need to consider a later
step before or concurrently with applying an earlier one.
Example 3-1
In applying step 1 to determine whether
a contract exists and reviewing the collectibility
threshold as required in ASC 606-10-25-1(e), an entity
will need to consider the “[amount] of the consideration
to which it will be entitled in exchange for the
[promised] goods or services.” The amount of
consideration “may be less than the price stated in the
contract if the consideration is variable because the
entity may offer the customer a price concession.” As a
result, the entity would need to apply step 3 (determine
the transaction price) and estimate the expected
discounts or price concessions before being able to
conclude that a valid contract exists under step 1.
Example 3-2
Under step 2 (identify the performance
obligations), ASC 606-10-25-14(b) requires entities to
identify as a performance obligation a “series of
distinct goods or services that are substantially the
same and that have the same pattern of transfer to the
customer.” In accordance with ASC 606-10- 25-15, that
series is a performance obligation only when the
following two criteria are met: (1) the performance
obligation satisfies the criteria in step 5 to be
recognized over time and (2) the same method to measure
progress is used. Therefore, the determination in step 2
about whether a series of distinct goods or services is
a single performance obligation relies on the
requirements in step 5 for determining how revenue is
recognized. As a result, an entity would need to
understand and make a determination about step 5 before
applying step 2.
Example 3-3
To determine the transaction price in
step 3, an entity is required to identify, estimate, and
potentially constrain variable consideration in
accordance with ASC 606-10-32-11 through 32-13. The
consideration in a contract may vary as a result of many
different factors, including when the price is a fixed
rate per increment of service (e.g., hours) but the
expected increments of service may vary throughout the
contract term. In this situation, step 3 would require
an entity to estimate the increments of service expected
to be provided over the contract term since such
increments would result in variable consideration that
the entity would need to estimate (and potentially
constrain) when determining the transaction price. Step
4 would require the transaction price to be allocated to
the distinct goods or services identified in the
contract on the basis of their relative stand-alone
selling prices, and the entity would need to determine
when (or how) the performance obligation is satisfied as
part of step 5, under which it would need to select a
single measure of progress to determine how control of
the promised services is transferred to the customer
over time. However, if the promise to provide services
qualifies as a series (which would be accounted for as a
single performance obligation), ASC 606-10-55-18
provides a practical expedient that allows an entity
that is recognizing revenue over time by using an output
method to recognize revenue equal to the amount that the
entity has the right to invoice if the invoiced amount
corresponds directly to the value transferred to the
customer.
If the amount that the entity is able to
invoice corresponds directly to the value transferred to
the customer (e.g., the invoiced amount is determined on
the basis of hours of service provided and a rate per
hour that corresponds to the value of the services), the
entity can recognize revenue in the amount that it is
entitled to bill. Thus, the entity effectively combines
steps 3, 4, and 5 when it determines that it can apply
the practical expedient in ASC 606-10-55-18.
3.1.2.1 Applying the Guidance Consistently to Contracts With Similar Characteristics and in Similar Circumstances
ASC 606-10
10-3 An entity shall consider the terms of the contract and all relevant facts and circumstances when applying
this guidance. An entity shall apply this guidance, including the use of any practical expedients, consistently to
contracts with similar characteristics and in similar circumstances.
When the FASB was developing the detailed recognition and measurement guidance, it found many
instances in which estimates and judgments would be required. In each of those instances, the Board
believed that entities should consider all relevant facts and circumstances in applying those estimates
and judgments. As a result, in the “General” section of the standard, the Board outlined requirements
that should be applicable throughout the standard.
For example, the guidance on allocating the transaction price to performance
obligations in accordance with step 4 (see Chapter 7) provides that if the
stand-alone selling price of a good or service is not directly observable,
an entity is required to estimate the stand-alone selling price by choosing
an appropriate method (e.g., the adjusted market assessment approach, the
expected cost plus a margin approach, or, in limited circumstances, the
residual approach). Once an entity decides which method to use, it is
required to apply the same method consistently to similar contracts in
accordance with the general guidance in ASC 606-10-10-3 on consistency in
application. Rather than repeat this general requirement throughout the
detailed guidance on recognition and measurement, the Board decided to state
it once at the beginning of the standard to make it applicable to the
standard’s guidance overall.
3.1.2.2 Portfolio Approach
ASC 606-10
10-4
This guidance specifies the
accounting for an individual contract with a
customer. However, as a practical expedient, an
entity may apply this guidance to a portfolio of
contracts (or performance obligations) with similar
characteristics if the entity reasonably expects
that the effects on the financial statements of
applying this guidance to the portfolio would not
differ materially from applying this guidance to the
individual contracts (or performance obligations)
within that portfolio. When accounting for a
portfolio, an entity shall use estimates and
assumptions that reflect the size and composition of
the portfolio.
During the initial development of the new guidance, the FASB’s and IASB’s proposed concepts were
consistently discussed on the basis of an individual contract. However, feedback on the early drafts of
the guidance indicated that it would sometimes not be practical and cost-effective to apply the guidance
on an individual contract basis. In response to this feedback, discussions ensued regarding the use of a
portfolio approach.
The boards ultimately concluded that the revenue standard should generally be
applied on an individual contract basis. However, as a practical expedient,
a portfolio approach is permitted if it is reasonably expected that the
approach’s impact on the financial statements will not be materially
different from the impact of applying the revenue standard on an individual
contract basis.
Some stakeholders had requested additional guidance on when and how to establish
portfolios. However, the boards declined to list specific conditions that
must be met for an entity to apply the revenue standard to a portfolio of
contracts. Instead, the boards used a principle to establish that a
portfolio approach may be used depending on whether the effects of applying
the guidance to a portfolio of contracts would differ materially from the
effects of applying the guidance to contracts individually. Further, as
noted in paragraph BC69 of ASU 2014-09, the boards “indicated that they did
not intend for an entity to quantitatively evaluate each outcome and,
instead, the entity should be able to take a reasonable approach to
determine the portfolios that would be appropriate for its types of
contracts.”
3.1.2.2.1 Deciding Whether a Portfolio Approach May Be Used
Some entities manage a very large number of customer
contracts and offer an array of product combination options (e.g.,
entities in the telecommunications industry may offer a wide selection
of handsets and wireless usage plan options). For these entities, it
would take significant effort to apply some of the requirements of ASC
606, such as the requirement to allocate the stand-alone selling price
to the identified performance obligations, on an individual contract
basis, and the capability of IT systems to capture the relevant
information may be limited.
An entity in this situation may want to use a portfolio
approach as a practical expedient in accordance with ASC 606-10-10-4.
However, a portfolio approach would be appropriate only if (1) it is
applied to a group of contracts (or performance obligations) with
“similar characteristics” and (2) the entity “reasonably expects” that
the effects on the financial statements of applying ASC 606 to the
portfolio “would not differ materially” from the effects of applying
guidance to the individual contracts (or performance obligations) in
that portfolio.
ASC 606 does not provide explicit guidance on how to (1)
evaluate “similar characteristics” and (2) establish a reasonable
expectation that the effects of using a portfolio approach would not
differ materially from those of applying the guidance at a contract or
performance obligation level. Accordingly, an entity will need to
exercise significant judgment in determining that the contracts or
performance obligations it has segregated into portfolios have similar
characteristics at a sufficiently granular level to ensure that the
outcome of using a particular portfolio approach can reasonably be
expected not to differ materially from the results of applying the
guidance to each contract or performance obligation in the portfolio
individually.
In segregating contracts (or performance obligations)
with similar characteristics into portfolios, an entity should apply
objective criteria associated with the particular contracts or
performance obligations and their accounting consequences. When
determining whether particular contracts have similar characteristics,
the entity may find it helpful to focus particularly on those
characteristics that have the most significant accounting consequences
under ASC 606 in terms of their effect on the timing of revenue
recognition or the amount of revenue recognized. Accordingly, the
assessment of which characteristics are most important for determining
similarity will depend on the entity’s specific facts and circumstances.
However, there may be practical constraints on the entity’s ability to
use existing systems to analyze a portfolio of contracts, and these
constraints could affect its determination of how the portfolio should
be segregated.
The table below lists objective factors that entities
may consider when assessing whether particular contracts or performance
obligations have similar characteristics in accordance with ASC
606-10-10-4. Since any of the requirements in ASC 606 could have
significant consequences for a particular portfolio of contracts, the
list provided is not exhaustive.
Objective Factors
|
Examples
|
---|---|
Contract deliverables
|
Mix of products and services;
options to acquire additional goods and services;
warranties; promotional programs
|
Contract duration
|
Short-term, long-term,
committed, or expected term of contract
|
Terms and conditions of the
contract
|
Rights of return, shipping
terms, bill and hold, consignment, cancellation
privileges, and other similar clauses
|
Amount, form, and timing of
consideration
|
Fixed, time and materials,
variable, up-front fees, noncash, significant
financing component
|
Characteristics of the
customers
|
Size, type, creditworthiness,
geographic location
|
Characteristics of the
entity
|
Volume of contracts that include
the various characteristics; historical
information available
|
Timing of transfer of goods or
services
|
Over time; at a point in
time
|
The example below illustrates how such factors may be
applied.
Example 3-4
Entity A, a telecommunications
company, offers various combinations of handsets
and usage plans to its customers under two-year
noncancelable contracts. It offers two handset
models: an older model that it offers free of
charge (stand-alone selling price is $250) and the
most recent model, which offers additional
features and functionalities and for which the
entity charges $200 (stand-alone selling price is
$500). The entity also offers two usage plans: a
400-minute plan and an 800-minute plan. The
400-minute plan sells for $40 per month, and the
800-minute plan sells for $60 per month (which
also corresponds to the stand-alone selling price
for each plan).
The table below illustrates the
possible product combinations and allocation of
consideration for each under ASC 606.
As the table indicates, the
effects of each product combination on the
financial statements differ from those of the
other product combinations. The four customer
contracts have different characteristics, and it
may be difficult to demonstrate that the entity
“reasonably expects” that the financial statement
effects of applying the guidance to the portfolio
(the four contracts together) “would not differ
materially” from those of applying the guidance to
each individual contract. The percentage of
contract consideration allocated to the handset
under the various product combinations ranges from
15 percent to 34 percent. The entity may consider
that this range might be too wide to apply a
portfolio approach; if so, some level of
segregation would be required. Alternatively, the
entity might determine that there are two
portfolios, one for old handsets and the other for
new handsets. Under this alternative approach, the
entity would need to perform additional analysis
to assess whether the accounting consequences of
using two rather than four portfolios would result
in financial statement effects that differ
materially.
The example above is relatively straightforward. In
practice, however, the contracts illustrated could involve additional
layers of complexity, such as (1) different contract durations; (2)
different call and text messaging plans; (3) different pricing schemes
(e.g., fixed or variable pricing based on usage); (4) different
promotional programs, options, and incentives; and (5) contract
modifications. Accounting for such contracts could be further
complicated by the high pace of change in product offerings.
In general, the more specific the factors an entity uses
to segregate its contracts or performance obligations into portfolios
(i.e., the “greater” the extent of disaggregation), the easier it should
be for the entity to conclude that the results of applying the guidance
to a particular portfolio are not expected to differ materially from the
results of applying the guidance to each individual contract (or
performance obligation) in the portfolio. However, further
disaggregation into separate sub-portfolios is likely to improve the
overall accuracy of estimates only if those sub-portfolios have some
different characteristics. For instance, segregating on the basis of
geographic location may not be beneficial if similar combinations of
products and services that have similar terms and conditions are sold to
a similar group of customers in different geographic areas. Likewise,
segregating on the basis of whether contract terms allow a right of
return may not be necessary if the returns are not expected to be
significant.
While there is no requirement in ASC 606 to
“quantitatively evaluate”1 whether using a portfolio approach would produce an outcome
materially different from that of applying the guidance at the contract
or performance obligation level, an entity should be able to demonstrate
why it reasonably expects the two outcomes not to differ materially. The
entity may do so by various means depending on its specific facts and
circumstances (subject to the constraints of a cost-benefit analysis).
Such means include, but are not limited to, the following:
-
Data analytics based on reliable assumptions and underlying data (internally or externally generated) related to the portfolio.
-
A sensitivity analysis that evaluates the characteristics of the contracts or performance obligations in the portfolio and the assumptions the entity used to determine a range of potential differences in applying the different approaches.
-
A limited quantitative analysis, supplemented by a more extensive qualitative assessment that may be performed when the portfolios are disaggregated.
Typically, some level of objective and verifiable
information would be necessary to demonstrate that using a portfolio
approach would not result in a materially different outcome. An entity
may also wish to (1) consider whether the costs of performing this type
of analysis potentially may outweigh the benefits of accounting on a
portfolio basis and (2) assess whether it is preferable to invest in
systems solutions that would allow accounting on an individual contract
basis.
3.1.2.2.2 Applying the Portfolio Approach to Some, but Not Other, Similar Contracts
The practical expedient in ASC 606-10-10-4 is available
only if it is reasonably expected that the financial statement
effects of applying ASC 606 to a portfolio of contracts would not differ
materially from the effects of applying ASC 606 to the individual
contracts within that portfolio. Accordingly, it is possible for
entities to prepare their consolidated financial statements by using a
mixture of approaches because the resulting accounting effects are not
reasonably expected to differ materially.
As discussed in Section 3.1.2.1, entities are required
to apply the revenue standard consistently to similar contracts. In
light of this, a company that uses the portfolio approach to account for
some of its contracts may wonder whether it is required to use the same
approach to account for all of its contracts. The example below
illustrates a situation in which it is acceptable for an entity to apply
the portfolio approach to some contracts and not apply it to others.
Example 3-5
Assume the following facts:
- Entity A consolidates Subsidiary B and Subsidiary C, both of which have a large number of contracts with customers with similar characteristics.
- Subsidiary B has elected to use a portfolio approach under ASC 606-10-10-4 when accounting for revenue from those contracts and does not have computer systems that would enable it to recognize revenue on a contract-by-contract basis.
- Subsidiary C does not elect to use a portfolio approach specified in ASC 606-10-10-4 when accounting for revenue from those contracts; instead, it has developed specialized computer systems that enable it to recognize revenue on a contract-by-contract basis.
In its consolidated financial statements, A may
apply a portfolio approach to contracts with B’s
customers without applying that approach to
contracts with C’s customers if it reasonably
expects that the use of that approach would not
differ materially from applying ASC 606 on a
contract-by-contract basis. In these
circumstances, B and C are materially applying the
same accounting policy to A’s revenue contracts
that have similar characteristics.
Connecting the Dots
A question was raised regarding the use of the
portfolio approach when an entity applies the guidance on
estimating and constraining variable consideration.
Specifically, the TRG discussed at its July 13, 2015, meeting
whether an entity is using the portfolio practical expedient
when it evaluates evidence from other similar contracts in
applying the expected value method of estimating variable
consideration. Q&A 39 of the FASB’s Revenue Recognition Implementation
Q&As (the “Implementation
Q&As”) specifies that an entity’s use of a portfolio of data
to establish an estimate is not the same process as using the
portfolio expedient in ASC 606-10-10-4. See Section 6.3.2
for the FASB staff’s conclusion.
3.1.3 Practical Expedients
An entity must make several policy elections and consider electing certain
practical expedients when accounting for revenue under ASC 606. The table below
provides a summary of practical expedients available to entities. Entities are
not required to adopt the practical expedients in ASC 606. An entity should
apply the use of any practical expedients consistently to contracts with similar
characteristics and in similar circumstances.
Codification Reference
|
Practical Expedient
|
Availability Under U.S. GAAP, IFRS Accounting Standards,
or Both
|
---|---|---|
Policy Elections Affecting the Measurement and
Recognition of Revenue
| ||
ASC 606-10-32-18
|
Significant financing component — An entity does
not need to adjust the promised amount of consideration
for the effects of a significant financing component if
it expects, at contract inception, that the period
between the entity’s transfer of a promised good or
service to a customer and the customer’s payment for
that good or service will be one year or less.
|
U.S. GAAP and IFRS Accounting Standards
|
ASC 606-10-32-2A
|
Sales taxes — An entity may elect to exclude from
its transaction price any amounts collected from
customers for all sales (and other similar) taxes.
|
U.S. GAAP only
|
ASC 340-40-25-4
|
Costs of obtaining a contract — An entity “may
recognize the incremental costs of obtaining a contract
as an expense when incurred if the amortization period
of the asset that the entity otherwise would have
recognized is one year or less.”
|
U.S. GAAP and IFRS Accounting
Standards
|
ASC 606-10-25-18B
|
Shipping and handling — An entity may elect to
account for shipping and handling activities that occur
after control of the related good transfers as
fulfillment activities instead of assessing such
activities as performance obligations.
|
U.S. GAAP only
|
ASC 606-10-10-4
|
Portfolio approach — An entity may apply the
revenue standard to a portfolio of contracts (or
performance obligations) with similar characteristics if
it “reasonably expects that the effects on the financial
statements of applying this guidance to the portfolio
would not differ materially from applying this guidance
to the individual contracts (or performance obligations)
within that portfolio.”
|
U.S. GAAP and IFRS Accounting Standards
|
ASC 606-10-55-18
|
Right to invoice — For performance obligations
satisfied over time, “if an entity has a right to
consideration from a customer in an amount that
corresponds directly with the value to the customer of
the entity’s performance completed to date (for example,
a service contract in which an entity bills a fixed
amount for each hour of service provided), the entity
may recognize revenue in the amount to which the entity
has a right to invoice.”
|
U.S. GAAP and IFRS Accounting Standards
|
ASC 952-606
|
Private-company franchisor — A franchisor that is
not a PBE (a “private-company franchisor”) may use a
practical expedient when identifying performance
obligations in its contracts with customers (i.e.,
franchisees) under ASC 606. When using the practical
expedient, a private-company franchisor that has entered
into a franchise agreement would treat certain
preopening services provided to its franchisee as
distinct from the franchise license. In addition, a
private-company franchisor that applies the practical
expedient must make a policy election to either (1)
apply the guidance in ASC 606 to determine whether the
preopening services that are subject to the practical
expedient are distinct from one another or (2) account
for those preopening services as a single performance
obligation. The practical expedient and policy election
are intended to reduce the cost and complexity of
applying ASC 606 to preopening services associated with
initial franchise fees.
|
U.S. GAAP only
|
Policy Elections Affecting Disclosures
| ||
ASC 606-10-50-14 and 50-14A
|
Disclosure:
|
The first exemption is available under U.S. GAAP and IFRS
Accounting Standards, and the second exemption is
available under U.S. GAAP only.
|
For many of the practical expedients outlined above, the revenue standard
requires disclosure that an entity has elected such policy. See Chapter 15 for disclosure requirements.
Footnotes
1
Paragraph BC69 of ASU 2014-09 states that the
FASB and the IASB “acknowledged that an entity would need to
apply judgment in selecting the size and composition of the
portfolio in such a way that the entity reasonably expects that
application of the revenue recognition model to the portfolio
would not differ materially from the application of the revenue
recognition model to the individual contracts or performance
obligations in that portfolio. In their discussions, the Boards
indicated that they did not intend for an entity to
quantitatively evaluate each outcome and, instead, the entity
should be able to take a reasonable approach to determine the
portfolios that would be appropriate for its types of
contracts.”
3.2 Scope
3.2.1 In General
ASC 606-10
Entities
15-1 The guidance in this Subtopic applies to all entities.
Transactions
15-2 An entity shall apply
the guidance in this Topic to all contracts with
customers, except the following:
- Lease contracts within the scope of Topic 842, Leases.
- Contracts within the scope of Topic 944, Financial Services — Insurance.
- Financial instruments and other
contractual rights or obligations within the scope
of the following Topics:1. Topic 310, Receivables2. Topic 320, Investments — Debt Securities2a. Topic 321, Investments — Equity Securities3. Topic 323, Investments — Equity Method and Joint Ventures4. Topic 325, Investments — Other5. Topic 405, Liabilities6. Topic 470, Debt7. Topic 815, Derivatives and Hedging8. Topic 825, Financial Instruments9. Topic 860, Transfers and Servicing.
- Guarantees (other than product or service warranties) within the scope of Topic 460, Guarantees.
- Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. For example, this Topic would not apply to a contract between two oil companies that agree to an exchange of oil to fulfill demand from their customers in different specified locations on a timely basis. Topic 845 on nonmonetary transactions may apply to nonmonetary exchanges that are not within the scope of this Topic.
15-2A An
entity shall consider the guidance in Subtopic 958-605
on not-for-profit entities — revenue recognition —
contributions when determining whether a transaction is
a contribution within the scope of Subtopic 958-605 or a
transaction within the scope of this Topic.
A key goal of the FASB when creating the new guidance was to improve
comparability of similar transactions across industries for financial statement
users. That is, the comprehensive revenue framework established in ASC 606 would
require entities in disparate industries to evaluate the new guidance
consistently.
Connecting the Dots
Consistency in application of the revenue standard across industries has been
discussed publicly to emphasize its importance. As noted in Deloitte’s
December 15, 2015, Heads Up, the staff in the
SEC’s Office of the Chief Accountant (OCA) reiterated at the 2015 AICPA
Conference on Current SEC and PCAOB Developments that it is focused on
consistent application of the guidance to similar fact patterns both
within and across industries. Companies should compare their application
of the standard with that of other companies and refer to the AICPA
industry task forces’ interpretive guidance, which can be used as a
resource to promote consistency among preparers. In addition, companies
can contact the OCA for help in addressing implementation questions.
Refer to Chapter 18
for recent SEC and AICPA developments related to the revenue
standard.
Generally speaking, the boards’ comprehensive framework was intended to cover
all revenue transactions across all industries and geographies. Accordingly, the
scope of the revenue standard is very broad and is governed by two key terms,
“contract” and “customer.” Because of the standard’s broad scope, any
arrangement that qualifies as a contract with a customer as those terms are
defined should be within the scope of the new guidance. However, during the
development of the revenue standard, the FASB acknowledged that it had already
developed or was developing comprehensive guidance on certain types of
revenue-generating transactions. Specifically, the Board already had or was
improving the guidance on leases, financial instruments, and insurance. As a
result, it was necessary for the scope exceptions in ASC 606-10-15-2 to be
created. Accordingly, a revenue-generating transaction related to a contract
with a customer would be outside the scope of the revenue standard only if it is
within the scope of one of these other models.
Connecting the Dots
Some revenue-generating transactions associated with insurance contracts
may be subject to the guidance in ASC 606. This is because an entity’s
insurance contracts are within the scope of ASC 944 only if the entity
is one of the types of entities described in ASC 944-10-15-2.
Since the revenue standard focuses on contracts with customers, companies
might naturally think that their scope assessment should be performed at the
contract level. However, it is important to remember that a contract can be made
up of different components (or separate promises). Accordingly, companies should
determine whether contracts include revenue and nonrevenue elements. See
Section 3.2.10
for further details.
2
See Section 3.2.12 for a
discussion of scope considerations related to contracts
accounted for under both ASC 606 and ASC 842.
The revenue standard includes implementation guidance on agreements containing a
requirement or option to buy back a good sold to a customer (“repurchase
agreements”). When a company has entered into a contract that includes such an
obligation or right, it must assess whether control of the product has been
transferred to the customer, as discussed in paragraph BC423 of ASU 2014-09. In
many circumstances, if these features are present, control of the product is not
transferred to the customer and the contract is treated as either a lease (i.e.,
accounted for in accordance with ASC 842) or a financing (i.e., accounted for in
accordance with ASC 606-10-55-70). The assessment of whether control is
transferred to a customer (i.e., the entity satisfies its performance
obligation) is outlined in step 5. For further discussion of transfer of
control, including repurchase agreements, see Chapter 8.
3.2.2 Guarantees
Contracts with customers that are guarantees (other than product
or service warranties) within the scope of ASC 460 are specifically excluded
from the scope of ASC 606.
Connecting the Dots
It might appear that the scope
of IFRS 15 is different from that of ASC 606
because the explicit scope exclusion for
guarantees in ASC 606-10-15-2(d) is not included
in IFRS 15. However, the inclusion of financial
guarantees within the scope of the IASB’s
financial instruments standards (IFRS 9 and IAS
39) made it unnecessary to provide a separate
scope exclusion in IFRS 15 for guarantees since
such an exclusion would be redundant with the
financial instruments exclusion in IFRS 15.
|
3.2.2.1 Performance Guarantees
Many performance guarantees would be outside the scope of
ASC 460 or would not be subject to ASC 460’s recognition and measurement
requirements. For example, ASC 460-10-15-7(i) states that a guarantee or
indemnification of an entity’s own future performance is not within the
scope of ASC 460. Therefore, performance guarantees would typically be
accounted for as assurance-type warranties (i.e., product warranties that
are subject to ASC 460’s disclosure requirements but not its recognition and
measurement requirements), service-type warranties that represent
performance obligations within the scope of ASC 606, or a form of variable
consideration within the scope of ASC 606.
Example 3-6
Entity X has entered into a contract
with a customer to operate a call center. The
contract includes a service level agreement
guaranteeing that the average service call response
time will be less than five minutes. If the call
center does not meet the five-minute average wait
time, X will have to pay the customer $1
million.
This service level guarantee is not within the scope
of ASC 460 because it is guaranteeing X’s own future
performance under the contract. Therefore, the
obligation to operate the call center would be
accounted for as a performance obligation within the
scope of ASC 606, and the potential payment of $1
million to the customer would be treated as variable
consideration.
Some performance guarantees or indemnification agreements would be within the
scope of ASC 460, particularly if they are not a guarantee or
indemnification of an entity’s own future performance. For example, if an
entity guarantees the performance of a third party by agreeing to pay the
indemnified party if that third party fails to perform, the guarantee would
most likely be subject to the recognition and measurement provisions of ASC
460.
Connecting the Dots
Because the general recognition and measurement
requirements of ASC 460 that apply to guarantees differ
significantly from the recognition and measurement requirements for
product warranties, it is important for entities to appropriately
determine whether an arrangement is subject to the guidance that
applies to product warranties. On the basis of informal discussions,
we understand that the OCA objected to an SEC registrant’s
conclusion that its guarantee to a customer of the functionality of
a security service provided by another customer was a product
warranty. Although the guarantee was part of a revenue arrangement
with multiple promised goods or services, the SEC staff believed
that a guarantee of a service provided to a customer by another
entity cannot be a product warranty because the guarantor was not
the entity that provided the service. In the staff’s view, such an
arrangement should be accounted for in accordance with the general
recognition and measurement guidance in ASC 460 that applies to
guarantee obligations.
3.2.2.2 Profit Margin Guarantees
Profit margin guarantees typically do not contain a
guarantee within the scope of ASC 460 because they qualify for scope
exceptions under ASC 460-10-15-7 — specifically, ASC 460-10-15-7(e) (vendor
rebates by the guarantor based on either the sales revenues of, or the
number of units sold by, the guaranteed party) or, in certain circumstances,
ASC 460-10-15-7(g) (guarantees that prevent the guarantor from being able to
recognize in earnings the profit from a sale transaction). Therefore, profit
margin guarantees should be accounted for as a form of variable
consideration within the scope of ASC 606.
Example 3-7
A clothing manufacturer sells
clothing to a retail store (the “retailer”) under a
contract that offers the retailer a refund of a
portion of the contract’s sales price at the end of
each season if the retailer has not met a minimum
sales margin (i.e., a profit margin guarantee). The
retailer takes title to the clothing, and title
remains with the retailer. The profit margin
guarantee is agreed to at the inception of the
contract and is a fixed amount.
This arrangement does not contain a guarantee within
the scope of ASC 460. Therefore, the clothing
manufacturer should account for the potential
payment to the retailer as a form of variable
consideration within the scope of ASC 606.
3.2.3 Contributions
Contributions are not within the scope of ASC 606. The ASC
master glossary (as amended by ASU 2018-08) defines a contribution
as follows:
An unconditional transfer of cash or other
assets, as well as unconditional promises to give, to an entity or a
reduction, settlement, or cancellation of its liabilities in a voluntary
nonreciprocal transfer by another entity acting other than as an owner.
Those characteristics distinguish contributions from:
-
Exchange transactions, which are reciprocal transfers in which each party receives and sacrifices approximately commensurate value
-
Investments by owners and distributions to owners, which are nonreciprocal transfers between an entity and its owners
-
Other nonreciprocal transfers, such as impositions of taxes or legal judgments, fines, and thefts, which are not voluntary transfers.
In a contribution transaction, the resource
provider often receives value indirectly by providing a societal benefit
although that benefit is not considered to be of commensurate value. In an
exchange transaction, the potential public benefits are secondary to the
potential direct benefits to the resource provider. The term contribution
revenue is used to apply to transactions that are part of the
entity’s ongoing major or central activities (revenues), or are peripheral
or incidental to the entity (gains). See also [the ASC master glossary’s
definition of an inherent contribution] and [the ASC master glossary’s
definition of a conditional contribution].
Therefore, a contribution, by definition, is a nonreciprocal
transfer and differs from an exchange transaction (e.g., a reciprocal transfer
in which an entity exchanges goods or services for consideration).
In June 2018, the FASB issued ASU 2018-08, which amends certain
aspects of the guidance to clarify the scope and accounting for contributions
received and contributions made. As part of these clarifications, ASU 2018-08
amends ASC 606 to include the guidance in ASC 606-10-15-2A, which states:
An entity shall consider the guidance in Subtopic 958-605
on not-for-profit entities — revenue recognition — contributions when
determining whether a transaction is a contribution within the scope of
Subtopic 958-605 or a transaction within the scope of [ASC 606].
As explained in paragraph BC28 of ASU 2014-09, ASC 606 applies
to only a subset of revenue — specifically, revenue from contracts with
customers. Therefore, because contributions are nonreciprocal transfers, the
counterparty (e.g., a donor) in a contribution transaction would not meet the
ASU’s definition of a customer:
A party that has contracted
with an entity to obtain goods or services that are an output of the
entity’s ordinary activities in exchange for
consideration. [Emphasis added]
However, if a not-for-profit entity transfers a good or service
for part or all of a contribution (i.e., a reciprocal transfer that is an
exchange transaction) and the counterparty to the transaction is a customer,
such a reciprocal transfer should be accounted for under ASC 606.
The above issue is addressed in Implementation Q&A 6 (compiled from previously issued
TRG Agenda Papers 26 and 34). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
3.2.4 Nonmonetary Transaction Between Entities in the Same Line of Business
An entity is not permitted to recognize revenue from a
nonmonetary transaction that is subject to the scope exception in ASC
606-10-15-2(e) related to nonmonetary exchanges between entities in the same
line of business to facilitate sales to customers or potential customers. ASC
606-10-15-2(e) states that an example of such a nonmonetary transaction is “a
contract between two oil companies that agree to an exchange of oil to fulfill
demand from their customers in different specified locations on a timely
basis.”
As explained in paragraphs BC58 and BC59 of ASU 2014-09, since
the party exchanging inventory with the entity in a transaction of this nature
meets the definition of a customer, the entity might recognize revenue once for
the exchange of inventory and do so again for the sale of inventory to the end
customer in the absence of the specific scope exclusion. The FASB and IASB
concluded that this outcome would be inappropriate because (1) it would gross up
revenues and expenses and thereby make it difficult for financial statement
users to assess the entity’s performance and gross margins and (2) the
counterparty in such an exchange transaction could be viewed as acting as a
supplier rather than as a customer.
Questions have arisen about what constitutes the “same line of
business” under the scope exception in ASC 606-10-15-2(e). We generally believe
that entities are in the same line of business when they are undertaking similar
activities or operations, as opposed to only being in the same industry or
sector. In determining whether entities are undertaking similar activities or
operations, an entity should use judgment and consider factors such as (1) the
nature of the activities being performed, (2) the nature of the items being
exchanged, and (3) the purpose of the exchange.
In addition, if two entities in the same line of business are exchanging
inventories, we believe that for the inventories to qualify for the nonmonetary
exchange scope exception (i.e., measurement based on the carrying amount of the
inventory transferred in accordance with ASC 845-10-30-16), the exchange should
be of like-kind inventory for like-kind inventory (i.e., raw materials or
work-in-process inventory exchanged for raw materials, work-in-process, or
finished goods inventory; or finished goods inventory exchanged for finished
goods inventory) and should be to facilitate sales to end customers.
Accordingly, it would generally not be appropriate for an entity to apply the
scope exception in ASC 606-10-15-2(e) if it is exchanging finished goods
inventory for another entity’s raw materials or work-in-process inventory
regardless of whether the entities are in the same line of business.
The scope exception would also apply if cash is exchanged (unless the net cash
received by one of the counterparties is at least 25 percent of the fair value
of the exchange) as long as the exchange would otherwise meet the scope
exception.
Example 3-8
Entity X enters into an inventory buy/sell arrangement
with Entity Y. The entities are in the same line of
business. Each entity has raw material stored in a
location near the other party’s manufacturing facility.
The purpose of the buy/sell arrangement is to avoid
transportation time and cost and thereby expedite sales
to end customers.
Entity X will purchase Raw Material A, which has a fair
value of $12, from Y. In exchange, Y will purchase Raw
Material B, which has a fair value of $12 and a cost
basis of $10, from X. The parties will invoice each
other $12. Both entities use Raw Material A and Raw
Material B in the same line of business.
This transaction is
outside the scope of ASC 606, and ASC 845 indicates that
the exchange should be accounted for at carrying value.
Therefore, X should record its purchase of Raw Material
A from Y at the carrying amount of Raw Material B as
follows:
In addition, X should
record its sale of Raw Material B to Y as follows:
3.2.4.1 Identifying and Accounting for Boot in an Inventory Buy/Sell Arrangement
In inventory buy/sell arrangements that are within the scope of ASC 845, gross
cash is often exchanged. ASC 845-10-15-6 and 15-7 require that if the
transactions were entered into in contemplation of one another, they should be
combined and accounted for as a single exchange. This requirement applies even
though both parties exchanged cash in the arrangement. However, ASC 845-10-15-9
indicates that when determining whether the exchange is monetary or nonmonetary,
an entity should consider the guidance on boot in ASC 845-10-15.
ASC 845-10-25-6 indicates that if boot is significant (at least 25 percent of the
fair value of the exchange), the transaction should be considered monetary (see
Section
3.2.4.2). If the boot is less than 25 percent of the fair value
of the exchange, the transaction should be considered nonmonetary. For
nonmonetary inventory exchanges recorded at carrying value in accordance with
ASC 845, the pro rata gain recognition guidance in ASC 845-10-30-6 should be
applied by the receiver of the boot.
Example 3-9
Entity X purchases 10 units of Raw Material A from Entity
Y for $100 in cash. In addition, X sells 8 units of Raw
Material B to Y, which uses that raw material in the
same line of business, for $120 in cash. The 8 units of
Raw Material B have a cost basis of $90 to X and a fair
value of $120. In this example, the boot should be
calculated as the net cash exchanged, which is $20
(i.e., $120 – $100).
The boot would not be considered significant in this
example since it is only 16.7 percent ($20 ÷ $120) of
the fair value of the exchange. Because the exchange
involves raw materials that are used in the same line of
business, X should record the exchange at carrying
value, except that X can record a pro rata gain of $5 on
the exchange. The pro rata gain is calculated as
follows:
Alternatively, because ASC 845-10-30-6 defines the
realized gain as the amount of monetary receipt that
exceeds a proportionate share of the recorded amount of
the asset surrendered (the proportion is based on the
ratio of monetary consideration to total consideration
received), the calculation could be performed as
follows:
3.2.4.2 Nonmonetary Exchange Involving Cash
ASC 845-10-30-6 states that nonmonetary exchanges “that would otherwise be based
on recorded amounts (see paragraph 845-10-30-3) may include an amount of
monetary consideration.” However, there is a point at which monetary
consideration is so significant that the entire transaction is considered
monetary and, therefore, outside the scope of ASC 845. ASC 845-10-25-6
states:
An exchange of nonmonetary assets that would otherwise be based
on recorded amounts but that also involves monetary consideration (boot)
shall be considered monetary (rather than nonmonetary) if the boot is
significant. Significant shall be defined as at least 25 percent of the fair
value of the exchange. If the boot in a transaction is less than 25 percent,
the pro rata gain recognition guidance in paragraph 845-10-30-6 shall be
applied by the receiver of boot, and the payer of boot would not recognize a
gain.
Example 3-10
Entity A is contemplating an exchange of
its finished goods inventory for finished goods
inventory sold by Customer B. In accordance with ASC
845-10-30-3(b), the transaction would be considered to
facilitate sales to customers. Entity A expects that the
fair value of the inventory it transfers to B will be
approximately 50 percent of the fair value of the
inventory to be transferred by B; accordingly, A is
expecting to pay cash for the difference in value.
Because the monetary consideration is
significant, this exchange (1) should be considered
monetary in its entirety under ASC 845-10-25-6 and (2)
is outside the scope of ASC 845.
3.2.5 Nonmonetary Exchange and Barter Credit Transactions
3.2.5.1 Nonmonetary Exchange Transactions
Most revenue transactions require the transfer of monetary assets by the customer
in exchange for goods and services sold by an entity. However, certain
transactions may involve the sale of goods or services in exchange for primarily
nonmonetary assets. If the transaction is not subject to the scope exception in
ASC 606-10-15-2(e) related to nonmonetary exchanges between entities in the same
line of business to facilitate sales to customers or potential customers, as
described in Section
3.2.4, the transaction would typically be accounted for as a
revenue arrangement under ASC 606 with noncash consideration received from a
customer (see Section 6.5). If the counterparty is not a customer and the
transaction is the sale of nonfinancial assets (or in-substance nonfinancial
assets), the transaction may be subject to ASC 610-20 instead of ASC 606.
3.2.5.1.1 Buy/Sell Arrangements That Cross Reporting Periods
If only one side of a buy/sell transaction that is accounted for as the sale
of inventory in exchange for other inventory has occurred as of the end of a
reporting period, each side of the transaction should be accounted for as it
occurs. The amount of the entry to record to inventory depends on whether
the exchange is recorded at carrying value or fair value (see ASC
845-10-30-3 and ASC 845-10-30-15 and 30-16). If an exchange is accounted for
under ASC 606, any revenue should generally be recognized at the time the
customer obtains control of the finished goods.
No additional journal entries are necessary as of the balance sheet date. For
an exchange that did not involve the exchange of cash, the balance sheet
will already reflect a receivable or payable as a result of recording the
first side of the transaction. For an exchange that involves cash, the
balance sheet will reflect a receivable or payable for the difference
between the cash exchanged and the value of the inventory. It would not be
appropriate to accrue for the second half of the exchange, since the
contract is executory and an entry would result in a gross-up of the balance
sheet.
Example 3-11
Entity X, a calendar-year-end entity, enters into a
buy/sell arrangement with Entity Y. Entity X
purchases raw materials with a fair value of $100
from Y on December 29, 20X1. In exchange, X will
sell finished goods with a carrying value of $80 and
a fair value of $100 to Y on January 2, 20X2. The
companies will invoice each other $90. The exchange
is subject to the guidance in ASC 606. Entity X
should record the following entries:
Example 3-12
Assume the same facts as Example
3-11, except that no cash is exchanged.
In this case, Entity X should record the following
entries:
3.2.5.1.2 Round-Trip Transactions
Although it can take many forms, a round-trip transaction essentially is a
transaction in which one entity sells an item (e.g., goods, services,
financial assets) to another entity, which in turn sells something back to
the initial seller. Round-trip transactions often lack commercial substance.
If such a transaction is not accounted for properly, it can lead to
artificial inflation of the revenues of each entity.
The substance of the transaction is critical to determining the appropriate
accounting. The individual transactions in a round-trip transaction are
often entered into in contemplation of one another. Entities should consider
whether those individual transactions should be combined and accounted for
as a nonmonetary exchange. ASC 845-10-25-4 identifies factors indicating
that transactions may have been entered into in contemplation of one another
and that they therefore should be combined. Although the factors are
discussed in the context of inventory exchanges, they can be applied, by
analogy, to other types of exchanges. If the transactions are combined and
accounted for under ASC 845, the exchange should not be accounted for at
fair value if it lacks commercial substance or if it was performed to
facilitate sales to customers (see ASC 845-10-30-3).
In a speech at the 2002 AICPA Conference on Current SEC Developments, the SEC
staff also cautioned entities to evaluate the substance, rather than the
form, of transactions to determine the proper accounting treatment. In
addition, the SEC staff noted that it is not clear that the substance of the
transaction is the same as its form if the customer in a round-trip
transaction (1) does not need the goods or services provided, (2) would not
normally have purchased the goods or services at that time, (3) purchased
quantities in excess of its needs, or (4) would have been unable to pay in
the absence of the concurrent investment. Accordingly, when a round-trip
transaction lacks substance, revenue recognition is not appropriate.
3.2.5.1.3 Multiparty Exchange Involving Monetary Assets
Companies often structure transactions as “like-kind” exchanges for favorable
tax treatment under Section 1031 of the Internal Revenue Code, whereby the
tax basis in the new asset is the same as that in the old asset. These
transactions are often structured as “three-party” or “three-corner”
transactions in which three unrelated parties contribute and receive
monetary and nonmonetary assets through an escrow account or trust
arrangement.
The transaction, in substance, consists of one monetary transaction, the sale
of an asset to one party, followed by another monetary transaction, the
purchase of a replacement asset from a different party. As with the
accounting for other monetary transactions, a three-party transaction would
generally be recorded separately. The involvement of an unrelated third
party is critical to this conclusion. Had the transaction involved only two
parties, the transaction would be the sale of an asset in exchange for
noncash consideration, even if cash was transferred to an escrow agent or
both parties transferred equal amounts of cash to each other.
Example 3-13
Entity A will sell a parcel of land to Entity B. The
cash purchase price will be placed into an escrow
account. At the direction of A, B will use the cash
later to purchase a parcel of land from Entity C.
Entity A will receive title to the land and C will
be paid from the escrow account. Entity A would
generally assess whether the sale of the land to B
should be accounted for under ASC 606 or ASC 610-20.
By using an escrow account, A has avoided the actual
exchange of monetary assets. However, in such
circumstances, the transaction would generally be
accounted for separately as (1) the sale of land in
exchange for cash and (2) the purchase of land in
exchange for cash.
3.2.5.2 Barter Credit Transactions
In some industries, entities may enter into arrangements
referred to as “barter credit transactions.” Barter credit transactions may
occur in many forms. In one common form, an entity provides goods or services
and in return receives “credits” that can be used for a specific period to
acquire products or services from either (1) a specific company that is a party
to the exchange of products or services or (2) members of a “barter” exchange
network. Barter exchange networks allow one member to exchange products or
services of another member even if the member providing the products or services
was not the counterparty to the original barter contribution. Barter credit
transactions are structured in various ways and may differ significantly in
terms of business motives or levels of risk.
Barter credit transactions may include exchanges of items such
as the following:
-
Products or services for advertising credits.
-
Professional services for travel credits.
-
Air travel or other vacation travel for advertising credits.
Although barter credit transactions may create opportunities for
barter participants, they pose various risks principally related to the
measurement of the transaction, including:
-
Failure to recognize impairment in value of products given up in a barter transaction.
-
Difficulties in converting products or credits received in a barter transaction to cash when no market for the products or credits exists.
-
Expiration of unused barter credits.
-
Inadequate internal controls over barter credits.
-
Inability to acquire products or services in return that are worth as much as the products or services contributed.
-
Inability to reasonably determine the value of products or services received in return.
It is important to understand the substance and purpose of the barter credit
transaction as well as the appropriate valuation of, and accounting treatment
for, the transaction. Further, entering into a barter transaction may indicate a
lack of a normal distribution channel or an alternative use for the goods sold
by an entity. Such situations may indicate an asset impairment.
Under ASC 845-10-30-19, additional impairment write-downs should be recognized if
either of the following is true:
- The fair value of any remaining barter credits is less than the carrying amount.
- It is probable that the entity will not use all of the remaining barter credits.
Potential uses for the barter credits should be evaluated to determine the true
economic benefit (e.g., discounted or “real” prices, rather than list or “rack”
rate prices, should be considered). Professional skepticism should be heightened
for entities entering into barter transactions involving their own inventory,
especially at or near quarter- or year-ends. These transactions may indicate
that excess or obsolete inventory exists or that barter activity is merely being
used to avoid or delay a necessary write-down.
Since barter credit transactions are akin to nonmonetary
exchanges, entities should consider whether particular barter credit
transactions are subject to the scope exception for nonmonetary exchanges in ASC
606-10-15-2(e).
In accordance with ASC 606-10-15-2(e), nonmonetary exchanges
between entities in the same line of business to
facilitate sales to customers or potential customers are outside the scope of
ASC 606 and may be subject to the guidance in ASC 845 on nonmonetary
transactions. Typically, no revenue is recognized when the guidance in ASC 845
is applied to such nonmonetary exchanges outside the scope of ASC 606.
Accordingly, for an entity to determine whether a barter credit
transaction should be accounted for under ASC 606 or under ASC 845, the entity
should understand the substance and purpose of the barter credit transaction. If
the entity determines that the barter credit transaction represents a contract
with a customer that is within the scope of ASC 606, it should account for the
barter credits received from the customer as noncash consideration, as discussed
in Section
6.5.2.
3.2.6 Fixed-Odds Wagering Contracts
Fixed-odds wagers are wagers placed by bettors (i.e., customers)
who typically know the odds of winning in gaming activities3 at the time the bets are placed with gaming industry entities. After the
revenue standard was issued, stakeholders reporting under U.S. GAAP questioned
whether fixed-odds wagering contracts should be accounted for as revenue
transactions (i.e., when or as control is transferred in accordance with the
revenue standard) or as derivatives (i.e., adjusted to fair value through net
income each reporting period). The issue arose for the following reasons:
-
The revenue standard, which does not apply to contracts accounted for as derivatives under ASC 815, eliminated the legacy guidance in ASC 924-605, under which fixed-odds wagers were generally recognized as revenue when settled.
-
Regarding an issue that the IFRS Interpretations Committee considered adding to its agenda in 2007, the Committee noted (in an agenda decision reported in the July 2007 IFRIC Update) that an unsettled wager is a financial instrument that is likely to meet the definition of a derivative financial instrument under IAS 39.4
In November 2015, the FASB staff noted its belief that the FASB
did not intend to change how entities reporting under U.S. GAAP would account
for fixed-odds wagers upon adoption of the revenue standard. That is, the FASB
staff believed that the Board intended for entities reporting under U.S. GAAP to
continue accounting for fixed-odds wagering contracts as revenue transactions.
On the other hand, the FASB staff further indicated in TRG Agenda Paper 47 that “if fixed odds wagering contracts
were excluded from the scope of the new revenue standard, then those
arrangements likely would be accounted for as derivatives.”
In December 2016, the FASB issued ASU 2016-20 on
technical corrections to the revenue standard, which created a derivatives
guidance scope exception for fixed-odds wagering contracts. Specifically, ASU
2016-20 added ASC 924-815, which clarifies that such contracts are revenue
contracts within the scope of ASC 606.
3.2.7 Scope of Guidance on Contract Costs
Although the clear focus of the boards’ project was to improve the recognition of revenue, the boards
also decided to include new guidance on contract costs in the final revenue standard. Accordingly, ASU
2014-09, which added ASC 606, also added ASC 340-40 to provide such cost guidance. Specifically,
ASC 340-40 contains guidance on how to account for two types of costs related to a contract with a
customer:
- “Incremental costs of obtaining a contract with a customer.”
- “Costs incurred in fulfilling a contract with a customer that are not in the scope of another Topic.”
For details on accounting for these types of costs, see Chapter 13.
The direct linkage between ASC 606 and ASC 340-40 resides in the following paragraph from the
Codification:
ASC 606-10
15-5 Subtopic 340-40 on other assets and deferred costs from contracts with customers includes guidance on
accounting for the incremental costs of obtaining a contract with a customer and for the costs incurred to fulfill
a contract with a customer if those costs are not within the scope of another Topic (see Subtopic 340-40). An
entity shall apply that guidance only to the costs incurred that relate to a contract with a customer (or part of
that contract) that is within the scope of the guidance in this Topic.
In certain industries, most notably the automotive supplier and
aerospace and defense industries, an entity may incur costs related to
activities it performed before producing a good for a customer. Sometimes, an
entity may incur costs for these activities before executing a contract with a
customer and may even be entitled to consideration from the potential customer
in connection with the initial activities. An entity may be willing to incur
such costs (even in excess of amounts due from the potential customer) because
of an expectation, based on current negotiations or on perceived customer demand
for the product, that a contract will be executed in the near term. Costs
incurred are typically related to engineering, design, and development
activities, along with the manufacturing or purchase of specific equipment,
molds, tools, or dies that will be used to produce the good.
With the introduction of the cost guidance in ASC 340-40,
stakeholders have questioned whether these sorts of preproduction costs would be
within the scope of ASC 340-40 and would therefore need to be assessed for
capitalization under the criteria in ASC 340-40-25-5. The cost guidance in ASC
340-40 applies to costs incurred to fulfill a contract with a customer within
the scope of ASC 606, noting that the costs could be related to an
anticipated contract with a customer. Therefore, in evaluating
whether these preproduction costs should be accounted for under ASC 340-40, an
entity will need to determine whether the costs in question are incurred in
connection with a contract (or anticipated contract) that is within the scope of
ASC 606. An entity may need to use judgment when determining whether the
preproduction activities are within the scope of ASC 606 because (1) the
preproduction activities transfer a good or service to a customer that is part
of the entity’s ordinary activities or (2) the costs are fulfillment costs
incurred in connection with an anticipated contract with a customer.
The above issue is addressed in Implementation Q&A 66 (compiled from previously issued
TRG Agenda Papers 46 and 49). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C. See also Section 13.3.4.
As a result of questions raised by stakeholders and diversity in
practice under legacy U.S. GAAP, the FASB instructed its staff to conduct
outreach to various stakeholders to better understand how existing practice
developed and what, if any, additional education would help stakeholders
determine how to apply the new guidance in ASC 606 and ASC 340-40. At the
February 15, 2017, FASB meeting, the FASB staff reported to the Board the
results of its outreach. In the handout for the meeting, the staff included a decision tree
to help stakeholders evaluate whether preproduction activities are within the
scope of ASC 606 and ASC 340-40. The decision tree is reproduced below.
5
“For example, the activities do not constitute
an entity’s ongoing major or central operations (Master Glossary
– Revenue).”
6
“This may result in the reimbursement being
recorded as other income or as contra-expense.”
7
“If the NRE and the subsequent production units
are in a single contract or the contracts meet the criteria for
contract combination in paragraph 606-10-25-9, this may result
in revenue being recognized over a period longer than the
preproduction period. For example, it may result in revenue
being recognized over subsequent production units.”
Although the FASB provided some interpretative guidance in the
form of the February 2017 Board meeting handout (illustrated above),
stakeholders (particularly in the automotive supplier industry) continued to
raise questions about the appropriate guidance to apply to account for
preproduction costs and related reimbursements. Specifically, stakeholders in
the automotive industry questioned whether diversity in practice would continue
to be appropriate upon the adoption of ASC 606 and ASC 340-40. On the basis of
discussions with the SEC staff after the February 2017 FASB meeting, we
understand that some diversity in practice will continue to be acceptable
depending on the facts and circumstances and an entity’s historical conclusions
about scope. Specific considerations related to accounting for preproduction
costs and related reimbursements in the automotive supplier industry are as
follows:
-
Automotive suppliers that historically concluded that their preproduction costs were within the scope of ASC 340-10 should continue to apply that guidance upon adoption of the revenue standard. Automotive suppliers that historically applied the guidance in ASC 340-10 by analogy should evaluate their preproduction costs under the fulfillment cost guidance in ASC 340-40 upon adoption of the revenue standard.
-
Diversity in practice will continue to be acceptable for accounting for reimbursements received from original equipment manufacturers for a supplier’s preproduction activities. If a supplier historically accounted for the reimbursements as revenue under ASC 605, it would most likely be acceptable for the supplier to continue to account for the reimbursements as revenue under ASC 606. Similarly, if a supplier historically accounted for the reimbursements as an offset to the related costs (i.e., not revenue), this practice would continue to be acceptable upon the adoption of the revenue standard. The resulting policy should be consistent with the principles of ASC 606 and related discussion of the TRG in November 2015 (see Implementation Q&A 65 [compiled from previously issued TRG Agenda Papers 46 and 49]).
-
If a supplier would like to change its accounting policy for reimbursements received for preproduction activities, further analysis may be required. We generally believe that a supplier should consider consulting with the SEC staff if the supplier believes that a change in its accounting policy for reimbursements for preproduction activities (i.e., a change from revenue to cost reimbursement, or a change from cost reimbursement to revenue) is warranted under ASC 606.
This topic was addressed by Joseph Epstein, then professional
accounting fellow in the OCA, in a speech at the 2017 AICPA Conference on Current SEC and
PCAOB Developments. In his speech, Mr. Epstein acknowledged that the SEC staff
was engaged in a prefiling consultation with an SEC registrant regarding the
accounting for a preproduction arrangement. Mr. Epstein further noted that the
SEC staff did not object to the following conclusions reached by the registrant
(footnotes omitted):
-
The “design activities did not transfer control of a good or service to the counterparty, and therefore were not a performance obligation under Topic 606, because the periodic information provided to the counterparty related to the design activities over the course of the arrangement was not detailed enough to enable the counterparty to avoid having to re-perform the design work, for example, if the design efforts were not successful or if the counterparty selected another manufacturer for the specialized good.”
-
The “pre-production design activities should be accounted for as research and development expenses and . . . payments received should be accounted for as an advance payment for the future sale of the specialized good to the counterparty.”
-
It was appropriate to treat the change in accounting for a preproduction arrangement as part of the registrant’s transition to ASC 606 rather than as a voluntary change in accounting principle under ASC 250.
Mr. Epstein also noted that the SEC staff would not object if
registrants that have historically accounted for preproduction activities as
nonrevenue arrangements continue to apply their nonrevenue models to
preproduction arrangements after adoption of the revenue standard. However, he
encouraged such registrants to consult with the OCA if they are considering
either the application of a revenue model under ASC 606 or changes to their
historical nonrevenue models.
3.2.8 Determining the Customer in a Contract
ASC 606-10
15-3 An entity shall apply
the guidance in this Topic to a contract (other than a
contract listed in paragraph 606-10-15-2) only if the
counterparty to the contract is a customer. A customer
is a party that has contracted with an entity to obtain
goods or services that are an output of the entity’s
ordinary activities in exchange for consideration.
As noted in the Background Information and Basis for Conclusions of ASU 2014-09,
the FASB defined the term “customer” in the glossary of the revenue standard to
help companies understand and establish which transactions are within the
standard’s scope. For the purposes of ASC 606, a customer is a “party that has
contracted with an entity to obtain goods or services that are an output of the
entity’s ordinary activities in exchange for consideration.” Despite some
requests for further clarification, the Board purposefully did not define what
constitutes “ordinary activities.” In part, this decision was a compromise since
the FASB’s and IASB’s respective conceptual frameworks differ from each other in
the words used to define revenue. Specifically, the IASB’s Conceptual Framework
description of revenue refers to the “ordinary activities of an entity,” and the
legacy definition in the FASB’s Concepts Statements describes revenue in terms
of the entity’s “ongoing major or central operations.”8 As discussed in paragraphs BC29 and BC53 of ASU 2014-09, the boards did
not reconsider those definitions as part of the development of the revenue
standard.
Connecting the Dots
Ordinary Activities Versus Ongoing Major or Central
Operations
While the boards compromised on the definition of a customer, at the time ASU
2014-09 was issued, they did not change their respective definitions of
revenue, which differ from each other in IFRS 15 and ASC 606. However,
despite the difference in wording between “ordinary activities” and
“ongoing major or central operations,” we do not expect substantial
differences between the two definitions.
There is separate guidance on transactions that do not meet the definition of
revenue (i.e., the counterparty to the contract is not a customer).
Typically, transactions not occurring with a customer may be one-off or
infrequent transactions, such as the sale of a piece of equipment or the
sale of a corporate headquarters building. For those instances, the FASB
created a new subtopic, ASC 610-20, which is further discussed in Chapter 17.
Updated Definition of Revenue in the FASB’s Concepts
Statements
In December 2021, the FASB updated the definition of
revenue in FASB Concepts Statement 8, Chapter
4 (the “FASB Concepts Statement”). Under the revised
definition, revenues are “inflows or other enhancements of assets of an
entity or settlements of its liabilities (or a combination of both) from
delivering or producing goods, rendering services, or carrying out other
activities.” Notably, the FASB eliminated the phrase “ongoing major or
central operations.” However, the Board has not amended the ASC master
glossary and ASC 606 to conform the Codification’s definitions of
revenue and a customer with the FASB Concepts Statement’s revised
definition of revenue, and the FASB Concepts Statement does not
represent authoritative guidance. In addition, entities should consider
the following in the FASB Concepts Statement’s Basis for Conclusions:
-
In paragraph BC4.44, the Board states, in part, that it “concluded that delivering or producing goods and rendering services are primary factors in distinguishing revenue from gains and expenses from losses, regardless of whether they are considered major or central to an entity.”
-
In paragraph BC4.45, the Board observes that “delivery of or producing goods or rendering services should always result in revenues and expenses.”
-
In paragraph BC4.46, the Board notes that regarding its decision “to retain the phrase other activities” in the FASB Concepts Statement’s revised definition of revenue, (1) “inclusion of that phrase allows sources such as investment income to be considered revenue” and (2) “[i]t is not the Board’s intention to suggest that the phrase other activities is an all-encompassing notion that captures every inflow and outflow.”
Further, paragraph E90 of the FASB Concepts Statement states the following:
The primary purpose of distinguishing gains and losses from
revenues and expenses is to make displays of financial
information about an entity’s sources of comprehensive income as
useful as possible. Ultimately, those decisions will be made
at a standards level with considerations for the objective
of financial reporting and presentation concepts.
[Emphasis added]
On the basis of the above, we do not expect the updated definition of
revenue in the FASB Concepts Statement to result in a change in practice
regarding the determination of which transactions should be accounted
for and presented as revenue under ASC 606.
Contracts With Another Entity That Is Both a Customer and a
Vendor
In certain arrangements, an entity may enter into one or
more contracts with another entity that is both a customer and a
vendor.9 That is, the reporting entity may enter into one or more contracts
with another entity to (1) sell goods or services that are an output of
the reporting entity’s ordinary activities in exchange for consideration
from the other entity and (2) purchase goods or services from the other
entity.
In these types of arrangements, the reporting entity
will need to use judgment to determine whether the other entity is
predominantly a customer or predominantly a vendor. It may not be
possible to make this determination solely on the basis of the
contractual terms. In such cases, the reporting entity will need to
consider the facts and circumstances of the overall arrangement with the
other entity. The reporting entity’s conclusion that the other entity in
the arrangement is predominantly a customer or predominantly a vendor
may determine whether (1) the consideration received from the other
entity should be accounted for under ASC 705-20 as consideration
received from a vendor or (2) the consideration paid to the other entity
should be accounted for under ASC 606 as consideration payable to a
customer.
Applying the guidance on consideration payable to a
customer and consideration received from a vendor is further discussed
in Sections
6.6.2 and 6.6.5,
respectively.
3.2.9 Collaborative Arrangements
Companies often enter into arrangements with third parties for the development or
commercialization of goods and services in an effort to share in both the costs
and risks associated with such activities. When an entity enters into a
collaboration, management must consider whether the arrangement meets the U.S.
GAAP definition of a collaborative arrangement to determine whether the
arrangement is subject to the requirements of ASC 808. The legal
characterization of an arrangement (e.g., as a collaboration or a collaborative
arrangement) does not necessarily make the arrangement qualify as a
collaborative arrangement under U.S. GAAP.
ASC 808-10-20 defines a collaborative arrangement as a “contractual arrangement
that involves a joint operating activity” and involves two (or more) parties
that are both of the following:
- “[A]ctive participants in the activity.”
- “[E]xposed to significant risks and rewards dependent on the commercial success of the activity.”
On the basis of these criteria, some types of collaborations may
not meet the definition of a collaborative arrangement and therefore would not
be within the scope of ASC 808. For example, certain arrangements in which one
party solely provides financial resources for an endeavor and is generally not
an active participant would not meet the definition of a collaborative
arrangement. Alternatively, arrangements between two parties that involve
codevelopment, comarketing, or copromotion activities, as well as the sharing of
risks and rewards based on the success of such activities, would generally meet
the definition of a collaborative arrangement.
A collaboration can begin at any point in the life cycle of an
endeavor (e.g., during the research and development [R&D] phase or after a
product has been commercially launched). The facts and circumstances associated
with the arrangement will dictate whether the parties (1) represent active
participants and (2) are exposed to significant risks and rewards.
ASC 808-10-15-8 cites the following examples of situations in which active
participation may exist:
- Directing and carrying out the activities of the joint operating activity
- Participating on a steering committee or other oversight or governance mechanism
- Holding a contractual or other legal right to the underlying intellectual property.
In addition, ASC 808-10-15-11 lists circumstances that might indicate that
participants are not exposed to significant risks and rewards:
- Services are performed in exchange for fees paid at market rates.
- A participant is able to exit the arrangement without cause and recover all (or a significant portion) of its cumulative economic participation to date.
- Initial profits are allocated to only one participant.
- There is a limit on the reward that accrues to a participant.
Further, in accordance with ASC 808-10-15-12, an entity should also consider
other factors when evaluating participants’ exposure to significant risks and
rewards, including (1) the “stage of the endeavor’s life cycle” and (2) the
“expected duration or extent of the participants’ financial participation . . .
in relation to the endeavor’s total expected life or total expected value.”
A collaborative arrangement may, in whole or in part, represent a contract with
a customer that should be accounted for under ASC 606. The Background
Information and Basis for Conclusions of ASU 2014-09 explains that the
relationship between a customer and a vendor varies from industry to industry
and that companies will therefore have to consider their own facts and
circumstances to determine who is a customer in an arrangement. For many
contracts, this will not be very difficult to determine; however, paragraph BC54
of ASU 2014-09 provides the following examples of arrangements in which the
facts and circumstances would have to be assessed:
-
Collaborative research and development efforts between biotechnology and pharmaceutical entities or similar arrangements in the aerospace and defense, technology, and healthcare industries, or in higher education.
-
Arrangements in the oil and gas industry in which partners in an offshore oil and gas field may make payments to each other to settle any differences between their proportionate entitlements to production volumes from the field during a reporting period.
-
Arrangements in the not-for-profit industry in which an entity receives grants and sponsorship for research activity and the grantor or sponsor may specify how any output from the research activity will be used.
The example below illustrates how an entity would determine whether an
arrangement is a collaborative arrangement and, if so, whether it should be
accounted for under ASC 606.
Example 3-14
Biotech B and Pharma P enter into an agreement to research, develop, and
commercialize drug X. Biotech B will perform the
R&D, and Pharma P will commercialize the drug. Both
parties agree to participate equally in all activities
that result from the research, development, and
commercialization. The reporting entity concludes that a
collaborative arrangement exists because both parties
are active participants and have agreed to share in the
risks and rewards.
Despite this conclusion, however, there still could be an entity-customer
relationship as a result of the collaborative agreement
or other contracts between the two entities. If such a
relationship exists, those parts of the contract that
are related to the entity-customer relationship should
be accounted for under ASC 606.
It is important to understand that a contract could be within
the scope of both the revenue standard and the guidance on collaborative
agreements, as indicated in paragraph BC55 of ASU 2014-09:
The Boards noted that a contract with a collaborator or a partner (for
example, a joint arrangement as defined in IFRS 11, Joint
Arrangements, or a collaborative arrangement within the scope of
Topic 808, Collaborative Arrangements) also could be within the scope of
Topic 606 if that collaborator or partner meets the definition of a customer
for some or all of the terms of the arrangement.
This is important because companies may have to assess the scope
of both ASC 606 and ASC 808 for these types of arrangements.
In November 2018, the FASB issued ASU 2018-18, which
made targeted improvements to the guidance on collaborative arrangements in ASC
808, including the following clarifications:
-
In the evaluation of whether a transaction in a collaborative arrangement is within the scope of ASC 606, the unit of account is a distinct good or service.
-
When the collaborative participant is a customer, the recognition, measurement, presentation, and disclosure requirements of ASC 606 should be applied to the transaction.
-
An entity in a collaborative arrangement is precluded from presenting a transaction as revenue if the collaborative participant counterparty is not a customer.
While the amendments in ASU 2018-18 primarily affected the
guidance in ASC 808, the ASU also amended ASC 606-10-15-3 to remove the
following guidance:
A counterparty to the contract would not
be a customer if, for example, the counterparty has contracted with the
entity to participate in an activity or process in which the parties to the
contract share in the risks and benefits that result from the activity or
process (such as developing an asset in a collaboration arrangement) rather
than to obtain the output of the entity’s ordinary activities.
3.2.9.1 Collaborative Arrangements Outside the Scope of ASC 606
In determining the accounting for collaborative arrangements outside the
scope of ASC 606, many entities have historically applied revenue
recognition guidance by analogy. These entities often conclude that the
collaborative activities do not represent separate deliverables (i.e., they
conclude that there is one “unit of account,” which represents the right to
actively participate in the collaborative arrangement over its term and to
share in the profits or losses from the underlying endeavor).
Before the FASB issued ASU 2018-18, we believed that when analogizing to
authoritative accounting literature, an entity should apply all (as opposed
to limited) aspects of that literature to the extent applicable. For
example, suppose that a biotechnology company entered into a collaborative
arrangement with a pharmaceutical company and, as part of the collaboration,
(1) provided the pharmaceutical company a license to use IP related to a
drug candidate and (2) performed R&D services jointly with the
pharmaceutical company. The biotechnology company may have concluded that
while the arrangement meets the definition of a collaborative arrangement in
accordance with ASC 808, none of its elements are within the scope of ASC
606. Nevertheless, the biotechnology company may have further concluded that
revenue literature (e.g., ASC 606) represents appropriate authoritative
guidance that the company should apply by analogy to determine the unit(s)
of account, recognition, and measurement. Accordingly, if the company
concluded that the license is not a distinct performance obligation, the
revenue literature would require the license and R&D services to be
combined for accounting purposes. Further, with respect to the appropriate
income statement presentation for consideration allocated to the combined
unit of account (in this case, the license and R&D services), such
consideration would generally be presented consistently in the same category
for income statement presentation purposes given the conclusion that the
license and R&D services should be combined for accounting purposes.
However, as noted above, the FASB issued ASU 2018-18 in November 2018.
Although the Board decided to provide unit-of-account guidance in ASC 808
and align that guidance with the guidance in ASC 606 for distinct goods or
services, the Board decided not to include recognition and measurement
guidance for nonrevenue transactions in a collaborative arrangement. The
Board’s reason for not including such guidance was to avoid developing a
“one size fits all” accounting model for the various types of collaborative
arrangements. The decision to align the unit-of-account guidance with the
guidance in ASC 606 for distinct goods or services is limited to the context
of assessing the scope of the revenue guidance. As noted in paragraph BC31
of ASU 2018-18, “the Board decided to continue to permit an entity to apply
the revenue guidance in Topic 606 by analogy or, if there is no appropriate
analogy, as a policy election, without requiring the entity to apply all
the guidance in Topic 606, as long as it presents the transaction
separate from revenue recognized from contracts with customers” (emphasis
added). Accordingly, it is possible for an entity to conclude on the basis
of its facts and circumstances that ASC 606 represents an “appropriate
analogy” for determining the nonrevenue unit(s) of account but may not
represent an appropriate analogy for recognizing or measuring such unit(s)
of account. In such a case, the above guidance would support a conclusion
that analogizing to ASC 606 could be limited to an entity’s determination of
the unit(s) of account. The entity would then be required to establish a
policy that is “reasonable, rational, and consistently applied” as long as
the nonrevenue transaction is presented separately from any revenue
recognized from contracts with customers under ASC 606.
3.2.10 Contracts That Include Both Revenue and Nonrevenue Elements
ASC 606-10
15-4 A contract with a customer may be partially within the scope of this Topic and partially within the scope of
other Topics listed in paragraph 606-10-15-2.
- If the other Topics specify how to separate and/or initially measure one or more parts of the contract, then an entity shall first apply the separation and/or measurement guidance in those Topics. An entity shall exclude from the transaction price the amount of the part (or parts) of the contract that are initially measured in accordance with other Topics and shall apply paragraphs 606-10-32-28 through 32-41 to allocate the amount of the transaction price that remains (if any) to each performance obligation within the scope of this Topic and to any other parts of the contract identified by paragraph 606-10-15-4(b).
- If the other Topics do not specify how to separate and/or initially measure one or more parts of the contract, then the entity shall apply the guidance in this Topic to separate and/or initially measure the part (or parts) of the contract.
When a contract includes multiple performance obligations, or deliverables (see
Chapter 5 for
information about defining a performance obligation), some of which are within
the scope of other standards, any separation and initial measurement
requirements of the other standards are applied first and the deliverables
within the scope of the revenue model are ascribed any residual amount. For
example, if a contract includes performance obligations subject to ASC 606 and a
guarantee subject to ASC 460 (e.g., an indirect guarantee of the indebtedness of
others), the guarantee would typically be recognized at its fair value, with the
residual transaction price recognized under ASC 606.
If there are no separation or initial measurement requirements in those other
standards, the requirements in ASC 606 are applied. That is, the guidance in ASC
606 is the default guidance to be used if there is no other relevant guidance.
For example, consider an entity that enters into a single contract to lease a
boat to a customer and provide cleaning services for that boat. Assume that the
entity assesses the promises in the contract and determines that (1) the lease
of the boat is within the scope of the guidance on leases and (2) the cleaning
services are within the scope of ASC 606. Further, assume that the entity has
adopted both the revenue standard and the leasing standard (ASC 842) and that
the entity has not elected to use the available practical expedient that would
allow it to avoid separating lease and nonlease components (as discussed in
Section
3.2.12 below and Section 4.3.3.2 of Deloitte’s
Roadmap Leases . In accordance with ASC 606, the entity would
first look to the other guidance (the leasing standard, in this situation) for
guidance on how to allocate the consideration from the contract; if the other
standard did not have allocation guidance, the entity would apply the allocation
guidance in ASC 606. In this situation, the leasing standard says to apply the
allocation guidance in ASC 606. Therefore, the entity would use the revenue
standard’s guidance to identify the performance obligations and allocate
consideration between the revenue and nonrevenue (i.e., lease) components.
3.2.11 Contracts That Pose Scope Challenges
Some contracts may pose scope challenges. Entities will need to
use judgment to determine whether the performance obligations in contracts meet
one of the scope exceptions of the revenue standard.
3.2.11.1 Lapsed Unexercised Warrants
Entities often issue warrants (options issued on the
entity’s own shares) for cash. If these warrants meet the definition of
equity instruments under ASC 815-40, the amount received for issuing them is
credited to equity. When the warrants lapse unexercised, revenue should not
be recognized. The issuance of warrants for cash is not a transaction with
customers; rather, it is a transaction with equity participants. The
definition of comprehensive income (which encompasses both revenue and gains
in accordance with the conceptual framework) excludes contributions from
equity participants. The fact that an equity participant no longer has an
equity claim on the assets of the entity does not convert the equity
contribution into income. Amounts for warrants classified as equity
instruments may be transferred to another account within equity (e.g.,
contributed surplus) as of the date the warrants expire.
3.2.11.2 Incentive-Based Capital Allocation Arrangements
Compensation for asset managers commonly consists of both
management fees (usually a percentage of assets under management) and
incentive-based fees (i.e., fees based on the extent to which a fund’s
performance exceeds predetermined thresholds). Often, a private-equity or
real estate fund manager (who may be the general partner and have a small
ownership percentage in the fund) will receive incentive-based fees by way
of an allocation of capital from the fund’s limited partnership interests
(commonly referred to as “carried interests”).
One common arrangement is referred to as “2 and 20” (i.e., 2 percent and 20
percent). The 2 percent refers to an annual management fee computed on the
basis of assets under management. Management fees are generally separate and
distinct from performance-based capital allocations since management fees
are usually in the form of a cash-based contractual relationship between the
asset manager and the fund. Therefore, management fees would be subject to
ASC 606.
The 20 percent refers to a term in a performance fee arrangement under which
the asset manager participates in a specified percentage (e.g., 20 percent)
of returns after other investors have achieved a specified return on their
investments, which is referred to as a hurdle rate (e.g., 8 percent).
Under a prevalent form of such an arrangement, the performance fee is in the
legal form of a capital account within the equity structure of the fund, or
“carried interest.” As noted above, the asset manager’s capital account
receives allocations of the returns of a fund when those returns exceed
predetermined thresholds. In addition to the carried interest, the asset
manager or affiliates often acquire a small ownership interest in the fund
through general partner or limited partner interests on the same basis as
other investors. Such interests receive only pro rata allocations of fund
returns and are not typically subject to the accounting guidance in ASC 606
since there are no incentive or performance aspects to the arrangement.
In other cases, the fund manager’s performance fee may be in the form of a
contractual arrangement with the fund rather than an allocation of capital
within an equity interest.
Under the revenue standard, the incentive fee portion of an
asset management arrangement is likely to represent variable consideration,
as discussed further below. As illustrated in Example 25 of the standard
(ASC 606-10-55-221 through 55-225), the application of the variable
consideration constraint may result in a delay in recognition of incentive
fees. In some cases, this delay may be significant.
3.2.11.2.1 Views Proposed by Stakeholders
While Example 25 of the revenue standard contains
implementation guidance that demonstrates how to apply the variable
consideration constraint to an asset management contract, “the example
does not state that the form of the incentive fee is a capital
allocation or cash (or some other asset).”10 That is, Example 25 does not specify whether it “applies to
equity-based arrangements in which the asset manager is compensated for
performance-based fees via an equity interest (that is, incentive-based
capital allocations such as carried interest).”11 Consequently, stakeholders have expressed the following views on
whether carried interests are within the scope of the revenue
standard:
-
View A — Carried interests are within the scope of the revenue standard.
-
View B — Carried interests are outside the scope of the revenue standard.
-
View C — An entity’s accounting for carried interests may vary in accordance with the nature and substance of the arrangement.
Proponents of View A believe that carried interests are
revenue transactions and analogize such interests to performance bonuses
in contracts with customers in other industries (i.e., they believe that
the purpose of carried interest arrangements and other similar
arrangements is to compensate asset managers for their services).
Accordingly, under View A, carried interests would be included in the
transaction price subject to the constraint guidance on variable
consideration. (See Chapter 6 for further discussion about estimating and
constraining estimates of variable consideration.) Further, entities
would be required to disclose additional information about these
contracts in accordance with ASC 606-10-50.
Conversely, supporters of View B believe that the
arrangements “are ownership interests and should be accounted for under
other GAAP”12 because an asset manager’s investment in a limited partnership may
meet the definition of financial assets or financial instruments, which
are outside the scope of ASC 606.
Proponents of View C believe that because these
arrangements vary, entities would need to apply significant judgment in
evaluating their nature and substance to determine the appropriate
accounting.
At the TRG meeting in April 2016, the FASB staff
supported View A because it believes that:
-
Example 25 is evidence that the Board intended asset management service contracts, including those with incentive- or performance-based fees, to be within the scope of ASC 606.
-
Carried interests are designed to compensate an asset manager for its services (i.e., in managing and investing in the fund).
-
The Board confirmed that carried interests are more akin to services than to an ownership interest when it excluded performance-based fees from an entity’s consolidation analysis (i.e., in determining whether the entity is the primary beneficiary of a variable interest entity) during its deliberations of ASU 2015-02.
After significant discussion, the TRG did not reach
general agreement on whether carried interests in asset management
arrangements are within the scope of ASC 606 and thus subject to the
revenue standard’s variable consideration constraint guidance. The Board
reiterated that its intention was to include these arrangements within
the scope of ASC 606 because the Board viewed these incentive-based fees
as compensation for services provided (i.e., part of revenue
transactions). Many TRG members agreed that the arrangements are within
the scope of ASC 606.13
However, some TRG members expressed an alternative view
that a carried interest could be regarded as an equity arrangement
because it is, in form, an interest in the entity. As a result of this
view, those TRG members indicated that if the arrangements are
considered equity interests outside the scope of ASC 606, questions
could arise in a consolidation analysis — specifically, questions
related to whether the asset managers should consolidate the funds.
The SEC staff’s view is characterized in Implementation Q&A 3 as follows:
The SEC staff observer at the TRG meeting indicated
that he anticipates the SEC staff would accept an application of
Topic 606 for those arrangements. However, the observer noted that
there may be a basis for following an ownership model. If an entity
were to apply an ownership model, then the SEC staff would expect
the full application of the ownership model, including an analysis
of the consolidation model under Topic 810, the equity method of
accounting under Topic 323, or other relevant guidance.
We believe that an entity contemplating the ownership
model view under ASC 323 should consider consulting with its accounting
advisers and auditors.
The minutes of the TRG meeting (TRG Agenda Paper 55)
suggest that the FASB staff does not recommend that the Board undertake
standard-setting activity with respect to this topic.
3.2.11.2.2 Acceptable Views
We believe that there are two acceptable views (“View 1”
and “View 2”) on whether carried interests are within the scope of ASC 606:
- View 1 — Carried interests are within the scope of the revenue standard.
- View 2 — Carried interests may be outside the scope of the revenue standard depending on the nature and substance of the arrangement.
View 1 was supported by all seven FASB board members at
the April 2016 FASB-only TRG meeting. The Board reiterated that its
intention was to include these arrangements within the scope of ASC 606
because the Board viewed these incentive-based fees as compensation for
services provided (i.e., part of revenue transactions). At the same
meeting, the SEC staff observer indicated that he anticipates that the
SEC staff would find it acceptable to apply ASC 606 to such arrangements
(i.e., View 1 could be acceptable).
However, the SEC staff observer also noted that there
may be a basis for using an ownership model such as that in ASC 323
(i.e., View 2 could be acceptable). Specifically, certain entities may
be able to demonstrate that their incentive-based capital allocation
arrangements that involve an equity interest are financial instruments
within the scope of other U.S. GAAP, particularly ASC 323. In such
cases, these arrangements would qualify for the following scope
exception in ASC 606-10-15-2(c):
c. Financial instruments and
other contractual rights or obligations within the scope of
the following Topics:
1. Topic 310, Receivables
2. Topic 320, Investments — Debt Securities
2a. Topic 321, Investments — Equity Securities
3. Topic 323, Investments — Equity
Method and Joint Ventures
4. Topic 325, Investments — Other
5. Topic 405, Liabilities
6. Topic 470, Debt
7. Topic 815, Derivatives and Hedging
8. Topic 825, Financial Instruments
9. Topic 860, Transfers and Servicing. [Emphasis added]
Entities should carefully evaluate the scope guidance in
these ASC topics to determine whether their incentive-based capital
allocation arrangements can be accounted for under ASC 323. Entities
should consider the nature and legal form of such arrangements —
specifically, whether the incentive fee is an attribute of an equity
interest in the fund (e.g., a disproportionate allocation of fund
returns to a capital account owned by the manager).
When the incentive fee is not an allocation of fund
returns among holders of equity interests (e.g., when the fee is in the
form of a contractual arrangement with the fund), it should be accounted
for under ASC 606.
In addition, we understand that it is customary industry
practice for entities to use incentive-based capital allocation
arrangements if they were to reach a conclusion that such arrangements
are subject to the guidance in ASC 323.
We believe that under View 2, there are two acceptable
approaches that an entity can use to present carried interest
arrangements in its statement of performance:
-
Approach A: present within revenue — Proponents of this approach believe that incentive fees in carried interest arrangements continue to represent revenue14 earned by an entity and should therefore be presented within revenue. However, since these revenues are outside the scope of the revenue standard, they should not be labeled as (or be under a caption related to items that include) revenue from contracts with customers in an entity’s financial statements or in the accompanying footnotes and disclosures. If an entity has one or more captions related to revenue from customers, a separate, appropriately labeled caption would be necessary.
-
Approach B: present outside of revenue — Proponents of this approach believe that since incentive fees in carried interest arrangements are derived from an entity’s investment in equity method investees, they should be presented within the earnings of the entity’s equity method investee(s) in the statement of performance.Connecting the DotsIf an entity determines that fees under carried interest arrangements may be accounted for outside of ASC 606, we would encourage the entity to consult with accounting advisers regarding the nature and legal form of those arrangements. On the basis of informal discussions with the SEC staff, we understand that the staff would not object to a conclusion that (1) carried interests in the form of incentive-based capital allocation arrangements may be accounted for within the scope of either ASC 606 or ASC 323 (if the considerations described above are met) and (2) this is an accounting policy choice. Further, from a performance statement perspective, the SEC staff would not object to the presentation of performance-based capital allocation fees in accordance with either Approach A or Approach B as described above.
3.2.11.3 Financial Institution Transactions
The revenue standard excludes transactions from its scope
that are accounted for under other ASC topics, including those within the
scope of ASC 405 (liabilities), ASC 460 (guarantees), ASC 815 (derivatives
and hedging), and ASC 860 (transfers and servicing). The standard also notes
that entities should apply ASC 606 to contracts with a customer or portions
thereof if other ASC topics do not contain guidance on separation or initial
measurement. To determine which guidance applies to the fees associated with
certain common financial institution transactions, stakeholders have asked
the FASB to clarify whether (1) mortgage servicing rights15 should be accounted for under ASC 860, (2) deposit-related fees16 should be accounted for under ASC 405, (3) fees from financial
guarantees17 should be accounted for under ASC 460 or ASC 815, and (4) rights and
obligations under a credit card issuing bank’s contract as well as the
corresponding reward program should be accounted for under ASC 310. These
matters were discussed at the July 2015 and April 2016 TRG meetings, and the
TRG generally agreed with the FASB staff’s analysis and conclusions.
3.2.11.3.1 Mortgage Servicing Rights
The FASB staff noted that assets and liabilities
associated with mortgage servicing rights should be accounted for under
ASC 860. The staff believes that servicing arrangements within the scope
of ASC 860 are outside the scope of ASC 606 and that ASC 860 addresses
both the initial recognition and subsequent measurement of mortgage
servicing assets and liabilities. In the staff’s view, since the
subsequent measurement of the mortgage servicing assets and liabilities
depends on the cash flows associated with the mortgage servicing rights,
entities should apply the guidance in ASC 860 to account for such cash
flows.18
The above issue is addressed in Implementation Q&A 4 (compiled
from previously issued TRG Agenda Papers 52 and
55). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As,
see Appendix
C.
3.2.11.3.2 Deposit-Related Fees
The FASB staff noted that entities should account for
revenue from deposit-related fees in accordance with ASC 606. Financial
institutions should (1) record liabilities for customer deposits because
the deposits meet the definition of a liability and (2) account for
customer deposits in accordance with ASC 405. However, because ASC 405
does not contain specific guidance on how to account for deposit fees,
financial institutions should apply ASC 606 for deposit-related fees.
The FASB staff suggested that implementation concerns raised by some
stakeholders could be alleviated by careful analysis of the contract
terms between the financial institution and the customer. Because
customers generally have the right to cancel their depository
arrangement at any time, the FASB staff believes that most contracts
would be short term (e.g., day to day or minute to minute). As a result,
revenue recognition patterns would be similar regardless of the number
of performance obligations identified.
The above issue is addressed in Implementation Q&A 5 (compiled from previously
issued TRG Agenda Papers 52 and 55). For additional information and Deloitte’s
summary of the Implementation Q&As, see Appendix C.
3.2.11.3.3 Fees Related to Financial Guarantees
The FASB staff noted that fees related to financial
guarantees should be accounted for in accordance with either ASC 460 or
ASC 815. The basis for the staff’s view is partly due to its belief that
“the fee would not be received unless the guarantee was made, and the
guarantee liability is typically reduced (by a credit to earnings) as
the guarantor is released from the risk under the guarantee.”19 Further, the staff believes that ASC 460 or ASC 815 provides a
framework that addresses both initial recognition and subsequent
measurement of the guarantee. In addition, the staff cited paragraph
BC61 of ASU 2014-09 as further evidence of the Board’s intent to exclude
guarantees from the scope of ASC 606.
In December 2016, the FASB issued ASU 2016-20,
which amends the guidance in ASC 942-825-50-2 and ASC 310-10-60-4 to
clarify that guarantee fees within the scope of ASC 460 or ASC 815
(other than product or service warranties) are not within the scope of
ASC 606. For further discussion of the amendments in ASU 2016-20, refer
to Section
18.3.3.6.
See TRG Agenda Paper 52 for additional information.
3.2.11.3.4 Arrangements Involving Bank-Issued Credit Cards
Stakeholders have asked whether the guidance in ASC 310
or the guidance in ASC 606 should be applied to the rights and
obligations under a credit card issuing bank’s contract as well as the
corresponding reward program (i.e., a loyalty program). The guidance
that is applied would affect the timing of revenue recognition.
Credit card arrangements are typically accounted for
under ASC 310 because they are related to credit lending activities. ASC
606-10-15-2 indicates that financial instruments within the scope of
other Codification topics, including ASC 310, are excluded from the
scope of the revenue standard. However, ASC 606-10-15-4 notes that a
contract may be partially within the scope of ASC 606 if other
Codification topics “do not specify how to separate and/or initially
measure one or more parts of the contract.”
ASC 310-20-35-5 states:
Fees
deferred in accordance with paragraph 310-20-25-15 shall be
recognized on a straight-line basis over the period the fee entitles
the cardholder to use the card. This accounting shall also apply to
other similar card arrangements that involve an extension of credit
by the card issuer.
In contrast, if it is determined that some or all of the
arrangement is within the scope of ASC 606, an assessment must be made
to determine whether the rewards the customer earns are a material right
and therefore a performance obligation. If the rewards are a performance
obligation, the revenue allocated to the performance obligation cannot
be recognized until the rewards are redeemed for goods or services under
the reward program. This period could be longer than the period over
which revenue would be recognized under ASC 310.
This issue is addressed in Implementation Q&As 1 and 2 (compiled from
previously issued TRG Agenda Papers 36 and 44), which summarize the following observations and
conclusions of the FASB staff:
-
The FASB staff notes that all credit card fees have historically been accounted for under ASC 310 because they are related to credit lending activities (i.e., akin to loan origination fees). The staff also notes that the revenue standard does not include consequential amendments to ASC 310. Accordingly, the staff believes that entities should account for services exchanged for credit card fees under ASC 310 rather than ASC 606. However, the staff notes that as an anti-abuse measure, entities need to assess whether credit card fees and services should be accounted for under ASC 606 when the issuance of a credit card appears incidental to the arrangement (e.g., when a card is issued in connection with the transfer of (1) an automobile or (2) asset management services).
-
The FASB staff indicates that if an entity concludes that the credit card arrangement is within the scope of ASC 310, the associated reward program would also be within the scope of ASC 310.
Note that outcomes under U.S. GAAP may differ from those
under IFRS Accounting Standards because of differences between ASC 310
and IFRS 9.
3.2.11.4 Physically Settled Commodity Contracts That Are Derivatives
Entities that enter into contracts to deliver commodities
(e.g., oil and gas, power and utilities, mining and metals, agriculture) may
enter into firm contracts to deliver nonfinancial assets that are actively
traded on the open market (e.g., electricity, grains) on a forward basis in
exchange for a fixed amount of consideration. Even if an entity expects to
physically settle a contract of this nature (i.e., by delivering the
agreed-upon amount of the specified nonfinancial asset(s) on the forward
date), if the contract could be net settled, the contractual rights and
obligations might be within the scope of ASC 815.
If the rights and obligations associated with the contract
are within the scope of ASC 815, then the contract is outside the scope of
ASC 606 even if the derivative settles and the commodity is physically
delivered to the customer in exchange for cash consideration. This is the
case regardless of whether the entity’s ordinary activities may include
selling and physically delivering the commodity to third parties that would
otherwise meet the definition of a customer. Further, because the contract
is within the scope of ASC 815, the consideration received upon physical
settlement of the derivative contract is also within the scope of ASC 815
(rather than ASC 606).
“Customer” is defined in ASC 606-10-20 as a “party that has
contracted with an entity to obtain goods or services that are an output of
the entity’s ordinary activities in exchange for consideration.” If an
entity’s ordinary activities include selling and physically delivering
commodities to independent third parties in exchange for cash consideration,
one might conclude that the counterparty in such a contract is a customer
and that the contract is therefore within the scope of ASC 606. However, ASC
606-10-15-2 states, in part:
An entity shall apply the
guidance in this Topic to all contracts with customers, except the
following: . . .
c. Financial instruments and other
contractual rights or obligations within the scope of the
following Topics: . . .
7. Topic 815,
Derivatives and Hedging [Emphasis added]
The scope assessment for contractual rights and obligations
is performed at contract inception. That is, the contract is within the
scope of ASC 815 both at contract inception and throughout the contract
term. Therefore, even when the settlement of the contract — and physical
delivery of the underlying commodity — are an output of the entity’s
ordinary activities, the contract is outside the scope of ASC 606 on the
basis of the guidance in ASC 606-10-15-2(c)(7).
Further, ASC 815-10 provides a comprehensive framework for
recognition, measurement, and presentation of derivatives, which covers
settlement (including physical delivery). Consequently, the settlement of a
contract should be presented in accordance with the guidance in ASC 815 and
should not be included as a component of revenue from contracts with
customers.
Example 3-15
Entity X, an agribusiness company
whose ordinary activities include selling and
physically delivering corn to independent third
parties in exchange for cash consideration, enters
into a contract to sell and physically deliver 5,000
bushels of corn on a forward basis for a fixed
amount of cash consideration. In accordance with ASC
815-10-15-83, X has concluded the following:
-
The contract has an underlying (i.e., the price of corn).
-
The contract has a notional (i.e., 5,000 bushels of corn).
-
Entity X makes no initial net investment in the contract.
-
The underlying commodity to be physically delivered under the contract (i.e., corn) is readily convertible to cash (i.e., it meets the net settlement criteria).
On the basis of the characteristics
of the contract described above, X has concluded
that the rights and obligations associated with the
contract should be accounted for as a derivative
within the scope of ASC 815. Therefore, the contract
is initially and subsequently measured at fair
value, with changes in fair value recognized through
net income. Since the scope assessment for
contractual rights and obligations is performed at
contract inception, the contract is within the scope
of ASC 815 both at contract inception and throughout
the contract term. Therefore, even when the
settlement of the contract — and physical delivery
of the corn — are an output of the entity’s ordinary
activities, the contract is outside the scope of ASC
606 on the basis of the guidance in ASC
606-10-15-2(c)(7).
3.2.11.5 Accounting for Proceeds From the Sale of Scrap Materials or By-Products
Generally, we would expect proceeds from an entity’s sale of
scrap materials or by-products that are produced as a result of the entity’s
manufacturing process to be treated as revenue within the scope of ASC 606.
To determine whether to account for the proceeds as revenue under ASC 606,
the entity must consider whether the proceeds represent revenue from a
contract with a customer. Revenue is defined in the ASC 606 glossary as
“[i]nflows . . . from delivering or producing goods, rendering services, or
other activities that constitute the entity’s ongoing
major or central operations” (emphasis added). The ASC 606 glossary
defines a customer as a “party that has contracted with an entity to obtain
goods or services that are an output of the entity’s ordinary
activities in exchange for consideration” (emphasis added).
Determining the entity’s “ongoing major or central operations” and “ordinary
activities” requires careful consideration of its specific facts and
circumstances.
If it is determined that the proceeds from the sale are
income from activities outside the entity’s ongoing major or central
operations and are therefore outside the scope of ASC 606, the proceeds may
be within the scope of ASC 610-20 (see Chapter 17) and recognized outside
operations as other income.
3.2.12 Scope Considerations for Lessors
In accordance with ASC 842-10-15-2, an entity is required at
contract inception to determine whether a contract is or contains a lease. Not
all leases will be labeled as such, and a lease component may be embedded in a
larger arrangement. Therefore, entities should consider whether a contract, or
part of a contract, is within the scope of the leasing standard. See Chapter 3 of
Deloitte’s Roadmap Leases for more information on determining whether a
contract is or contains a lease.
If, after consideration of ASC 842-10-15-2, a lease component is
identified, further analysis may be necessary. In July 2018, the FASB issued
ASU 2018-11, under which
lessors may elect not to separate lease and nonlease components when certain
conditions are met. A lessor may elect to combine lease and associated nonlease
components provided that the nonlease component(s) would otherwise be accounted
for under ASC 606 and both of the conditions in ASC 842-10-15-42A(a) and (b) are
met. Those conditions require (1) the timing and pattern of transfer for the
components to be the same and (2) the lease component, if accounted for
separately, to be classified as an operating lease. See Section 4.3.3.2 of
Deloitte’s Roadmap Leases for additional considerations.
3.2.13 Business Combinations
In October 2021, the FASB issued ASU 2021-08 on accounting for contract assets and contract
liabilities from contracts with customers acquired in a business combination.
Under current guidance, revenue contracts acquired in a business combination are
subject to the general requirements of ASC 805, in accordance with which most
assets and liabilities acquired in a business combination are measured at fair
value on the acquisition date.
ASU 2021-08 amends ASC 805 to address inconsistencies and
diversity in practice related to the accounting for revenue contracts with
customers acquired in a business combination. The ASU’s amendments to ASC 805
require an entity to apply the guidance in ASC 606 when recognizing and
measuring contract assets and contract liabilities arising from those contracts.
In addition to revenue contracts with customers, the scope of the ASU includes
other contracts that are subject to the provisions of ASC 606 (e.g., contracts
within the scope of ASC 610-20). The guidance in ASC 606 on measuring contract
assets and contract liabilities differs from the fair value measurement model
that is applied to most assets and liabilities (e.g., customer relationship
intangibles) acquired in a business combination.
Further, ASU 2021-08 provides practical expedients in ASC 805
related to an entity’s application of the guidance in ASC 606 on (1) previously
modified contracts and (2) the determination of stand-alone selling prices.
Those practical expedients can be elected on an acquisition-by-acquisition
basis. An entity is required to disclose its election to use any of the
practical expedients provided.
ASU 2021-08 is effective (1) for public business entities (PBEs)
for fiscal years beginning after December 15, 2022, including interim periods
within those fiscal years, and (2) for all other entities for fiscal years
beginning after December 15, 2023, including interim periods within those fiscal
years. Early adoption is permitted for periods for which financial statements
have not yet been issued or made available for issuance. An entity that elects
to early adopt the amendments in the ASU in an interim period should apply the
ASU’s guidance retrospectively to all business combinations for which the
acquisition date occurs on or after the beginning of the fiscal year that
includes the interim period of early adoption. In addition, once adopted, the
amendments in the ASU should be applied prospectively to business combinations
that occur on or after the effective date with no transition disclosures.
Footnotes
2
See Section 3.2.12 for a
discussion of scope considerations related to contracts
accounted for under both ASC 606 and ASC 842.
3
Common gaming activities include table games, slot
machines, keno, bingo, and sports and race betting.
4
Currently, an entity that is required to
adopt IFRS 9 should apply IFRS 9 rather than IAS 39 when
accounting for derivatives.
5
“For example, the activities do not constitute
an entity’s ongoing major or central operations (Master Glossary
– Revenue).”
6
“This may result in the reimbursement being
recorded as other income or as contra-expense.”
7
“If the NRE and the subsequent production units
are in a single contract or the contracts meet the criteria for
contract combination in paragraph 606-10-25-9, this may result
in revenue being recognized over a period longer than the
preproduction period. For example, it may result in revenue
being recognized over subsequent production units.”
8
The concept of ordinary activities is derived from the legacy definition of revenue in FASB Concepts Statement 6, which states
that revenues “are inflows or other enhancements of assets of an entity
or settlements of its liabilities (or a combination of both) from
delivering or producing goods, rendering services, or other activities
that constitute the entity’s ongoing major or central operations.”
9
The ASC master glossary defines a vendor as a
“service provider or product seller, such as a manufacturer,
distributor, or reseller.”
11
Quoted from paragraph 12 of TRG Agenda Paper
50.
12
See footnote 10.
13
Q&A 3 of the FASB Staff Implementation
Q&As summarizes the views presented by the TRG members at
the TRG’s April 2016 meeting and states that “[t]he [FASB]
staff’s view is that incentive-based capital allocations are
within the scope of Topic 606.”
14
The legacy definition of revenue in paragraph 78 of FASB Concepts Statement 6 states
that “[r]evenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.” In December 2021, the FASB updated the definition of revenue in FASB Concepts Statement 8, Chapter 4 (the “FASB
Concepts Statement”). Under the revised definition,
revenues are ”inflows or other enhancements of
assets of an entity or settlements of its
liabilities (or a combination of both) from
delivering or producing goods, rendering services,
or carrying out other activities.” Notably, the FASB
eliminated the phrase ”ongoing major or central
operations.” However, the Board has not amended the
ASC master glossary and ASC 606 to conform the
Codification’s definitions of revenue and a customer
with the FASB Concepts Statement’s revised
definition of revenue, and the FASB Concepts
Statement does not represent authoritative guidance.
Therefore, we do not expect the updated definition
of revenue in the FASB Concepts Statement to result
in a change in practice regarding the determination
of which transactions should be presented as revenue
under ASC 606. See Section 3.2.8
for more information.
15
After originating a loan (or selling an originated
loan but retaining rights to service the loan), a financial
institution may perform services that include communicating with the
borrower; collecting payments for interest, principal, and other
escrow amounts; and performing recordkeeping activities.
16
Deposit-related fees are those that a financial
institution charges to a customer for amounts on deposit with the
financial institution. Fees may be charged to give customers access
to their funds and to cover other activities, including
recordkeeping and reporting. In addition, fees may be
transaction-based (such as fees to withdraw funds through an
automated teller machine) or may not be transaction-based (such as
account maintenance fees).
17
Fees charged by a financial institution to a
borrower on a loan, for example, in return for the financial
institution’s acting as a third-party guarantor on the borrower’s
debt.
18
As noted by the FASB staff, some entities
believe that there is a close link between ASC 860’s asset and
liability remeasurement requirements and the collection of
servicing fees (which gives rise to mortgage servicing
income).
19
Quoted from paragraph 61 of TRG Agenda Paper 52.
Chapter 4 — Step 1: Identify the Contract
Chapter 4 — Step 1: Identify the Contract
4.1 Overview
For contracts within the scope of ASC 606, the first step of the
revenue standard is to determine whether a contract exists, for accounting purposes,
between an entity and its customer. The criteria that need to be in place to
establish that a contract exists are intended to demonstrate that there is a valid
and genuine transaction between an entity and its customer and that the parties to
the contract have enforceable rights and obligations that will have true economic
consequences. If, at contract inception, the criteria in ASC 606-10-25-1 are met,
the contract would be accounted for under the remaining provisions of the standard.
Because the rest of the provisions of the standard rely on a careful analysis of the
enforceable rights and obligations under the contract, if any of the five criteria
required to establish a contract for accounting purposes are not met, the rest of
the revenue recognition model cannot be applied. In these circumstances, any
consideration received from the customer would be recognized as a liability (see
Section 4.6), and
revenue can only be recognized once (1) the contract existence criteria are met
(under the assumption that the rest of the revenue recognition model supports the
recognition of revenue) or (2) the consideration received is nonrefundable and one
or more of the following have occurred:
-
All of the performance obligations in the contract have been satisfied and substantially all of the promised consideration has been received.
-
The contract has been terminated or canceled.
-
The entity has transferred control of the goods or services to which the consideration received is related and has stopped transferring (and has no obligation to transfer) additional goods or services to the customer.
The revenue standard also provides guidance on when two or more
contracts should be combined and evaluated as a single contract for determining
revenue recognition (see Section
4.7) as well as the accounting for contract modifications (see
Chapter 9).
4.2 Identifying a Contract With a Customer
An important step in the revenue standard is determining when an
agreement with a customer represents a contract for accounting purposes. A contract
creates enforceable rights and obligations between two or more parties.
Enforceability of the rights and obligations is a matter of law. An agreement does
not need to be in writing to constitute a contract. A contract may exist if parties
orally agree to an arrangement’s terms. Alternatively, a contract could be implied
through customary business practices if those practices create enforceable rights
and obligations.
ASC 606-10
25-2 A contract is an agreement
between two or more parties that creates enforceable rights
and obligations. Enforceability of the rights and
obligations in a contract is a matter of law. Contracts can
be written, oral, or implied by an entity’s customary
business practices. The practices and processes for
establishing contracts with customers vary across legal
jurisdictions, industries, and entities. In addition, they
may vary within an entity (for example, they may depend on
the class of customer or the nature of the promised goods or
services). An entity shall consider those practices and
processes in determining whether and when an agreement with
a customer creates enforceable rights and obligations.
Because the rest of the revenue model cannot be applied until a
valid contract is in place, it is important to determine when enforceable rights and
obligations are created between two or more parties. Varying contracting practices
can sometimes make this determination difficult. Even if two parties are in basic
agreement about the main terms of a contract, no contract would exist if the
parties’ rights and obligations under the contract are not legally enforceable.
Determining whether a contractual right or obligation is enforceable is a question of
law, and the factors that determine enforceability may differ between jurisdictions.
The best evidence of an enforceable agreement is a written contract, especially if
the seller’s standard practice is to use written contracts.
Although ASC 606 does not require a written contract as evidence of an agreement, a
contract that is being prepared but has not yet been signed may be evidence that an
agreement has not yet been reached. Entities should use caution before recognizing
revenue in such circumstances because the apparent absence of a contractual
understanding between the parties may make it unlikely that the conditions in ASC
606-10-25-1 have been met.
4.3 Criteria for Identifying a Contract With a Customer
As shown below, ASC 606-10-25-1 provides criteria that an entity
should evaluate at contract inception to determine whether an arrangement should be
accounted for under the revenue standard.
ASC 606-10
25-1 An entity shall account for a
contract with a customer that is within the scope of this
Topic only when all of the following criteria are met:
-
The parties to the contract have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations.
-
The entity can identify each party’s rights regarding the goods or services to be transferred.
-
The entity can identify the payment terms for the goods or services to be transferred.
-
The contract has commercial substance (that is, the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract).
-
It 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 (see paragraphs 606-10-55-3A through 55-3C). In evaluating whether collectibility of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 606-10- 32-7).
In many instances, the evaluation of the criteria in ASC 606-10-25-1
should be straightforward. However, certain arrangements will require careful
evaluation to determine whether the contract creates enforceable rights and
obligations between an entity and its customer.
Sections 4.3.1
through 4.3.5.5 further discuss each of the five criteria required to
establish a contract with a customer.
4.3.1 Each Party Has Approved the Contract and Is Committed to Perform
For a contract to be accounted for under the revenue standard, the parties must
approve the contract and be committed to perform their respective
obligations.
A party may approve a contract in writing, orally, or through its customary
business practices. If both parties to a contract do not approve the contract,
it is unclear whether that contract creates enforceable rights and obligations
that bind the parties to perform their respective obligations. Paragraph BC35 of
ASU
2014-09 states, in part, that “the form of the contract does
not, in and of itself, determine whether the parties have approved the
contract.” Entities will need to evaluate all relevant facts and circumstances,
including their customary business practices, to determine whether both parties
have approved the contract.
As noted above, each party must also be committed to perform under the contract.
However, paragraph BC36 of ASU 2014-09 clarifies that each party will not always
need to be committed to performing all of its obligations to meet this
requirement. To illustrate, paragraph BC36 cites an example in which a customer
is contractually required to make a minimum monthly purchase of goods provided
by an entity. Despite the requirement, the customer does not always make the
minimum monthly purchase and historically has not been forced by the entity to
comply. In this example, the contractual requirement could still be met because
the parties have demonstrated that they are “substantially committed to the
contract.”1
ASC 606 does not apply to a wholly unperformed contract when each party has the
unilateral ability to terminate the contract without compensating the other
party. Accordingly, entities will need to carefully consider termination clauses
when evaluating whether each party is committed to the contract. For further
discussion, see Sections
4.4 and 4.8.
Sometimes, after a contract between two parties expires and before they execute
a new contract, both parties will continue to perform under the terms of the
expired contract, thereby indicating that even in the absence of a formally
executed contract, a contract may exist since both parties remain committed to
perform. Entities should use caution in making this assessment and ensure that a
careful evaluation of the specific facts and circumstances is performed to
determine whether an enforceable contract exists.
Example 4-1
On May 1, 20X7, Entity A entered into a
6-month contract with Customer B to provide services in
exchange for $100 per month. The contract did not
include any automatic extension provisions and expired
on October 31, 20X7. After the contract expired, the
parties commenced negotiations for a new contract, under
which A would provide the same services to B. The price
that A would charge B for the services was the main
point of negotiations between the parties. The two
parties completed negotiations and executed a new,
12-month contract on January 31, 20X8, that is
retroactive to November 1, 20X7. The new contract
requires B to pay $150 per month.
Entity A’s customary business practice
is to continue providing services to a customer while
negotiations for a new contract occur after the
expiration of an existing contract. Accordingly, during
the interim period (i.e., November 1, 20X7, through
January 31, 20X8) in which contract negotiations
occurred, A continued to provide services and B
continued to pay $100 per month. The $100 monthly fee
paid by B during the interim period is
nonrefundable.
Aside from the increased fee and longer
contract duration, all other contract attributes are the
same between the expired contract and the new contract,
and no disputes occurred during the interim period.
To determine whether a contract existed
during the interim period while a new contract was being
negotiated, A should evaluate whether each party had
enforceable rights and obligations during the interim
period. ASC 606-10-25-2 states, in part, that
“[e]nforceability of the rights and obligations in a
contract is a matter of law.” This assessment requires
judgment, especially in the absence of automatic renewal
provisions in the original contract. Accordingly, A
should analyze the parties’ rights and obligations to
determine the legal enforceability of the contract in
the relevant jurisdiction.
Entity A should also consider whether
the negotiations and execution of the new contract are
within the scope of the revenue standard’s guidance on
contract modifications. ASC 606-10-25-11 notes that a
contract modification may exist when a change in the
scope or price of the contract has not yet been
resolved. When a change in scope has been approved by
the parties, an entity is required under ASC
606-10-25-11 to “estimate the change to the transaction
price arising from the modification in accordance with
paragraphs 606-10-32-5 through 32-9 on estimating
variable consideration and paragraphs 606-10-32-11
through 32-13 on constraining estimates of variable
consideration.”
In the situation described above, it
appears that a contract existed during the interim
period because A continued to provide services to B in a
manner consistent with A’s customary business practice.
Further, in exchange for the services and in accordance
with the terms of the original contract, B continued to
pay A $100 per month, which is nonrefundable. On the
basis of these facts, it appears that both parties had
enforceable rights and obligations during the interim
period and that it would therefore be inappropriate to
delay revenue recognition until the new agreement was
signed on January 31, 20X8. Upon execution of the new
agreement, A should analyze the revenue standard’s
guidance on contract modifications to determine the
appropriate accounting.
Certain arrangements provide a customer with free goods or
services at the onset of the arrangement. The period over which such free goods
or services are provided is sometimes referred to as a trial period. 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. In these
circumstances, an entity must carefully evaluate whether all of the criteria in
ASC 606-10-25-1 are met, particularly whether the parties have each approved the
contract and are committed to perform their respective obligations. 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 offer 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 of the promised goods or services is transferred to
the customer. 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.
Example 4-2
Entity A has a marketing program that offers a
three-month “trial period” during which a customer can
obtain free issues of a monthly magazine. If the
customer does not cancel at the end of three months, it
will be charged the annual subscription fee of $144, or
$12 per month (inclusive of the trial period).
Because the customer in the arrangement is not committed
to perform, no contract exists during the free trial
period unless and until the customer “accepts” the
offer. Once the customer accepts the offer and has the
intent and ability to pay $144 for an annual
subscription to the monthly magazine (i.e.,
collectibility is probable), a valid contract exists and
the rest of the revenue recognition model can be
applied.
Questions have been raised about whether
any of the transaction price should be allocated to the
free goods or services once the existence of a contract
is established. For further discussion, see Section
8.9.3.
4.3.2 The Entity Can Identify Each Party’s Rights
An entity must be able to identify each party’s rights related to the promised
goods or services in the contract. Without knowing each party’s rights, an
entity would not be able to identify its performance obligations and determine
when control of the goods and services are transferred to the customer (i.e.,
when to recognize revenue). Parties to the contract have valid rights and
obligations when both (1) the entity has a right to receive consideration from
the customer in exchange for the transfer of goods or services and (2) the
customer has a right to require the entity to perform (i.e., transfer goods or
services).
4.3.3 The Entity Can Identify the Payment Terms
A contract must include payment terms for each of the promised goods and
services in an arrangement for an entity to determine the transaction price. The
payment terms do not need to be fixed, but the contract must contain enough
information to allow an entity to reasonably estimate the consideration to which
it will be entitled for transferring the goods and services to the customer. See
Section 6.1 for more
information on determining the transaction price and Section 6.3 for information about variable
consideration.
4.3.4 The Contract Has Commercial Substance
For a contract to have commercial substance, the risk, timing, or amount of an
entity’s future cash flows must be expected to change as a result of the
contract. That is, the transaction(s) between the parties should have economic
consequences. Most business transactions will involve an entity’s sale of goods
or services in exchange for cash; therefore, an entity’s future cash flows are
expected to change as a result of the arrangement. Arrangements that include
noncash consideration may require an entity to perform further analysis in
evaluating whether the contract has commercial substance. The commercial
substance requirement in the revenue standard is consistent with the principles
of ASC 845 for evaluating whether a nonmonetary exchange has commercial
substance; however, the criterion needs to be evaluated for all contracts (not
just those with nonmonetary consideration).
Connecting the Dots
Exchange transactions involving nonmonetary consideration often require careful
analysis to determine the substance of the arrangement. For example, a
round-trip transaction is an arrangement in which an entity sells goods
or services to a customer that in turn sells the same or similar goods
or services back to the entity. The substance of the transaction is
critical to determining the appropriate accounting. The individual
transactions in a round-trip transaction are often entered into in
contemplation of one another and may lack commercial substance. That is,
the entity’s future cash flows are not expected to change as a result of
the arrangement. If such a transaction is not accounted for properly, it
can lead to artificial inflation of the revenues of each party to the
contract.2
As noted above, the standard’s revenue model cannot be applied (and no revenue
can be recognized) until a contract exists for accounting purposes. However,
entities sometimes commence activities under a specific anticipated contract
with a customer (e.g., construction of an asset) before the parties have agreed
to all of the contract terms or before the criteria for identifying the contract
in ASC 606-10-25-1 have been satisfied. No revenue can be recognized during the
precontract phase since the contract existence criteria have not been met. See
Section 8.9.2
for a discussion of how to account for these types of arrangements once the
contract existence criteria are met. In addition, see Section 13.3 for further discussion of
capitalization of certain costs that an entity incurred to fulfill a specific
anticipated contract with a customer.
4.3.5 Collectibility Is Probable
ASC 606-10-25-1(e) requires an entity to evaluate whether it is probable3 that substantially all of the consideration to which the entity will be
entitled for goods or services transferred to the customer will be collected.
This analysis is performed at contract inception and is not revisited unless
there is a significant change in facts and circumstances (see Section 4.5). Such an
evaluation should take into account only the customer’s ability and intention to
pay the consideration when it is due. All facts and circumstances should be
considered in the evaluation of a customer’s ability and intention to pay
amounts due. Such facts and circumstances could include past experience with the
customer, class of customer, and expectations about the customer’s financial
stability, as well as other factors.
4.3.5.1 Price Concessions
As part of determining whether a valid and genuine contract exists, an entity is
required to evaluate whether it is probable that the entity will collect
substantially all of the consideration to which it is entitled under the
contract. However, the consideration to which an entity is ultimately
entitled may be less than the price stated in the contract because the
customer is offered a price concession. Price concessions are a form of
variable consideration (see Section 6.3) and need to be analyzed when the transaction price
is being determined (as part of step 3 of the standard’s revenue model).
However, as part of step 1, an entity would evaluate whether it is probable
that the entity will collect the consideration to which it will be entitled
for providing goods or services to a customer after considering any price
concessions. This evaluation requires aspects of step 3 to be performed in
conjunction with step 1. Differentiating between credit risk (i.e., the risk
of collecting less consideration than the amount the entity legitimately
expected to collect from the customer) and price concessions (i.e., entering
into a contract with a customer with the expectation of accepting less than
the contractual amount of consideration in exchange for goods or services)
may be difficult. Entities will need to use significant judgment on the
basis of all relevant facts and circumstances in determining whether they
have provided an implicit price concession (variable consideration to be
estimated in step 3, as discussed in Chapter 6) or have accepted a
customer’s credit risk (to be evaluated in step 1 herein). This is
particularly true of entities in highly regulated industries, such as health
care and consumer energy, which may be required by law to provide certain
goods and services to their customers regardless of the customers’ ability
to pay.
The following indicators may suggest that rather than accepting the
customer’s credit risk, the entity has offered a price concession (which
would be evaluated as variable consideration):
-
The entity has a customary business practice of providing discounts or accepting as payment less than the contractually stated price regardless of whether such a practice is explicitly stated at contract inception or specifically communicated or offered to the customer.
-
The customer has a valid expectation that the entity will accept less than that contractually stated price. This could be due to customary business practices, published policies, or specific statements made by the entity.
-
The entity transfers the goods or services to the customer, and continues to do so, even when historical experience indicates that it is not probable that the entity will collect the billed amount.
-
Other facts and circumstances indicate that the customer intends to pay an amount that is less than the contractually stated price, and the entity nonetheless enters into a contract with the customer.
-
The entity has a customary business practice of not performing a credit assessment before transferring goods or services to the customer (e.g., the entity is required by law or regulation to provide emergency medical services before assessing the customer’s ability or intention to pay).
Examples 2 and 3 in ASC 606 illustrate how an entity would
evaluate implicit price concessions when assessing whether the
collectibility criterion is met.
ASC 606-10
Example 2 — Consideration Is Not the
Stated Price — Implicit Price Concession
55-99 An entity sells 1,000
units of a prescription drug to a customer for
promised consideration of $1 million. This is the
entity’s first sale to a customer in a new region,
which is experiencing significant economic
difficulty. Thus, the entity expects that it will
not be able to collect from the customer the full
amount of the promised consideration. Despite the
possibility of not collecting the full amount, the
entity expects the region’s economy to recover over
the next two to three years and determines that a
relationship with the customer could help it to
forge relationships with other potential customers
in the region.
55-100 When assessing whether
the criterion in paragraph 606-10-25-1(e) is met,
the entity also considers paragraphs 606-10-32-2 and
606-10-32-7(b). Based on the assessment of the facts
and circumstances, the entity determines that it
expects to provide a price concession and accept a
lower amount of consideration from the customer.
Accordingly, the entity concludes that the
transaction price is not $1 million and, therefore,
the promised consideration is variable. The entity
estimates the variable consideration and determines
that it expects to be entitled to $400,000.
55-101 The entity considers
the customer’s ability and intention to pay the
consideration and concludes that even though the
region is experiencing economic difficulty it is
probable that it will collect $400,000 from the
customer. Consequently, the entity concludes that
the criterion in paragraph 606-10-25-1(e) is met
based on an estimate of variable consideration of
$400,000. In addition, based on an evaluation of the
contract terms and other facts and circumstances,
the entity concludes that the other criteria in
paragraph 606-10-25-1 are also met. Consequently,
the entity accounts for the contract with the
customer in accordance with the guidance in this
Topic.
Example 3 — Implicit Price
Concession
55-102 An entity, a hospital,
provides medical services to an uninsured patient in
the emergency room. The entity has not previously
provided medical services to this patient but is
required by law to provide medical services to all
emergency room patients. Because of the patient’s
condition upon arrival at the hospital, the entity
provides the services immediately and, therefore,
before the entity can determine whether the patient
is committed to perform its obligations under the
contract in exchange for the medical services
provided. Consequently, the contract does not meet
the criteria in paragraph 606-10-25-1, and in
accordance with paragraph 606-10-25-6, the entity
will continue to assess its conclusion based on
updated facts and circumstances.
55-103 After providing
services, the entity obtains additional information
about the patient including a review of the services
provided, standard rates for such services, and the
patient’s ability and intention to pay the entity
for the services provided. During the review, the
entity notes its standard rate for the services
provided in the emergency room is $10,000. The
entity also reviews the patient’s information and to
be consistent with its policies designates the
patient to a customer class based on the entity’s
assessment of the patient’s ability and intention to
pay. The entity determines that the services
provided are not charity care based on the entity’s
internal policy and the patient’s income level. In
addition, the patient does not qualify for
governmental subsidies
55-104 Before reassessing
whether the criteria in paragraph 606-10-25-1 have
been met, the entity considers paragraphs
606-10-32-2 and 606-10-32-7(b). Although the
standard rate for the services is $10,000 (which may
be the amount invoiced to the patient), the entity
expects to accept a lower amount of consideration in
exchange for the services. Accordingly, the entity
concludes that the transaction price is not $10,000
and, therefore, the promised consideration is
variable. The entity reviews its historical cash
collections from this customer class and other
relevant information about the patient. The entity
estimates the variable consideration and determines
that it expects to be entitled to $1,000.
55-105 In accordance with
paragraph 606-10-25-1(e), the entity evaluates the
patient’s ability and intention to pay (that is, the
credit risk of the patient). On the basis of its
collection history from patients in this customer
class, the entity concludes it is probable that the
entity will collect $1,000 (which is the estimate of
variable consideration). In addition, on the basis
of an assessment of the contract terms and other
facts and circumstances, the entity concludes that
the other criteria in paragraph 606-10-25-1 also are
met. Consequently, the entity accounts for the
contract with the patient in accordance with the
guidance in this Topic.
4.3.5.2 Evaluating Credit Risk
The existence of the collectibility requirement does not eliminate credit risk
in a contract with a customer. Not all differences between the contractually
stated price and the amount ultimately collected by the entity will be due
to explicit or implied concessions. Entities may (1) assume collection risk
and (2) incur bad debt.
The following indicators may suggest that rather than
granting a price concession, the entity has incurred a bad debt:
-
The entity has the ability and intent to stop transferring goods or services to the customer and has no obligation to transfer additional goods or services in the event of nonpayment for goods or services already transferred to the customer (e.g., in the event of nonpayment by a utility customer, the utility provider ceases to provide further services to the customer).
-
The entity believes that it will collect the consideration due and intends to enforce the contract price, but it knowingly accepts the risk of default by the customer. For example, the entity is able to conclude that the criterion in ASC 606-10-25-1(e) is met, but it is aware of the customer’s increased risk of bankruptcy and chooses to provide the contractually agreed-upon goods or services to the customer despite this fact.
-
The customer’s financial condition has significantly deteriorated since contract inception.
-
The entity has a pool of homogeneous customers that have similar credit profiles. Although it is expected that substantially all of the customers will be able to pay amounts when due, it is also expected that a small (not currently identifiable) number of customers may not be able to pay amounts when due.
The criterion in ASC 606-10-25-1(e) acts as a collectibility
threshold and requires an entity to assess its customer’s credit risk in
determining whether a valid contract exists. The term “probable” is defined
in the ASC 606 glossary as the “future event or events are likely to
occur.”
4.3.5.3 Collectibility Assessment — Other Considerations
Paragraph BC46 of ASU 2014-09 notes that the FASB and IASB intended the collectibility assessment
to be made only for consideration to which an entity would be entitled in exchange for the goods or
services that will be transferred to the customer. That is, if the customer fails to pay for goods or services
transferred and the entity reacts by not transferring any additional goods or services to the customer,
only the consideration associated with the goods or services already transferred to the customer should
be assessed for collectibility.
In ASU
2016-12,4 the FASB (1) further clarified the objective of the collectibility
threshold, (2) provided implementation guidance on how to evaluate
circumstances in which credit risk is mitigated, and (3) added guidance on
when revenue should be recognized if a contract fails to meet the
requirements in ASC 606-10-25-1 (see Section 4.6).
ASU 2016-12 added the following implementation guidance to assist in the
analysis of the collectibility threshold:
ASC 606-10
55-3A Paragraph
606-10-25-1(e) requires an entity to assess whether
it 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.
The assessment, which is part of identifying whether
there is a contract with a customer, is based on
whether the customer has the ability and intention
to pay the consideration to which the entity will be
entitled in exchange for the goods or services that
will be transferred to the customer. The objective
of this assessment is to evaluate whether there is a
substantive transaction between the entity and the
customer, which is a necessary condition for the
contract to be accounted for under the revenue model
in this Topic.
55-3B The collectibility assessment in paragraph 606-10-25-1(e) is partly a forward-looking assessment.
It requires an entity to use judgment and consider all of the facts and circumstances, including the entity’s
customary business practices and its knowledge of the customer, in determining whether it 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 the entity expects to transfer to the customer. The assessment is not necessarily based on the
customer’s ability and intention to pay the entire amount of promised consideration for the entire duration of
the contract.
55-3C When assessing whether a contract meets the criterion in paragraph 606-10-25-1(e), an entity should
determine whether the contractual terms and its customary business practices indicate that the entity’s
exposure to credit risk is less than the entire consideration promised in the contract because the entity has
the ability to mitigate its credit risk. Examples of contractual terms or customary business practices that might
mitigate the entity’s credit risk include the following:
- Payment terms — In some contracts, payment terms limit an entity’s exposure to credit risk. For example, a customer may be required to pay a portion of the consideration promised in the contract before the entity transfers promised goods or services to the customer. In those cases, any consideration that will be received before the entity transfers promised goods or services to the customer would not be subject to credit risk.
- The ability to stop transferring promised goods or services — An entity may limit its exposure to credit risk if it has the right to stop transferring additional goods or services to a customer in the event that the customer fails to pay consideration when it is due. In those cases, an entity should assess only the collectibility of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer on the basis of the entity’s rights and customary business practices. Therefore, if the customer fails to perform as promised and, consequently, the entity would respond to the customer’s failure to perform by not transferring additional goods or services to the customer, the entity would not consider the likelihood of payment for the promised goods or services that will not be transferred under the contract.
An entity’s ability to repossess an asset transferred to a customer should not be considered for the purpose of
assessing the entity’s ability to mitigate its exposure to credit risk.
The objective of the collectibility assessment is to determine whether there is a substantive transaction
between the entity and the customer. There is deemed to be a substantive transaction between the
two parties if it is probable that the entity will collect substantially all of the consideration attributed to
goods or services that will be transferred to the customer. If the entity has an ability, and an established
business practice, to mitigate collection risk by not transferring additional goods or services to a
nonpaying customer, the entity would assess collectibility of only the consideration associated with the
goods or services that will be transferred to the customer. Once the criteria in ASC 606-10-25-1 are met,
the remainder of the guidance in ASC 606 should be applied to all of the promised goods or services
in the contract. That is, an entity will assume that it will transfer all goods or services promised under
the contract with its customer for purposes of identifying performance obligations, determining and
allocating the transaction price, and recognizing revenue.
The following examples in ASC 606, which were added by ASU 2016-12, further illustrate the collectibility
assessment:
ASC 606-10
Example 1 — Collectibility of the Consideration
Case A — Collectibility Is Not Probable
55-95 An entity, a real
estate developer, enters into a contract with a
customer for the sale of a building for $1 million.
The customer intends to open a restaurant in the
building. The building is located in an area where
new restaurants face high levels of competition, and
the customer has little experience in the restaurant
industry.
55-96 The customer pays a
nonrefundable deposit of $50,000 at inception of the
contract and enters into a long-term financing
agreement with the entity for the remaining 95
percent of the promised consideration. The financing
arrangement is provided on a nonrecourse basis,
which means that if the customer defaults, the
entity can repossess the building but cannot seek
further compensation from the customer, even if the
collateral does not cover the full value of the
amount owed.
55-97 The entity concludes
that not all of the criteria in paragraph
606-10-25-1 are met. The entity concludes that the
criterion in paragraph 606-10-25-1(e) is not met
because it is not probable that the entity will
collect substantially all of the consideration to
which it is entitled in exchange for the transfer of
the building. In reaching this conclusion, the
entity observes that the customer’s ability and
intention to pay may be in doubt because of the
following factors:
- The customer intends to repay the loan (which has a significant balance) primarily from income derived from its restaurant business (which is a business facing significant risks because of high competition in the industry and the customer’s limited experience).
- The customer lacks other income or assets that could be used to repay the loan.
- The customer’s liability under the loan is limited because the loan is nonrecourse.
55-98 The entity continues
to assess the contract in accordance with paragraph
606-10-25-6 to determine whether the criteria in
paragraph 606-10-25-1 are subsequently met or
whether the events in paragraph 606-10-25-7 have
occurred.
Case B — Credit Risk Is Mitigated
55-98A An entity, a service provider, enters into a three-year service contract with a new customer of low
credit quality at the beginning of a calendar month.
55-98B The transaction price
of the contract is $720, and $20 is due at the end
of each month. The standalone selling price of the
monthly service is $20. Both parties are subject to
termination penalties if the contract is
cancelled.
55-98C The entity’s history with this class of customer indicates that while the entity cannot conclude it is
probable the customer will pay the transaction price of $720, the customer is expected to make the payments
required under the contract for at least 9 months. If, during the contract term, the customer stops making the
required payments, the entity’s customary business practice is to limit its credit risk by not transferring further
services to the customer and to pursue collection for the unpaid services.
55-98D In assessing whether the contract meets the criteria in paragraph 606-10-25-1, the entity assesses
whether it is probable that the entity will collect substantially all of the consideration to which it will be entitled
in exchange for the services that will be transferred to the customer. This includes assessing the entity’s history
with this class of customer in accordance with paragraph 606-10-55-3B and its business practice of stopping
service in response to customer nonpayment in accordance with paragraph 606-10-55-3C. Consequently,
as part of this analysis, the entity does not consider the likelihood of payment for services that would not be
provided in the event of the customer’s nonpayment because the entity is not exposed to credit risk for those
services.
55-98E It is not probable that the entity will collect the entire transaction price ($720) because of the
customer’s low credit rating. However, the entity’s exposure to credit risk is mitigated because the entity
has the ability and intention (as evidenced by its customary business practice) to stop providing services if
the customer does not pay the promised consideration for services provided when it is due. Therefore, the
entity concludes that the contract meets the criterion in paragraph 606-10-25-1(e) because it is probable that
the customer will pay substantially all of the consideration to which the entity is entitled for the services the
entity will transfer to the customer (that is, for the services the entity will provide for as long as the customer
continues to pay for the services provided). Consequently, assuming the criteria in paragraph 606-10-25-1(a)
through (d) are met, the entity would apply the remaining guidance in this Topic to recognize revenue and
only reassess the criteria in paragraph 606-10-25-1 if there is an indication of a significant change in facts or
circumstances such as the customer not making its required payments.
Case C — Credit Risk Is Not Mitigated
55-98F The same facts as in Case B apply to Case C, except that the entity’s history with this class of customer
indicates that there is a risk that the customer will not pay substantially all of the consideration for services
received from the entity, including the risk that the entity will never receive any payment for any services
provided.
55-98G In assessing whether the contract with the customer meets the criteria in paragraph 606-10-25-1, the
entity assesses whether it is probable that it 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. This includes assessing
the entity’s history with this class of customer and its business practice of stopping service in response to the
customer’s nonpayment in accordance with paragraph 606-10-55-3C.
55-98H At contract inception, the entity concludes that the criterion in paragraph 606-10-25-1(e) is not
met because it is not probable that the customer will pay substantially all of the consideration to which the
entity will be entitled under the contract for the services that will be transferred to the customer. The entity
concludes that not only is there a risk that the customer will not pay for services received from the entity,
but also there is a risk that the entity will never receive any payment for any services provided. Subsequently,
when the customer initially pays for one month of service, the entity accounts for the consideration received
in accordance with paragraphs 606-10-25-7 through 25-8. The entity concludes that none of the events in
paragraph 606-10-25-7 have occurred because the contract has not been terminated, the entity has not
received substantially all of the consideration promised in the contract, and the entity is continuing to provide
services to the customer.
55-98I Assume that the customer has made timely payments for several months. In accordance with
paragraph 606-10-25-6, the entity assesses the contract to determine whether the criteria in paragraph
606-10-25-1 are subsequently met. In making that evaluation, the entity considers, among other things, its
experience with this specific customer. On the basis of the customer’s performance under the contract,
the entity concludes that the criteria in 606-10-25-1 have been met, including the collectibility criterion in
paragraph 606-10-25-1(e). Once the criteria in paragraph 606-10-25-1 are met, the entity applies the remaining
guidance in this Topic to recognize revenue.
Case D — Advance Payment
55-98J An entity, a health club, enters into a one-year membership with a customer of low credit quality. The
transaction price of the contract is $120, and $10 is due at the beginning of each month. The standalone selling
price of the monthly service is $10.
55-98K On the basis of the customer’s credit history and in accordance with the entity’s customary business
practice, the customer is required to pay each month before the entity provides the customer with access
to the health club. In response to nonpayment, the entity’s customary business practice is to stop providing
service to the customer upon nonpayment. The entity does not have exposure to credit risk because all
payments are made in advance and the entity does not provide services unless the advance payment has been
received.
55-98L The contract meets the criterion in paragraph 606-10-25-1(e) because it is probable that the entity will
collect the consideration to which it will be entitled in exchange for the services that will be transferred to the
customer (that is, one month of payment in advance for each month of service).
Connecting the Dots
As noted in ASC 606-10-55-3B, the collectibility assessment is partly a forward-looking
assessment that requires an entity to evaluate a customer’s intention and ability to pay
promised consideration when due. An entity may need to consider both the current and future
financial condition of a customer when making this assessment. For example, in a situation
involving a license of intellectual property (IP) for which consideration due is in the form of sales- and
usage-based royalties, the entity may determine that the customer does not currently have
the financial capacity to pay all of the expected sales- and usage-based royalties at contract
inception; however, once the customer generates cash flows from the usage of the IP, it is
expected that the customer will have the financial capacity to make the required payments
when due. When performing its analysis, the entity would need to consider the customer’s other
payment obligations in addition to the royalty payments. That is, the entity could not solely rely
on the cash generated from the use of the IP to conclude that it is probable that the customer
will pay amounts when due. Rather, the entity would need to consider all relevant facts and
circumstances when evaluating whether the customer has the intention and ability to pay
amounts when due.
An entity may evaluate the collectibility criterion by analyzing its collection
history with the same customer or similar types of customers (e.g., similar
industry, size, geographic region). It should also consider any specifically
identified events or circumstances related to the customer (e.g., the
customer’s significantly deteriorating financial position or a default on
the customer’s loan covenant).
4.3.5.4 Whether to Assess Collectibility at the Portfolio Level or the Individual Contract Level
Collectibility should be assessed at the individual contract
level. For each individual contract, if it is considered probable that the
entity will collect the consideration to which it will be entitled, the
general requirements of ASC 606 should be applied. However, if an entity has
a portfolio of contracts that are all similar, particularly in terms of
collectibility, and historical evidence suggests that a proportion of the
consideration due from contracts in the portfolio will not be collected, the
entity may evaluate that portfolio to assess whether an individual contract
is collectible.
For example, if the entity has a portfolio of 100 similar
contracts and historical experience has indicated that the entity will only
collect amounts due on 98 of those contracts, this does not suggest that
there are two contracts that should not be accounted for under the general
requirements of ASC 606. Rather, the entity should consider collectibility
in the context of the individual contracts. If there is a 98 percent
probability that amounts due under each contract will be collected, each
contract will meet the criterion in ASC 606-10-25-1(e).
However, consideration should be given to any evidence that
collection of amounts due under any specific contract is not probable. That
is, an entity should not ignore information that suggests that there is a
specific (i.e., identified) contract within a portfolio for which
collectibility is not considered probable. If that is considered to be the
case, the specific contract should be excluded from the portfolio and
evaluated on an individual basis; if the contract does not meet the
collectibility criterion, it should be accounted for in accordance with ASC
606-10-25-7.
When a contract meets the criteria in ASC 606-10-25-1,
including collectibility, the entity should recognize revenue as it
satisfies its performance obligations under the contract on the basis of the
amount of consideration to which it expects to be entitled (rather than the
amount that it expects to collect). Therefore, for example, if the entity
expects to be entitled to consideration of $500 from each of its contracts,
it should recognize that $500 as revenue notwithstanding its historical
experience of a 2 percent level of default.
The entity should then evaluate any associated receivable or
contract asset for impairment and present any difference between the
measurement of the contract asset or receivable and the corresponding amount
of revenue as an expense in accordance with ASC 310 (or ASC 326, once
adopted5).
In the circumstances under consideration, this will result
in recognized revenue of $50,000 ($500 × 100) and, under the assumption that
the estimated 98 percent collection rate proves accurate, impairment (bad
debts) of $1,000 ($50,000 × 2%).
The above issue is addressed in Q&A 9 (compiled from
previously issued TRG Agenda Papers 13 and 25) 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.
4.3.5.5 Assessing Collectibility in Real Estate Sales
As noted in Section 4.2, the contract existence
criteria need to be met before a sale can be recorded in accordance with ASC
606 or ASC 610-20 (see Chapter 17). Collectibility of substantially all of the
consideration to which the entity expects to be entitled affects the
evaluation of whether a contract exists for accounting purposes. Upon a
determination that it is not probable that the entity will collect
substantially all of the consideration to which it will be entitled (i.e., a
determination that the collectibility threshold is not met), no contract is
deemed to exist and no sale can be recorded.
ASC 606 contains an example of a real estate sale (see
Section
4.3.5.3) in which the buyer pays a 5 percent nonrefundable
deposit for the property and the seller finances the remaining purchase
price. The buyer’s ability to pay the outstanding purchase price is
contingent solely on its ability to generate profits from the use of the
real estate. In the original example in ASU 2014-09, on the basis of the
facts and circumstances, the seller concludes that the collectibility
threshold in ASC 606-10-25-1 is not met because the buyer’s intent and
ability to pay the outstanding amount are not probable. In the example (as
modified by ASU 2016-12), the contract existence criteria are deemed not to
have been met. Further, control of the building is not transferred to the
buyer. Entities will need to use considerable judgment when evaluating the
criteria for determining (1) whether a contract exists and (2) whether and,
if so, when control is transferred for accounting purposes.
Footnotes
1
Quoted from paragraph BC36 of ASU 2014-09.
2
ASC 845 addresses purchases and sales of
inventory with the same counterparty and the circumstances in
which nonmonetary exchanges of inventory in the same line of
business are recognized at the carrying amount of the inventory
transferred.
3
As noted in Appendix A, the collectibility
threshold under U.S. GAAP differs from that under IFRS Accounting
Standards.
4
The IASB did not amend IFRS 15 to clarify the
Board’s intent with respect to collectibility. However, the FASB and
IASB do not expect significant differences in application. See Appendix A for a
summary of differences between U.S. GAAP and IFRS Accounting
Standards on revenue-related topics.
5
See ASC 326-10-65-1 through 65-5 for effective date
and transition guidance related to ASC 326.
4.4 Contract Term
Determining the term of the contract is an important step in the
revenue recognition process since the contract term could affect the identification
of promises under the contract as well as the transaction price. ASC 606 provides
guidance on determining the contract duration, including the effect of termination
clauses and contract renewals. The contract term is determined on the basis of the
period over which the parties to the contract have present enforceable rights and
obligations. The contract term would not include optional renewal periods or the
delivery of optional goods or services. However, the existence of purchase options
in a contract with a customer could give rise to a material right. For further
discussion of material rights, see Chapter 11.
ASC 606-10
25-3 Some contracts with customers
may have no fixed duration and can be terminated or modified
by either party at any time. Other contracts may
automatically renew on a periodic basis that is specified in
the contract. An entity shall apply the guidance in this
Topic to the duration of the contract (that is, the
contractual period) in which the parties to the contract
have present enforceable rights and obligations. In
evaluating the criterion in paragraph 606-10-25-1(e), an
entity shall assess the collectibility of the consideration
promised in a contract for the goods or services that will
be transferred to the customer rather than assessing the
collectibility of the consideration promised in the contract
for all of the promised goods or services (see paragraphs
606-10-55-3A through 55-3C). However, if an entity
determines that all of the criteria in paragraph 606-10-25-1
are met, the remainder of the guidance in this Topic shall
be applied to all of the promised goods or services in the
contract.
4.4.1 Termination Clauses and Penalties
When contracts have termination clauses and penalties, the
duration of a contract is predicated on the contract’s enforceable rights and
obligations. Accordingly, regardless of whether one or both parties have the
right to terminate the contract, an entity would need to evaluate the nature of
the termination provisions, including whether any termination penalty is
substantive. For example, an entity would assess factors such as (1) whether the
terminating party is required to pay compensation, (2) the amount of such
compensation, and (3) the reason for the compensation (i.e., whether the
compensation is in addition to amounts due for goods and services already
delivered). Substantive termination penalties suggest that the parties’ rights
and obligations extend for the duration of the contract term.
A contract’s accounting term could be less than the contract’s stated term if a
termination penalty is not substantive. For example, a 12-month stated contract
term could, in effect, be a month-to-month contract if the contract could be
terminated each month and the termination penalty is not substantive. An entity
will need to carefully consider the effect of nonsubstantive termination
penalties on the timing and amount of revenue to be recognized.
Because the assessment of termination clauses and penalties focuses on legally
enforceable rights and obligations, certain economic factors such as economic
compulsion should not be considered. Rather, the assessment depends on whether
the terminating party is required to compensate the other party. For example, an
entity may have a long-term agreement with a customer for a unique good or
service that is critical to the customer’s operations. If the agreement allows
the customer to terminate it at any point and there are no contractual penalties
if the customer does not purchase any goods or services, a contract for the
purchase of additional goods or services does not exist even if it is highly
likely that the customer will not terminate the agreement.
The economic considerations related to forgoing a discount on optional purchases
would not be viewed as a substantive penalty suggesting that the parties’ rights
and obligations extend for a longer contract term. The discount on optional
purchases should be assessed for the existence of a material right instead.
Therefore, while an “economic” penalty may be incurred by a customer that elects
not to purchase future but optional goods at a discount, that economic penalty
would not rise to the level of a substantive penalty that lengthens the contract
term.
The determination of whether a termination penalty is
substantive requires judgment and would be evaluated both quantitatively and
qualitatively. For example, data about the frequency of contract terminations
may be useful in such a determination (i.e., a high frequency of payments made
to terminate contracts may suggest that the termination penalty is not
substantive). Determining the enforceable term of a contract that includes
termination provisions (e.g., cancellation fees) may be challenging,
particularly when only the customer has a right to terminate the contract. When
a customer has a right to terminate the contract without penalty, such
termination provision is substantively the same as a renewal provision, as
supported by paragraph BC391 of ASU 2014-09 (as well as by
Implementation Q&A 8). The example below illustrates
how an entity should consider a fixed-term contract that allows a customer to
terminate the contract without penalty after a certain period.
Example 4-3
Company A has a contract to deliver various goods and
services to Customer B. The contract includes pricing
for the goods or services for a two-year period but
allows B to cancel the contract at any time after six
months without paying a penalty. In this scenario, we
generally believe that the enforceable rights and
obligations of the contract are for six months;
therefore, the contract term is six months. Since the
pricing terms of the arrangement are fixed for two
years, A would also need to evaluate whether a material
right exists for purchases beyond six months.
Connecting the Dots
As discussed above, 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 certain economic
factors into account (e.g., economic compulsion). Accordingly, the
economic considerations related to forgoing a discount on optional
purchases would not be viewed as a substantive penalty suggesting that
the parties’ rights and obligations extend for a longer contract term.
The discount on optional purchases should be assessed for the existence
of a material right instead. This approach is consistent with the
discussion in Implementation Q&A 8, which states that “an
entity would still evaluate whether the termination right (which is akin
to an option for additional goods or services) gives rise to a material
right.” Therefore, while an “economic” penalty may be incurred by a
customer that elects not to purchase future but optional goods at a
discount, that economic penalty would not rise to the level of a
substantive penalty that lengthens the contract term.
The above issue is addressed in Implementation Q&As 7 and 8 (compiled from previously
issued TRG Agenda Papers 10, 11, 48, and 49). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
4.4.1.1 Termination Clauses in License Arrangements
As noted in Section 4.4.1, an entity needs to
evaluate the nature of termination provisions, including whether any
penalties are substantive (i.e., whether the transfer of any consideration,
including noncash consideration, from the customer to the entity is
substantive). Careful consideration is required in the evaluation of whether
giving up license rights is a form of penalty.
Implementation Q&As 7 and 8 include the following
factors that an entity should consider when determining whether a
termination penalty is substantive:
-
Whether the terminating party is required to pay compensation.
-
The amount of such compensation.
-
The reason for the compensation (i.e., whether the compensation is in addition to amounts due for goods and services already delivered).
The two examples below illustrate how an entity would determine whether a
license arrangement includes a substantive termination penalty.
Example 4-4
License
Arrangement Includes a Substantive Termination
Penalty
Company A, a pharmaceutical company
in the United States, owns and maintains a portfolio
of patents related to an antibiotic that treats
life-threatening diseases. On February 23, 20X8, A
grants Customer B (a pharmaceutical company in
Ireland) the exclusive right to use its patented
drug formula to commercialize and supply the
antibiotic in Europe. The IP is fully developed, and
regulatory approval has been obtained; therefore, B
is able to commercialize the IP. Company A has
determined that the patented drug formula is
functional IP and that therefore, the license grants
B the right to use the IP. In exchange for the
exclusive right to use the patented drug formula, B
agrees to pay A the following amounts:
-
An up-front fee of $300 million.
-
Annual fixed fees of $50 million payable at the end of each year in which the contract is effective.
-
Sales-based royalties of 5 percent of B’s sales of the antibiotic in Europe (recognized in accordance with the sales-based royalty exception in ASC 606-10-55-65).
The contract states that B has the
exclusive right to use the patented drug formula
through the patent term, which expires in 10 years
(i.e., the contract ends when the patent expires).
Notwithstanding the stated contract term, the
contract states that B may terminate the contract
before the expiration of the patent by providing
three months’ notice to A. All amounts already paid
by B are nonrefundable in the event of early
termination. The contract does not include an
explicit termination penalty (i.e., B is not
required to pay additional cash consideration to A
upon early termination); however, upon early
termination, the right to the patented drug formula
in Europe would revert back to A, and A would be
able to relicense the patented drug formula to a
different pharmaceutical company in Europe. Unless B
terminates the contract before the end of the stated
term, A would not be able to benefit from licensing
the patented drug formula to a different
pharmaceutical company in Europe (i.e., A would
receive this benefit only upon B’s early termination
of the contract).
Under these facts, A’s contract to
license the exclusive right to use its patented drug
formula to B contains a substantive termination
penalty. As previously discussed in Section
4.4.1, it is important for an entity to
evaluate the nature of the termination provisions in
its contracts to determine the appropriate contract
term for applying ASC 606.
In this example, A’s contract to
license the patented drug formula to B does not
include an explicit termination penalty. That is, B
can terminate the contract before the end of the
stated term by providing three months’ notice
without paying additional cash consideration to A.
Although the contract does not require B to pay
additional cash consideration to A upon early
termination, in the event that B terminates the
contract early, the exclusive license rights related
to the patented drug formula would revert back to A.
Company A would then be able to license the patented
drug formula to another customer in Europe for the
remainder of the patent term, which it would not
have been able to do if B had not terminated the
contract. Therefore, although B is not paying
additional cash to A upon termination, B is
providing consideration (i.e., something of value)
to A, and A is receiving something of value from B
(i.e., the right to relicense the patented drug
formula), upon termination. Although Implementation
Q&As 7 and 8 focus on compensation as additional
cash that an entity’s customer would pay to the
entity upon termination, compensation may also
include noncash consideration that is of value to
the entity. The fact that B is forfeiting its rights
to the patented drug formula and providing A with
something of value (i.e., the ability to relicense
the patented drug formula to another customer in
Europe) from the forfeiture upon early termination
represents a substantive termination penalty in the
contract.
In accordance with Implementation Q&As 7 and 8,
the substantive termination penalty suggests that
the parties’ rights and obligations extend for the
duration of the stated contract term. That is, the
contract term is 10 years.
Example 4-5
License
Arrangement Does Not Include a Substantive
Termination Penalty
Company X, a multinational software
company, is a provider of financial software that
can be used to track a user’s investments. On June
29, 20X8, X grants Customer Y a nonexclusive license
to use X’s financial software to track Y’s personal
investments for five years. The contract also
includes postcontract customer support (PCS) for the
five-year term. Company X also grants other
customers a similar license to use its financial
software (i.e., the license is not exclusive).
In exchange for the right to use X’s
financial software, Y agrees to pay X the following
amounts:
-
An up-front fee of $500.
-
An annual fee of $50, payable at the beginning of each year.
The contract states that Y may
terminate the contract before the expiration of the
five-year stated term by providing three months’
notice to X. All amounts already paid by Y are
nonrefundable in the event of early termination. The
contract does not include an explicit termination
penalty (i.e., Y is not required to pay additional
cash consideration to X upon early termination).
Upon early termination, Y must forfeit its right to
use X’s financial software (and, accordingly,
terminate the PCS arrangement).
Under these facts, X’s contract to
license its financial software to Y does not contain
a substantive termination penalty. Like the contract
in Example 4-4, X’s contract with Y does
not contain an explicit termination penalty (i.e., Y
is not required to pay additional cash consideration
to X upon early termination). However, as
illustrated in that example, it is important to
consider whether the licensor is receiving other
forms of compensation (i.e., noncash consideration
that represents value to the licensor from the
licensee upon termination) to determine whether the
contract includes a substantive termination penalty.
Unlike the license in that example, X’s license to
use its financial software is not exclusive to one
customer. In addition to licensing the software to
Y, X licenses the software to other customers at the
same time. Although Y must forfeit its right to use
X’s financial software upon termination of the
contract, Y is not providing anything of value to X,
and X is not receiving anything of value from Y,
upon early termination. Therefore, the contract does
not contain a substantive termination penalty. In a
manner consistent with the discussion in Section
4.4.1, this would suggest that X and Y
have enforceable rights and obligations for only the
first three months of the contract because three
months is the amount of time that Y would need to
provide as notice to X to terminate the contract.
Refer to Section
4.4.1.1.2 for further considerations
related to the evaluation of termination provisions
in licensing arrangements.
4.4.1.1.1 Termination Clauses That Include Refunds for Prepayments in Software Arrangements
In some software arrangements, a customer prepays for a term-based
license and maintenance (i.e., PCS). If a customer prepays but can
terminate at any point and receive a pro rata refund for the portion of
the term-based license and PCS that is unused, the arrangement would be
accounted for as a daily contract. Undelivered performance obligations
associated with such arrangements would generally be excluded from
deferred revenue and instead be classified as some other liability
account (e.g., “refund liability” or “customer arrangements with
termination rights”). They would also generally be excluded from the
requirement in ASC 606 to disclose “remaining performance obligations,”
although an entity would not necessarily be precluded from specifying
amounts that are subject to termination in the notes to its financial
statements if it properly describes these GAAP amounts.
The examples below illustrate how an entity might determine the
contractual term in various software arrangements with termination
clauses.
Example 4-6
Term-Based Software License With Pro Rata
Refund Upon Termination
On March 1, 20X1, a vendor sells a one-year
term-based license with PCS for $1,200. The
vendor’s customer has the right to terminate the
arrangement at its convenience at the end of each
month. If the customer terminates, it is entitled
to a pro rata refund and loses the right to use
the software. The vendor concludes that it has two
distinct performance obligations: (1) the license
and (2) the PCS. If there was no termination
provision, the vendor would have allocated $800 to
the license and $400 to the PCS (on the basis of
their stand-alone selling prices). Further, it
would have recognized the license fee ($800) up
front and the PCS ratably over time ($33 per
month).
In this circumstance, the vendor should account
for the arrangement as 12 individual monthly
contracts since the term is the lesser of the
contractual period or the period in which the
contract cannot be terminated without substantive
penalty. Accordingly, the arrangement would
continue to be accounted for ratably ($100 per
month).6
Example 4-7
Term-Based Software License Sold to Reseller
With Pro Rata Refund Upon Termination
Assume the same facts as in
Example 4-6, except that the
customer is a reseller that has a committed
(noncancelable) contract with its end-user
customer for the duration of the arrangement (one
year).
Since the vendor is not a party
to the reseller’s end-user arrangement (i.e., the
reseller, not the end user, is the vendor’s
customer), the end-user agreement is not relevant
in the performance of step 1 under ASC 606 (i.e.,
identifying the contract with the customer). The
vendor should therefore account for the
arrangement in the same manner as it does for the
arrangement discussed in Example 4-6.
Example 4-8
Perpetual Software License With Pro Rata
Refund Upon Termination
A vendor sells a perpetual license with one year
of PCS for $6,000. The vendor’s customer has the
right to terminate the arrangement at its
convenience at the end of each month. The
contractual prices of the license and the PCS are
$5,000 and $1,000, respectively. Upon termination,
the customer will be entitled to a pro rata refund
for the PCS and a computed pro rata refund for the
perpetual license, which has a three-year life. If
the customer exercises its termination right, it
loses the right to use the software. The vendor
concludes that it has two distinct performance
obligations: (1) the license and (2) the PCS. If
there was no termination provision, the vendor
would have allocated $5,000 to the license and
$1,000 to the PCS on the basis of their
stand-alone selling prices. Further, it would have
recognized the license fee ($5,000) up front and
the PCS ratably over time ($83 per month).
The vendor should account for the license as 36
individual monthly contracts and for the PCS as 12
individual monthly contracts. As a result, the
license would be recognized over 36 months and the
PCS would be recognized over 12 months, both
ratably ($139 per month for 36 months7 and $83 per month for 12 months).
Example 4-9
Perpetual Software License With Pro Rata
Refund on PCS Only Upon Termination
A vendor sells a perpetual license with one year
of PCS for $6,200. The vendor’s customer has the
right to terminate the PCS at its convenience at
the end of each month. The contractual prices of
the license and the PCS are $5,000 and $1,200,
respectively. Upon termination, the customer will
be entitled to a pro rata refund for the PCS and
no refund for the license. Upon exercising the
termination right, the customer retains the right
to the perpetual license. The vendor concludes
that it has two distinct performance obligations:
(1) the license and (2) the PCS. If there was no
termination provision, the vendor would have
allocated $5,200 to the license and $1,000 to the
PCS on the basis of their stand-alone selling
prices. Further, it would have recognized the
license fee ($5,200) up front and the PCS ratably
over time ($83 per month).
The vendor should account for the PCS as 12
individual monthly contracts and for the license
as part of the initial monthly contract. As a
result, the license would be recognized upon
delivery ($5,020) and the PCS would be recognized
monthly ($80 in the first month and $100 per month
thereafter).8 The total revenue recognized in the first
month would be limited to an amount less than what
would have been recognized on the basis of
relative stand-alone selling price if the contract
were to be accounted for as a one-year contract.
Note that there is no material right for
“renewals” of PCS since the renewals are priced at
$100, which is greater than the stand-alone
selling price of $83.
Example 4-10
Perpetual Software License With a Negotiated
Refund Upon Termination and Separate Stock-Keeping
Units (SKUs)
A vendor sells a perpetual license with one year
of PCS for $6,000. The vendor’s customer has the
right to terminate the arrangement at its
convenience at the end of each month. The
contractual prices of the license and the PCS
(which have separate SKUs) are $5,000 and $1,000,
respectively. The contract specifies that upon
termination, the vendor and the customer will
negotiate, in good faith, the amount of refund, if
any, to which the customer would be entitled. The
vendor concludes that it has two distinct
performance obligations: (1) the license and (2)
the PCS.
Generally, if the amount that would be refunded
is not stated (i.e., unknown) because it is
subject to negotiation and not legally
enforceable, the arrangement would be accounted
for as a one-year contract if a substantive
termination penalty is legally enforceable.
Example 4-11
Term-Based Software License With an Uncertain
Refund Upon Termination and a Combined SKU
A vendor sells a one-year term license with
coterminous PCS for $6,000. The customer has the
right to terminate at its convenience the PCS at
the end of each month. The contractual prices of
the license and PCS are not separately stated
(i.e., the license and PCS do not have separate
SKUs). Accordingly, the amount that would be
refunded upon termination is not known. The vendor
concludes that it has two distinct performance
obligations: (1) the license and (2) the PCS.
Generally, if the amount that would be refunded
is not stated (i.e., unknown) because it is
subject to negotiation and not legally
enforceable, the arrangement would be accounted
for as a one-year contract if a substantive
termination penalty is legally enforceable.
4.4.1.1.2 License Keys and Termination Provisions
The example below illustrates how termination provisions in a software
licensing contract requiring the delivery of a license key for the
customer to use the software affect the contract term and the
recognition of revenue.
Example 4-12
Company LEH enters into an arrangement to license
its software (a right-to-use license for which
revenue is recognized at a point in time) to
Customer MJR for one year with coterminous PCS.
The annual fee for the license and PCS is $5,000
(paid quarterly). Company LEH determines that the
stand-alone selling price of the license is $4,000
and the stand-alone selling price of the PCS is
$1,000. Company LEH delivers a license key to MJR
at the beginning of each quarter; the license key
is required for MJR to use the software. Company
LEH determines that the license and PCS are
distinct performance obligations.
Consider the following cases:
-
Case A: contract may be terminated at the end of each quarter during the one-year license term — In Case A, MJR may choose not to make the next quarterly payment, thereby alleviating LEH’s obligation to deliver the quarterly license key and provide further PCS. Customer MJR’s election not to pay the quarterly fee is not deemed to be a breach of the contract, and LEH has no recourse against MJR if payment is not received (other than to discontinue providing the license and PCS). In effect, the contract is cancelable each quarter. Upon cancellation, MJR’s rights to use the license and receive PCS for the remainder of the one-year license term are also revoked.
-
Case B: contract may not be terminated during the one-year license term — In Case B, LEH is required to deliver or make available the license key to MJR at the beginning of each quarter (such obligation is not contingent on MJR’s making quarterly payments). If LEH does not deliver or make available the license key at the beginning of each quarter, LEH will be in breach of its contractual obligations. Similarly, MJR will be in breach of its contractual obligations if it does not make the quarterly payments. Company LEH has agreed to deliver license keys on a quarterly basis as protection against a breach of contract by MJR. For example, if MJR fails to make payment on time at the start of the second quarter, LEH would still deliver the license key for that quarter. But if MJR has still not paid by the end of the second quarter and is therefore clearly in breach of its contractual commitments, LEH could consider whether to withhold the license key for the third quarter in response to MJR’s breach of contract. The contract may not be terminated by either LEH or MJR during the one-year license term, and LEH has a history of enforcing the contract term.
In Case A, because the contract may be canceled
at the end of each quarter, LEH does not have an
unconditional obligation to deliver the license
key to MJR after the first quarter, nor does MJR
have the unconditional obligation to continue
making quarterly payments to LEH. Because the
contract is cancelable by MJR each quarter, the
contract term is limited to one quarter unless MJR
renews the contract (by making the quarterly
payment). At contract inception (i.e., when the
first license key is transferred to MJR), MJR
obtains a right to use a license for only a term
of one quarter. If MJR elects not to cancel the
contract and LEH transfers an additional key to
MJR, MJR obtains the rights to use and benefit
from the software and receive PCS for an
additional quarter.
In this case, LEH transfers control of a license
for one quarter and is required to provide one
quarter of PCS each time MJR elects not to
terminate the contract. Therefore, LEH should
recognize revenue of $1,000 allocated to the
license at the beginning of each quarter and $250
allocated to PCS over the quarterly PCS
period.
In Case B, LEH should account for the arrangement
as a promise to transfer a one-year term license
and one year of PCS. Although a new license key is
required to be delivered or made available at the
beginning of each quarter, LEH and MJR have
entered into a noncancelable contract that gives
MJR the right to use the software for one year.
Control of a license can be transferred even if
the product key is not transferred to the customer
as long as the key is made available to the
customer (and accessing the key is within the
customer’s control). In Case B, MJR has an
enforceable right to demand the license key, and
LEH is obligated to transfer or otherwise make
available to MJR the key each quarter (regardless
of whether MJR makes timely payments).
Accordingly, once LEH initially transfers the
license (and key) to MJR, MJR obtains control of
the one-year term license. Because LEH does not
have the ability to terminate the contract in the
absence of a breach of contract by MJR or to
prevent MJR from accessing the license key each
quarter, LEH transfers all of the rights to use
and benefit from the software for the entire
one-year license term at contract inception.
Similarly, MJR does not have the right to
terminate the contract and cease making quarterly
payments since the contract is noncancelable and
LEH has a history of enforcing the contract
term.
Accordingly, LEH should recognize revenue of
$4,000 allocated to the license at contract
inception (when the initial key is delivered) and
$1,000 allocated to PCS over the PCS term (i.e.,
one year).
Footnotes
6
Revenue associated with the license would be
recognized at the beginning of each month, which
is similar to ratable recognition given the short
term (i.e., monthly).
7
See footnote 6.
8
Total noncancelable
consideration of $5,100 for the initial month is
allocated on a relative stand-alone selling price
basis — that is, approximately 98 percent to the
license and 2 percent to one month of PCS.
4.5 Reassessing the Criteria for Identifying a Contract
An entity is required to evaluate the criteria in ASC 606-10-25-1 at contract
inception to determine whether a valid and genuine transaction exists for accounting
purposes. Once an entity concludes that the criteria are met (i.e., that a valid
contract exists), it is not required to reassess the criteria unless there has been
a significant change in facts and circumstances (i.e., changes that might call into
question the existence of a contract rather than minor changes that might reasonably
be expected over the contract term, particularly for long-term contracts). A
reassessment may be required, for example, if an entity determines that its
remaining contractual rights and obligations are no longer enforceable or if other
changes suggest that a valid and genuine transaction no longer exists.
If an entity is required to reassess its contract because of a
significant change in facts and circumstances, the criteria in ASC 606-10-25-1 would
only be evaluated in the context of the remaining goods or services that have yet to
be provided. The reassessment would not affect any assets or revenue that has been
recognized from satisfied performance obligations. However, assets would need to be
evaluated for impairment under other applicable guidance, such as ASC 310 (or ASC
326, once adopted9).
ASC 606-10
25-5 If a contract with a
customer meets the criteria in paragraph 606-10-25-1 at
contract inception, an entity shall not reassess those
criteria unless there is an indication of a significant
change in facts and circumstances. For example, if a
customer’s ability to pay the consideration deteriorates
significantly, an entity would reassess whether it is
probable that the entity will collect the consideration to
which the entity will be entitled in exchange for the
remaining goods or services that will be transferred to the
customer (see paragraphs 606-10- 55-3A through 55-3C).
25-6 If a contract with a customer does not meet the criteria in paragraph 606-10-25-1, an entity shall continue
to assess the contract to determine whether the criteria in paragraph 606-10-25-1 are subsequently met.
There may be situations in which an entity concludes at contract inception that the
criterion in ASC 606-10-25-1(e) is met but subsequent changes in circumstances lead
the entity to question whether it will collect consideration from the customer. In
general, once an entity makes a determination that a contract exists in accordance
with ASC 606-10-25-1, the determination is not reevaluated. However, in accordance
with ASC 606-10-25-5, an entity should reassess the criteria in ASC 606-10-25-1 when
“there is an indication of a significant change in facts and circumstances.” As a
result, when concerns arise regarding the collectibility of consideration, an entity
will need to use judgment to determine whether those concerns arise from a
significant change in facts and circumstances in the context of ASC 606-10-25-5.
Example 4 in ASC 606-10-55-106 through 55-109, which is reproduced below, illustrates
when a change in the customer’s financial condition is so significant that a
reassessment of the criteria in ASC 606-10-25-1 is required. As a result of the
reassessment, the entity in the example determines that the collectibility criterion
is not met and that the contract therefore fails step 1. Accordingly, the entity is
precluded from recognizing additional revenue under the contract until the criteria
in ASC 606-10-25-7 are met or collectibility becomes probable. The entity also
assesses any related contract assets or accounts receivable for impairment.
ASC 606-10
Example 4 — Reassessing the Criteria for
Identifying a Contract
55-106 An entity licenses a patent
to a customer in exchange for a usage-based royalty. At
contract inception, the contract meets all the criteria in
paragraph 606-10-25-1, and the entity accounts for the
contract with the customer in accordance with the guidance
in this Topic. The entity recognizes revenue when the
customer’s subsequent usage occurs in accordance with
paragraph 606-10-55-65.
55-107 Throughout the first year of
the contract, the customer provides quarterly reports of
usage and pays within the agreed-upon period.
55-108 During the second year of
the contract, the customer continues to use the entity’s
patent, but the customer’s financial condition declines. The
customer’s current access to credit and available cash on
hand are limited. The entity continues to recognize revenue
on the basis of the customer’s usage throughout the second
year. The customer pays the first quarter’s royalties but
makes nominal payments for the usage of the patent in
quarters 2–4. The entity accounts for any impairment of the
existing receivable in accordance with Topic 310 on
receivables.
Pending Content (Transition Guidance: ASC
326-10-65-1)
55-108 During the second year of the
contract, the customer continues to use the
entity’s patent, but the customer’s financial
condition declines. The customer’s current access
to credit and available cash on hand are limited.
The entity continues to recognize revenue on the
basis of the customer’s usage throughout the
second year. The customer pays the first quarter’s
royalties but makes nominal payments for the usage
of the patent in quarters 2–4. The entity accounts
for any credit losses on the existing receivable
in accordance with Subtopic 326-20 on financial
instruments measured at amortized cost.
55-109 During the third year of the
contract, the customer continues to use the entity’s patent.
However, the entity learns that the customer has lost access
to credit and its major customers and thus the customer’s
ability to pay significantly deteriorates. The entity
therefore concludes that it is unlikely that the customer
will be able to make any further royalty payments for
ongoing usage of the entity’s patent. As a result of this
significant change in facts and circumstances, in accordance
with paragraph 606-10-25-5, the entity reassesses the
criteria in paragraph 606-10-25-1 and determines that they
are not met because it is no longer probable that the entity
will collect the consideration to which it will be entitled.
Accordingly, the entity does not recognize any further
revenue associated with the customer’s future usage of its
patent. The entity accounts for any impairment of the
existing receivable in accordance with Topic 310 on
receivables.
Pending Content (Transition Guidance: ASC
326-10-65-1)
55-109 During the third year of the
contract, the customer continues to use the
entity’s patent. However, the entity learns that
the customer has lost access to credit and its
major customers and thus the customer’s ability to
pay significantly deteriorates. The entity
therefore concludes that it is unlikely that the
customer will be able to make any further royalty
payments for ongoing usage of the entity’s patent.
As a result of this significant change in facts
and circumstances, in accordance with paragraph
606-10-25-5, the entity reassesses the criteria in
paragraph 606-10-25-1 and determines that they are
not met because it is no longer probable that the
entity will collect the consideration to which it
will be entitled. Accordingly, the entity does not
recognize any further revenue associated with the
customer’s future usage of its patent. The entity
accounts for additional credit losses on the
existing receivable in accordance with Subtopic
326-20.
Connecting the Dots
Stakeholders have questioned how to evaluate the reassessment criteria in ASC
606-10-25-5 to determine when to reassess whether a contract continues to
meet the collectibility threshold. The assessment of whether a significant
change in facts and circumstances occurred will be situation-specific (e.g.,
a significant change due to a bankruptcy) and will often be a matter of
judgment.
The above issue is addressed in Implementation Q&A 10 (compiled from previously
issued TRG Agenda Papers 13 and 25). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
Footnotes
9
See footnote 5.
4.6 Consideration Received When the Criteria for Identifying a Contract Are Not Met
If a contract does not meet the criteria in ASC 606-10-25-1 at contract
inception, no revenue can be recognized until either the contract existence criteria
are met or other conditions are satisfied. That is, any consideration received from
a customer, including nonrefundable consideration, is precluded from being
recognized as revenue until certain events have occurred.
ASC 606-10
25-7 When a contract with a customer does not meet the criteria in paragraph 606-10-25-1 and an entity
receives consideration from the customer, the entity shall recognize the consideration received as revenue only
when one or more of the following events have occurred:
- The entity has no remaining obligations to transfer goods or services to the customer, and all, or substantially all, of the consideration promised by the customer has been received by the entity and is nonrefundable.
- The contract has been terminated, and the consideration received from the customer is nonrefundable.
- The entity has transferred control of the goods or services to which the consideration that has been received relates, the entity has stopped transferring goods or services to the customer (if applicable) and has no obligation under the contract to transfer additional goods or services, and the consideration received from the customer is nonrefundable.
25-8 An entity shall recognize the consideration received from a customer as a liability until one of the events
in paragraph 606-10-25-7 occurs or until the criteria in paragraph 606-10-25-1 are subsequently met (see
paragraph 606-10-25-6). Depending on the facts and circumstances relating to the contract, the liability
recognized represents the entity’s obligation to either transfer goods or services in the future or refund the
consideration received. In either case, the liability shall be measured at the amount of consideration received
from the customer.
Connecting the Dots
The contract existence criteria provide a framework for determining when a contract with a
customer includes all of the elements required to apply the rest of the revenue recognition
model. The model relies on a complete analysis of the rights and obligations under the contract.
For an entity to recognize revenue in an amount that depicts the consideration to which it
expects to be entitled in exchange for promised goods or services, the entity needs to be able
to adequately determine both the promised goods or services and the consideration to which it
expects to be entitled (along with meeting the other criteria). When any of the contract existence
criteria are not met (including the collectibility threshold), the entity is unable to determine how
to allocate consideration to promised goods or services under the contract because either
the promised consideration or the promised goods or services are inadequately defined.
Consequently, even if nonrefundable consideration is received from a customer and the entity
has transferred some of the goods or services promised under the contract, if the contract
existence criteria are not met and none of the events in ASC 606-10-25-7 have occurred, the
entity is unable to conclude that the consideration received is related entirely to satisfied (or
partially satisfied) performance obligations. Therefore, any such consideration received needs
to be recorded as a liability until the entity determines that either the contract existence criteria
are met or one of the events in ASC 606-10-25-7 has occurred.
4.6.1 Whether a Contract Can Be Deemed Terminated if Pursuit of Collection Continues
ASU 2014-09 did not include the criterion in ASC 606-10-25-7(c).
In some cases, questions arose about whether the criterion in ASC 606-10-25-7(b)
was met — specifically, whether a contract can be deemed to be terminated if
goods or services were transferred to a customer and some nonrefundable
consideration was received, but the customer paid less than the full transaction
price and the entity continued to pursue collection of outstanding balances to
which it was entitled. ASU 2016-12 added a third criterion, ASC
606-10-25-7(c),10 to enable an entity to recognize consideration received from a customer as
revenue when the contract does not meet the criteria in ASC 606-10-25-1 if (1)
the “entity has transferred control of the goods or services to which the
consideration that has been received relates,” (2) “the entity has stopped
transferring goods or services to the customer (if applicable) and has no
obligation under the contract to transfer additional goods or services,” and (3)
“the consideration received from the customer is nonrefundable.”
When the events described in ASC 606-10-25-7(c) occur, it will be evident that
nonrefundable consideration received from a customer is entirely related to
satisfied performance obligations (or satisfied portions of a performance
obligation that is satisfied over time). That is, the customer will no longer
have rights to obtain additional goods or services from the entity, and the
entity has no further obligation (or intention) to transfer goods or services to
the customer. In these circumstances, the contract can be accounted for as if it
were terminated (i.e., revenue can be recognized for the nonrefundable
consideration received) even if the entity continues to pursue collection of
outstanding balances from the customer.
4.6.2 Whether a Receivable Can Be Recorded When a Contract Fails Step 1 Because Collectibility Is Not Probable
If an entity decides to transfer its promised goods or services
before collecting consideration from its customer and the collection of such
consideration is not probable, a question arises about whether the entity can
recognize a receivable for the amount of consideration to which it is legally
entitled.
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}.
In general, an entity cannot record a receivable if it transfers a good or
service to its customer but the accounting contract fails step 1 because
collectibility of the expected consideration is not probable. While an entity
may have a legal contract, if it cannot conclude that a contract exists from an
accounting perspective, it cannot recognize revenue and typically would not
recognize a receivable.
Example 1, Case A, in ASC 606-10-55-95 through 55-98 illustrates
a situation in which an entity concludes that it does not have a contract with a
customer because one of the criteria in ASC 606-10-25-1 is not met —
specifically, collectibility of the expected consideration is not probable. In
the revenue standard as originally issued, the example11 included the following text (subsequently deleted from ASC 606-10-55-98 by
ASU 2016-12), which we still believe appropriately reflects the timing of
recognizing receivables for contracts that have not yet met the criteria in step
1:
Because the criteria in paragraph 606-10-25-1 are not
met, the entity applies paragraphs 606-10-25-7 through 25-8 to determine the
accounting for the nonrefundable deposit of $50,000. The entity observes
that none of the events described in paragraph 606-10-25-7 have occurred —
that is, the entity has not received substantially all of the consideration
and it has not terminated the contract. Consequently, in accordance with
paragraph 606-10-25-8, the entity accounts for the nonrefundable $50,000
payment as a deposit liability. The entity continues to account for the
initial deposit, as well as any future payments of principal and interest,
as a deposit liability and does not derecognize the real estate asset. Also,
the entity does not recognize a receivable until
such time that the entity concludes that the criteria in paragraph
606-10-25-1 are met (that is, the entity is able to conclude that it is
probable that the entity will collect the consideration) or one of the
events in paragraph 606-10-25-7 has occurred. [Emphasis
added]
ASU 2016-12 deleted the text above from ASC 606-10-55-98 to make the Codification
example focus only on the evaluation of the collectibility threshold. We believe
that the principle in the original example is still appropriate and that a
receivable would generally not be recognized if goods or services are
transferred to a customer but the contract fails step 1 because collectibility
is not probable.
When an entity has a right to recover products from customers, it may be
acceptable for the entity to record an asset (and corresponding adjustment to
cost of sales) for its right to recover products from customers on settling the
refund liability. For example, if the entity is unable to conclude that a
contract has met all of the step 1 criteria because collectibility of the
expected consideration is not probable, but the entity has already transferred
inventory to the customer, the entity may record an asset for the right to the
inventory if the legal contract stipulates that the entity has the right to take
back the inventory in the event that the customer does not pay.
Footnotes
10
The IASB did not amend IFRS 15 to add this third
criterion. For a summary of differences between U.S. GAAP and IFRS
Accounting Standards on revenue-related topics, see Appendix A.
11
That is, what the revenue standard, as amended by ASU
2016-12, refers to as Case A of Example 1. Before ASU 2016-12 was
issued, Example 1 had only one fact pattern.
4.7 Combining Contracts
Generally, the revenue standard is applied at the individual contract level
unless the portfolio approach has been elected (see Section 3.1.2.2). However, an entity’s contracting
practice could result in a single arrangement with a customer that is governed by
multiple legal contracts. That is, the commercial substance of a single arrangement
to provide goods or services to a customer could be addressed by multiple contracts
with the same customer. The revenue standard requires multiple contracts with a
customer to be combined and accounted for as a single contract when certain
conditions are present.
ASC 606-10
25-9 An entity shall combine two or more contracts entered into at or near the same time with the same
customer (or related parties of the customer) and account for the contracts as a single contract if one or more
of the following criteria are met:
- The contracts are negotiated as a package with a single commercial objective.
- The amount of consideration to be paid in one contract depends on the price or performance of the other contract.
- The goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation in accordance with paragraphs 606-10-25-14 through 25-22.
The contract combination guidance should be assessed at contract inception. An
entity will need to use judgment in determining whether multiple contracts are
“entered into at or near the same time.” As a general rule, the longer the period
between entering contracts with the same customer, the more likely those contracts
are not economically linked.
4.8 Wholly Unperformed Contracts
An entity may have entered into a legal contract with a customer under which neither party has
performed and either party can cancel the contract for no consideration.
ASC 606-10
25-4 For the purpose of applying the guidance in this Topic, a contract does not exist if each party to the
contract has the unilateral enforceable right to terminate a wholly unperformed contract without compensating
the other party (or parties). A contract is wholly unperformed if both of the following criteria are met:
- The entity has not yet transferred any promised goods or services to the customer.
- The entity has not yet received, and is not yet entitled to receive, any consideration in exchange for promised goods or services.
As previously discussed in Section
4.3.1, the revenue standard does not apply to wholly unperformed
contracts that allow either party the unilateral ability to terminate a contract.
See Section 4.4.1 for further
discussion of termination provisions. If an entity enters into a contract with a
customer and only the entity can cancel the contract (i.e., the customer does not
have an ability to terminate the contract), the contract exists for accounting
purposes under ASC 606 because the entity has an enforceable right to consideration
if it chooses to perform (e.g., transfer goods or services to the customer).
4.9 Modifying Contracts
A contract may be modified after an entity has already accounted for some or all
of the revenue related to that contract. The impact on revenue recognition will
depend on how that contract has been modified. This is discussed in Chapter 9.
Chapter 5 — Step 2: Identify the Performance Obligations
Chapter 5 — Step 2: Identify the Performance Obligations
5.1 Introduction to Step 2
Step 2 is one of the most critical steps in the standard’s revenue framework
since it establishes the unit of account for revenue recognition. A material
miscalculation in this step will often lead to an error in the recognition of
revenue. This step requires an entity to identify what it has promised to the
customer. In many arrangements, this will be obvious and therefore simple; in other
arrangements, however, there are critical judgments that an entity must make in
determining the correct unit of account (i.e., performance obligation).
The decision tree below illustrates the revenue standard’s process for
identifying performance obligations in a contract.
This chapter also addresses topics such as stand-ready obligations, options for
additional goods and services, warranties, and nonrefundable up-front fees because
these topics are integral to the proper identification of performance
obligations.
When identifying a performance obligation, an entity should determine whether it is a principal or an
agent in the transaction because that determination will affect how (and sometimes when) the entity
reports the revenue earned. While step 2 is probably the best stage of the revenue recognition process
for determining whether an entity is a principal or an agent, there are many considerations that go
into that determination. Accordingly, principal-versus-agent considerations are discussed separately in
Chapter 10.
In addition, an entity’s contract with a customer may give the customer a choice of
whether to purchase additional goods or services. In some cases, options for
additional goods or services are marketing or promotional efforts to gain future
contracts with customers. However, in other cases, such options may be considered
performance obligations, which are referred to as material rights. While the
determination of whether a customer option for additional goods or services gives
rise to a material right should be performed as part of step 2, there are many
considerations related to material rights that affect the other steps of the revenue
recognition model. Accordingly, material right considerations are discussed
separately in Chapter 11.
5.2 Promises in Contracts With Customers
5.2.1 In General
Identification of all promises in a contract is important because promises are what comprise
performance obligations and entities recognize revenue on the basis of the satisfaction of performance
obligations. ASC 606-10-25-18 lists examples of what could constitute a promise in a contract:
ASC 606-10
25-18 Depending on the
contract, promised goods or services may include, but
are not limited to, the following:
-
Sale of goods produced by an entity (for example, inventory of a manufacturer)
-
Resale of goods purchased by an entity (for example, merchandise of a retailer)
-
Resale of rights to goods or services purchased by an entity (for example, a ticket resold by an entity acting as a principal, as described in paragraphs 606-10-55-36 through 55-40)
-
Performing a contractually agreed-upon task (or tasks) for a customer
-
Providing a service of standing ready to provide goods or services (for example, unspecified updates to software that are provided on a when-and-if-available basis) or of making goods or services available for a customer to use as and when the customer decides
-
Providing a service of arranging for another party to transfer goods or services to a customer (for example, acting as an agent of another party, as described in paragraphs 606-10-55-36 through 55-40)
-
Granting rights to goods or services to be provided in the future that a customer can resell or provide to its customer (for example, an entity selling a product to a retailer promises to transfer an additional good or service to an individual who purchases the product from the retailer)
-
Constructing, manufacturing, or developing an asset on behalf of a customer
-
Granting licenses (see paragraphs 606-10-55-54 through 55-60 and paragraphs 606-10-55-62 through 55-65B)
-
Granting options to purchase additional goods or services (when those options provide a customer with a material right, as described in paragraphs 606-10-55-41 through 55-45).
5.2.2 Implied Promises
ASC 606-10
25-16 A contract with a customer generally explicitly states the goods or services that an entity promises to
transfer to a customer. However, the promised goods and services identified in a contract with a customer may
not be limited to the goods or services that are explicitly stated in that contract. This is because a contract with
a customer also may include promises that are implied by an entity’s customary business practices, published
policies, or specific statements if, at the time of entering into the contract, those promises create a reasonable
expectation of the customer that the entity will transfer a good or service to the customer.
For some contracts, it will be easy to identify all promises because they are
all specifically stated. However, the FASB and IASB decided to require entities
to identify the implied promises as well. The reason for the boards’ decision,
as discussed in paragraph BC87 of ASU 2014-09, was to ensure that all
of the promises in a contract are appropriately identified so that when an
entity allocates consideration to the performance obligations identified, it
will recognize revenue when control of all of the promised goods and services in
the contract is transferred to the customer. Paragraph BC87 goes on to state,
“The Boards also noted that the implied promises in the contract do not need to
be enforceable by law. If the customer has a valid[1] expectation, then the customer would view those promises as part of the
negotiated exchange (that is, goods or services that the customer expects to
receive and for which it has paid).” Therefore, promises that an entity’s
customer reasonably expects the entity to fulfill even though they are not
explicitly stated in the contract are implied promises that should be accounted
for.
Connecting the Dots
Software companies may be familiar with identifying implied promises through
software upgrades and updates that are not explicitly identified in the
arrangement. In addition, a manufacturer of furniture may provide a
written warranty to its customers to repair the products in the first
year after purchase. However, if the manufacturer also has historically
provided repairs free of charge beyond the first year in accordance with
the manufacturer’s customary business practice, an implied promise may
exist.
The concept of implied promises is important because if an entity does not identify an implied promise in a contract,
it could recognize revenue at the wrong time. For example, the entity could recognize all
revenue from the contract because it has satisfied all explicitly stated promises in the contract.
However, because the entity still has an unidentified implied promise to satisfy for the customer,
no consideration was allocated to that promise. As a result, the entity recognized more revenue
from the contract than it should have at that point.
The guidance on implied promises will require an entity to use judgment to
determine whether a customer has a reasonable expectation based on
customary business practices or the entity’s previous transactions with
the customer that the entity will provide a good or service not
specifically stated in the contract.
5.2.2.1 Illustrative Examples in ASC 606 of Explicit and Implicit Promises (ASC 606-10-55-151 Through 55-157A)
Cases A, B, and C of Example 12 in ASC 606, which are reproduced below, further discuss explicit and
implicit promises.
ASC 606-10
Example 12 — Explicit and Implicit Promises in a Contract
55-151 An entity, a manufacturer, sells a product to a distributor (that is, its customer), who will then resell it to
an end customer.
Case A — Explicit Promise of Service
55-152 In the contract with the distributor, the entity promises to provide maintenance services for no
additional consideration (that is, “free”) to any party (that is, the end customer) that purchases the product from
the distributor. The entity outsources the performance of the maintenance services to the distributor and pays
the distributor an agreed-upon amount for providing those services on the entity’s behalf. If the end customer
does not use the maintenance services, the entity is not obliged to pay the distributor.
55-153 The contract with the customer includes two promised goods or services — (a) the product and (b) the
maintenance services (because the promise of maintenance services is a promise to transfer goods or services
in the future and is part of the negotiated exchange between the entity and the distributor). The entity assesses
whether each good or service is distinct in accordance with paragraph 606-10-25-19. The entity determines
that both the product and the maintenance services meet the criterion in paragraph 606-10-25-19(a). The
entity regularly sells the product on a standalone basis, which indicates that the customer can benefit from
the product on its own. The customer can benefit from the maintenance services together with a resource the
customer already has obtained from the entity (that is, the product).
55-153A The entity further
determines that its promises to transfer the product
and to provide the maintenance services are
separately identifiable (in accordance with
paragraph 606-10-25-19(b)) on the basis of the
principle and the factors in paragraph 606-10-25-21.
The product and the maintenance services are not
inputs to a combined item in this contract. The
entity is not providing a significant integration
service because the presence of the product and the
services together in this contract do not result in
any additional or combined functionality. In
addition, neither the product nor the services
modify or customize the other. Lastly, the product
and the maintenance services are not highly
interdependent or highly interrelated because the
entity would be able to satisfy each of the promises
in the contract independent of its efforts to
satisfy the other (that is, the entity would be able
to transfer the product even if the customer
declined maintenance services and would be able to
provide maintenance services in relation to products
sold previously through other distributors). The
entity also observes, in applying the principle in
paragraph 606-10-25-21, that the entity’s promise to
provide maintenance is not necessary for the product
to continue to provide significant benefit to the
customer. Consequently, the entity allocates a
portion of the transaction price to each of the two
performance obligations (that is, the product and
the maintenance services) in the contract.
Case B — Implicit Promise of Service
55-154 The entity has historically provided maintenance services for no additional consideration (that is, “free”)
to end customers that purchase the entity’s product from the distributor. The entity does not explicitly promise
maintenance services during negotiations with the distributor, and the final contract between the entity and the
distributor does not specify terms or conditions for those services.
55-155 However, on the basis of its customary business practice, the entity determines at contract inception
that it has made an implicit promise to provide maintenance services as part of the negotiated exchange with
the distributor. That is, the entity’s past practices of providing these services create reasonable expectations of
the entity’s customers (that is, the distributor and end customers) in accordance with paragraph 606-10-25-16.
Consequently, the entity assesses whether the promise of maintenance services is a performance obligation.
For the same reasons as in Case A, the entity determines that the product and maintenance services are
separate performance obligations.
Case C — Services Are Not a Promised Service
55-156 In the contract with the distributor, the entity does not promise to provide any maintenance services.
In addition, the entity typically does not provide maintenance services, and, therefore, the entity’s customary
business practices, published policies, and specific statements at the time of entering into the contract have
not created an implicit promise to provide goods or services to its customers. The entity transfers control of
the product to the distributor and, therefore, the contract is completed. However, before the sale to the end
customer, the entity makes an offer to provide maintenance services to any party that purchases the product
from the distributor for no additional promised consideration.
55-157 The promise of maintenance is not included in the contract between the entity and the distributor
at contract inception. That is, in accordance with paragraph 606-10-25-16, the entity does not explicitly or
implicitly promise to provide maintenance services to the distributor or the end customers. Consequently, the
entity does not identify the promise to provide maintenance services as a performance obligation. Instead, the
obligation to provide maintenance services is accounted for in accordance with Topic 450 on contingencies.
55-157A Although the maintenance services are not a promised service in the current contract, in future
contracts with customers the entity would assess whether it has created a business practice resulting in an
implied promise to provide maintenance services.
5.2.2.2 Accounting for Virtual Goods
Many developers of online games allow customers to access
and play the games for no charge. Rather than licensing the software to
their customers, the developers generally host the software for their
customers to access. Arrangements that allow customers of online game
developers to access and play online games are accounted for as a service
(hosted software as a service [SaaS]) rather than as the transfer of a
software license because the customers typically cannot take possession of
the software associated with the online games.
To enhance the gaming experience of customers who can access and play online
games for no charge, online game developers may give them the option to
purchase virtual goods or services (i.e., virtual items). These virtual
items are generally classified as either (1) consumables (i.e., items that
are consumed by a specific action and are no longer available to a customer
once consumed, such as virtual groceries) or (2) durables (i.e., items that
are accessible to a customer for use throughout the entire game, such as a
virtual house). In addition, customers may have the ability to purchase
virtual currency, which enables them to purchase other virtual items.
In effect, customers are enhancing their gaming experience
through optional purchases. Some of these purchases are “consumed” by a
player immediately or shortly after he or she gains access to them, and
others are consumed by the player over time. Nevertheless, even when an item
is consumed immediately, it may still have an ongoing effect on the player’s
gaming experience (e.g., if consumption of the item enables the player to
reach another level that would otherwise have been inaccessible).
Generally, a developer is not contractually obligated to continue making an
online game available to a customer. Further, a developer can terminate a
customer’s account at any time for no cause, regardless of whether the
customer has purchased virtual items. Nevertheless, many developers have a
customary business practice of notifying customers when they are planning to
shut down an online game, although such notification is not contractually
required.
Generally, an implied promise would exist since the developer has implicitly
promised to provide hosting services after the customer purchases a virtual
item. Without the hosting services, the customer would not be able to use
and benefit from the enhanced gaming experience that it receives through the
game as a result of purchasing the virtual item. Although the developer is
not contractually obligated (i.e., it has not explicitly promised) to
continue hosting the online game for the customer, it has established a
customary business practice of (1) continuing to host the online game and
(2) notifying customers when it is planning to shut down the game. The
developer’s customary business practice creates a reasonable expectation
that the developer will continue to host the software so that the virtual
item (or the enhanced gaming experience derived from the virtual item) will
remain available to the customer.
A developer should carefully consider the nature of the
implied promise to its customer in determining the appropriate recognition
model. Customers often simultaneously receive and consume the benefits of
the developer’s performance of making the hosted software available to the
customer. Consequently, the developer may determine that it should recognize
revenue for its implied promise either at a point in time (e.g., upon
consumption) or over time by using a method that faithfully depicts its
performance in transferring control of the promised services (i.e., the
benefits of the enhanced gaming experience related to the purchase of
virtual items promised to the customer). Immediate recognition of revenue at
the point in time when a customer purchases a virtual item may not be
appropriate if the benefits of the enhanced gaming experience are provided
over time. Rather, the entity may need to consider the period over which the
customer benefits from the enhanced gaming experience that it receives by
purchasing the virtual item when determining the appropriate period and
pattern of revenue recognition.
We believe that the following may be relevant factors for an entity to
consider in making this assessment:
- Whether the nature of the implied promise is to provide an enhanced gaming experience through the hosted service over time or to enable the player to consume virtual items.
- The period over which the enhanced gaming experience is provided if the benefits are consumed throughout the hosting period (e.g., user life, gaming life).
- The life span over which, or number of times, the virtual item may be accessed or used.
- Whether the virtual item must be used immediately or may be stored for later use.
- How and over what period the virtual item benefits the customer’s gaming experience (e.g., a consumable such as a virtual meal that is used immediately vs. a durable that allows a player to “level up” within the game in such a way that the increased performance continues to enhance the gaming experience).
- Whether the benefit of purchasing the virtual item on the customer’s gaming experience is temporary or permanent.
For additional information about the timing of revenue recognition, see
Chapter 8.
5.2.3 Immaterial Promises
ASC 606-10
25-16A An entity is not
required to assess whether promised goods or services
are performance obligations if they are immaterial in
the context of the contract with the customer. If the
revenue related to a performance obligation that
includes goods or services that are immaterial in the
context of the contract is recognized before those
immaterial goods or services are transferred to the
customer, then the related costs to transfer those goods
or services shall be accrued.
25-16B An entity shall not apply the guidance in paragraph 606-10-25-16A to a customer option to acquire
additional goods or services that provides the customer with a material right, in accordance with paragraphs
606-10-55-41 through 55-45.
When the FASB and IASB were developing the revenue standard, they received
feedback, as noted in paragraph BC88 of ASU 2014-09, that there can be
situations in which promises in contracts could be considered “marketing
expenses or incidental obligations.” The boards considered the feedback but
decided that allowing management to determine whether promises are a marketing
expense would result in too much subjectivity on the part of management and
therefore could lead to inconsistent application of the concept. As a result,
the boards determined that every promise, either on its own or jointly with
other promises, should give rise to a performance obligation.
Paragraph BC90 of ASU 2014-09 notes that the boards “decided not to exempt an
entity from accounting for performance obligations that the entity might regard
as being perfunctory or inconsequential. Instead, an entity should assess
whether those performance obligations are immaterial to its financial
statements.”
However, questions arose about whether it was necessary for an entity to
identify immaterial goods or services when identifying performance
obligations.
In April 2016, the FASB issued ASU 2016-10,2 which states that an entity “is not required to assess whether promised
goods or services are performance obligations if they are immaterial in the
context of the contract with the customer.” In addition, the ASU indicates that
an entity should consider materiality of items or activities only at the
contract level (as opposed to aggregating such items and performing an
assessment at the financial statement level). This change should not apply to an
entity’s assessment of optional goods and services offered to a customer, which
the entity must evaluate under ASC 606-10-55-42 and 55-43 to determine whether
they give the customer a material right (i.e., an optional good offered for free
or at a discount, such as that provided through loyalty point programs, may not
be material for an individual contract but could be material in the aggregate
and accounted for as a material right). Material rights are further discussed in
Chapter 11.
ASU 2016-10 permits entities to choose not to evaluate whether immaterial items
or activities represent performance obligations. Thus, the exclusion of such
immaterial items or activities under the revenue standard would not be
considered a departure from GAAP and need not be aggregated as a
misstatement.
5.2.3.1 Accounting for Perfunctory or Inconsequential Performance Obligations
Under ASC 606, perfunctory or inconsequential promises in a
contract may be, but are not presumed to be, immaterial in the context of
the contract.
Example 5-1
Entity X enters into a contract to
transfer Product A and Item B to a customer. Product
A and Item B meet the criteria in ASC 606-10-25-19
to be considered distinct and do not meet the
criteria in ASC 606-10-25-14(b) (i.e., they do not
constitute a series of distinct goods or services
that are substantially the same and have the same
pattern of transfer to the customer). Item B may be
either a substantive promise in the arrangement
(e.g., free maintenance on Product A for two years)
or inconsequential (e.g., certain promises to
participate in a joint committee, delivery of an
installation or training manual, a simple
installation process that only requires unpacking
and plugging in, a simple inspection service).
Even if Item B is considered
perfunctory or inconsequential, X cannot ignore the
guidance in ASC 606 when determining whether and, if
so, how to account for it. Perfunctory or
inconsequential promises in a contract may be, but
are not presumed to be, immaterial in the context of
the contract. As a result, X may need to reevaluate
historical conclusions by using the framework
outlined in ASC 606-10-25-16A and 25-16B.
5.2.3.2 Framework for Identifying Immaterial Promised Goods or Services
ASC 606-10-25-16A and 25-16B (reproduced in Section 5.2.3) provide guidance on
immaterial goods and services. Stakeholders have asked about the framework
an entity should use to identify a potential good or service that is
immaterial in the context of the contract. We believe that the following
considerations are relevant to the assessment of whether a good or service
is immaterial in the context of the contract:
-
An entity may conclude that a potential good or service is immaterial in the context of the contract if the estimated stand-alone selling price of the potential good or service is immaterial (quantitatively) compared with the total consideration in the contract (i.e., the amount that would be allocated to such good or service is immaterial in the context of the contract).
-
An entity may conclude that a potential good or service is immaterial in the context of the contract if it determines that the customer does not consider the potential good or service material to the contract (i.e., the entity would evaluate qualitative factors, including the customer’s perspective, in determining whether a potential good or service is immaterial in the context of the contract).
-
An entity may conclude that a potential good or service is immaterial in the context of the contract if it determines that the customer would have entered into the contract and paid the same (or similar) consideration if the potential good or service was excluded from the contract.
In addition, we think that when an entity performs an
assessment to identify immaterial promised goods or services, it should also
consider the guidance in ASC 606-10-25-16B on customer options (i.e.,
potential material rights) as well as the SEC staff’s view of “material” as
discussed in SAB
Topic 1.M. For additional information about the
accounting for material rights, see Chapter
11.
5.2.4 Consideration of Activities
ASC 606-10
25-17 Promised goods or services do not include activities that an entity must undertake to fulfill a contract
unless those activities transfer a good or service to a customer. For example, a services provider may need to
perform various administrative tasks to set up a contract. The performance of those tasks does not transfer a
service to the customer as the tasks are performed. Therefore, those setup activities are not promised goods
or services in the contract with the customer.
There is a difference between promises and activities in contracts. The FASB and
IASB wanted this to be clear because the revenue standard is based on
recognizing revenue as an entity transfers control of goods or services to
customers. When an entity promises goods and services to customers, it is going
to transfer those goods or services to the customers. In contrast, activities
that an entity is required to undertake to fulfill promises in a contract do not
necessarily transfer goods or services to the customer. Therefore, since the
completion of an activity does not represent transfer of control, an entity
would not recognize revenue on the basis of the completion of an activity.
5.2.4.1 Assessing Whether a Preproduction Activity Forms Part of the Delivery of a Promised Good or Service
In some long-term supply arrangements, before goods can be
delivered to a customer, an entity may be required to undertake
preproduction activities such as “up-front” engineering and design (e.g., to
create new technology or adapt existing technology to the needs of the
customer). Because of the nature of the underlying tasks, preproduction
activities are often carried out over time.
If a preproduction activity transfers a good or service to a
customer as the preproduction activity is carried out, it will be
appropriate, subject to the other requirements of ASC 606, to recognize
revenue as the preproduction activity is carried out.3
If a preproduction activity does not transfer a good or
service to a customer as the preproduction activity is carried out, no
revenue should be recognized as the preproduction activity is carried out.
Instead, the associated costs should either be capitalized (e.g., if they
meet the criteria in ASC 340-40-25-5) or expensed as incurred.
When performing an assessment of whether preproduction
activities transfer a good or service to a customer, an entity should
identify the nature of its promise(s) to the customer to determine whether
the preproduction activity represents either of the following:
-
A promised good or service (or part of a promised good or service) that is transferred to the customer.
-
A fulfillment activity that does not transfer a good or service to the customer.
In making this determination, an entity will need to use
judgment. In addition to the guidance in ASC 606-10-25-14 through 25-22 on
identifying performance obligations, an entity might look to the guidance in
ASC 606-10-25-27 through 25-29 on satisfying a performance obligation over
time.
One scenario in which a performance obligation is satisfied
over time is when the “customer simultaneously receives and consumes the
benefits provided by the entity’s performance as the entity performs” (see
ASC 606-10-25-27(a)). A determination that the customer simultaneously
receives and consumes benefits as the entity carries out the preproduction
activity would indicate that the preproduction activity is, or forms part
of, a performance obligation. In the entity’s assessment of whether the
customer simultaneously receives and consumes benefits, it may be helpful to
consider, in accordance with ASC 606-10-55-6, whether another entity would
need to substantially reperform the preproduction activities if that other
entity were to fulfill the remaining performance obligation to the customer.
When making this assessment, the reporting entity should assume that the
other entity would not have the benefit of any asset that the reporting
entity would continue to control if the contract were terminated.
Another scenario in which a performance obligation is
satisfied over time is when the entity’s performance creates or enhances an
asset that the customer controls as the asset is created or enhanced. A
determination that the preproduction activity creates or enhances an asset
that the customer controls as the asset is created or enhanced would
indicate that the preproduction activity is, or forms part of, a performance
obligation.
Example 5-2
An entity enters into a contract
with a customer to develop and produce a new
product. As part of its development of that new
product for the customer, the entity performs
engineering and development activities. The entity
determines that (1) the customer will own the
intellectual property (patents) that results from
those activities and (2) those activities are
creating an asset that the customer controls as the
asset is created.
Accordingly, the entity concludes
that (1) the engineering and development activities
are transferring a good or service to the customer
over time and (2) those activities are, or form part
of, the performance obligation(s) in the contract
with the customer.
The above issue is addressed in Q&A 16 (compiled from
previously issued TRG Agenda Papers 46 and 49) 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.
5.2.4.2 Promise to Stand Ready to Accept a Returned Product
Entities often offer customers the right to return a product
within a certain period after its initial sale, provided that the product
has not been used or damaged. ASC 606-10-55-24 states that 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”
(emphasis added). Therefore, a right of return is not a separate performance
obligation. However, a customer’s right to return a product may affect the
amount of revenue recognized (the transaction price) because revenue may
only be recognized for goods that are not expected to be returned.
For further discussion of sales with a right of return, see Section
6.3.5.3. For stand-ready obligations to provide goods or
services, see Section
5.4.3.
5.2.4.3 Shipping and Handling Activities
ASC 606-10
25-18A An entity that promises a good to a customer also might perform shipping and handling activities
related to that good. If the shipping and handling activities are performed before the customer obtains control
of the good (see paragraphs 606-10-25-23 through 25-30 for guidance on satisfying performance obligations),
then the shipping and handling activities are not a promised service to the customer. Rather, shipping and
handling are activities to fulfill the entity’s promise to transfer the good.
25-18B If shipping and handling activities are performed after a customer obtains control of the good, then
the entity may elect to account for shipping and handling as activities to fulfill the promise to transfer the good.
The entity shall apply this accounting policy election consistently to similar types of transactions. An entity that
makes this election would not evaluate whether shipping and handling activities are promised services to its
customers. If revenue is recognized for the related good before the shipping and handling activities occur, the
related costs of those shipping and handling activities shall be accrued. An entity that applies this accounting
policy election shall comply with the accounting policy disclosure requirements in paragraphs 235-10-50-1
through 50-6.
Stakeholders asked the FASB to clarify whether shipping and handling services
that do not represent the predominant activity in the contract should be
accounted for as a promised service (i.e., potentially a separate
performance obligation to which a portion of the transaction price must be
allocated) or as a fulfillment cost that should be accounted for under the
new fulfillment cost guidance in ASC 340-40.
In April 2016, the FASB issued ASU 2016-10,4 which provides a practical expedient that permits an entity to account
for shipping and handling activities that occur after the customer has
obtained control of a good as fulfillment activities (i.e., an expense)
rather than as a promised service (i.e., a revenue element). An entity may
also elect to account for shipping and handling activities that occur after
control of the good is transferred to the customer as a promised service.
When the practical expedient is elected and revenue for the related good is
recognized before the shipping and handling activities occur, the entity
should accrue the costs of the shipping and handling activities at the time
control of the related good is transferred to the customer (i.e., at the
time of sale).
ASU 2016-10 also explains that shipping and handling activities performed before control of a product
is transferred do not constitute a promised service to the customer in the contract (i.e., they represent
fulfillment costs).
Connecting the Dots
The election to account for shipping and handling services as a promised service (a revenue
element) or a fulfillment activity (a cost element) typically should not apply to entities whose
principal service offering is shipping or transportation. Further, we believe that such election
(1) should be applied consistently and (2) is available to entities that recognize revenue for the
sale of goods either at a point in time or over time.
In a speech at the 2017 AICPA Conference on Current SEC and PCAOB Developments, Barry Kanczuker, associate chief accountant in the SEC’s Office of the Chief Accountant (OCA), provided the following guidance on the classification of shipping and handling expenses:
The staff has received questions under Topic 606 regarding the classification of shipping and handling expenses. Under Topic 606, if the shipping and handling activities are performed before the customer obtains control of the good, a registrant would account for the shipping and handling as activities to fulfill the promise to transfer the good. If shipping and handling is performed after a customer obtains control of the good, an entity may either account for shipping and handling as a promised service to the customer or elect to account for shipping and handling as activities to fulfill the promise to transfer the good. The questions we received related specifically to those shipping and handling expenses that were accounted for as activities to fulfill the promise to transfer the good, and these questions arose because the prior guidance on classification of shipping and handling expenses, and the explicit policy election regarding classification of such costs, was superseded by the new revenue standard, which now does not include any guidance that addresses the classification of shipping and handling expenses.
Given the noted absence of any guidance, I believe an entity will need to apply reasonable judgment in determining the appropriate classification of shipping and handling expenses for those shipping and handling activities that are accounted for as activities to fulfill the promise to transfer the good. Hence, the staff noted it would not object to the following approaches. First, the staff noted that it would not object to classification of these expenses within cost of sales. Second, given that there is no explicit guidance within Topic 606 related to the classification of shipping and handling expenses, the staff noted that it also would not object to an entity continuing to apply its previous policy regarding classification of these expenses, which could potentially be outside of cost of sales. I believe that a registrant that classifies significant shipping and handling costs outside of cost of sales should consider whether it should disclose the amount of such costs and the line item or items on the income statement that include them, similar to the disclosures required under the previous guidance. [Footnotes omitted]
5.2.4.4 Mobilization Activities
In some industries, entities may perform “mobilization” activities at or near
contract inception to fulfill their performance obligations under contracts
within the scope of ASC 606 (e.g., transportation of equipment to the
construction site). Questions have arisen about how an entity should account
for such mobilization activities. Frequently, these activities do not result
in the transfer of a good or service to the customer; rather, they represent
set-up activities and are therefore not accounted for as part of the
performance obligation(s) in the contract with the customer. Refer to
Section
13.3.5 for a discussion about the accounting for incurred
costs related to set-up activities and mobilization.
Footnotes
[1]
In April 2016, the FASB issued ASU 2016-10.
As a result of ASU 2016-10, the customer’s “valid” expectation, as
discussed in paragraph BC87 of ASU 2014-09, was changed to the
customer’s “reasonable” expectation under ASC 606-10-25-16.
2
The IASB did not amend IFRS 15 to expressly address
immaterial promises. Accordingly, IFRS 15 does not include similar
guidance on determining the materiality of promised goods or services.
Rather, an entity’s overall materiality considerations should be used in
the evaluation of promised goods or services under IFRS 15. The boards
do not expect a significant difference in application. For a summary of
differences between U.S. GAAP and IFRS Accounting Standards on
revenue-related topics, see Appendix A.
3
Such a preproduction activity could be a performance
obligation in its own right or could form part of a larger
performance obligation.
4
The IASB did not amend IFRS 15 to expressly address
shipping and handling activities. Accordingly, IFRS 15 does not
include similar elections. See Appendix A for a summary of
differences between U.S. GAAP and IFRS Accounting Standards on
revenue-related topics.
5.3 Identifying Performance Obligations in a Contract
5.3.1 In General
After identifying the promises in a contract with a customer, an entity must determine whether a
promise or multiple promises represent performance obligations to the customer. To accomplish this,
the entity should determine whether the promises in the contract are distinct in accordance with ASC
606-10-25-14.
ASC 606-10
25-14 At contract inception, an entity shall assess the goods or services promised in a contract with
a customer and shall identify as a performance obligation each promise to transfer to the customer
either:
- A good or service (or a bundle of goods or services) that is distinct
- A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see paragraph 606-10-25-15).
The identification of performance obligations is critical to the
recognition of revenue because entities will use performance obligations as a
means to measure the progress of satisfying the transfer of control of the goods
or services. However, such identification will require judgment and will
sometimes be time-consuming and complex.
Connecting the Dots
The process of identifying performance obligations is
sometimes referred to as “unbundling,” which is not optional. Proper
identification of the performance obligations in a contract is a
critical aspect of the core principle of ASC 606, which is to “recognize
revenue to depict the transfer of promised goods or services to
customers in an amount that reflects the consideration to which the
entity expects to be entitled in exchange for those goods or services.”
Failure to identify and account for the separate performance obligations
in a contract could result in the incorrect timing of revenue
recognition.
As a practical matter, however, it may not be necessary
to apply the detailed guidance in ASC 606 on unbundling if the amounts
recognized and disclosed in the financial statements will be the same
irrespective of whether unbundling is performed. For example, when
control of two or more goods or two or more services is transferred at
exactly the same time, or on the same basis over the same period, and if
those items do not need to be segregated for disclosure purposes, it
will not be necessary to unbundle each of those concurrently delivered
items because the amount and timing of revenue recognized and disclosed
under the model would not differ if the items were unbundled. The boards
acknowledged this in paragraph BC116 of ASU 2014-09 as follows:
In
their redeliberations, the Boards observed that paragraph
606-10-25-14(b) applies to goods or services that are delivered
consecutively, rather than concurrently. The Boards noted that Topic
606 would not need to specify the accounting for concurrently
delivered distinct goods or services that have the same pattern of
transfer. This is because, in those cases, an entity is not
precluded from accounting for the goods or services as if they were
a single performance obligation, if the outcome is the same as
accounting for the goods and services as individual performance
obligations.
In addition, paragraph BC47 of ASU 2016-10 states:
In many contracts,
distinct sets of rights are coterminous. That is, the rights are
transferred to the customer at the same point in time (in the case
of licenses that provide a right to use intellectual property) or
over the same period of time (in the case of licenses that provide a
right to access intellectual property). Consistent with the
discussion in paragraph BC116 of Update 2014-09, an entity would not
be required to separately identify each set of distinct rights if
those rights are transferred concurrently. For example, a licensor
would not be precluded from accounting for the two sets of distinct
rights in Example 61B as a single performance obligation if the
facts of that example were modified such that the customer was able
to begin to use and benefit from both sets of rights on January 1,
20X1 (rather than Class 1 on January 1, 20X1, and Class 2 on January
1, 20X2).
The next sections discuss various types of performance
obligations. However, for a discussion of material rights, see Chapter 11.
5.3.2 Criteria to Be Distinct
ASC 606-10
25-19 A good or service that is promised to a customer is distinct if both of the following criteria are met:
- The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct).
- The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract).
25-22 If a promised good or
service is not distinct, an entity shall combine that
good or service with other promised goods or services
until it identifies a bundle of goods or services that
is distinct. In some cases, that would result in the
entity accounting for all the goods or services promised
in a contract as a single performance obligation.
To be a performance obligation, a promised good or service must be both (1)
capable of being distinct and (2) distinct within the context of the contract.
Early in the development of the revenue standard, the FASB and IASB thought that
goods and services should have a distinct function.5 Entities asked for further explanation of what that meant. Accordingly,
the boards provided the guidance in ASC 606-10- 25-19(a) and (b) (paragraph
27(a) and (b) of IFRS 15).
Not all promises individually will meet both of these criteria. Under ASC
606-10-25-22, if an entity assesses a promise and determines that the promise
does not meet the criteria, the entity is required to combine the promise with
other promised goods or services in the contract until the criteria are met. For
illustrations of how an entity should combine the promises in a contract until
those promises meet the criteria to be a performance obligation, see Cases A, B,
and C of Example 10 in ASC 606, which are reproduced in Section 5.3.2.3.
5.3.2.1 Capable of Being Distinct
The first criterion in ASC 606-10-25-19 that must be met for a promised good or
service to be distinct (i.e., the good or service is capable of being
distinct) is expanded in ASC 606-10-25-20.
ASC 606-10
25-20 A customer can benefit from a good or service in accordance with paragraph 606-10-25-19(a) if the
good or service could be used, consumed, sold for an amount that is greater than scrap value, or otherwise
held in a way that generates economic benefits. For some goods or services, a customer may be able to benefit
from a good or service on its own. For other goods or services, a customer may be able to benefit from the
good or service only in conjunction with other readily available resources. A readily available resource is a
good or service that is sold separately (by the entity or another entity) or a resource that the customer has
already obtained from the entity (including goods or services that the entity will have already transferred to the
customer under the contract) or from other transactions or events. Various factors may provide evidence that
the customer can benefit from a good or service either on its own or in conjunction with other readily available
resources. For example, the fact that the entity regularly sells a good or service separately would indicate that a
customer can benefit from the good or service on its own or with other readily available resources.
As noted in paragraph BC99 of ASU 2014-09, the FASB and IASB determined that the first criterion for
assessing whether goods or services in a contract are distinct would require an entity to assess whether
a customer could economically benefit from the goods or services on their own or together with
other readily available resources. “Readily available resources” could be those that have already been
transferred to the customer as part of the current contract or prior contracts. The fact that a good or
service is typically sold on its own is an indicator that the good or service meets the first criterion.
In paragraph BC97 of ASU 2014-09, the FASB and IASB describe an arrangement that fails the “capable
of being distinct” criterion. Specifically, the boards state that if an entity transfers control of a machine to
a customer, but the machine will not provide an economic benefit to the customer without installation
that only the entity can perform, the machine is not distinct.
Application of the “capable of being distinct” criterion is further illustrated
in Example 56, Case A, of the revenue standard. In that example, which is
reproduced in Section
12.3, an entity determines that a pharmaceutical patent license
is not distinct from the entity’s promise to manufacture the drug for the
customer because the customer cannot benefit from the license without the
corresponding manufacturing service.
The assessment of whether the customer can economically benefit from the goods or services on
its own should not be based on the customer’s intended use of the goods or services. As stated
in paragraph BC101 of ASU 2014-09, the FASB and IASB “observed that it would be difficult, if not
impossible, for an entity to know the customer’s intentions in a given contract.” Accordingly, paragraph
BC100 of ASU 2014-09 notes that the assessment of whether the customer can benefit from the
goods or services on its own “should be based on the characteristics of the promised goods or services
themselves” and should exclude “contractual limitations that might preclude the customer from
obtaining readily available resources from a source other than the entity.”
However, paragraph BC102 of ASU 2014-09 indicates that in developing the revenue
standard, the FASB and IASB determined that it may be impractical to
separate every promised good or service that is capable of being distinct.
More importantly, the boards noted that doing so could produce outcomes that
(1) are not decision-useful and (2) do not faithfully represent an entity’s
performance related to delivering on its promises in a contract. A simple
example to illustrate this notion is a construction-type contract in which
an entity transfers to a customer multiple goods or services — such as raw
materials and construction labor services — that are capable of being
distinct. Separating, measuring, and recognizing revenue for each of these
goods or services would result in the recognition of revenue when the
materials and other services are provided instead of as the entity performs
by using the materials to construct an item promised to the customer and for
which the customer ultimately contracted.
Accordingly, the FASB and IASB developed a second criterion that must also be met for a promised
good or service to be distinct. Specifically, under ASC 606-10-25-19(b) (paragraph 27(b) of IFRS 15), the
promised good or service must be distinct within the context of the contract.
5.3.2.2 Distinct Within the Context of the Contract
ASC 606-10
25-21 In assessing whether an entity’s promises to transfer goods or services to the customer are separately
identifiable in accordance with paragraph 606-10-25-19(b), the objective is to determine whether the nature
of the promise, within the context of the contract, is to transfer each of those goods or services individually or,
instead, to transfer a combined item or items to which the promised goods or services are inputs. Factors that
indicate that two or more promises to transfer goods or services to a customer are not separately identifiable
include, but are not limited to, the following:
- The entity provides a significant service of integrating goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted. In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer. A combined output or outputs might include more than one phase, element, or unit.
- One or more of the goods or services significantly modifies or customizes, or are significantly modified or customized by, one or more of the other goods or services promised in the contract.
- The goods or services are highly interdependent or highly interrelated. In other words, each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, in some cases, two or more 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.
As indicated in ASC 606-10-25-19(b), the second criterion that must be met for a
promise to be a performance obligation is that the promised good or service
is distinct within the context of the contract. The FASB and IASB decided to
include this criterion because there could be situations in which a good or
service is typically sold on its own and therefore is capable of being
distinct, but the entity’s contract with the customer requires the entity to
provide additional goods and services and what the customer is actually
acquiring is the combined goods and services (e.g., as in the
construction-type contract noted in Section 5.3.2.1). Accordingly, the entity
should combine the goods and services so that it can recognize revenue
associated with the performance obligation in a way that truly depicts the
transfer of control of the promised goods and services.
As discussed in paragraph BC103 of ASU 2014-09, the second separation criterion
was developed to help stakeholders identify “separable risks.” That is, “the
individual goods or services in a bundle would not be distinct if the risk
that an entity assumes to fulfill its obligation to transfer one of those
promised goods or services to the customer is a risk that is inseparable
from the risk relating to the transfer of the other promised goods or
services in that bundle.” Observing that the concept of separable risks was
not well understood by stakeholders, the boards indicated that the objective
of the second criterion is to evaluate whether an entity’s promise to
transfer a good or service is “separately identifiable” from other promises
in the contract. However, this framework was also not well understood, and
stakeholders requested that the FASB provide additional guidance on the
second criterion to clarify when a promise is separately identifiable. As a
result, the FASB issued ASU 2016-10, which clarifies the intent of the
“separately identifiable” principle in ASC 606-10-25-21 by providing, in a
manner consistent with the notion of separable risks, what paragraph BC31 of
ASU 2016-10 describes as “three factors that indicate that an entity’s
promises to transfer goods or services to a customer are not separately
identifiable.” Accordingly, the focus is now on the bundle of goods or
services instead of individual goods or services.
5.3.2.2.1 Providing a Service to Integrate a Good or Service With Other Goods or Services
As discussed in paragraph BC107 of ASU 2014-09, when an entity evaluates whether a contract with a customer provides for a significant service of integrating a good or service with other goods or services, the entity should consider whether the risk of transferring that good or service is inseparable from the risk of transferring the other goods or services because the promise in the contract is to ensure that the individual goods or services are incorporated into the combined output for which the customer has contracted. An example of the factor in ASC 606-10-25-21(a) is a construction contract to build a house (as noted in Section 5.3.2.1). The contract will require the entity to provide the materials and labor needed to build the house. However, identifying all items that are capable of being distinct, such as wood or cement, would not represent the entity’s true obligation because the customer is not purchasing those items individually. Rather, the customer contracted with the entity to purchase a house. Therefore, it would make more sense to identify the performance obligation as the entity’s overall promise to build a house.
This concept is further discussed in paragraph BC29 of ASU 2016-10, which
states that the entity should consider “whether the multiple promised
goods or services in the contract are outputs or, instead, are inputs to
a combined item (or items).” The paragraph goes on to explain that the
combined item “is greater than (or substantively different from) the sum
of those promised (component) goods and services.” If multiple promised
goods or services represent inputs rather than individual outputs, such
goods or services would not be separately identifiable.
In a speech at the 2018 AICPA Conference on Current SEC and PCAOB Developments, OCA Professional Accounting Fellow Sheri York discussed her views on determining whether an entity provides a significant integration service that results in a combined performance obligation of equipment and services:
In a recent consultation with OCA, a registrant provided its customer with a commercial security monitoring service by integrating a variety of cameras and sensors . . . with the registrant’s technology platform. . . . The registrant believed it was providing a significant service of integrating the goods and services in the contract into a bundle that represented the combined output for which the customer had contracted. More specifically, the delivery of a “smart” security monitoring service would not be possible if the equipment were not integrated with the technology platform. . . . In this fact pattern, the entity demonstrated reasonable judgment that they were providing a significant integration service that transformed the equipment and services into a combined output that provided the customer with an overall service offering that was greater than the customer could receive from each individual part. [Footnotes omitted]
5.3.2.2.2 Significant Modification or Customization
In certain circumstances, an entity’s contract with a customer may contain a promise to modify or customize another promised good or service in the contract such that the customer’s expectation is the delivery of the modified or customized good or service. An example of the factor in ASC 606-10-25-21(b) is a software contract in which the entity promises to customize software for the customer (see paragraphs BC109 and BC110 of ASU 2014-09). In determining how many performance obligations exist, the entity would have to consider whether the customer could really benefit from the software without the customization.
5.3.2.2.3 Goods or Services Are Highly Interdependent or Interrelated
In certain cases, goods or
services are so highly interdependent or
interrelated that the utility of each individual
good or service is significantly affected by other
goods or services in the contract. The factor in
ASC 606-10-25-21(c) is illustrated by a third
scenario described in ASU 2014-09, in which an
entity designs and manufactures a new experimental
product for a customer (see paragraphs BC111 and
BC112 of ASU 2014-09). The entity expects that as
it develops the product, it will have to make many
revisions to the product to meet the customer’s
needs. The entity also expects the manufacturing
process to affect the product’s design because the
entity will need to determine how to manufacture
the product for the customer. Since both the
design and the manufacturing of the product are
necessary to satisfy the contract with the
customer and neither process alone will provide
the customer with a product that it can use, both
processes would be combined and treated as one
performance obligation.
|
Paragraphs BC32 and BC33 of ASU 2016-10 further expand on the concept of
whether goods or services are highly interdependent of interrelated.
Paragraph BC32 of ASU 2016-10 states, in part:
The separately
identifiable principle is intended to consider the level of
integration, interrelation, or interdependence among promises to
transfer goods or services. That is, the separately identifiable
principle is intended to evaluate when an entity’s performance in
transferring a bundle of goods or services in a contract is, in
substance, fulfilling a single promise to a customer. Therefore, the
entity should evaluate whether two or more promised goods or
services (for example, a delivered item and an undelivered item)
each significantly affect the other (and, therefore, are highly
interdependent or highly interrelated) in the contract. The entity
should not merely evaluate whether one item, by its nature, depends
on the other (for example, an undelivered item that would never be
obtained by a customer absent the presence of the delivered item in
the contract or the customer having obtained that item in a
different contract).
Paragraph BC33(b) of ASU 2016-10 discusses how the utility of a promised
good or service may depend on the other promised goods or services in a
contract and therefore each good or service may significantly affect the
other. Paragraph BC33(b) of ASU 2016-10 states, in part:
[T]he
evaluation of whether two or more promises in a contract are
separately identifiable also considers the utility of the promised
goods or services (that is, the ability of each good or service to
provide benefit or value). This is because an entity may be able to
fulfill its promise to transfer each good or service in a contract
independently of the other, but each good or service may
significantly affect the other’s utility to the customer. For
example, in Example 10, Case C, or in Example 55, the entity’s
ability to transfer the initial license is not affected by its
promise to transfer the updates or vice versa, but the provision (or
not) of the updates will significantly affect the utility of the
licensed intellectual property to the customer such that the license
and the updates are not separately identifiable. They are, in
effect, inputs to the combined solution for which the customer
contracted. The “capable of being distinct” criterion also considers
the utility of the promised good or service, but merely establishes
the baseline level of economic substance a good or service must have
to be “capable of being distinct.” Therefore, utility also is
relevant in evaluating whether two or more promises in a contract
are separately identifiable because even if two or more goods or
services are capable of being distinct because the customer can
derive some economic benefit from each one, the customer’s ability
to derive its intended benefit from the contract may depend on the
entity transferring each of those goods or services.
If the functionality of a promised good or service is significantly
limited or diminished without the use of another promised good or
service, and vice versa, that significantly limited or diminished
functionality may indicate that the goods or services (1) are highly
interdependent or highly interrelated (i.e., they significantly affect
each other) and (2) function together as inputs to a combined output.
This, in turn, may indicate that the promises are not distinct within
the context of the contract since the customer cannot obtain the
intended benefit of one good or service without the other. That is,
while the customer may be able to obtain some functionality from a good
or service on a stand-alone basis, it would not obtain the intended
outputs from each good or service individually because each good or
service is critical to the customer’s intended use of the combined
output. In this situation, the entity cannot fulfill its promise to the
customer by transferring each good or service independently (i.e., the
customer could not choose to purchase one good or service without
significantly affecting the other good or service in the contract).
In addition, transformative functionality should be assessed separately
from additive functionality. Transformative functionality comprises
features that significantly affect the overall operation and interaction
of the combined output. To be transformative, the inputs must
significantly affect each other. That is, the promised goods or services
are inputs to a combined output such that the combined output has
greater value than, or is substantively different from, the sum of the
inputs. By contrast, additive functionality comprises features that
provide an added benefit to the customer without substantively altering
(1) the manner in which the functionality is used and (2) the benefits
derived from the functionality of a good or service on a stand-alone
basis. Even if added functionality is significant, it may not be
transformative. It is more likely that goods or services are highly
interdependent or highly interrelated when the functionality of the
combined output is transformative rather than additive.
In a speech at the 2017 AICPA Conference on Current SEC and PCAOB Developments, Joseph Epstein, professional accounting fellow in the OCA, provided the following guidance on the identification of performance obligations — specifically, whether an entity’s promise to transfer a good or service to a customer is separately identifiable from other promises in the contract:
I’d also like to take this opportunity to remind registrants that in evaluating whether two or more promised goods or services each significantly affect the other (and, therefore, are highly interdependent or highly interrelated), registrants should not merely evaluate whether one item, by its nature, depends on the other. Rather, those goods or services should significantly affect each other. [Emphasis added, footnote omitted]
Sarah Esquivel, associate chief accountant in the OCA, elaborated on this topic
in a speech at the 2018 AICPA Conference on Current SEC
and PCAOB Developments. In her speech, Ms. Esquivel described a fact
pattern related to the identification of performance obligations in a
contract for the sale of off-the-shelf patent application software. The
software enabled the customer to prepare patent applications and also
allowed the customer to print out the applications so that they could be
submitted by mail. In addition, the contract included a free, one-time
service of electronically submitting a patent application to the
appropriate government agency. Ms. Esquivel made the following comments
on whether the electronic submission service and the software were
sufficiently interdependent or interrelated to constitute a single
performance obligation:
In this fact pattern, the
service was a convenience to the customer, but it was not required .
. . . In addition, the choice of whether or not to use the service
did not significantly impact the utility of the software, and thus
the identified promises did not significantly affect each other, and
therefore were not highly interdependent or highly interrelated. As
a result, OCA objected to the registrant’s conclusion that the
promises in the contract comprised a single performance obligation.
[Footnote omitted]
This example emphasizes the view that entities should not merely evaluate whether one item depends on the other (one-way dependency); rather, they should evaluate whether the goods or services significantly affect each other (interdependency, or two-way dependency).
In a speech at the 2019 AICPA Conference on Current SEC
and PCAOB Developments, OCA Professional Accounting Fellow Susan Mercier
expanded on those views presented at the previous AICPA Conferences on
determining whether an entity provides a combined performance obligation
of software and updates. In addition, Ms. Mercier provided commentary of
the use of the term “solution”:
While I understand that the term “solution” is commonly used
nomenclature, I would observe that the staff is not persuaded
that promises should be combined into a single performance
obligation simply because a registrant labels those promises as
a “solution” that the “customer wants.” . . . I think that the
notion of considering if the registrant’s combined output is
greater than or substantively different from the sum of the
parts is helpful in many cases. . . .
In [a recent] consultation, the registrant
licenses software that allows its customers, application (“app”)
developers, to build and deploy, and therefore monetize, their
own apps on various third-party platforms. The third-party
platforms include phones as well as home entertainment systems,
which, as you can imagine, are frequently undergoing their own
updates. The registrant’s software and updates ensure that the
app built using the software is compatible with all platforms
that it supports, both when the app is initially deployed on a
platform and over time as that platform is updated. Therefore,
the registrant partners with the third-party platforms to
understand their timelines for internal updates so that the
registrant can ensure compatibility by initiating corresponding
updates to its software. Without these updates, the customer’s
ability to benefit from the software would be significantly
limited over the contract term.
Ultimately, the staff did not object to the registrant’s
conclusion that the software and updates represent a single
performance obligation. In the staff’s view, the registrant’s
promises to provide the software and the updates are, in effect,
inputs that together fulfill a single promise to the customer —
that is, to continually be able to deploy and monetize content
using third-party platforms of the customer’s choice in a
rapidly changing environment — and that the updates are integral
to maintaining the utility of the software. In other words, in
this fact pattern, the staff thinks that the combined output
(whether or not you label it a “solution”) is greater than, or
substantively different than, the individual promises (that is,
the software and the updates). [Footnotes omitted]
Further, in a speech at the 2020 AICPA Conference on Current SEC
and PCAOB Developments, OCA Professional Accounting Fellow Kevin
Cherrstrom provided insights (similar to those provided by Ms. Mercier
above) into an arrangement in which a software license and updates are
highly interdependent or interrelated and there is significant two-way
dependency between the software and the updates:
First, I would like to discuss a fact pattern whereby a
registrant concluded that its software license, along with
updates to the software license, represent a single performance
obligation. The assessment of whether a software license is
distinct from related services can have a significant effect on
the financial statements. Revenue from software and services
that are one combined performance obligation would be recognized
over time, while revenue from a software license that is
distinct would be recognized when control of the software
license transfers to the customer.
The registrant developed a new data analytics software platform
that it provides to its customers under a one-year license. The
software’s core functionality allows its customers to aggregate
data from multiple sources and analyze that data on a real-time
basis. To achieve that result, the software must be updated
periodically in response to both a customer’s internal changes,
such as new data sources or hardware added to the customer’s IT
environment, and to external changes, such as updates to
third-party software that impact the ability of the registrant’s
software to obtain real-time data from those third-party
systems. As part of the registrant’s promises to its customer,
it monitors the software for required updates and provides
updates to the licensed software as needed, on an on-going
basis, throughout the contract term.
The registrant performed a detailed assessment to determine the
nature of each of its updates in order to identify those
specific updates that are critical to maintaining the utility of
the software. The frequency of the critical software updates
varies depending on each customer’s unique IT environment,
ranging from critical updates provided on a daily basis for
customers with more dynamic IT systems, to critical updates
every few months for customers with static IT environments.
Regardless of the frequency of each customer’s critical updates,
if they were not provided to the customer, the software would
not be able to access and analyze the customer’s data. The
registrant concluded that the software license and updates are
highly interdependent or interrelated, such that they
significantly affect one another, and there is a significant
two-way dependency between the software and the related
updates.
In this fact pattern, the staff did not object to the
registrant’s conclusion that the software license and related
updates should be combined into a single performance
obligation.
5.3.2.3 Applying the “Distinct” Criteria
Now that the concepts have been established, the examples below will help illustrate how to apply them
in different situations.
ASC 606-10
Example 10 — Goods and Services Are Not Distinct
Case A — Significant Integration Service
55-137 An entity, a
contractor, enters into a contract to build a
hospital for a customer. The entity is responsible
for the overall management of the project and
identifies various promised goods and services,
including engineering, site clearance, foundation,
procurement, construction of the structure, piping
and wiring, installation of equipment, and
finishing.
55-138 The promised goods
and services are capable of being distinct in
accordance with paragraph 606-10- 25-19(a). That is,
the customer can benefit from the goods and services
either on their own or together with other readily
available resources. This is evidenced by the fact
that the entity, or competitors of the entity,
regularly sells many of these goods and services
separately to other customers. In addition, the
customer could generate economic benefit from the
individual goods and services by using, consuming,
selling, or holding those goods or services.
55-139 However, the
promises to transfer the goods and services are not
separately identifiable in accordance with paragraph
606-10-25-19(b) (on the basis of the factors in
paragraph 606-10-25-21). This is evidenced by the
fact that the entity provides a significant service
of integrating the goods and services (the inputs)
into the hospital (the combined output) for which
the customer has contracted.
55-140 Because both
criteria in paragraph 606-10-25-19 are not met, the
goods and services are not distinct. The entity
accounts for all of the goods and services in the
contract as a single performance obligation.
Case B — Significant Integration Service
55-140A An entity enters
into a contract with a customer that will result in
the delivery of multiple units of a highly complex,
specialized device. The terms of the contract
require the entity to establish a manufacturing
process in order to produce the contracted units.
The specifications are unique to the customer based
on a custom design that is owned by the customer and
that were developed under the terms of a separate
contract that is not part of the current negotiated
exchange. The entity is responsible for the overall
management of the contract, which requires the
performance and integration of various activities
including procurement of materials; identifying and
managing subcontractors; and performing
manufacturing, assembly, and testing.
55-140B The entity
assesses the promises in the contract and determines
that each of the promised devices is capable of
being distinct in accordance with paragraph
606-10-25-19(a) because the customer can benefit
from each device on its own. This is because each
unit can function independently of the other
units.
55-140C The entity
observes that the nature of its promise is to
establish and provide a service of producing the
full complement of devices for which the customer
has contracted in accordance with the customer’s
specifications. The entity considers that it is
responsible for overall management of the contract
and for providing a significant service of
integrating various goods and services (the inputs)
into its overall service and the resulting devices
(the combined output) and, therefore, the devices
and the various promised goods and services inherent
in producing those devices are not separately
identifiable in accordance with paragraphs
606-10-25-19(b) and 606-10-25-21. In this Case, the
manufacturing process provided by the entity is
specific to its contract with the customer. In
addition, the nature of the entity’s performance
and, in particular, the significant integration
service of the various activities mean that a change
in one of the entity’s activities to produce the
devices has a significant effect on the other
activities required to produce the highly complex
specialized devices such that the entity’s
activities are highly interdependent and highly
interrelated. Because the criterion in paragraph
606-10-25-19(b) is not met, the goods and services
that will be provided by the entity are not
separately identifiable, and, therefore, are not
distinct. The entity accounts for all of the goods
and services promised in the contract as a single
performance obligation.
Case C — Combined Item
55-140D An entity grants a
customer a three-year term license to anti-virus
software and promises to provide the customer with
when-and-if available updates to that software
during the license period. The entity frequently
provides updates that are critical to the continued
utility of the software. Without the updates, the
customer’s ability to benefit from the software
would decline significantly during the three-year
arrangement.
55-140E The entity
concludes that the software and the updates are each
promised goods or services in the contract and are
each capable of being distinct in accordance with
paragraph 606-10-25-19(a). The software and the
updates are capable of being distinct because the
customer can derive economic benefit from the
software on its own throughout the license period
(that is, without the updates the software would
still provide its original functionality to the
customer), while the customer can benefit from the
updates together with the software license
transferred at the outset of the contract.
55-140F The entity
concludes that its promises to transfer the software
license and to provide the updates, when-and-if
available, are not separately identifiable (in
accordance with paragraph 606-10-25-19(b)) because
the license and the updates are, in effect, inputs
to a combined item (anti-virus protection) in the
contract. The updates significantly modify the
functionality of the software (that is, they permit
the software to protect the customer from a
significant number of additional viruses that the
software did not protect against previously) and are
integral to maintaining the utility of the software
license to the customer. Consequently, the license
and updates fulfill a single promise to the customer
in the contract (a promise to provide protection
from computer viruses for three years). Therefore,
in this Example, the entity accounts for the
software license and the when- and-if available
updates as a single performance obligation. In
accordance with paragraph 606-10-25-33, the entity
concludes that the nature of the combined good or
service it promised to transfer to the customer in
this Example is computer virus protection for three
years. The entity considers the nature of the
combined good or service (that is, to provide
anti-virus protection for three years) in
determining whether the performance obligation is
satisfied over time or at a point in time in
accordance with paragraphs 606-10-25-23 through
25-30 and in determining the appropriate method for
measuring progress toward complete satisfaction of
the performance obligation in accordance with
paragraphs 606-10-25-31 through 25-37.
Example 11 — Determining Whether
Goods or Services Are Distinct
Case A — Distinct Goods or
Services
55-141 An entity, a software
developer, enters into a contract with a customer to
transfer a software license, perform an installation
service, and provide unspecified software updates
and technical support (online and telephone) for a
two-year period. The entity sells the license,
installation service, and technical support
separately. The installation service includes
changing the web screen for each type of user (for
example, marketing, inventory management, and
information technology). The installation service is
routinely performed by other entities and does not
significantly modify the software. The software
remains functional without the updates and the
technical support.
55-142 The entity assesses the goods and services promised to the customer to determine which goods and
services are distinct in accordance with paragraph 606-10-25-19. The entity observes that the software is
delivered before the other goods and services and remains functional without the updates and the technical
support. The customer can benefit from the updates together with the software license transferred at the
outset of the contract. Thus, the entity concludes that the customer can benefit from each of the goods and
services either on their own or together with the other goods and services that are readily available and the
criterion in paragraph 606-10-25-19(a) is met.
55-143 The entity also considers the principle and the factors in paragraph 606-10-25-21 and determines that
the promise to transfer each good and service to the customer is separately identifiable from each of the other
promises (thus, the criterion in paragraph 606-10-25-19(b) is met). In reaching this determination the entity
considers that although it integrates the software into the customer’s system, the installation services do not
significantly affect the customer’s ability to use and benefit from the software license because the installation
services are routine and can be obtained from alternate providers. The software updates do not significantly
affect the customer’s ability to use and benefit from the software license because, in contrast with Example 10
(Case C), the software updates in this contract are not necessary to ensure that the software maintains a high
level of utility to the customer during the license period. The entity further observes that none of the promised
goods or services significantly modify or customize one another and the entity is not providing a significant
service of integrating the software and the services into a combined output. Lastly, the entity concludes that the
software and the services do not significantly affect each other and, therefore, are not highly interdependent or
highly interrelated because the entity would be able to fulfill its promise to transfer the initial software license
independent from its promise to subsequently provide the installation service, software updates, or technical
support.
55-144 On the basis of this assessment, the entity identifies four performance obligations in the contract for
the following goods or services:
- The software license
- An installation service
- Software updates
- Technical support.
55-145 The entity applies paragraphs 606-10-25-23 through 25-30 to determine whether each of the
performance obligations for the installation service, software updates, and technical support are satisfied at a
point in time or over time. The entity also assesses the nature of the entity’s promise to transfer the software
license in accordance with paragraphs 606-10-55-59 through 55-60 and 606-10-55-62 through 55-64A (see
Example 54 in paragraphs 606-10-55-362 through 55-363B).
Case B — Significant Customization
55-146 The promised goods and services are the same as in Case A, except that the contract specifies that, as
part of the installation service, the software is to be substantially customized to add significant new functionality
to enable the software to interface with other customized software applications used by the customer. The
customized installation service can be provided by other entities.
55-147 The entity assesses the goods and services promised to the customer to determine which goods and
services are distinct in accordance with paragraph 606-10-25-19. The entity first assesses whether the criterion
in paragraph 606-10-25-19(a) has been met. For the same reasons as in Case A, the entity determines that
the software license, installation, software updates, and technical support each meet that criterion. The entity
next assesses whether the criterion in paragraph 606-10-25-19(b) has been met by evaluating the principle
and the factors in paragraph 606-10-25-21. The entity observes that the terms of the contract result in a
promise to provide a significant service of integrating the licensed software into the existing software system by
performing a customized installation service as specified in the contract. In other words, the entity is using the
license and the customized installation service as inputs to produce the combined output (that is, a functional
and integrated software system) specified in the contract (see paragraph 606-10-25-21(a)). The software is
significantly modified and customized by the service (see paragraph 606-10-25-21(b)). Consequently, the
entity determines that the promise to transfer the license is not separately identifiable from the customized
installation service and, therefore, the criterion in paragraph 606-10-25-19(b) is not met. Thus, the software
license and the customized installation service are not distinct.
55-148 On the basis of the same analysis as in Case A, the entity concludes that the software updates and
technical support are distinct from the other promises in the contract.
55-149 On the basis of this assessment, the entity identifies three performance obligations in the contract for
the following goods or services:
- Software customization which is comprised of the license to the software and the customized installation service
- Software updates
- Technical support.
55-150 The entity applies paragraphs 606-10-25-23 through 25-30 to determine whether each performance
obligation is satisfied at a point in time or over time and paragraphs 606-10-25-31 through 25-37 to measure
progress toward complete satisfaction of those performance obligations determined to be satisfied over time.
In applying those paragraphs to the software customization, the entity considers that the customized software
to which the customer will have rights is functional intellectual property and that the functionality of that
software will not change during the license period as a result of activities that do not transfer a good or service
to the customer. Therefore, the entity is providing a right to use the customized software. Consequently, the
software customization performance obligation is completely satisfied upon completion of the customized
installation service. The entity considers the other specific facts and circumstances of the contract in the
context of the guidance in paragraphs 606-10-25-23 through 25-30 in determining whether it should recognize
revenue related to the single software customization performance obligation as it performs the customized
installation service or at the point in time the customized software is transferred to the customer.
Case C — Promises Are Separately Identifiable (Installation)
55-150A An entity contracts with a customer to sell a piece of equipment and installation services. The
equipment is operational without any customization or modification. The installation required is not complex
and is capable of being performed by several alternative service providers.
55-150B The entity identifies two promised goods and services in the contract: (a) equipment and (b)
installation. The entity assesses the criteria in paragraph 606-10-25-19 to determine whether each promised
good or service is distinct. The entity determines that the equipment and the installation each meet the
criterion in paragraph 606-10-25-19(a). The customer can benefit from the equipment on its own, by using it
or reselling it for an amount greater than scrap value, or together with other readily available resources (for
example, installation services available from alternative providers). The customer also can benefit from the
installation services together with other resources that the customer will already have obtained from the entity
(that is, the equipment).
55-150C The entity further determines that its promises to transfer the equipment and to provide the
installation services are each separately identifiable (in accordance with paragraph 606-10-25-19(b)). The entity
considers the principle and the factors in paragraph 606-10-25-21 in determining that the equipment and
the installation services are not inputs to a combined item in this contract. In this Case, each of the factors
in paragraph 606-10-25-21 contributes to, but is not individually determinative of, the conclusion that the
equipment and the installation services are separately identifiable as follows:
- The entity is not providing a significant integration service. That is, the entity has promised to deliver the equipment and then install it; the entity would be able to fulfill its promise to transfer the equipment separately from its promise to subsequently install it. The entity has not promised to combine the equipment and the installation services in a way that would transform them into a combined output.
- The entity’s installation services will not significantly customize or significantly modify the equipment.
- Although the customer can benefit from the installation services only after it has obtained control of the equipment, the installation services do not significantly affect the equipment because the entity would be able to fulfill its promise to transfer the equipment independently of its promise to provide the installation services. Because the equipment and the installation services do not each significantly affect the other, they are not highly interdependent or highly interrelated.
On the basis of this assessment, the entity identifies two performance obligations (the equipment and
installation services) in the contract.
55-150D The entity applies paragraphs 606-10-25-23 through 25-30 to determine whether each performance
obligation is satisfied at a point in time or over time.
Case D — Promises Are Separately Identifiable (Contractual
Restrictions)
55-150E Assume the same facts as in Case C, except that the customer is contractually required to use the
entity’s installation services.
55-150F The contractual requirement to use the entity’s installation services does not change the evaluation of
whether the promised goods and services are distinct in this Case. This is because the contractual requirement
to use the entity’s installation services does not change the characteristics of the goods or services themselves,
nor does it change the entity’s promises to the customer. Although the customer is required to use the entity’s
installation services, the equipment and the installation services are capable of being distinct (that is, they
each meet the criterion in paragraph 606-10-25-19(a)), and the entity’s promises to provide the equipment
and to provide the installation services are each separately identifiable (that is, they each meet the criterion in
paragraph 606-10-25-19(b)). The entity’s analysis in this regard is consistent with Case C.
Case E — Promises Are Separately Identifiable (Consumables)
55-150G An entity enters into a contract with a customer to provide a piece of off-the-shelf equipment (that is,
it is operational without any significant customization or modification) and to provide specialized consumables
for use in the equipment at predetermined intervals over the next three years. The consumables are produced
only by the entity, but are sold separately by the entity.
55-150H The entity determines that the customer can benefit from the equipment together with the readily
available consumables. The consumables are readily available in accordance with paragraph 606-10-25-20
because they are regularly sold separately by the entity (that is, through refill orders to customers that
previously purchased the equipment). The customer can benefit from the consumables that will be delivered
under the contract together with the delivered equipment that is transferred to the customer initially under the
contract. Therefore, the equipment and the consumables are each capable of being distinct in accordance with
paragraph 606-10-25-19(a).
55-150I The entity determines that its promises to transfer the equipment and to provide consumables
over a three-year period are each separately identifiable in accordance with paragraph 606-10-25-19(b). In
determining that the equipment and the consumables are not inputs to a combined item in this contract,
the entity considers that it is not providing a significant integration service that transforms the equipment
and consumables into a combined output. Additionally, neither the equipment nor the consumables are
significantly customized or modified by the other. Lastly, the entity concludes that the equipment and the
consumables are not highly interdependent or highly interrelated because they do not significantly affect
each other. Although the customer can benefit from the consumables in this contract only after it has
obtained control of the equipment (that is, the consumables would have no use without the equipment) and
the consumables are required for the equipment to function, the equipment and the consumables do not
each significantly affect the other. This is because the entity would be able to fulfill each of its promises in
the contract independently of the other. That is, the entity would be able to fulfill its promise to transfer the
equipment even if the customer did not purchase any consumables and would be able to fulfill its promise to
provide the consumables even if the customer acquired the equipment separately.
55-150J On the basis of this assessment, the entity identifies two performance obligations in the contract for
the following goods or services:
- The equipment
- The consumables.
55-150K The entity applies paragraphs 606-10-25-23 through 25-30 to determine whether each performance
obligation is satisfied at a point in time or over time.
5.3.2.3.1 Assessing the Availability of Alternative Service Providers and Its Impact on the Identification of Performance Obligations
The illustrative examples in ASC 606 provide certain
facts used to support a determination of whether a promised good or
service is distinct and therefore a separate performance obligation.
However, some facts may vary between examples while the conclusions are
consistent. For instance, in Example 11, Case C (ASC 606-10-55-150A
through 55-150D), one of the facts provided to support the conclusion
that the equipment and installation services represent two performance
obligations is that others can provide the installation services.
However, in Example 11, Case E (ASC 606-10-55-150G through 55-150K), the
conclusion that the equipment and specialized consumables are two
performance obligations is reached even though the specialized
consumables are not available from other entities. This is because the
entity in the example would be able to fulfill each of its promises in
the contract (i.e., each promise to provide an item of equipment and
consumables) independently of the other promises.
If a good or service (e.g., installation service) is
unavailable from alternative providers, or available from only a limited
number of alternative providers, an entity is not precluded from
considering the good or service a separate performance obligation. The
unavailability of a good or service from alternative providers is a
factor for an entity to consider in evaluating whether the good or
service is distinct (and therefore a separate performance obligation),
but that factor is not individually determinative (as noted in the
examples cited above). Entities need to use judgment in evaluating
whether a promise to provide a good or service, in addition to other
goods or services, is capable of being distinct and is distinct within
the context of the contract (i.e., separately identifiable) in
accordance with ASC 606-10-25-19. In making that determination, an
entity may focus on why a good or service is or is not available from
other providers, especially when evaluating the following factors in ASC
606-10-25-21 to conclude on whether the good or service is separately
identifiable:
-
Whether there is a significant service of integrating goods or services.
-
Whether the good or service significantly modifies or customizes another good or service.
-
Whether the good or service and one or more other goods or services are highly interdependent or highly interrelated.
For example, if an entity sells equipment and provides
installation of that equipment, the determination of whether the
installation services are available from another entity would be a
factor to be considered in the evaluation of whether the installation is
distinct within the context of the contract, but that factor alone would
not be determinative. It is important for the reporting entity to
consider why the installation is unavailable from (or available from
only a limited number of) alternative providers to determine whether the
installation is separately identifiable in accordance with ASC
606-10-25-21. For example, if the entity has a standard installation
process that does not significantly customize or modify the equipment
for the entity’s customer, the entity may conclude that the installation
is separately identifiable regardless of whether there are no other
installation providers or only a limited number of such providers.
However, installation services that are unique and significantly modify
or customize the equipment for the customer may suggest that the
services are not separately identifiable and therefore are not distinct
within the context of the contract.
5.3.2.3.2 Identifying Performance Obligations in Co-Branded Credit Card Arrangements
An entity (e.g., a retailer or an airline) may enter
into a co-branded or private-label credit card arrangement with a
financial institution under which the financial institution issues
credit cards that bear the entity’s brand name or logo to individual
consumers. In both co-branded and private-label credit card
arrangements, the financial institution is issuing credit and operating
the card on its own behalf. Under a private-label credit card
arrangement, the credit card can be used to purchase goods or services
from only the entity (the “sponsoring entity”). However, under a
co-branded credit card arrangement, the credit card can be used to
purchase goods or services from any merchant that accepts that type of
credit card (e.g., MasterCard or Visa). When a cardholder uses a
private-label or co-branded credit card to make purchases, he or she
generally earns loyalty or rewards points that can be redeemed for free
or discounted products or services from the sponsoring entity.
Under co-branded credit card arrangements, the
sponsoring entity usually has various obligations to the financial
institution, including:
-
Licensing its brand name (for use on the credit card and marketing materials).
-
Providing access to its customer list (for marketing purposes).
-
Marketing the credit card program.
-
Providing products or services (or discounts on products or services) as part of a loyalty or rewards program.
-
Maintaining the loyalty or rewards program.
The sponsoring entity in a co-branded credit card
arrangement generally receives some combination of (1) an up-front or
incentive fee upon executing the credit card arrangement (such as a
signing bonus), (2) a fee for each new cardholder who signs up for a
credit card (sometimes referred to as a “bounty fee”), (3) a specified
percentage of the cardholders’ annual purchases or program profits, and
(4) reimbursements from the financial institution for certain costs,
such as products or services provided under the rewards program,
marketing expenses, or other related expenses (such as credit card
processing fees).
A sponsoring entity should carefully evaluate its
contractual arrangement with a financial institution when identifying
its performance obligations, as described more fully in the next
sections.
5.3.2.3.2.1 Identifying the Promised Goods or Services in Co-Branded Credit Card Arrangements
The first step in the evaluation is to identify all
of the promised goods or services in the contract. A typical
co-branded credit card arrangement consists of the following
promised goods or services:
-
License of brand name.
-
Access to customer list.
-
Marketing activities.
-
Maintaining the loyalty or rewards program.
Although the sponsoring entity has an obligation to
maintain the loyalty or rewards program, maintenance activities
related to the loyalty or rewards program generally do not
constitute a promised good or service in the arrangement. Rather,
the maintenance and administration of the loyalty or rewards program
are typically activities that a sponsoring entity undertakes to
fulfill its contract with the financial institution (specifically,
its obligation to license its brand name and provide access to its
customer list). That is, having a loyalty or rewards program makes
the sponsoring entity’s brand name more valuable to the financial
institution because individuals are more likely to sign up for the
credit card when they know that they can earn loyalty or rewards
points and redeem them with the sponsoring entity. In addition,
sponsoring entities generally maintain a loyalty or rewards program
for purposes other than the fulfillment of their credit card
arrangements and therefore would undertake these activities even
without entering into a contract with a financial institution.
Therefore, we generally do not believe that these activities
transfer a separate good or service to the financial
institution.
5.3.2.3.2.2 Identifying the Performance Obligations in Co-Branded Credit Card Arrangements
The next step in the evaluation is to identify which
of the promised goods or services in the contract represent distinct
performance obligations. In general, we believe that a co-branded
credit card arrangement such as the one described above contains at
least two performance obligations: (1) a license bundled with access
to the sponsoring entity’s customer list (the “brand performance
obligation”) and (2) an obligation to provide products or services
in the future for free or at a discount (the “rewards performance
obligation”). On the basis of the entity’s assessment, marketing the
credit card program may constitute a performance obligation of its
own or may be combined with the brand performance obligation.
Considerations relevant to the determination of
which promised goods or services in a co-branded credit card
arrangement are distinct (i.e., capable of being distinct and
separately identifiable) are as follows:
-
Brand performance obligation — Generally, the right to use an entity’s brand name is not sold separately from access to the entity’s customer list. Nevertheless, we believe that both the license of the sponsoring entity’s brand name and access to the sponsoring entity’s customer list are capable of being distinct because the financial institution could benefit from each one in conjunction with other readily available resources. That is, the sponsoring entity could sell each item separately, and the financial institution could separately perform the other activities (marketing and supply of products or services) on its own to derive economic benefits from the arrangement. However, we do not believe that the license to the brand name and the customer list are separately identifiable because the license and access to the customer list are highly interdependent.Generally, a significant portion of the value to the financial institution in this type of arrangement comes from the financial institution’s right to market to the sponsoring entity’s loyalty or rewards members, which is provided through access to the sponsoring entity’s customer list. In addition, strong brand recognition is intended to entice potential customers to enter into an arrangement with the financial institution for the co-branded credit card. Therefore, the value of the two items combined significantly exceeds the sum of the values that could be ascribed to the two individually. That is, the brand and access to the sponsoring entity’s customer list are highly interdependent.
-
Rewards performance obligation — The rewards performance obligation represents the sponsoring entity’s obligation to honor a cardholder’s redemption of loyalty or rewards points for free or discounted products or services in the future that are provided to the cardholder in connection with entering into a credit card agreement with the financial institution or through the use of the co-branded credit card. We believe that in this context, the rewards performance obligation could be accounted for in the same manner as a material right, which an entity is required to treat as a separate performance obligation under ASC 606-10-55-41 through 55-45. While we recognize that this obligation is technically to the customer’s customer (i.e., the cardholder) rather than the customer itself (i.e., the financial institution), we believe that the same principle applies since the sponsoring entity is promising the financial institution that it will provide and redeem the loyalty points. That is, the sponsoring entity is committed to providing goods or services in the future for free or at a discount, and accounting recognition should be given to this obligation. In some cases, the sponsoring entity may be separately selling loyalty points to the financial institution, whereas in other cases, the sponsoring entity grants the financial institution the right to issue loyalty points on its behalf. In both types of situations, the sponsoring entity has essentially granted the financial institution the right to provide loyalty or rewards points to cardholders on the basis of their spending level, and we believe that this right is appropriately accounted for as a separate performance obligation.
-
Marketing activities — Many co-branded credit card arrangements include some element of marketing activities. We believe that the marketing activities performed by the sponsoring entity typically are capable of being distinct because other entities (e.g., marketing agencies) regularly sell similar services on a stand-alone basis. In addition, the financial institution is able to benefit from these services along with other resources that have already been obtained from the sponsoring entity (i.e., the brand performance obligation). However, careful evaluation of the nature of marketing activities is required to determine whether they represent a separate performance obligation. For example, there may be certain marketing activities that only the entity is capable of providing (e.g., promotion of the card by sales personnel at the time of checkout) and that are not sold on a stand-alone basis. In addition, the marketing activities may not be separately identifiable in the contract because those activities and one or more other elements in the arrangement (e.g., the brand performance obligation) may be highly interdependent or highly interrelated. This is because the marketing activities may be specific to the co-branded credit card program, thereby enhancing the value of the brand used by the financial institution. That is, the marketing activities may be part of the sponsoring entity’s obligation to maintain and support the value of the sponsoring entity’s brand as the brand is used by the financial institution. Even if an entity concludes that the marketing activities are distinct within the context of the contract and therefore compose a separate performance obligation, that performance obligation would often be satisfied over the same period as the brand performance obligation. Therefore, the timing of revenue recognition may not differ between the alternative views.
5.3.2.3.3 Identifying Performance Obligations in a Cloud Computing Arrangement That Includes Implementation Services
Entities that sell a cloud-based or hosted software
solution (e.g., in a SaaS arrangement)6 often include implementation services. These services are
performed either (1) at the outset of the customer arrangement or (2)
during the SaaS term (in many cases because of added modules or features
of the SaaS solution7). Depending on the facts and circumstances of the arrangement, an
entity may need to use judgment to determine whether the implementation
services represent (1) activities that do not transfer a good or service
to the customer, (2) a promise that is not distinct from the SaaS, or
(3) a distinct performance obligation.
5.3.2.3.3.1 Identifying Whether Implementation Services Are a Promised Good or Service
ASC 606-10-25-17 states the following regarding the identification of
promised goods or services in an arrangement:
Promised goods or
services do not include activities that an entity must undertake
to fulfill a contract unless those activities transfer a good or
service to a customer. For example, a services provider may need
to perform various administrative tasks to set up a contract.
The performance of those tasks does not transfer a service to
the customer as the tasks are performed. Therefore, those setup
activities are not promised goods or services in the contract
with the customer.
In addition, ASC 606-10-55-53 states:
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 entity should assess whether
costs incurred in setting up a contract have resulted in an
asset that should be recognized in accordance with paragraph
340-40-25-5.
Further, paragraph BC93 of ASU 2014-09 indicates that even if an
activity is “required to successfully transfer the goods or services
for which the customer has contracted,” that activity may not
“directly transfer goods or services to the customer.”
Implementation Q&A 48 (compiled from
previously issued TRG Agenda Papers 41 and 44) contains an example in which the FASB staff
discusses up-front implementation services that are provided with a
SaaS solution. In the example, (1) the hosting period begins when
the implementation services are complete and the customer cannot
access or use the service until that time, (2) the vendor’s solution
is proprietary and no other vendors can provide the implementation
services, (3) the customer cannot derive any benefit from the
implementation services or the SaaS until implementation is
complete, and (4) the implementation services are not capable of
being distinct from the hosting services. While the example is
intended to illustrate considerations related to whether the
implementation services were relevant to an entity’s measurement of
progress toward completion of a performance obligation, it also
addresses whether such implementation services would represent a
performance obligation at all. According to the FASB staff, “the
nature of the entity’s overall promise is the hosting service and
the implementation service does not transfer a service to a
customer”; thus, the services would be disregarded in a manner
similar to the treatment of the set-up activities described in ASC
606-10-25-17. This view is analogous to that discussed in Example 53
in ASC 606-10-55-358 through 55-360, in which set-up activities
related to transaction processing services “do not transfer a good
or service to the customer and, therefore, do not give rise to a
performance obligation.”
Since the nature and composition of implementation services can vary
in practice, we do not believe that the example in Implementation
Q&A 48 was intended to address all types of implementation
services. Accordingly, an entity would have to carefully analyze the
facts and circumstances of its SaaS arrangements and related
implementation services to determine whether the activities a vendor
performs for implementation services (1) transfer a good or service
to the customer or (2) are akin to set-up activities. The entity’s
analysis would be based on whether the customer obtains control of
the implementation services as they are performed. In the
determination of whether the customer obtains such control, we
believe that it may be helpful for the entity to consider the following:
-
Whose assets are being enhanced, improved, or customized by those activities. If the implementation activities are performed on the entity’s internal infrastructure and applications (i.e., “behind the firewall”), the activities most likely do not transfer a good or service to the customer and the entity therefore would not consider the services in identifying performance obligations. This would be the case even if the customer benefits from the implementation activities. Because the activities are performed on the entity’s assets, the entity retains control of any benefits those activities confer. By contrast, if the implementation activities are performed on the customer’s infrastructure and applications, the activities may represent the transfer of a promised good or service to the customer. Paragraph BC129 of ASU 2014-09 discusses “situations in which an entity’s performance creates or enhances an asset that a customer clearly controls as the asset is created or enhanced.” It states, in part:In those cases, because the customer controls any work in process, the customer is obtaining the benefits of the goods or services that the entity is providing . . . . For example, in the case of a construction contract in which the entity is building on the customer’s land, the customer generally controls any work in process arising from the entity’s performance.
-
Whether the services are provided directly to the customer (i.e., the services are simultaneously received and consumed by the customer; another entity would not need to substantially reperform the entity’s performance to date). Paragraph BC125 of ASU 2014-09 states, in part:In many typical “service” contracts, the entity’s performance creates an asset only momentarily because that asset is simultaneously received and consumed by the customer. In those cases, the simultaneous receipt and consumption of the asset that has been created means that the customer obtains control of the entity’s output as the entity performs . . . . For example, consider an entity that promises to process transactions on behalf of a customer. The customer simultaneously receives and consumes a benefit as each transaction is processed.
To the extent that the activities do not transfer a
good or service to the customer, they should not be considered in
the identification of performance obligations. See Section 8.9.4 for considerations
related to the recognition of fees that may have been contractually
assigned to activities that do not result in the transfer of a
promised good or service to the customer.
Example 5-3
Company S enters into a noncancelable SaaS
arrangement with Customer T for a three-year term.
As part of the arrangement, S has agreed to
perform certain activities to add functionality to
the SaaS before the commencement of the contract
term (i.e., customization services) for an
incremental fee. The added functionality is needed
for the SaaS to work as intended by T. To perform
the customization services, S must make
modifications to its software applications that
will be used to provide the SaaS. Customer T can
only access the added functionality through the
SaaS and has no other rights to the enhancements.
That is, S continues to retain ownership of the
improvements.
The customization services are not promised
goods or services to the customer. Since the
customization services will take place behind the
firewall, the functionality is added only to S’s
assets, which S controls. The services will not
enhance, improve, or customize a
customer-controlled asset. Therefore, the
arrangement does not result in a promise to
transfer (i.e., does not transfer control of)
services to the customer and would not be assessed
as a promise under the contract. Rather, the
customization services would be akin to set-up
activities as described in ASC 606-10-25-17.
Example 5-4
Assume the same facts as in
the example above except that Company S has also
agreed to perform other implementation activities
before the commencement of the contract term
(i.e., implementation services) for an incremental
fee. These activities, which are performed on
Customer T’s assets, include adapting and
configuring T’s infrastructure and T’s in-place
systems for communication with S’s infrastructure.
In addition, S will convert and migrate T’s data
in a format that is compatible with the SaaS
platform and train T’s employees in the SaaS’s
optimal use.
In this scenario, the additional implementation
services are promised goods or services to the
customer. Most of the activities enhance, improve,
or customize T-controlled assets (i.e., T’s
infrastructure, in-place systems, and data). In
addition, the training is provided directly to T’s
employees (as opposed to S’s employees), which
permits T to simultaneously receive and consume
the benefit conferred by the training. Therefore,
the implementation services represent promises to
transfer services to the customer and should be
assessed as such under the contract.
5.3.2.3.3.2 Identifying Whether Implementation Services Are a Distinct Performance Obligation
If an entity has determined that implementation
services represent promised goods or services to the customer, it
would next assess whether such services and the SaaS are (1) each a
distinct performance obligation or (2) a combined performance
obligation. Under ASC 606-10-25-19, for a promised good or service
to be a separate performance obligation, the promise must be both
(1) capable of being distinct (i.e., the customer can benefit from
the good or service either on its own or together with other
resources that are readily available to the customer) and (2)
distinct within the context of the contract (i.e., the entity’s
promise to transfer the good or service to the customer is
separately identifiable from other promises in the contract).
We believe that the following factors (not all-inclusive) may be
helpful in an entity’s determination of whether implementation
services are a distinct performance obligation (the analysis may in
some circumstances need to be performed separately for each promise
because implementation services often consist of multiple activities
that represent separate promises):
-
Whether the entity or other entities (e.g., consulting firms, SaaS competitors) provide the implementation services on a stand-alone basis — We believe that this is a key consideration in the entity’s assessment of whether the implementation services are distinct. For example, if the entity has a number of partnerships or alliances with other organizations that enable those other businesses to provide the implementation services to the entity’s customers, the implementation services are likely to be distinct.
-
Whether the implementation services will provide an asset or incremental benefit to the customer without the SaaS arrangement (i.e., alternative use) — An entity would evaluate whether the implementation services (1) are specific to the SaaS arrangement or (2) can be leveraged by the customer for use in other SaaS arrangements or circumstances. For example, an entity may provide professional services that enable the customer to use the SaaS to more efficiently analyze data. If those same professional services can be applied to other competitors’ SaaS solutions, the services may be distinct.
-
Whether the customer must obtain the implementation services to use and benefit from the SaaS arrangement (i.e., whether the SaaS is functional without the implementation services) — An entity would evaluate whether the customer can maintain a reasonable degree of utility of the SaaS without the implementation services. For example, a SaaS that has no utility or value without the entity’s implementation services may be an indicator that the implementation services are not distinct.
-
Whether there are instances in which the SaaS was provided to customers without implementation services — Customers’ frequent purchasing of the entity’s SaaS without purchasing its implementation service may be an indicator that the implementation services are distinct.
-
Whether the implementation services significantly alter any features or functionality of the SaaS — For example, the implementation services may include significant customization of the customer’s infrastructure and applications to enable the SaaS to process transactions it could not process otherwise. Such customization may be an indicator that the implementation services are not distinct; however, if the customization’s benefits could be applied to another SaaS platform (i.e., another readily available resource), the implementation services may be distinct.
-
Whether the implementation services and the SaaS are so significantly integrated, interrelated, or interdependent that the entity could not fulfill its promises to transfer the implementation services and the SaaS independently — For example, to enable the SaaS to perform unique functions that are critical to the customer’s intended use of the SaaS, the implementation services may require significant customization of both the entity’s and the customer’s systems. In such cases, the implementation services may not be distinct because there is likely to be an interdependency between the implementation services and the SaaS (i.e., as a result of the services, there is an enhancement to the combined functionality of the SaaS and the customer’s systems). In addition, as discussed in Section 5.3.2.3.3.1, the customization of the entity’s systems is not likely to be a promised good or service in the arrangement.
-
Whether using the SaaS or providing implementation services requires a highly specialized or complex skill set that neither the customer nor third parties possess — For example, an entity may provide to a governmental agency a highly customized and complex SaaS solution that requires the entity to employ scientists. If there is significant risk associated with the entity’s ability to provide the implementation services and the level of effort and time needed to complete them is extensive, the implementation services may not be distinct. By contrast, if it is not difficult to configure or set up the customer’s systems and interfaces, the implementation services may be distinct.
-
Whether the entity markets the implementation services and the SaaS as a combined solution — While marketing the services and SaaS in such a manner is not a determinative factor, it may support a conclusion that the implementation services are not distinct.
5.3.2.3.4 Identifying Performance Obligations in Arrangements That Include Smart Devices, Updates, and Cloud-Based Services
Many technology entities offer solutions in which a
customer purchases (1) a smart device with an embedded software
component (e.g., firmware), (2) maintenance and support (i.e.,
postcontract customer support [PCS]), and (3) a cloud-based service. In
these offerings, the firmware allows the smart device to connect to the
cloud-based application, which is physically hosted on the technology
entity’s systems (or hosted by the entity’s cloud-computing vendor) and
accessed by the customer over the Internet. For arrangements in which
the software is always embedded in the smart device and the software is
essential to the device’s core functionality, an entity will typically
conclude that the embedded software is not distinct from the smart
device. This is because the software is a component of the tangible
device and integral to the functionality of that device in accordance
with ASC 606-10-55-56(a).
Because PCS and a cloud-based service typically are sold together, are
coterminous, and have the same pattern of transfer (i.e., ratably over
time as stand-ready obligations), they will be referred to collectively
as “subscription services.” In some cases, the smart device and both the
PCS and the cloud-based service may constitute a combined performance
obligation. However, there may be instances in which the smart device
and either the PCS (without the cloud-based service) or the cloud-based
service (without the PCS) constitute a combined performance
obligation.
Connecting the Dots
At the 2021 AICPA & CIMA Conference on
Current SEC and PCAOB Developments, OCA Senior Associate Chief
Accountant Jonathan Wiggins noted that complex consultations on
the identification of performance obligations have included fact
patterns in which an entity promises to provide (1) a good or
service up front, such as a software license or a “smart”
device, and (2) a related service over time, such as PCS for the
software license or a cloud-based service for the smart device.
This topic was also addressed by Ms. York in her speech at the
2018 AICPA Conference on Current SEC and PCAOB Developments. In
that speech, Ms. York discussed a consultation with an SEC
registrant regarding the identification of performance
obligations with respect to a commercial security monitoring
service. The registrant’s technology platform incorporated an
element of artificial intelligence (AI) to create a “smart”
security monitoring service. As Ms. York observed, the
registrant concluded that the promises in the contract were not
distinct within the context of the contract because it “believed
it was providing a significant service of integrating the goods
and services in the contract into a bundle that represented the
combined output for which the customer had contracted.” Ms. York
noted that the SEC staff did not object to the registrant’s
conclusion.
The functionality of smart devices and subscription
services can vary between offerings to customers and between entities.
When identifying performance obligations in these arrangements, an
entity should consider the guidance in ASC 606-10-25-19 to determine
whether the smart device and the subscription services are distinct
(i.e., whether each promise is capable of being distinct and distinct
within the context of the contract). While a smart device and related
subscription services are each often capable of being distinct,
determining whether they are distinct within the context of the contract
is much more challenging. An entity should consider the guidance in ASC
606-10-25-21 in making such a determination.
We believe that an entity may consider the following
indicators, which are not individually determinative or all-inclusive,
in determining whether its smart device is distinct from its
subscription services:
-
Whether the entity’s smart device and subscription services are ever sold separately — The entity’s practice of selling the smart device and the subscription services separately typically indicates that there are two separate performance obligations (i.e., the promises should not be combined) since the customer may benefit from the smart device or the subscription services offering on its own. In addition, separate sales also suggest that the smart device and the subscription services each have significant stand-alone functionality, which indicates that those items are distinct within the context of the contract.
-
Whether the customer can benefit from each product or service (i.e., the smart device or the subscription services) either on its own or together with other resources that are readily available to the customer — For example, suppose that the customer has the ability to (1) obtain from a different vendor a smart device or subscription services offering that is the same as or similar to that sold by the entity, (2) use the alternative vendor’s smart device with the entity’s subscription services (or use the alternative vendor’s subscription services with the entity’s smart device), and (3) receive substantially the same functionality as that of the entity’s combined offering. That ability may indicate that the entity’s smart device and subscription services are each capable of being distinct and are distinct within the context of the contract since (1) the entity is not providing a significant integration service for the device and the subscription services and (2) it is less likely that the smart device and the subscription services are highly interdependent or highly interrelated.Alternatively, suppose that the functionality of the smart device is significantly integrated with (rather than just improved by) the subscription services in such a way that the entity’s combined offering provides significant additional capabilities that cannot be obtained from an alternative vendor providing the subscription services. In that case, the presence of an alternative vendor providing a portion of the same utility with its subscription services would indicate that the promises are capable of being distinct, but the integrated nature of the promises would indicate that the promises are not distinct within the context of the contract.
-
Whether the subscription services significantly modify the smart device — The subscription services and the smart device may not be distinct within the context of the contract if rather than just enhancing the capabilities of the smart device, the subscription services modify and significantly affect the functionality of the smart device. For example, suppose that the subscription services (1) employ AI or machine learning that teaches and significantly affects the functionality of the smart device and (2) cannot employ the AI or machine learning without using the functionality of the smart device. This situation would indicate that the subscription services and the smart device are not distinct within the context of the contract because rather than just enhancing the capabilities of the smart device, the subscription services modify and significantly affect the functionality of the smart device.
-
Whether the absence of either the smart device or the subscription services significantly limits or diminishes the utility (i.e., the ability to provide benefit or value) of the other — If the smart device’s functionality is significantly limited or diminished without the use of the subscription services, and vice versa, that significantly limited or diminished functionality may indicate that the smart device and the subscription services (1) are highly interdependent or highly interrelated (i.e., they significantly affect each other) and (2) function together as inputs to a combined output. This, in turn, may indicate that the promises are not distinct within the context of the contract since the customer cannot obtain the intended benefit of the smart device or the subscription services without the other. That is, while the customer may be able to obtain some functionality from the smart device on a stand-alone basis, it would not obtain the intended outputs from the smart device if the smart device is not updated by or connected to the subscription services because the subscription services are critical to the customer’s intended use of the combined solution. In this situation, the entity cannot fulfill its promise to the customer by transferring the smart device or the subscription services independently (i.e., the customer could not choose to purchase one good or service without significantly affecting the other good or service in the contract).
-
Whether the functionality of the combined smart device and subscription services is transformative rather than additive — Transformative functionality should be assessed separately from added functionality. Transformative functionality comprises features that significantly affect the overall operation and interaction of the smart device and the subscription services (e.g., integrated data analytics, pushdown learning, customization). To be transformative, the smart device and the subscription services must significantly affect each other. That is, the smart device and the subscription services are inputs to a combined output such that the combined output has greater value than, or is substantively different from, the sum of the inputs. By contrast, added functionality comprises features that provide an added benefit to the customer without substantively altering (1) the manner in which the functionality is used and (2) the benefits derived from that functionality of the smart device or the subscription services on a stand-alone basis. Even if the added functionality is significant, it may not be transformative. It is more likely that the smart device and the subscription services are highly interdependent or highly interrelated when the functionality of the combined offering is transformative rather than additive.
-
Whether the entity’s smart devices and subscription services are always sold on a one-to-one basis — If the entity has a practice of selling smart devices without the subscription services, this may indicate that the customer can obtain its intended benefit from the smart devices separately. For example, if a customer purchases the entity’s subscription services and 10 devices and has an option to subsequently purchase additional devices without additional subscription services, the entity is able to fulfill any promise to provide additional devices without any related subscription services. If the entity is able to fulfill its promise to provide a smart device independently from its promise to provide subscription services, the smart device and the subscription services may not be highly interdependent or highly interrelated. By contrast, if a customer is always required to purchase additional subscription services for each smart device purchased, this may indicate that the smart device and the subscription services are not distinct.
-
Whether the smart devices are sold on a stand-alone basis through a distribution channel or in an aftermarket — If the entity’s smart devices are sold on a stand-alone basis by other third parties and the entity will sell its subscription services separately to any customer that has purchased or obtained a smart device from a third party, the entity is able to fulfill its promise to provide subscription services independently from any promise to provide smart devices. This indicates that the smart device and the subscription services are not highly interdependent or highly interrelated. By contrast, if the entity will not sell its subscription services to a customer unless the customer has purchased a smart device directly from the entity, this may indicate that the smart device and the subscription services are not distinct.
-
Whether the entity’s marketing materials support a conclusion that the arrangement is for a combined solution rather than separate products or service offerings — The entity’s marketing materials may help clarify what the entity has promised to deliver to its customer and may provide evidence of the customer’s intended use of the smart device and the subscription services. Circumstances in which an entity markets its product as a “solution” (i.e., the materials discuss the functions, features, and benefits of the combined offering with little or no discussion of the smart device and the subscription services separately) may help support a conclusion that the entity’s promise is a combined performance obligation. However, the entity should exercise caution when relying on its marketing materials since the manner in which the entity markets its combined offering would not, by itself, be sufficient to support a conclusion that the smart device and the subscription services represent a combined performance obligation.
Example 5-5
Entity X sells a bundled
cybersecurity solution to protect against advanced
cybersecurity threats to enterprise customers. In
its standard revenue contracts, X promises to
provide customers with a smart device (i.e.,
hardware with embedded software) and annual
subscription services. The smart device has
behavior and security analytics engines that use
machine learning and AI to monitor and protect a
customer’s IT infrastructure (including e-mails,
Internet applications, endpoints, and networks) on
a real-time basis against cyberattacks. The
subscription services include (1) a cloud-based
service that pulls data on cyberattacks and other
intelligence updates from various sources and (2)
PCS that consists of support and critical software
updates that enable the cloud-based service to
stay compatible with the smart device. The
cloud-based service is provided hourly in response
to evolving cybersecurity threats, and software
updates are provided on a daily or weekly basis.
Entity X never sells the smart device without
subscription services, but subscription services
are sold separately on a renewal basis
(approximately 95 percent of X’s customers renew
each year). Customers are required to purchase
subscription services with each smart device
purchased, and the smart device must be purchased
from X directly (i.e., there are no distributors
or resellers). Customers are also prohibited from
reselling the smart device, and X will not sell
subscription services to a customer that has not
purchased the smart device directly from X (i.e.,
there is no aftermarket for the smart device).
The smart device on a
stand-alone basis is functional and will monitor
and prevent some level of cyberattacks. However,
given the nature of the security updates and the
cybersecurity environment for enterprise
customers, the utility of the smart device
diminishes significantly and quickly without the
subscription services since the smart device would
not be able to respond to evolving cybersecurity
threats. The subscription services have no utility
without the smart device, and there is significant
integration of, and interaction between, the smart
device and the subscription services such that
together, they provide the functionality required
by the customer. The smart device and the
subscription services are proprietary and can only
be used with each other; no similar third-party
subscription services are compatible with X’s
smart device, and no similar third-party smart
devices are compatible with X’s subscription
services. Entity X markets its smart device and
subscription services as a single integrated
offering; X does not describe the smart device or
subscription services separately, and it refers
only to the features, functionality, and benefits
of the combined offering.
Entity X determines that there
is a transformative relationship between the smart
device and the subscription services such that
they are inputs to a combined output. Further,
because the smart device and the subscription
services each have little or no utility without
the other, they are highly interrelated and highly
interdependent. Entity X therefore concludes that
there is a single performance obligation in its
contracts.8
We believe that it is reasonable
to conclude that there is one performance
obligation for the following reasons:
-
Entity X’s smart device is never sold separately.
-
The customer cannot obtain the intended benefit from the smart device or the subscription services offering on its own. There are no smart devices or subscription services available from other vendors that can function with X’s offering.
-
The functionality of the smart device is significantly integrated with the subscription services in such a way that only together can they provide the functionality (i.e., the intended benefit) required by the customer.
-
The absence of either the smart device or the subscription services significantly limits or diminishes the utility (i.e., the ability to provide benefit or value) of the other. The smart device’s functionality is significantly limited or diminished without the use of the subscription services, and vice versa. Therefore, the smart device and the subscription services (1) are highly interdependent and interrelated (i.e., they significantly affect each other) and (2) function together as inputs to a combined output. The customer cannot obtain the full intended benefit of the smart device or the subscription services on a stand-alone basis because the smart device and the subscription services are each critical to the customer’s intended use of the security solution.
-
The functionality of the combined smart device and subscription services is transformative rather than additive. That transformative functionality comprises features that significantly affect the overall operation and interaction of the smart device and the subscription services in such a way that the smart device and the subscription services significantly affect each other.
-
Entity X always sells the smart device and the subscription services on a one-to-one basis. In addition, the smart device must be purchased from X directly (i.e., there are no distributors or resellers). Customers are also prohibited from reselling the smart device, and X will not sell subscription services to a customer that has not purchased the smart device directly from X (i.e., there is no aftermarket for the smart device). Therefore, X cannot fulfill its promise to the customer by transferring the smart device or the subscription services independently (i.e., the customer could not choose to purchase one good or service without significantly affecting the other good or service in the contract).
-
Entity X’s marketing materials support a conclusion that the arrangement is for a combined solution rather than separate product or service offerings.
Example 5-6
Entity Y sells GPS tracking
devices (with embedded software) that enable its
customers to monitor the location of its various
products. In its standard revenue contracts, Y
also sells a one-year cloud-based subscription
service so that customers can monitor the devices
online and perform data analytics. The devices
have minimal functionality unless a customer has
an active subscription service (i.e., the
subscription service is required to enable a
customer to monitor the devices). Likewise, if a
customer has an active subscription service
without an associated device, the subscription
service will not monitor anything. The
subscription service does not alter or modify the
existing firmware on the device. In addition, Y is
not providing a significant integration service
that transforms the device and subscription
service into a combined output.
Entity Y markets and sells the
device and the subscription service as one bundled
offering but does have stand-alone sales of the
device and the subscription service. In addition
to selling the device directly, Y sells the device
to independent distributors. The device can also
be resold in an aftermarket. If a customer
purchases a device from a reseller or in an
aftermarket, the customer will purchase the
subscription service separately from Y. In
addition, Y sells the subscription service
separately on a renewal basis (approximately 95
percent of Y’s customers renew each year).
Entity Y concludes that it has
multiple performance obligations in its contracts
with direct customers: (1) each device and (2) the
subscription service.
We believe that it is reasonable
to conclude that there are multiple performance
obligations for the following reasons:
-
While Y markets and sells the device and the subscription service as one bundled offering, it has stand-alone sales of the device and the subscription service. Entity Y sells the device separately to distributors and sells the subscription service separately to direct customers.
-
Entity Y is not providing a significant integration service that transforms the device and the subscription service into a combined item.
-
The device is not modified by the subscription service.
-
The device and the subscription service are not highly interdependent or highly interrelated. Although the customer can only benefit from the functionality of the device with the subscription service (i.e., the device would have minimal functionality without the subscription service) and the device is required for the subscription service to function, the device and the subscription service do not significantly affect each other. This is because Y would be able to fulfill each of its promises in its contracts independently of the other, since (1) the device is sold separately through independent distributors and an aftermarket, and (2) Y will sell its subscription service separately to any customer that has purchased the device from a distributor or in the aftermarket. In addition, independent distributors and customers can obtain the benefits from the device separately by reselling it, and the buyer of the device can benefit from it by separately purchasing subscription services from Y.
5.3.3 Series Guidance
As previously noted, ASC 606-10-25-14 provides the following
guidance on what constitutes a performance obligation:
ASC 606-10
25-14 At contract inception,
an entity shall assess the goods or services promised in
a contract with a customer and shall identify as a
performance obligation each promise to transfer to the
customer either:
- A good or service (or a bundle of goods or services) that is distinct
- A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see paragraph 606-10-25-15).
ASC 606-10-25-14(b) explains that a performance obligation can
be a series of goods or services; however, the performance obligation must meet
certain requirements to qualify as a series. Specifically, the goods or services
must have substantially the same pattern of transfer to the customer as though
they were a single performance obligation. As explained in paragraph BC113 of
ASU 2014-09, the FASB and IASB came to this conclusion to provide the series
guidance because it would promote consistent application of the revenue standard
across similar goods and services. Further, the ASU’s Background Information and
Basis for Conclusions indicates that without the series provision, an entity
could encounter operational challenges in managing numerous performance
obligations and allocating the transaction price to those performance
obligations on a stand-alone selling price basis.
The following guidance in ASC 606-10-25-15 clarifies the meaning
of “the same pattern of transfer”:
ASC 606-10
25-15 A series of distinct
goods or services has the same pattern of transfer to
the customer if both of the following criteria are
met:
-
Each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in paragraph 606-10-25-27 to be a performance obligation satisfied over time [see Section 8.4].
-
In accordance with paragraphs 606-10-25-31 through 25-32 [see Section 8.5], the same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.
5.3.3.1 Determining Whether Distinct Goods or Services Are Substantially the Same
For distinct goods or services to be considered
substantially the same to be accounted for as a series under ASC
606-10-25-14(b), it is not necessary for each increment of distinct goods or
services to be identical. Instead, it is necessary to evaluate whether there
is a series of distinct goods or services that are substantially the
same.
The evaluation of whether distinct goods or services are
substantially the same requires significant judgment based on the relevant
facts and circumstances of the contract.
An entity should first determine the nature of the promised
goods or services to be provided under the contract by evaluating whether
the nature of the arrangement is to provide the customer with a specified
quantity of distinct goods or services or to stand ready to provide an
undefined quantity of goods or services over the duration of the contract
period.
This issue is addressed in Implementation Q&A 18 (compiled from previously
issued TRG Agenda Papers 39 and 44). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
5.3.3.1.1 Specified Quantity of Distinct Goods or Services
Generally, arrangements to deliver a specified quantity
of similar goods or services result in repetitive delivery of the goods
or services. An entity should evaluate whether each repetitive good or
service is substantially the same as the others, as illustrated in the
example below.
Example 5-7
Monthly Cleaning Services
Company A provides Customer Z monthly cleaning
services for one year. Company A has been
contracted to clean Z’s offices once a month, for
a total of 12 cleaning services in a year. Company
A concludes that each monthly service (1) is
distinct, (2) meets the criteria for recognizing
revenue over time, and (3) uses the same method
for measuring progress. In addition, A concludes
that the cleaning services each month are
substantially the same and result in the transfer
of substantially the same service (office
cleaning) to the customer each month. Therefore, A
concludes that the monthly cleaning services
satisfy the requirements of ASC 606-10-25-14(b) to
be accounted for as a single performance
obligation.
5.3.3.1.2 Undefined Services Over a Contract Period
A contract may require an entity to perform various
activities as part of transferring services over the contract period. In
these circumstances, an entity would need to determine whether the
nature of the promise is to provide the customer with (1) multiple
different services or (2) one integrated service (with different
activities). In making this determination, an entity might first
determine the nature of the services by evaluating the benefit provided
to the customer. If the entity determines that the customer benefits
from the integrated service over the contract term, it should then
evaluate whether each time increment (e.g., hour, day, or week) is
substantially the same. In these situations, each time increment of
service may be substantially the same even if the underlying activities
differ. Consider the examples below.
Example 5-8
Hotel
Management Services
Company B provides hotel
management services to Customer Y that include
hiring and managing employees, procuring goods and
services, and advertising and marketing the hotel.
In a given day, B could clean guest rooms, perform
marketing efforts to increase occupancy, and
operate the concierge desk.
Company B concludes that the
nature of the contract is to provide integrated
hotel management services over the term of the
contract and not a specific quantity of specified
services (e.g., cleaning 100 guest rooms per day).
The underlying activities in providing the hotel
management services can vary significantly from
day to day; however, the daily services are
activities that are required to satisfy B’s
obligation to provide an integrated hotel
management service. Therefore, the integrated
service of hotel management transferred to the
customer is substantially the same during each
period. That is, Y receives substantially the same
benefit each period.
Company B concludes that each
increment of service (i.e., day or week) is
distinct, meets the criteria for recognizing
revenue over time, and uses the same method for
measuring progress. Therefore, B would conclude
that the hotel management services satisfy the
requirements of ASC 606-10-25-14(b) to be
accounted for as a single performance
obligation.
Example 5-9
IT
Outsourcing Services
Company C provides IT
outsourcing services to Customer X for a five-year
period. The IT outsourcing services include
providing X with server capacity, maintenance of
the customer’s software portfolio, and access to
an IT help desk.
Company C considers the nature
of the promise to X. Company C concludes that its
promise to X is to provide continuous access to an
integrated outsourced IT solution and not to
provide a specified quantity of services (e.g.,
processing 100 transactions per day). The
underlying activities in providing IT outsourcing
services can vary significantly from day to day;
however, the daily services are activities
performed to fulfill C’s integrated IT outsourcing
service and are substantially the same. Company C
concludes that for each period, (1) C is providing
an integrated IT outsourcing service; (2) the
customer is continuously receiving substantially
the same benefit, which is distinct; and (3) each
increment of time is substantially the same (i.e.,
each increment provides the same integrated IT
outsourcing solution).
Company C concludes that each
distinct increment of time meets the criteria for
recognizing revenue over time and uses the same
method for measuring progress. Therefore, C
concludes that the IT outsourcing services satisfy
the requirements of ASC 606-10-25-14(b) to be
accounted for as a single performance
obligation.
5.3.3.2 Mandatory Treatment of a Series of Distinct Goods or Services as a Single Performance Obligation
Some entities may find it preferable to account for goods
and services individually instead of as a series even though the goods and
services meet the requirements of the series guidance. If an entity
concludes that a series of distinct goods or services meets the requirements
of ASC 606-10-25-14(b), it is required to treat that series as a single
performance obligation (i.e., it cannot choose to regard the distinct goods
or services in the series as individual performance obligations). Paragraph
BC113 of ASU 2014-09 clarifies the boards’ intent to mandate the use of this
simplification, stating that they “decided to specify that a promise to
transfer a series of distinct goods or services that are substantially the
same and that have the same pattern of transfer to the customer would be a single performance obligation if two
criteria are met” (emphasis added).
5.3.3.3 Other Issues Related to the Determination of Whether the Series Guidance Applies
In discussion with the TRG, the FASB staff noted that an
entity may determine that goods and services constitute a single performance
obligation if (1) they are “bundled” together because they are not distinct
or (2) they are distinct but meet the criteria that require the entity to
account for them as a series (and thus as a single performance obligation).
The staff further noted that a single performance obligation that comprises
a series of distinct goods or services rather than a bundle of goods or
services that are not distinct affects (1) how variable consideration is
allocated, (2) whether contract modifications are accounted for on a
cumulative catch-up or prospective basis, and (3) how changes in the
transaction price are treated. Because of the potential implications
associated with whether goods or services are determined to be a series,
stakeholders have raised questions about:
-
Whether goods must be delivered (or services must be performed) consecutively for an entity to apply the series provision.
-
Whether the accounting result for the series of distinct goods or services as a single performance obligation needs to be the same as if each underlying good or service were accounted for as a separate performance obligation. The staff noted that it does not believe that the accounting result needs to be “substantially the same.” Further, the staff stated that “[s]uch a requirement would almost certainly make it more difficult for entities to meet the requirement, and because the series provision is not optional, it likely would require entities to undertake a ‘with and without’ type analysis in a large number of circumstances to prove whether the series provision applies or not.”9
5.3.3.3.1 Applying the Series Provision When the Pattern of Transfer Is Not Consecutive
A series of goods or services will often be transferred
consecutively (e.g., under a contract to provide the same package of
cleaning services each consecutive week for 52 weeks). However,
sometimes the series of goods or services will not be delivered each
week on a consecutive basis (e.g., under a cleaning contract in which
services are not provided in certain weeks but are provided in other
weeks on an overlapping basis whereby cleaning begins before the
previous week’s work has been completed).
An entity should look to the series provision criteria
in ASC 606-10-25-15 to determine whether the goods or services are a
series of distinct goods or services for which the entity is not
explicitly required to identify a consecutive pattern of performance.
Further, while the term “consecutively” is used in the Background
Information and Basis for Conclusions of ASU 2014-09, the FASB staff
noted that it “does not think whether the pattern of performance is
consecutive is determinative to whether the series provision
applies.”10 That is, goods or services do not need to be transferred
consecutively to qualify as a series of distinct goods or services under
ASC 606-10-25-14(b) and, specifically, to have the “same pattern of
transfer to the customer.”
As noted in Section
5.3.3, the series requirement is intended to simplify the
application of the revenue model in ASC 606 and to promote consistency
in the identification of performance obligations. In certain instances,
it requires identification of a single performance obligation even
though the underlying goods and services are distinct (i.e., when
distinct goods or services are provided in a series). ASC 606-10-25-15
lists the two criteria that must be met for an entity to conclude that a
series of two or more goods or services is a single performance
obligation:
-
“Each distinct good or service . . . would meet the criteria . . . to be a performance obligation satisfied over time,” in accordance with ASC 606-10-25-27.
-
The “same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation,” in accordance with ASC 606-10-25-31 and 25-32.
Neither of these criteria refers to the consecutive
transfer of goods or services to the customer, and both criteria could
be met in each of the cleaning contract examples described above.
Therefore, the applicability of ASC 606-10-25-14(b) does not depend on
whether the goods (services) will be consecutively delivered
(performed).
The above issue is addressed in Implementation Q&A 19 (compiled from previously
issued TRG Agenda Papers 27 and 34). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
5.3.3.3.2 Whether Treating Distinct Goods or Services as a Series Under ASC 606-10-25-14(b) Must Produce the Same Accounting Result as Treating Each Distinct Good or Service as a Separate Performance Obligation
The application of ASC 606-10-25-14(b) does not have to produce the same
accounting result as treating each distinct good or service as a
separate performance obligation.
The above issue is addressed in Implementation Q&A 19 (compiled from previously
issued TRG Agenda Papers 27 and 34). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
5.3.3.4 Illustrative Example of a Series of Distinct Goods or Services (ASC 606-10-55-157B Through 55-157E)
Example 12A in ASC 606, which is reproduced below, further
discusses the accounting for a series of distinct goods or services.
ASC 606-10
Example 12A — Series of Distinct
Goods or Services
55-157B An entity, a hotel
manager, enters into a contract with a customer to
manage a customer-owned property for 20 years. The
entity receives consideration monthly that is equal
to 1 percent of the revenue from the customer-owned
property.
55-157C The entity evaluates
the nature of its promise to the customer in this
contract and determines that its promise is to
provide a hotel management service. The service
comprises various activities that may vary each day
(for example, cleaning services, reservation
services, and property maintenance). However, those
tasks are activities to fulfill the hotel management
service and are not separate promises in the
contract. The entity determines that each increment
of the promised service (for example, each day of
the management service) is distinct in accordance
with paragraph 606-10-25-19. This is because the
customer can benefit from each increment of service
on its own (that is, it is capable of being
distinct) and each increment of service is
separately identifiable because no day of service
significantly modifies or customizes another and no
day of service significantly affects either the
entity’s ability to fulfill another day of service
or the benefit to the customer of another day of
service.
55-157D The entity also
evaluates whether it is providing a series of
distinct goods or services in accordance with
paragraphs 606-10-25-14 through 25-15. First, the
entity determines that the services provided each
day are substantially the same. This is because the
nature of the entity’s promise is the same each day
and the entity is providing the same overall
management service each day (although the underlying
tasks or activities the entity performs to provide
that service may vary from day to day). The entity
then determines that the services have the same
pattern of transfer to the customer because both
criteria in paragraph 606-10-25-15 are met. The
entity determines that the criterion in paragraph
606-10-25-15(a) is met because each distinct service
meets the criteria in paragraph 606-10-25-27 to be a
performance obligation satisfied over time. The
customer simultaneously receives and consumes the
benefits provided by the entity as it performs. The
entity determines that the criterion in paragraph
606-10-25-15(b) also is met because the same measure
of progress (in this case, a time-based output
method) would be used to measure the entity’s
progress toward satisfying its promise to provide
the hotel management service each day.
55-157E After determining
that the entity is providing a series of distinct
daily hotel management services over the 20-year
management period, the entity next determines the
transaction price. The entity determines that the
entire amount of the consideration is variable
consideration. The entity considers whether the
variable consideration may be allocated to one or
more, but not all, of the distinct days of service
in the series in accordance with paragraph
606-10-32-39(b). The entity evaluates the criteria
in paragraph 606-10-32-40 and determines that the
terms of the variable consideration relate
specifically to the entity’s efforts to transfer
each distinct daily service and that allocation of
the variable consideration earned based on the
activities performed by the entity each day to the
distinct day in which those activities are performed
is consistent with the overall allocation objective.
Therefore, as each distinct daily service is
completed, the variable consideration allocated to
that period may be recognized, subject to the
constraint on variable consideration.
5.3.3.5 Application of the Series Provision in Life Sciences Arrangements
Entities in the life sciences industry may enter into
service arrangements with other entities in the industry as part of their
product development process. For example, the developer of a drug compound
or other IP may enter into an arrangement with an entity that agrees to
provide it with clinical outsourcing support services (“R&D services”).
These R&D services may involve various tasks such as patient enrollment,
clinical trial site management, and activities related to regulatory
filings. While the two entities agree to a set of objectives, the entity
providing the R&D services may not promise or guarantee an end result.
Instead, the entity providing the R&D services satisfies its performance
obligation by making available access to clinical professionals to advance
the R&D efforts toward agreed-upon objectives. Given the nature of such
R&D services, the services may not be performed consistently or
consecutively over the service period, and their nature and scope may change
as the work progresses.
An entity’s application of ASC 606 to a contract with a
customer may be affected by whether the entity determines that its promises
to the customer represent (1) a single combined performance obligation
comprising multiple activities that are not distinct or (2) a single
performance obligation consisting of a series of distinct increments.
Specifically, the application of the guidance on allocating variable
consideration, accounting for contract modifications, and providing
disclosures related to remaining performance obligations differs for a
series of distinct increments of goods or services. We believe that the
determination of whether R&D services provided by entities in the life
sciences industry represent a series may require significant judgment.
The first step in the evaluation of whether an entity’s
promise to provide R&D services to a customer represents a series is to
assess whether the nature of the promise is one of the following:
-
The delivery of a specified quantity of goods or services.
-
A stand-ready obligation to provide an indefinite amount of goods or services during a specified period.
If the nature of the promise is to deliver a specified
quantity of goods or services, the entity must determine whether each
good or service is distinct, is substantially the same as the
other goods or services, and has the same pattern of transfer to the
customer as that of the other goods or services. If, on the other hand, the
nature of the promise is to stand ready for a specified period, the entity
must determine whether, for each increment of time, its promise of
standing ready to provide the R&D services is distinct, is substantially
the same as its promise for each of the other increments of time, and has
the same pattern of transfer to the customer as its promise for each of the
other increments of time.
Contracts in the life sciences industry to perform R&D
services appear in various forms. For example, some contracts may include a
license to IP in addition to the R&D services. If it is determined that
the license and the R&D services are both within the scope of ASC 606
but are not distinct promises (or if the customer already has control of a
license and the entity’s only promise in the contract is to provide R&D
services), the series guidance may not apply to the combined performance
obligation if the R&D services provided throughout the development
period are cumulative in that each increment of service builds on and is
dependent on the increments that precede it (i.e., such services would not
be considered distinct within the context of the contract). In such a case,
the R&D services would generally be accounted for as a single combined
performance obligation consisting of multiple activities that are not
distinct, as opposed to a series of distinct increments of time or service.
In certain other cases, R&D services may meet the criteria to be
accounted for as a series, as illustrated in the example below.
Example 5-10
CRO, a contract research
organization, enters into an arrangement with
Pharma, the developer of a new drug compound, to
perform daily R&D services for Pharma as needed
during phase 3 clinical trials by giving Pharma
access to clinical professionals. In exchange for
the R&D services provided to Pharma, CRO will
receive a daily fee per person and success-based
milestone payments.
The activities to be performed may
vary each day as CRO and Pharma work toward
agreed-upon objectives in connection with the phase
3 clinical trials. While the activities may vary by
day, they represent fulfillment activities
associated with providing the daily R&D services
and do not represent separate promises in the
arrangement. Further, CRO has determined that such
services are readily available in the marketplace
and are not cumulative because each day’s research
and corresponding results are not dependent on the
prior day’s research; thus, each day of services
does not build on activities that precede it, and
each day of services and the activities that precede
it are not integrated, interdependent, or
interrelated. That is, no day of services
significantly affects either CRO’s ability to
fulfill another day of services or the benefit to
Pharma of another day of services.
CRO determines that Pharma is a
customer within the context of providing the
services and therefore likewise concludes that the
services are within the scope of ASC 606. In
addition, CRO determines that the services to be
provided to Pharma meet the criteria in ASC
606-10-25-27(a) for recognition of revenue over time
since the services performed during each increment
of time contribute to Pharma’s development of the
drug compound and thereby allow Pharma to
simultaneously receive and consume the benefits
provided by CRO’s performance as each task is
performed.
Nature of the
Promise
CRO determines that the nature of
its promise is to stand ready to provide daily
R&D services as needed during phase 3 clinical
trials. Accordingly, CRO must assess whether, for
each increment of time, its promise of standing
ready to provide the R&D services (1) is
distinct, (2) is substantially the same as its
promise for each of the other increments of time,
and (3) has the same pattern of transfer to the
customer as its promise for each of the other
increments of time.
Distinct
Pharma benefits from each day of
services on its own since the services contribute to
Pharma’s development of the drug compound and are
readily available in the marketplace. Consequently,
CRO concludes that each increment of services is
capable of being distinct.
In addition, CRO determines that
each increment of services is distinct within the
context of the contract. This is because each day of
services (1) does not significantly modify or
customize another day of services and (2) does not
significantly affect CRO’s ability to fulfill
another day of services or the benefit to Pharma of
another day of services since the R&D services
are not cumulative, as noted above.
Substantially
the Same
CRO determines that for all of the
increments of time during which R&D services are
performed, its promise of standing ready to perform
those services is substantially the same. While the
specific tasks or services performed during each
increment of time will vary, the nature of the
overall promise to provide Pharma with daily R&D
services remains the same throughout the contract
term.
Same Pattern of
Transfer
CRO determines that the services
have the same pattern of transfer to Pharma because
both criteria in ASC 606-10-25-15 are met. The
criterion in ASC 606-10-25-15(a) is met because each
distinct service meets the criteria in ASC
606-10-25-27 to be a performance obligation
satisfied over time since Pharma simultaneously
receives and consumes the benefits provided by CRO
as CRO performs. The criterion in ASC
606-10-25-15(b) is met because the same measure of
progress (in this case, a time-based output method)
would most likely be used to measure the progress of
CRO toward satisfying its promise to provide the
daily R&D services.
Conclusion
On the basis of the above, CRO
concludes that the R&D services are a series and
accounts for them accordingly.
Connecting the Dots
It is common in the life sciences industry for an
entity to transfer a license of IP along with R&D services to
the customer as a single performance obligation. The license may not
be capable of being distinct without the R&D services. That is,
the R&D services performed by the entity may be novel and
associated with proprietary IP, requiring the entity to provide the
R&D services for the customer to benefit from the license. In
determining when revenue should be recognized for the single
performance obligation with two promised goods (the delivery of the
license and R&D services), the entity must determine whether the
single performance obligation is satisfied over time or at a point
in time. In this type of transaction, the criteria in ASC
606-10-25-27(a) and (b) for recognizing revenue over time may be
met. The entity may conclude that the criterion in ASC
606-10-25-27(a) is met if it determines that the work that it has
completed to date (related to the R&D services) would not need
to be substantially reperformed by another entity if the other
entity were to step in to fulfill the remaining performance
obligation to the customer (since this would mean that the customer
simultaneously receives and consumes the benefits provided by the
entity’s performance of the R&D services as the entity performs
those services). In addition, the entity may conclude that the
criterion in ASC 606-10-25-27(b) is met if it determines that (1)
the customer obtains control of the license (i.e., the customer has
the ability to direct the use of, and obtain substantially all of
the remaining benefits from, the license) and (2) the R&D
services provided will enhance the license.
Alternatively, life sciences entities may enter into a contract with
a customer to perform R&D services and provide the customer with
an option to exclusively license the IP resulting from the R&D
services at a stated price during the period in which the R&D
services are performed or for a certain specified period after
performance of the R&D services is completed. The option is
priced at its stand-alone selling price and therefore does not
represent a material right. The promise to provide R&D services
may represent a single performance obligation; if so, the entity
must determine whether the performance obligation is satisfied over
time or at a point in time. In this type of transaction, the
criterion in ASC 606-10-25-27(a) for recognizing revenue over time
may be met. The entity may conclude that the criterion in ASC
606-10-25-27(a) is met if it determines that the work that it has
completed to date (related to the R&D services) and is
controlled by the customer would not need to be substantially
reperformed by another entity if the other entity were to step in to
fulfill the remaining performance obligation to the customer (since
this would mean that the customer simultaneously receives and
consumes the benefits provided by the entity’s performance of the
R&D services as the entity performs those services).
For additional information specific to the life
sciences industry, see Deloitte’s Life Sciences Industry Accounting
Guide.
5.3.4 Identifying Performance Obligations in Real Estate Sales
Sometimes, a seller remains involved with property that has been
sold. Under the revenue standard, if the arrangement includes ongoing
involvement with the property, the seller must evaluate each promised good or
service under the contract to determine whether it represents a separate
performance obligation, constitutes a guarantee, or prevents the transfer of
control. If a promised good or service is considered a separate performance
obligation, an allocated portion of the transaction price should be recognized
when (or as) the entity transfers control of the related good or service to the
customer.
For example, assume that as part of a sale of land, the seller agrees to erect a
building on the land in accordance with agreed-upon specifications. If the sale
of land and the construction of the building are considered separate performance
obligations, the seller would be required to recognize an allocated portion of
the total transaction price as control of each good or service is transferred to
the customer. However, if the sale of land and the construction of the building
are not considered separate performance obligations, the consideration received
in connection with the sale of the land would be included in the transaction
price attributed to the performance obligation (i.e., the combined obligation to
transfer the land and construct the building). The transaction price would be
recognized when (or as) the combined performance obligation is satisfied.
Connecting the Dots
Common Areas and Other Amenities in a Community
Development
Implementation concerns have been raised by various stakeholders in the
real estate industry, including real estate developers and construction
and engineering entities.
Real estate developers have questioned the accounting
for contracts for which it is expected that certain amenities or common
areas will be provided in a community development (to be owned by either
a homeowners association or the local municipality). Specifically, they
have asked whether these common areas and other amenities should be
accounted for as separate performance obligations. We believe that a
developer that intends to provide common areas (e.g., a community
center, parks, tennis courts) to a homeowners association as part of a
development would generally not consider such an arrangement to
represent a promise to deliver goods or services in the separate
contracts to sell real estate (e.g., a single-family home) to its other
customers. That is, the agreement with the homeowners association would
not be combined with an agreement to sell real estate to a separate
customer. Further, we believe that control of the common areas will not
be transferred to the community homeowners but will be transferred to
the homeowners association instead. Consequently, the expected
construction of the common areas would not represent a performance
obligation of the developer. Note that the guidance in ASC 970 requires
a developer to use a cost accrual approach upon sale of the real estate
to account for costs of the common areas.
Phases of Engineering, Design, Procurement, and
Construction
Construction and engineering entities often enter into
contracts that include promises that are completed over a number of
phases. Such phases often include engineering, design, procurement, and
construction of a facility or project. Stakeholders have raised
questions and have had differing views about whether phases of a project
(e.g., in typical design-and-build contracts) are distinct performance
obligations or part of one combined performance obligation because they
may not be distinct in the context of the contract. Under the revenue
standard, it may be difficult to assess whether phases of engineering,
design, procurement, and construction are part of one combined
performance obligation (e.g., because the phases are highly
interdependent and highly interrelated or part of a significant service
of integration) or are distinct performance obligations.
Such difficulty may affect the way revenue (or other
gains or losses, if the transaction is with a noncustomer) is recognized
(e.g., (1) at a point in time or over time and (2) the measure of
progress if revenue is recognized over time). Accordingly, entities will
need to exercise significant judgment and consider the specific facts
and circumstances of each contract.
Given that the accounting could vary significantly depending on whether an
arrangement involves multiple distinct performance obligations, entities should
carefully analyze their sales contracts to determine whether any promises of
goods or services represent distinct performance obligations.
5.3.5 Private-Company Franchisor Practical Expedient for Identifying Performance Obligations
In January 2021, the FASB issued ASU
2021-02, which allows a franchisor that is not a public
business entity (a “private-company franchisor”) to use a practical expedient
when identifying performance obligations in its contracts with customers (i.e.,
franchisees) under ASC 606. When using the practical expedient, a
private-company franchisor that has entered into a franchise agreement would
treat certain preopening services provided to its franchisee as distinct from
the franchise license. The practical expedient is intended to reduce the cost
and complexity of applying ASC 606 to preopening services associated with
initial franchise fees.
As used in ASU 2021-02, the terms “franchise agreement,” “franchisor,” and
“public business entity” are defined as follows:
ASC Master Glossary
Franchise Agreement
A written business agreement that meets the following
principal criteria:
- The relation between the franchisor and franchisee is contractual, and an agreement, confirming the rights and responsibilities of each party, is in force for a specified period.
- The continuing relation has as its purpose the distribution of a product or service, or an entire business concept, within a particular market area.
- Both the franchisor and the franchisee contribute resources for establishing and maintaining the franchise. The franchisor’s contribution may be a trademark, a company reputation, products, procedures, manpower, equipment, or a process. The franchisee usually contributes operating capital as well as the managerial and operational resources required for opening and continuing the franchised outlet.
- The franchise agreement outlines and describes the specific marketing practices to be followed, specifies the contribution of each party to the operation of the business, and sets forth certain operating procedures that both parties agree to comply with.
- The establishment of the franchised outlet creates a business entity that will, in most cases, require and support the full-time business activity of the franchisee. (There are numerous other contractual distribution arrangements in which a local businessperson becomes the authorized distributor or representative for the sale of a particular good or service, along with many others, but such a sale usually represents only a portion of the person’s total business.)
- Both the franchisee and the franchisor have a common public identity. This identity is achieved most often through the use of common trade names or trademarks and is frequently reinforced through advertising programs designed to promote the recognition and acceptance of the common identity within the franchisee’s market area
The payment of an initial franchise fee or a continuing
royalty fee is not a necessary criterion for an
agreement to be considered a franchise agreement.
Franchisor
The party who grants business rights (the franchise) to
the party (the franchisee) who will operate the
franchised business.
Public Business Entity
A public business entity is a business entity meeting any
one of the criteria below. Neither a not-for-profit
entity nor an employee benefit plan is a business
entity.
- It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
- It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
- It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
- It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
- It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business
entity solely because its financial statements or
financial information is included in another entity’s
filing with the SEC. In that case, the entity is only a
public business entity for purposes of financial
statements that are filed or furnished with the SEC.
Franchisors applying the revenue guidance in ASC 606 may need to exercise
significant judgment to determine whether preopening services provided to
franchisees (e.g., site selection assistance, training, and other services) are
distinct from one another, the franchise license, and any other goods or
services promised in the contract. This determination will affect the timing of
revenue recognition related to the franchisee’s payment of initial franchise
fees to the franchisor.
Private-company franchisors expressed concerns about the cost
and complexity of applying ASC 606, particularly with respect to the accounting
for initial franchise fees. Many franchise agreements include an up-front
payment (i.e., the initial franchise fee) plus a royalty paid to a franchisor
throughout the term of the arrangement. Under ASC 606, some franchisors may be
required to defer revenue recognition related to some or all of the initial
franchise fee over the term of the franchise license.
ASU 2021-02 added ASC 952-606 to provide a practical expedient
that allows a private-company franchisor that has entered into a franchise
agreement to treat certain preopening services provided to a franchisee as
distinct from the franchise license. Those preopening services consist of the
following activities:
- “Assistance in the selection of a site.”
- “Assistance in obtaining facilities and preparing the facilities for their intended use, including related financing, architectural, and engineering services, and lease negotiation.”
- “Training of the franchisee’s personnel or the franchisee.”
- “Preparation and distribution of manuals and similar material concerning operations, administration, and record keeping.”
- “Bookkeeping, information technology, and advisory services, including setting up the franchisee’s records and advising the franchisee about income, real estate, and other taxes or about regulations affecting the franchisee’s business.”
- “Inspection, testing, and other quality control programs.”
If a private-company franchisor applies the practical expedient,
it must disclose that fact.
If a private-company franchisor does not elect to use the
practical expedient, or if its contracts with customers include other promised
goods or services that are not consistent with the activities in the above list,
the entity must apply the guidance in ASC 606 on identifying performance
obligations. In addition, a private-company franchisor that applies the
practical expedient must make a policy election to either (1) apply the guidance
in ASC 606 to determine whether the preopening services that are subject to the
practical expedient are distinct from one another or (2) account for those
preopening services as a single performance obligation. A private-company
franchisor that elects to account for those preopening services as a single
performance obligation is required to disclose this accounting policy. Further,
an entity that applies the guidance in ASU 2021-02 should apply it consistently
to contracts with similar characteristics and in similar circumstances.
Although the practical expedient simplifies step 2 of ASC 606
(i.e., identifying the performance obligations), entities are still required to
apply the rest of the guidance in ASC 606, including the guidance on (1)
identifying other performance obligations (e.g., equipment sales), (2)
determining the stand-alone selling prices of the performance obligations, (3)
allocating the transaction price to the performance obligations, and (4)
determining the timing of revenue recognition. Further, ASU 2021-02 applies only
to certain preopening services provided by private-company franchisors, and
entities not within the scope of the ASU’s guidance are precluded from applying
the ASU directly or by analogy.
ASU 2021-02 provides an illustrative example that is codified in
ASC 952-606-55-1 through 55-5 as follows:
ASC 952-606
Example 1 —
Identifying Performance Obligations
55-1 An entity enters into a
contract with a customer and promises to grant a
franchise license to open a restaurant location. The
franchise license term is 10 years. In addition to the
license, the entity also promises to provide two
services related to the opening of the franchise
location — site selection and training. The entity
receives a fixed fee of $25,000, as well as a
sales-based royalty of 5 percent of the customer’s sales
for the term of the license. The fixed consideration of
$25,000 is payable on or before the opening of the
restaurant location.
55-2 The entity first assesses
whether it is eligible for the practical expedient for
identifying performance obligations in paragraph 952-606-25-2. The entity determines that
it is eligible because it is not a public business
entity, it is a franchisor that is within the scope
of Topic 952, and it has entered into a
franchise agreement with a customer.
55-3 In applying the practical
expedient, the entity compares its pre-opening services
(training and site selection) to the list of services in
paragraph 952-606-25-2 instead of applying the guidance
in paragraph 606-10-25-19. The entity determines that
those services may be accounted for as distinct from the
franchise license because they are consistent with the
list of services in paragraph 952-606-25-2. The entity
makes an accounting policy election to account for all
pre-opening services that are consistent with the list
in paragraph 952-606-25-2 as a single performance
obligation. Therefore, the entity determines that it has
two performance obligations — a franchise license and
pre-opening services.
55-4 The entity then applies
the guidance in paragraphs 606-10-32-28 through 32-45 to
allocate the transaction price to the performance
obligations and the guidance in paragraphs 606-10-25-23
through 25-37 and 606-10-55-65 through 55-65B to
determine when and how to recognize revenue for
satisfaction of the performance obligations.
55-5 The entity discloses its
use of the practical expedient and its accounting policy
election to treat the pre-opening services as a single
performance obligation in accordance with the disclosure
requirements in paragraphs 952-606-50-1 through
50-2.
Footnotes
5
See paragraph BC98 of ASU 2014-09.
6
In this publication, it is assumed that a SaaS
arrangement is accounted for as a service contract because the
customer does not have the ability to take possession of the
underlying software license on an on-premise basis.
7
If a customer purchases additional
implementation services after the SaaS term has commenced, the
entity would generally apply the modification guidance in ASC
606 and perform the same analysis as if it were analyzing
implementation services purchased up front. For additional
information about the accounting for contract modifications, see
Chapter
9.
8
Often in these arrangements, a
customer is required to pay an up-front fee for
the smart device but is not required to pay that
fee again upon renewal of the subscription
services. In those circumstances, if the smart
device is not distinct from the subscription
services, an entity should consider whether a
material right has been provided.
10
Quoted from Implementation Q&A 19
(compiled from previously issued TRG Agenda Papers 27 and
34).
5.4 Defining the Nature of the Promise
5.4.1 In General
As previously discussed, performance obligations can vary greatly across industries, within industries,
and even within a company. An entity must assess its contracts with customers to determine what
performance obligations it needs to satisfy. Once it completes this task, the entity will have to determine
the appropriate pattern of satisfaction of the performance obligations (see Chapter 8 for discussion
of step 5). As noted in paragraph BC159 of ASU 2014-09, an entity does not have a “free choice” in
determining the appropriate method for measuring progress toward satisfaction of the performance
obligations; rather, the entity should use judgment to choose a measurement method that faithfully represents
the pattern of satisfaction of the performance obligation. To accomplish this, the entity should assess
the nature of the promises in its performance obligations (i.e., consider how and when it will satisfy its
performance obligations).
5.4.2 Impact of Exclusivity on the Identification of Performance Obligations
Certain contracts with customers may include conditions related
to exclusivity that restrict the entity’s ability to sell goods or services to
other customers or in certain geographies. The exclusivity may be limited in
time or may be indefinite.
For example, an entity may provide a customer with an exclusive
license of IP, thus preventing the entity from issuing licenses of that IP to
other customers. Alternatively, an entity may enter into an exclusive
distribution arrangement to provide goods or services to a customer in a
specific geographic area, thereby limiting the entity’s ability to sell goods or
services to other customers in that geographic area.
Generally, it is not appropriate to identify exclusivity as a
performance obligation in a contract with a customer.
In paragraph BC412(b) of ASU 2014-09, the FASB and IASB
discussed the effect of exclusivity clauses in the context of licenses of IP.
They acknowledged that many respondents to the boards’ 2010 exposure draft on
revenue “explained that a distinction based on exclusivity was inconsistent with
the control principle because exclusivity does not affect the determination of
the entity’s performance.” In addition, the boards noted that “exclusivity is
another restriction that represents an attribute . . . rather than the nature of
the underlying intellectual property or the entity’s promise in granting a
license.” As a result, exclusivity is not accounted for separately in a license
arrangement.
Although the discussion above was in the context of licenses of
IP, the comments made are equally valid in the context of other goods and
services. Accordingly, exclusivity would generally be seen as an attribute of
the goods or services supplied, as opposed to a separate promise in itself,
because exclusivity does not affect the nature of the entity’s performance to
provide the underlying goods or services.
5.4.3 Stand-Ready Obligations
Contracts promise specific goods and services, but sometimes they also promise
to deliver those goods and services over a specified period. ASC 606-10-25-18(e)
describes a service of “standing ready” to provide goods or services
(“stand-ready obligation”). The customer receives and consumes a benefit from a
stand-ready obligation — namely, the assurance that a service (e.g., snow
removal during the winter) is available to the customer when and if needed or
called upon. When an entity enters into a contract with a customer and agrees to
make itself available to provide goods and services to the customer over a
specified period, such a promise is generally viewed as a stand-ready
obligation. In this type of arrangement, (1) a customer may make requests of the
entity to deliver some or all of the goods and services at some point during the
period defined in the contract, or (2) the delivery of some or all of the goods
and services on a when-and-if-available basis may be in the control of the
entity.
The TRG discussed stand-ready obligations because of the
concerns and questions that stakeholders have raised. Stakeholders have
identified four broad types of promises or arrangements that may constitute
stand-ready obligations, including those for which the obligation to deliver
goods or services is:
-
Within the entity’s control, but for which additional development of the goods, services, or IP is required (“Type A”).
-
Outside both the entity’s and the customer’s control (“Type B”).
-
Solely within the customer’s control (“Type C”).
The fourth category identified is promises to make an entity’s
goods or services available to the customer continuously over the contractual
period — such as a health club membership, which is the only example of
measuring progress toward completion of a stand-ready obligation in the revenue
standard11 (“Type D”). A potential way to account for a Type D arrangement is for the
entity to record revenue ratably over the performance period on a straight-line
basis. Straight-line revenue recognition results because (1) the customer is
required to pay regardless of how frequently he or she uses the health club and
(2) the entity stands ready to make its goods or services available to the
customer on a constant basis over the contract period.
Because the revenue standard provides an example of Type D
arrangements but not others, questions have arisen regarding the identification
of other stand-ready obligations (i.e., Types A through C) and how to
appropriately measure progress toward completion of delivering the promised
goods or services. Specifically, views differ on (1) what constitutes the nature
of the promise in the aforementioned arrangements (e.g., whether it is the act
of standing ready or the actual delivery of the goods or services to the
customer) and (2) the methods used to measure progress toward the complete
satisfaction of a stand-ready obligation (e.g., a time-based, input, or output
method).
Entities will need to use judgment when evaluating arrangements
that have characteristics of Types A through C as described above. Sections 5.4.3.1 and 5.4.3.2 provide additional guidance to help
entities make the necessary judgments.
5.4.3.1 Assessing Whether a Promise Is a Stand-Ready Performance Obligation
Distinguishing a performance obligation to deliver goods or
services from a stand-ready obligation to deliver goods or services may be
complex and will require an entity to consider the arrangement’s relevant
facts and circumstances. However, an entity should begin by identifying the
nature of the promise in the contract. For example, the determination of
whether the promise is an obligation to provide one or more defined goods or
services or is instead an obligation to provide an unknown type or quantity
of goods or services might be a strong indicator of the nature of the
entity’s promise in the contract. While in either case the entity
might be required to “stand ready” to deliver the good(s) or service(s)
whenever called for by the customer or upon the occurrence of a contingent
event (e.g., snowfall), the fact that the entity will not know when or how
extensively the customer will receive the entity’s good(s) or service(s)
during the contract term may be a strong indicator that the entity is
standing ready to perform.
Example 18 in ASC 606-10-55-184 through 55-186 discusses
stand-ready obligations in health club memberships. The example notes that
the entity’s promise is to provide a service of making the health clubs
available because the extent to which a customer uses the health clubs does
not affect the amount of the remaining goods and services to which the
customer is entitled. This is consistent with the discussion in paragraph
BC160 of ASU 2014-09.
Other examples of stand-ready performance obligations may
include the following:
-
Snow removal services — An entity promises to remove snow on an “as needed” basis. In this type of arrangement, the entity does not know and most likely cannot reasonably estimate whether, how often, and how much it will snow. This suggests that the entity’s promise is to stand ready to provide these services on a when-and-if-needed basis.
-
Software updates and upgrades — An entity promises to make unspecified (i.e., when-and-if-available) software updates and upgrades available to a customer, and the entity has no discernible pattern of providing updates and upgrades. The nature of the entity’s promise is fundamentally one of providing the customer with assurance that any updates or upgrades developed by the entity during the period will be made available because the entity stands ready to transfer updates or upgrades when and if they become available.
-
SaaS — An entity promises to make its SaaS available to the customer, and the customer has unlimited usage of the SaaS over the contract term.
-
Extended warranty — A customer purchases an extended product warranty for a good (e.g., equipment), and the entity promises to remediate any issues with the product when and if problems arise. That is, the entity is standing ready to make repairs when and if needed. For further discussion, see Connecting the Dots below.
See Section 8.5.10 for
additional considerations on measuring progress toward the complete
satisfaction of a stand-ready obligation that is satisfied over time.
The above issue is addressed in Implementation Q&A 22 (compiled from previously
issued TRG Agenda Papers 16 and 25). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
Connecting the Dots
In Implementation Q&A 22, the FASB staff discusses
maintenance contracts under which a customer would receive repair or
maintenance services as needed over a prescribed period. The Q&A
states the following:
The staff thinks that whether the obligation is
to provide a defined good or service (or goods or services), or
instead, to provide an unknown type or quantity of goods or
services might be a strong indicator as to the nature of the
entity’s promise in the contract. The staff notes, however, that
in either case the entity might be required to “stand ready” to
deliver the good(s) or service(s) whenever the customer calls
for them or upon the occurrence of a contingent event (for
example, snowfall).
If an entity has entered into maintenance contracts to
provide maintenance services on equipment only on an as-needed basis, it
may be appropriate for the entity to account for its performance
obligations under those contracts as stand-ready obligations by
recording revenue as the stand-ready services are provided. However, the
entity must evaluate its contracts that include maintenance goods or
services to determine the nature of its promises on the basis of the
specific facts and circumstances of each contract.
Assessing whether the promise in a maintenance contract
is a stand-ready obligation will require judgment. However, an entity
may consider indicators supporting a conclusion that a stand-ready
obligation does not exist. Such indicators include, but are not limited
to, the following:
-
The contract contains a promise to provide services that is specific about amounts and timing, as opposed to a promise to provide services as needed.
-
The services vary in nature, frequency, or complexity each time they are performed.
-
The goods or services are highly integrated or interrelated as a result of the complexity involved in providing them, making it difficult for another entity to take over the maintenance services.
-
Modifications to the contract often include promises for specific additional goods or services.
If an entity concludes that it does not have a
stand-ready obligation, it would account for the goods or services on
the basis of the specific promises in the contract.
5.4.3.2 Determining Whether a Contract Includes a Stand-Ready Obligation or an Obligation to Provide a Defined Amount of Goods or Services
It will sometimes be necessary to determine whether the
nature of an entity’s promise under a contract is (1) to stand ready to
provide goods or services or (2) to provide a defined amount of discrete
goods or services. A promise to stand ready to provide goods or services is
often satisfied over time as the customer benefits from being able to call
upon a resource if and when needed throughout the stand-ready obligation
period. However, an obligation to provide a defined amount of discrete goods
or services is satisfied when or as those discrete goods or services are
transferred to the customer.
An entity may be required to use judgment to distinguish
between a stand-ready obligation and an obligation to provide a defined
amount of goods or services. It will often be helpful for an entity to focus
on the extent to which a customer’s use of a resource affects the remaining
resources to which the customer is entitled. A determination that the nature
of the entity’s obligation to the customer is to provide resources as and
when required by the customer and that the customer’s future entitlement is
unaffected by the extent to which resources have already been provided is
indicative of a stand-ready obligation. In contrast, a determination that
the contract is to supply a specified number of units of the resource and
that the remaining entitlement diminishes as each unit is consumed is
indicative of an obligation to provide a defined amount of goods or
services.
Paragraph BC160 of ASU 2014-09 discusses the concept of a
stand-ready obligation as follows:
To meet [the]
objective of depicting the entity’s performance, an entity would need to
consider the nature of the promised goods or services and the nature of
the entity’s performance. For example, in a typical health club
contract, the entity’s promise is to stand ready for a period of time
(that is, by making the health club available), rather than providing a
service only when the customer requires it. In this case, the customer
benefits from the entity’s service of making the health club available.
This is evidenced by the fact that the extent to
which the customer uses the health club does not, in itself, affect
the amount of the remaining goods or services to which the customer
is entitled. In addition, the customer is obliged to pay the
consideration regardless of whether it uses the health club.
Consequently, in those cases, the entity would need to select a measure
of progress based on its service of making goods or services available
instead of when the customer uses the goods or services made available
to them. [Emphasis added]
Example 5-11
Company X enters into a software
arrangement with Customer Y, who pays up-front
nonrefundable consideration in exchange for a
software license and a specified quantity of service
credits. The credits can be redeemed for consulting
services as and when needed by the customer over a
three-year term.
Each credit is equivalent to a
predetermined number of consulting hours. The
agreement requires X to be available to provide
consulting services in exchange for credits when
requested by Y. The credits expire after the
three-year term; however, customers generally use
all of their credits.
As discussed above, for an entity to
distinguish between a stand-ready obligation and an
obligation to provide a defined amount of goods or
services, it will often be helpful to focus on the
extent to which the customer’s use of a resource
affects the remaining resources to which the
customer is entitled.
In the circumstances described, Y
pays in advance for a defined amount of consulting
services to be provided by X when and if needed by
Y. In contrast to the example in paragraph BC160 of
ASU 2014-09, when Y redeems credits for consulting
services, this does affect the amount of the
remaining services to which it is entitled,
indicating that X’s promise is to deliver specified
services rather than to stand ready.
In this example, assuming that X
does not expect to be entitled to breakage, X should
recognize revenue as the consulting services are
provided to Y for redeemed credits or when the
credits expire at the end of the three-year
arrangement.
However, if X’s obligation was to
provide an unspecified amount of consulting services
over time (e.g., an obligation to provide whatever
level of consulting services was needed by Y), a
different revenue recognition pattern would most
likely result because X’s promise would be to stand
ready. In this scenario, Y’s entitlement to future
consulting services would not be affected by the
extent to which Y had already received consulting
services.
See Section 8.5.10 for
an additional illustration of this distinction.
5.4.3.2.1 Determining Whether a SaaS Arrangement Represents a Stand-Ready Obligation or an Obligation to Provide a Specified Amount of Services
To determine the appropriate revenue recognition model to apply to its
SaaS arrangements, an entity must first determine the nature of its
promise to provide services. In some arrangements, the entity may price
a SaaS arrangement on the basis of the expected volume of usage, but it
may not always be clear whether the nature of the promise is (1) an
obligation to provide a specified amount of services (e.g., a promise to
process 5,000 transactions) or (2) a stand-ready obligation to provide
services if and when the customer needs them (e.g., a promise to make
the SaaS available throughout a specified term to process all
transactions submitted during the period).
An entity will need to carefully consider the rights and obligations in
the contract to identify the nature of the promise and to determine an
appropriate measure of the progress toward complete satisfaction of the
performance obligation.
The following factors may indicate that the nature of the entity’s
promise is an obligation to provide a specified amount of services:
-
The customer has the right to “roll over” unused volume into a future period.
-
The customer’s right to use the SaaS terminates upon reaching the specified volume.
-
Upon reaching the specified volume, the customer must make a separate purchasing decision with respect to additional services and the entity is not obligated to provide those services before the customer exercises its rights (e.g., the customer and entity need to enter into a contract modification to continue service).
The following factors may indicate that the nature of the entity’s
promise is to stand ready to provide the service:
-
The contract does not include any specified volumes of usage (i.e., the customer has “unlimited access” to the SaaS).
-
The specified volume is set as the maximum amount the customer can use, but it is not substantive (e.g., the limit is set as a protective measure and, in reality, is substantially higher than is actually expected to be used by the customer).
-
The entity is required to stand ready to provide the service over the entire contractual period regardless of whether the customer exceeds the specified volume (i.e., the customer can continue use of the SaaS without requesting such ability from the entity, even if it has to pay an incremental fee for the excess).
If the nature of the entity’s promise is to provide a specific amount of
services, revenue is typically recognized when (or as) those services
are provided. Breakage may be considered if a customer is not expected
to use all the specified volume (see Section
8.8).
If the nature of the entity’s promise is to stand ready to provide the
SaaS, there are additional considerations related to applying the series
guidance, determining an appropriate measure of progress, and
determining how variable consideration (if present) is recognized.
5.4.3.3 Unspecified Future Goods or Services in a Software Arrangement — Timing of Revenue Recognition
There can be situations in which the contract with a customer is not specific
about what is promised to a customer. This type of contract could appear to
be a stand-ready obligation. A common example of this situation arises in
software contracts.
An entity may enter into a contract with a customer that
includes two performance obligations: (1) a license of software and (2) a
promise to provide unspecified updates and upgrades12 to the software on a “when and if available” basis. The unspecified
updates and upgrades are different from, and extend beyond, an
assurance-type warranty.
When a contract with a customer transfers the rights to unspecified future
updates, upgrades, or products, an entity is required to use judgment to
determine whether the nature of the promise (performance obligation) is
either of the following:
- To stand ready to maintain or enhance the software as needed.
- To develop and provide a new or significantly enhanced version of the software.
If the nature of the promise represents an obligation by the entity to stand
ready to maintain or enhance the software as needed to ensure that the
customer can continue to receive and consume the benefit of the software
throughout the contract term, the value to the customer is transferred over
time as the entity stands ready to perform. That is, the entity would (1)
satisfy the performance obligation over time and (2) determine the
appropriate measure of progress to recognize revenue over time.
If the nature of the promise represents an implied obligation to develop and
provide new or significantly enhanced versions of the software through
specified upgrades, the benefits of those upgrades are received and consumed
when and if they are made available to the customer. That is, the
performance obligation is only satisfied at the individual points in time
when those upgrades are delivered to the customer.
Footnotes
11
ASC 606-10-55-184 through 55-186.
12
The nature of the entity’s promise when it commits
to provide unspecified updates and upgrades to a customer differs
from the entity’s obligation when it commits to deliver specified
upgrades. This discussion addresses only unspecified updates and
upgrades. For specified upgrades, the analysis will most likely be
different since specified upgrades will often be a separate
performance obligation.
5.5 Warranties
5.5.1 In General
Early in the drafting of the revenue standard, the FASB and IASB thought to
treat all warranties similarly because generally, all warranties represent an
entity’s promise to stand ready to repair or replace the good or service that
the entity has provided to a customer in accordance with the terms of the
parties’ contract. However, stakeholders informed the boards that some
warranties are different from others and that entities should account for such
warranties differently. The boards agreed with the stakeholders’ feedback.
5.5.2 Types of Warranties
ASC 606-10
55-30 It is common for an entity to provide (in accordance with the contract, the law, or the entity’s customary
business practices) a warranty in connection with the sale of a product (whether a good or service). The nature
of a warranty can vary significantly across industries and contracts. Some warranties provide a customer with
assurance that the related product will function as the parties intended because it complies with agreed-upon
specifications. Other warranties provide the customer with a service in addition to the assurance that the
product complies with agreed-upon specifications.
It is important to determine what type of warranty an entity offers to a customer because the way in
which revenue is recognized will vary depending on that determination. An entity should determine
whether it offers the customer an assurance-type warranty or a service-type warranty. An assurance-type
warranty provides the customer with the peace of mind that the entity will fix or possibly replace
a good or service if the original good or service was faulty. It is the type of warranty with which most
customers are familiar. In contrast, a service-type warranty provides the customer with a service that is
incremental to the assurance that the good or service will meet the expectations agreed to in the contract.
5.5.3 Determining Whether a Warranty Is a Performance Obligation (Service-Type Warranties)
ASC 606-10
55-31 If a customer has the option to purchase a warranty separately (for example, because the warranty
is priced or negotiated separately), the warranty is a distinct service because the entity promises to provide
the service to the customer in addition to the product that has the functionality described in the contract.
In those circumstances, an entity should account for the promised warranty as a performance obligation in
accordance with paragraphs 606-10-25-14 through 25-22 and allocate a portion of the transaction price to that
performance obligation in accordance with paragraphs 606-10-32-28 through 32-41.
55-34 If a warranty, or a part
of a warranty, provides a customer with a service in
addition to the assurance that the product complies with
agreed-upon specifications, the promised service is a
performance obligation. Therefore, an entity should
allocate the transaction price to the product and the
service. If an entity promises both an assurance-type
warranty and a service-type warranty but cannot
reasonably account for them separately, the entity
should account for both of the warranties together as a
single performance obligation.
55-35 A law that requires an
entity to pay compensation if its products cause harm or
damage does not give rise to a performance obligation.
For example, a manufacturer might sell products in a
jurisdiction in which the law holds the manufacturer
liable for any damages (for example, to personal
property) that might be caused by a consumer using a
product for its intended purpose. Similarly, an entity’s
promise to indemnify the customer for liabilities and
damages arising from claims of patent, copyright,
trademark, or other infringement by the entity’s
products does not give rise to a performance obligation.
The entity should account for such obligations in
accordance with the guidance on loss contingencies in
Subtopic 450-20 on contingencies.
The decision tree below illustrates the revenue standard’s process for
determining whether a warranty represents a separate performance obligation.
An entity may need to use judgment to determine whether a warranty is a
service-type warranty (i.e., performance obligation). This is important because,
depending on the outcome of the entity’s assessment, consideration could be
allocated to the performance obligation and consequently change the pattern of
revenue recognition.
To assess the nature of a warranty, an entity should consider whether the
warranty provides an additional service. An easy way to determine this is if a
warranty is sold separately. A contract is considered separately priced if the
customer has the option of purchasing the contract for an expressly stated
amount separate from the price of the product. As discussed in paragraph BC371
of ASU 2014-09, an entity could also separately negotiate a warranty with a
customer and determine that a performance obligation exists.
However, a warranty does not necessarily have to be separately sold or separately negotiated to be
considered a performance obligation. To determine whether a warranty is a performance obligation, an
entity should consider various indicators in accordance with ASC 606-10-55-33.
ASC 606-10
55-33 In assessing whether a warranty provides a customer with a service in addition to the assurance that the
product complies with agreed-upon specifications, an entity should consider factors such as:
- Whether the warranty is required by law — If the entity is required by law to provide a warranty, the existence of that law indicates that the promised warranty is not a performance obligation because such requirements typically exist to protect customers from the risk of purchasing defective products.
- The length of the warranty coverage period — The longer the coverage period, the more likely it is that the promised warranty is a performance obligation because it is more likely to provide a service in addition to the assurance that the product complies with agreed-upon specifications.
- The nature of the tasks that the entity promises to perform — If it is necessary for an entity to perform specified tasks to provide the assurance that a product complies with agreed-upon specifications (for example, a return shipping service for a defective product), then those tasks likely do not give rise to a performance obligation.
A warranty that provides a service in
addition to the entity’s assurance that the goods or services
transferred to a customer will function as intended or meet agreed-upon
specifications would represent a separate performance obligation. Accordingly,
the entity would need to allocate a portion of the transaction price to the
separate service and recognize the related revenue when (or as) performance is
completed even when this warranty is neither separately priced nor separately
negotiated.
If the warranty merely provides what ASC 606-10-55-30 describes
as “assurance that the related product will function as the parties intended
because it complies with agreed-upon specifications,” the assurance is not a
service and therefore not a separate performance obligation. For an
assurance-type warranty obligation incurred in connection with the sale of a
product (i.e., an obligation that is not separately priced or sold or otherwise
a separate performance obligation), the costs associated with providing the
warranty would be accrued in accordance with ASC 460-10 (see ASC
606-10-55-32).
Assessing the substance of the promise in a warranty arrangement
that is neither separately priced nor separately negotiated often will require
judgment. To aid in such an assessment, ASC 606-10-55-33 lists three factors
that an entity should consider in determining whether a warranty provides the
customer with a service in addition to the entity’s assurance that the good or
service complies with agreed-upon specifications: (1) whether the warranty is
required by law, (2) the length of the coverage period, and (3) the nature of
the tasks that are promised.
Questions continually arise about how an entity would determine
whether a product warranty that is not separately priced is a performance
obligation (i.e., whether the warranty represents a service rather than a
guarantee of the product’s intended functionality). For illustrative purposes,
TRG members in March 2015 discussed an example in which a luggage company
provides a lifetime warranty to repair any damage to the luggage free of charge
and noted that such a warranty would be a separate performance obligation
because the company agreed to repair any damage (i.e., repairs that
extend beyond those that fix defects preventing the luggage from functioning as
intended).
TRG members generally agreed with the conclusion that the
warranty in the luggage example would represent a separate performance
obligation but that it “illustrates a relatively [straightforward] set of facts
and circumstances that demonstrate an instance of when a warranty provides a
service.”13 However, the conclusion for other warranty arrangements may be less clear.
Accordingly, an entity will need to assess the substance of the promises in a
warranty arrangement and exercise judgment on the basis of the entity’s specific
facts and circumstances.
In addition, while the duration of the warranty (e.g., the
lifetime warranty in the luggage company example discussed) may be an indicator
of whether a warranty is a separate performance obligation, it is not
determinative.
Example 5-12
In accordance with customary business
practices, a luggage manufacturer provides all customers
with a one-year warranty that covers only manufacturing
defects.
This warranty does not represent a
separate performance obligation because it only provides
assurance that the luggage will function as intended
over a short (and customary) period. This is an
“assurance-type” warranty, which should be accounted for
under ASC 460. As a result, there is no revenue deferral
for the warranty.
Example 5-13
A luggage manufacturer provides all
customers with a lifetime warranty that covers all
defects and damages, including those arising from normal
wear and tear.
This warranty represents a separate
performance obligation because the manufacturer has
agreed to provide repairs for all damage (i.e., it has
agreed to provide a service of repairing the luggage for
all damage, which extends beyond rectifying
manufacturing defects) and over a longer period than is
customary (i.e., the life of the luggage). The luggage
manufacturer should (1) determine the stand-alone
selling price of the repair service and allocate an
appropriate portion of the transaction price to it and
(2) recognize that portion as revenue over the period in
which the service is delivered.
The above issue is addressed in Implementation Q&A 17 (compiled from previously issued
TRG Agenda Papers 29 and 34). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
5.5.4 Warranties Within the Scope of Other Guidance (Assurance-Type Warranties)
Warranties could be within the scope of guidance outside the revenue standard
under certain circumstances. For example, warranties that are determined to be
separate performance obligations in accordance with the guidance in ASC
606-10-55-30 through 55-35 might appear to be insurance contracts. However, such
warranties would only be considered insurance contracts within the scope of
applicable guidance in ASC 944 if they are directly issued by a third-party
insurance entity. Further, a warranty could be within the scope of the guidance
on product warranties in ASC 460-10 if it only provides assurance that a product
complies with agreed-upon specifications, as explained in ASC 606-10-55-32.
ASC 606-10
55-32 If a customer does not have the option to purchase a warranty separately, an entity should account for
the warranty in accordance with the guidance on product warranties in Subtopic 460-10 on guarantees, unless
the promised warranty, or a part of the promised warranty, provides the customer with a service in addition to
the assurance that the product complies with agreed-upon specifications.
Example 44 in ASC 606 illustrates how to account for an
assurance-type warranty.
ASC 606-10
Example 44 — Warranties
55-309 An entity, a
manufacturer, provides its customer with a warranty with
the purchase of a product. The warranty provides
assurance that the product complies with agreed-upon
specifications and will operate as promised for one year
from the date of purchase. The contract also provides
the customer with the right to receive up to 20 hours of
training services on how to operate the product at no
additional cost. The training services will help the
customer optimize its use of the product in a short time
frame. Therefore, although the training services are
only for 20 hours and are not essential to the
customer’s ability to use the product, the entity
determines that the training services are material in
the context of the contract on the basis of the facts
and circumstances of the arrangement.
55-310 The entity assesses
the goods and services in the contract to determine
whether they are distinct and therefore give rise to
separate performance obligations.
55-311 The product and
training services are each capable of being distinct in
accordance with paragraphs 606-10-25-19(a) and
606-10-25-20 because the customer can benefit from the
product on its own without the training services and can
benefit from the training services together with the
product that already has been transferred by the entity.
The entity regularly sells the product separately
without the training services.
55-312 The entity next
assesses whether its promises to transfer the product
and to provide the training services are separately
identifiable in accordance with paragraphs
606-10-25-19(b) and 606-10-25-21. The entity does not
provide a significant service of integrating the
training services with the product (see paragraph
606-10-25-21(a)). The training services and product do
not significantly modify or customize each other (see
paragraph 606-10-25-21(b)). The product and the training
services are not highly interdependent or highly
interrelated as described in paragraph 606-10-25-21(c).
The entity would be able to fulfill its promise to
transfer the product independent of its efforts to
subsequently provide the training services and would be
able to provide training services to any customer that
previously acquired its product. Consequently, the
entity concludes that its promise to transfer the
product and its promise to provide training services are
not inputs to a combined item and, therefore, are each
separately identifiable.
55-313 The product and
training services are each distinct in accordance with
paragraph 606-10-25-19 and therefore give rise to two
separate performance obligations.
55-314 Finally, the entity
assesses the promise to provide a warranty and observes
that the warranty provides the customer with the
assurance that the product will function as intended for
one year. The entity concludes, in accordance with
paragraphs 606-10-55-30 through 55-35, that the warranty
does not provide the customer with a good or service in
addition to that assurance and, therefore, the entity
does not account for it as a performance obligation. The
entity accounts for the assurance-type warranty in
accordance with the requirements on product warranties
in Subtopic 460-10.
55-315 As a result, the
entity allocates the transaction price to the two
performance obligations (the product and the training
services) and recognizes revenue when (or as) those
performance obligations are satisfied.
5.5.5 Implicit Warranty Beyond the Contractual Period
In addition to providing a warranty that guarantees that an
entity’s product or service complies with agreed-upon specifications for a
specified period, entities in many industries may continue to provide
warranty-type services (e.g., repairs) beyond the original specified period as
part of their customary business practices. In accordance with ASC 606-10-55-34,
if an entity’s warranty, or part of its warranty, provides a customer with a
service in addition to the assurance that the product complies with agreed-upon
specifications, the promised service represents a performance obligation.
Regardless of whether the warranty services are explicitly
promised in the contract for a specified period or are implied by customary
business practices, the entity must assess whether the services to be provided
represent an assurance-type warranty (which should be accounted for in
accordance with ASC 460-10) or a promised service (in addition to the assurance
that the product complies with agreed-upon specifications) in the contract. This
assessment requires an analysis of the nature of (1) the products or services
that are subject to the specific warranty and (2) any other products or services
that are provided as part of the entity’s customary business practice.
Example 5-14
Entity X sells long-life LED lightbulbs
to customers with a two-year contractual warranty
period. Entity X also has a customary business practice
of providing its customers with a replacement lightbulb
free of charge if a defective lightbulb is returned
within three years of the date of purchase.
In accordance with ASC 606-10-55-32 and
ASC 606-10-55-34, the practice of replacement in the
third year is not considered an additional service
(i.e., it is not a separate performance obligation) and
therefore should not be accounted for as a service-type
warranty. Entity X concludes that the practice of
replacement in the third year should be accounted for as
an assurance-type warranty, and is not a separate
performance obligation, because X is only guaranteeing
that the lightbulb will function as intended. Therefore,
X accounts for the warranty in accordance with ASC
460-10.
Footnotes
13
Quoted from Implementation Q&A 17.
5.6 Nonrefundable Up-Front Fees
ASC 606-10
55-50 In some contracts, an entity charges a customer a nonrefundable upfront fee at or near contract
inception. Examples include joining fees in health club membership contracts, activation fees in
telecommunication contracts, setup fees in some services contracts, and initial fees in some supply contracts.
55-51 To identify performance obligations in such contracts, an entity should assess whether the fee relates
to the transfer of a promised good or service. 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 (see paragraph 606-10-
25-17). 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. The revenue recognition period
would extend beyond the initial contractual period if the entity grants the customer the option to renew the
contract and that option provides the customer with a material right as described in paragraph 606-10-55-42.
55-52 If the nonrefundable upfront fee relates to a good or service, the entity should evaluate whether to
account for the good or service as a separate performance obligation in accordance with paragraphs 606-10-
25-14 through 25-22.
55-53 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 entity should assess whether costs incurred in
setting up a contract have resulted in an asset that should be recognized in accordance with paragraph
340-40-25-5.
Nonrefundable up-front fees are payments made by customers at the start of a
contract for various reasons. The revenue standard cites health club membership
fees, activation fees in telecommunication contracts, and set-up fees as examples of
nonrefundable up-front fees. Entities need to assess nonrefundable up-front fees to
determine whether the fees (1) are for goods or services provided at contract
inception or (2) provide the customer with an option for additional goods or
services that gives rise to a material right (a performance obligation).
Example 53 in ASC 606 illustrates the application of the revenue standard’s
guidance on nonrefundable up-front fees.
ASC 606-10
Example 53 — Nonrefundable Upfront Fees
55-358 An entity enters into a contract with a customer for one year of transaction processing services. The
entity’s contracts have standard terms that are the same for all customers. The contract requires the customer
to pay an upfront fee to set up the customer on the entity’s systems and processes. The fee is a nominal
amount and is nonrefundable. The customer can renew the contract each year without paying an additional
fee.
55-359 The entity’s setup
activities do not transfer a good or service to the customer
and, therefore, do not give rise to a performance
obligation.
55-360 The entity concludes that the renewal option does not provide a material right to the customer that
it would not receive without entering into that contract (see paragraph 606-10-55-42). The upfront fee is, in
effect, an advance payment for the future transaction processing services. Consequently, the entity determines
the transaction price, which includes the nonrefundable upfront fee, and recognizes revenue for the
transaction processing services as those services are provided in accordance with paragraph 606-10-55-51.
The example below illustrates how an entity would determine the
period over which to recognize a nonrefundable up-front fee.
Example 5-15
Entity X agrees to provide a customer with
services on a monthly basis at a price of $400 per month,
payable at the start of each month. At the outset, X also
charges the customer a one-time, nonrefundable up-front fee
of $50, for which no separate goods or services are
transferred. The customer can cancel the contract at any
time without penalty, but it will not be entitled to any
refund of amounts already paid. Entity X’s average customer
life is two years.
The period over which the up-front fee
should be recognized depends on whether the up-front fee
provides the customer with a material right with respect to
renewing X’s services. In determining whether the up-front
fee provides the customer with such a material right, X
should consider both quantitative and qualitative factors
(e.g., the renewal price compared with the price a new
customer would pay or the price paid for services already
transferred, inclusive of the nonrefundable up-front
fee).
If X concludes that the up-front fee does
provide a material right, that fee should be recognized over
the service period during which the customer is expected to
benefit from not having to pay a further up-front fee upon
renewal of service.
If X concludes that the up-front fee does
not provide the customer with a material right, the entire
transaction price of $450 (which comprises the minimum
one-month service fee and the up-front fee) is viewed as
advance payment for the promised services (i.e., the first
month only) and should be recognized over the first month
during which the services are provided.
The above issue is addressed in Implementation Q&A 52 (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.
Refer to Section 8.9.4 for
additional discussion of the accounting for nonrefundable up-front fees.
5.6.1 Termination Clauses and Nonrefundable Up-Front Fees in Software Arrangements
Under some software arrangements, the customer must pay a nonrefundable up-front
fee. ASC 606 requires entities to consider whether the fee is (1) associated
with the transfer of promised goods or services or (2) an advance payment for
future goods or services.14 In addition, some software arrangements give the customer the right to
terminate the contract at the customer’s convenience. For example, an
arrangement for a one-year term license and PCS may contain a provision that
allows the customer to terminate the contract after a 30-day notice period. If
the customer can terminate a contract without having to pay a substantive
penalty, generally only the noncancelable portion of the contract (e.g., the
initial 30 days) is accounted for under ASC 606, even if the customer is
unlikely to exercise its termination right.
Questions have arisen in practice regarding how to account for nonrefundable
up-front fees associated with a software arrangement that contains a termination
provision. The examples below illustrate this scenario and discuss the
accounting considerations.
Example 5-16
All Fees Are Nonrefundable
A vendor sells a one-year term-based license with PCS for
an up-front nonrefundable fee of $1.25 million. The
stand-alone selling prices of the license and PCS are $1
million and $250,000, respectively. The vendor’s
customer has the right to terminate the arrangement at
its convenience at the end of each month without paying
any penalty. If the customer terminates, it loses the
right to use the software and receive support. The
customer also has the right to renew the contract
annually for the same fee.
Under the assumption that the license is distinct from
the PCS, the vendor has two performance obligations: (1)
a one-year term license and (2) one year of PCS. While
the customer has the right to terminate the contract at
the end of each month without paying the vendor a
penalty, the customer has, in substance, paid up front
for all the goods and services in the contract — the
one-year term license and one year of PCS. That is,
while a termination provision is treated similarly to a
renewal option, there is no incremental fee to “renew”
(i.e., not terminate) the contract each month, nor is
there a refundable payment for termination. Therefore,
the nonrefundable up-front fee is payment for the term
license and PCS for the full year. In addition, the
contract does not give the customer a material right
since the annual renewal provision is priced at the
stand-alone selling prices of the term license and
PCS.
Example 5-17
Nonrefundable License Fees and Pro Rata Refund for
PCS
A vendor sells a one-year term-based license with PCS for
an up-front fee of $1.25 million. The stand-alone
selling prices of the license and PCS are $1 million and
$250,000, respectively. The vendor’s customer has the
right to terminate the arrangement at its convenience at
the end of each month without paying any penalty. If the
customer terminates, it loses the right to receive
support and $1 million of the up-front fee. However, the
customer receives a pro rata refund for the PCS
($250,000) and retains the software license for the
remainder of the year. The customer also has the right
to renew the contract annually for the same fee.
Under the assumption that the license is distinct from
the PCS, the vendor has two performance obligations: (1)
a one-year term license and (2) one month of PCS. The
contract terms are one year for the license and one
month for the PCS. While the customer has the right to
terminate the contract at the end of each month without
paying the vendor a penalty, the customer has, in
substance, paid up front for the one-year term license
since the fee for the license is nonrefundable and the
customer retains the right to use the license for the
entire year, even if the contract is terminated.
However, the termination provision is treated similarly
to a renewal option for PCS since there is a pro rata
refund for PCS. Therefore, the incremental fee to renew
the contract each month is for optional renewals of PCS
only. In addition, the contract does not give the
customer a material right since (1) the annual renewal
provision is priced at the stand-alone selling prices of
the term license and PCS and (2) the monthly renewal of
PCS is priced at the stand-alone selling price of
PCS.
Example 5-18
Nonrefundable License Fees and Pro Rata Refund for
Mandatory PCS
A vendor sells a one-year term-based license with PCS for
an up-front fee of $1.25 million. The stand-alone
selling prices of the license and PCS are $1 million and
$250,000, respectively. The vendor’s customer has the
right to terminate the arrangement at its convenience at
the end of each month without paying any penalty. If the
customer terminates, it loses the right to use the
software and receive support, but it receives a pro rata
refund that is based on the PCS fee stated in the
contract. The vendor intends to enforce compliance with
the requirement to relinquish the use of the term
license if PCS is not renewed. The stated fee for PCS
($250,000) is refundable, and the remainder of the
up-front payment for the license ($1 million) is
nonrefundable. The customer also has the right to renew
the contract annually for the same fee.
Under the assumption that the license is distinct from
the PCS, we believe that it may be reasonable to
conclude that the vendor has three performance
obligations: (1) a one-month term license, (2) one month
of PCS, and (3) a material right. If the termination
provision is substantive, the contract term is likely to
be one month (i.e., the enforceable rights and
obligations are likely to be limited to one month). The
customer has the right to terminate the contract at the
end of each month without paying the vendor a penalty.
While the customer does not receive a refund of the
up-front payment of $1 million and also loses the right
to use the software license in the event of a
termination, neither loss is considered a substantive
termination penalty. ASC 606 specifies that a
termination penalty compensates the other party. We do
not believe that the relinquishment of the software
would be considered a termination penalty because the
customer is not compensating the vendor for terminating
the contract. Because software licenses are typically
sold on a nonexclusive basis and can be replicated an
unlimited number of times at minimal or no cost, no
substantive asset is returned to the vendor (i.e., the
vendor does not receive a returned product that it can
resell or otherwise obtain economic value from). Such
licenses can be contrasted with exclusive licenses to
IP, which may have value if returned to a vendor. In
addition, we do not believe that the loss of the
up-front, nonrefundable payment is compensation to the
vendor because the initial contract already gave the
vendor the right to that payment (i.e., the vendor
retains the payment irrespective of whether the customer
cancels or renews the contract). Rather, the up-front
nonrefundable fee should be assessed under ASC
606-10-55-50 and 55-51.
The termination provision is treated similarly to a
renewal option since there is a pro rata refund for PCS
if the contract is terminated (which can also be viewed
as an incremental fee to renew). In deciding not to
terminate the contract (i.e., by renewing the contract),
the customer renews both the term license and PCS,
because if PCS is not renewed, the customer loses the
right to the license. Therefore, because of the
termination provision, the vendor might conclude that
present enforceable rights and obligations only exist
for a term license and PCS for one month.
In evaluating whether the up-front, nonrefundable fee is
either (1) a payment for the transfer of promised goods
or services in the initial contract or (2) an advance
payment for future goods or services, the vendor should
determine whether a material right has been provided for
the monthly renewals.15 If the contract is renewed, the incremental fee
(i.e., the refundable portion) is only associated with
the stated PCS fee. In effect, the customer obtains
control of both a term license and PCS by only paying
the fee for PCS. Since the monthly renewal is priced at
a significant and incremental discount to the price that
would be charged to similarly situated customers (i.e.,
the term license and PCS are not renewed at their
stand-alone selling prices), the customer receives a
material right. That material right would be accounted
for as a performance obligation that is recognized with
the renewals of the term license and PCS. If the
practical alternative in ASC 606-10-55-45 is elected,
the transaction price would be allocated to the renewals
of the term license and PCS by reference to the renewals
expected to be provided and the corresponding expected
consideration. If renewals are expected over the entire
stated term (i.e., one year), the entire contractually
stated fee (i.e., $1.25 million) would be allocated
evenly to each monthly term license and PCS. The amount
associated with each month (approximately $104,000)
would then be allocated to the one-month term license
and PCS and recognized when the customer obtains control
of the term license (at a point in time at the beginning
of each month) and as PCS is provided (ratably over the
month) on the basis of their relative stand-alone
selling prices.
For a vendor to conclude that a termination provision
affects the contract term, the provision must be
substantive (i.e., the customer is making a purchasing
decision to renew or terminate the contract). In
determining whether the termination/renewal provision is
substantive, the vendor should consider quantitative and
qualitative factors. For example, the amount subject to
refund must be substantive relative to the total
contract fee. Further, there should be a business
purpose for the provision, and the vendor must intend to
enforce the requirement to relinquish the use of the
term license if PCS is not renewed. The factors to
consider and the relevance of those factors will depend
on the specific facts and circumstances of each
arrangement, and the use of significant judgment may be
required. Companies are therefore encouraged to consult
with their accounting advisers and auditors.
Example 5-19
Nonrefundable License Fees and Nonsubstantive Pro Rata
Refund for Mandatory PCS
A vendor sells a one-year term-based license with PCS for
an up-front fee of $1.25 million. The stand-alone
selling prices of the license and PCS are $1 million and
$250,000, respectively. The vendor’s customer has the
right to terminate the arrangement at its convenience at
the end of each month without paying any penalty. If the
customer terminates, it loses the right to use the
software and receive support, but it receives a pro rata
refund for PCS. The vendor intends to enforce compliance
with the requirement to relinquish the use of the term
license if PCS is not renewed. The stated fee for PCS is
$50,000, and the remainder of the up-front payment ($1.2
million) is nonrefundable. The customer also has the
right to renew the contract annually for the same
fee.
Under the assumption that the license is distinct from
the PCS, we believe that it is reasonable to conclude
that the vendor has two performance obligations: (1) a
one-year license and (2) one year of PCS. The contract
term is likely to be one year (i.e., the enforceable
rights and obligations are likely to be for the full
stated term). The customer has the right to terminate
the contract at the end of each month without paying the
vendor a penalty. While the customer does not receive a
refund related to the up-front payment of $1.2 million
and also loses the right to use the software license in
the event of a termination, neither loss is a
substantive termination penalty. However, unlike the
termination provision in Example 5-18, the provision in this
scenario is not likely to be considered substantive
since the amount subject to refund is only $50,000.
In evaluating whether the up-front nonrefundable fee is
either (1) a payment for the transfer of promised goods
or services in the initial contract or (2) an advance
payment for future goods or services, the vendor would
consider that substantially all of the total contract
fee is the up-front nonrefundable fee. The customer has
the right to terminate the contract at the end of each
month without paying the vendor a penalty; however, the
customer has, in substance, substantially paid up front
for all the stated goods and services in the contract —
the one-year term license and one year of PCS. That is,
while a termination provision is treated similarly to a
renewal option, there is no substantive incremental fee
to “renew” the contract (i.e., there is no substantive
refundable payment for terminating the contract).
Therefore, as in Example
5-16, the nonrefundable up-front fee (in
addition to the nonsubstantive refundable payment) is
considered an up-front payment for the term license and
PCS for the full year. In addition, the contract does
not give the customer a material right since the annual
renewal provision is priced at the stand-alone selling
prices of the term license and PCS.
Footnotes
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.
Chapter 7 — Step 4: Allocate the Transaction Price to the Performance Obligations
Chapter 7 — Step 4: Allocate the Transaction Price to the Performance Obligations
7.1 Background
In step 4 of the revenue standard, an entity allocates the
transaction price to each of the identified performance obligations. For a contract
containing more than one performance obligation, the allocation is generally
performed on the basis of the relative stand-alone selling price of each performance
obligation. However, as discussed below, there are exceptions that allow an entity
to allocate a disproportionate amount of the transaction price to a specific
performance obligation or distinct good or service. For example, an entity may
allocate a discount to a single performance obligation rather than proportionately
to all performance obligations if certain factors indicate that the discount is
related to a specific performance obligation.
ASC 606-10
32-28 The objective when allocating
the transaction price is for an entity to allocate the
transaction price to each performance obligation (or
distinct good or service) in an amount that depicts the
amount of consideration to which the entity expects to be
entitled in exchange for transferring the promised goods or
services to the customer.
7.2 Stand-Alone Selling Price
ASC 606-10
32-29 To meet the allocation
objective, an entity shall allocate the transaction price to
each performance obligation identified in the contract on a
relative standalone selling price basis in accordance with
paragraphs 606-10-32-31 through 32-35, except as specified
in paragraphs 606-10-32-36 through 32-38 (for allocating
discounts) and paragraphs 606-10-32-39 through 32-41 (for
allocating consideration that includes variable
amounts).
32-30 Paragraphs 606-10-32-31
through 32-41 do not apply if a contract has only
one performance obligation. However, paragraphs
606-10-32-39 through 32-41 may apply if an entity
promises to transfer a series of distinct goods or
services identified as a single performance
obligation in accordance with paragraph 606-10-
25-14(b) and the promised consideration includes
variable amounts.
The principle of allocating the transaction price to each performance obligation
is that consideration should be allocated on the basis of the relative stand-alone
selling price of each distinct good or service in the contract. The result of
allocating consideration on this basis should be consistent with the overall core
principle of the revenue standard (i.e., to recognize revenue in an amount that
depicts the consideration to which the entity expects to be entitled in exchange for
the promised goods or services).
ASC 606-10-32-29 requires an entity to allocate the transaction price to each performance obligation on
a relative stand-alone selling price basis. In determining the allocation, an entity is required to maximize
the use of observable inputs. When the stand-alone selling price of a good or service is not directly
observable, an entity is required to estimate the stand-alone selling price. The example below, which is
reproduced from ASC 606, illustrates how to apply the standard’s allocation method.
ASC 606-10
Example 33 — Allocation Methodology
55-256 An entity enters into a contract with a customer to sell Products A, B, and C in exchange for $100. The
entity will satisfy the performance obligations for each of the products at different points in time. The entity
regularly sells Product A separately, and, therefore the standalone selling price is directly observable. The
standalone selling prices of Products B and C are not directly observable.
55-257 Because the standalone selling prices for Products B and C are not directly observable, the entity must
estimate them. To estimate the standalone selling prices, the entity uses the adjusted market assessment
approach for Product B and the expected cost plus a margin approach for Product C. In making those
estimates, the entity maximizes the use of observable inputs (in accordance with paragraph 606-10-32-33). The
entity estimates the standalone selling prices as follows:
55-258 The customer receives a discount for purchasing the bundle of goods because the sum of the
standalone selling prices ($150) exceeds the promised consideration ($100). The entity considers whether it
has observable evidence about the performance obligation to which the entire discount belongs (in accordance
with paragraph 606-10-32-37) and concludes that it does not. Consequently, in accordance with paragraphs
606-10-32-31 and 606-10-32-36, the discount is allocated proportionately across Products A, B, and C. The
discount, and therefore the transaction price, is allocated as follows:
7.3 Determine the Stand-Alone Selling Price
ASC 606-10
32-31 To allocate the transaction
price to each performance obligation on a relative
standalone selling price basis, an entity shall determine
the standalone selling price at contract inception of the
distinct good or service underlying each performance
obligation in the contract and allocate the transaction
price in proportion to those standalone selling prices.
The stand-alone selling price may be, but is not presumed to be, the
contract price. The best evidence of the stand-alone selling price is an observable
price for selling the same good or service separately to a similar customer. If a
good or service is not sold separately, an entity must estimate the stand-alone
selling price by using an approach that maximizes the use of observable inputs.
Acceptable estimation methods include, but are not limited to, (1) the adjusted
market assessment approach, (2) the expected cost plus margin approach, and (3) the
residual approach (when the stand-alone selling price is not directly observable and
is either highly variable or uncertain).
7.3.1 Observable Stand-Alone Selling Prices
ASC 606-10
32-32 The standalone selling
price is the price at which an entity would sell a
promised good or service separately to a customer. The
best evidence of a standalone selling price is the
observable price of a good or service when the entity
sells that good or service separately in similar
circumstances and to similar customers. A contractually
stated price or a list price for a good or service may
be (but shall not be presumed to be) the standalone
selling price of that good or service.
7.3.2 Estimating Stand-Alone Selling Prices
ASC 606-10
32-33 If a standalone selling
price is not directly observable, an entity shall
estimate the standalone selling price at an amount that
would result in the allocation of the transaction price
meeting the allocation objective in paragraph
606-10-32-28. When estimating a standalone selling
price, an entity shall consider all information
(including market conditions, entity-specific factors,
and information about the customer or class of customer)
that is reasonably available to the entity. In doing so,
an entity shall maximize the use of observable inputs
and apply estimation methods consistently in similar
circumstances.
32-34 Suitable methods for
estimating the standalone selling price of a good or
service include, but are not limited to, the
following:
-
Adjusted market assessment approach — An entity could evaluate the market in which it sells goods or services and estimate the price that a customer in that market would be willing to pay for those goods or services. That approach also might include referring to prices from the entity’s competitors for similar goods or services and adjusting those prices as necessary to reflect the entity’s costs and margins.
-
Expected cost plus a margin approach — An entity could forecast its expected costs of satisfying a performance obligation and then add an appropriate margin for that good or service.
-
Residual approach — An entity may estimate the standalone selling price by reference to the total transaction price less the sum of the observable standalone selling prices of other goods or services promised in the contract. However, an entity may use a residual approach to estimate, in accordance with paragraph 606-10-32-33, the standalone selling price of a good or service only if one of the following criteria is met:
-
The entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts (that is, the selling price is highly variable because a representative standalone selling price is not discernible from past transactions or other observable evidence).
-
The entity has not yet established a price for that good or service, and the good or service has not previously been sold on a standalone basis (that is, the selling price is uncertain).
-
32-35 A combination of methods
may need to be used to estimate the standalone selling
prices of the goods or services promised in the contract
if two or more of those goods or services have highly
variable or uncertain standalone selling prices. For
example, an entity may use a residual approach to
estimate the aggregate standalone selling price for
those promised goods or services with highly variable or
uncertain standalone selling prices and then use another
method to estimate the standalone selling prices of the
individual goods or services relative to that estimated
aggregate standalone selling price determined by the
residual approach. When an entity uses a combination of
methods to estimate the standalone selling price of each
promised good or service in the contract, the entity
shall evaluate whether allocating the transaction price
at those estimated standalone selling prices would be
consistent with the allocation objective in paragraph
606-10-32-28 and the guidance on estimating standalone
selling prices in paragraph 606-10-32-33.
Stand-alone selling prices must be estimated if, and only if,
they are not directly observable. Although ASC 606 does not prescribe a specific
approach for estimating stand-alone selling prices that are not directly
observable, an entity is required to use an approach that maximizes the use of
observable inputs and faithfully depicts the selling price of the promised goods
or services if the entity sold those goods or services separately to a similar
customer in similar circumstances. The selected method should be used
consistently to estimate the stand-alone selling price of goods and services
that have similar characteristics. In addition, an entity should consider all
information that is reasonably available in determining a stand-alone selling
price.
Under ASC 606-10-32-34(c), the residual approach may be used if (1) there are
observable stand-alone selling prices for one or more of the performance
obligations and (2) one of the two criteria in ASC 606-10-32-34(c)(1) and (2) is
met. In addition, even when the criteria for using the residual approach are
met, the resulting allocation would need to be consistent with the overall
allocation objective. That is, if the residual approach results in either a
stand-alone selling price that is not within a range of reasonable stand-alone
selling prices or an outcome that is not aligned with the entity’s observable
evidence, use of the residual approach would not be appropriate regardless of
whether the criteria in ASC 606-10-32-34(c) are met. For example, since a
performance obligation, by definition, has value on a stand-alone basis, the
stand-alone selling price of a performance obligation cannot be zero. An entity
should use all available information to determine the stand-alone selling price,
which may include an assessment of market conditions adjusted for
entity-specific factors. When such an analysis results in a highly variable or
broad range and the residual approach is used to estimate the stand-alone
selling price, this observable information should still be used to support the
reasonableness of the resulting residual amount.
As discussed in paragraph BC272 of ASU 2014-09, the residual
approach under the revenue standard can be used if two or more performance
obligations have highly variable or uncertain stand-alone selling prices when
they are bundled with other performance obligations that have observable
stand-alone selling prices. For example, an entity may enter into a contract to
sell a customer two separate software licenses along with professional services
and PCS (which are each distinct). The entity may have observable stand-alone
selling prices for both the professional services and the PCS, but the
stand-alone selling prices of the licenses may be highly variable or uncertain.
In such a scenario, the entity might use the residual approach to determine the
amount of the transaction price that should be allocated to the two licenses in
aggregate and then use another method to further allocate the residual
transaction price to each license. When estimating the amount to be allocated to
each performance obligation in this way, an entity should consider the guidance
in ASC 606-10-32-28 on the objective of allocating the transaction price and the
guidance in ASC 606-10-32-33 on estimating stand-alone selling prices.
7.3.3 Examples of Determining the Stand-Alone Selling Price
7.3.3.1 Stand-Alone Selling Price of Postcontract Support Based on a Stated Renewal Percentage
It is common for software contracts to include both a
software license and PCS for a defined term. After the initial PCS term,
such contracts will often allow for renewal of PCS at a stated percentage of
the contractual license fee (e.g., 20 percent of the initial contractual
license fee). Contractual license fees will often vary between customers;
consequently, the renewal price for the related PCS also often varies
between customers.
ASC 606-10-32-32 states, in part, that the “best evidence of
a standalone selling price is the observable price of a good or service when
the entity sells that good or service separately in similar circumstances
and to similar customers” and that the “contractually stated price or a list
price for a good or service may be (but shall not be presumed to be) the
standalone selling price of that good or service.” Further, ASC 606-10-32-33
requires entities to estimate the stand-alone selling price when that price
is not observable.
Because the actual amount paid for the PCS in the software
arrangements described above varies between contracts, it may not represent
the “observable price” for the PCS when an entity sells the PCS separately
“in similar circumstances and to similar customers.” Since the prices vary
by individual contract, the contractually stated renewal rate may not
necessarily represent the stand-alone selling price for the PCS, especially
when PCS is renewed for a broad range of amounts.
If an entity determines that it does not have observable
pricing of PCS based on consistent renewal of PCS priced at consistent
dollar amounts, it may be appropriate for the entity to consider PCS
renewals stated as a constant percentage of the license fee to determine an
observable stand-alone selling price for PCS. This approach may be
appropriate when the entity routinely prices PCS as a consistent percentage
of the license fee, the entity has consistent pricing practices, and the
resulting stand-alone selling price results in an allocation that is
consistent with the overall allocation objective.
However, when an entity determines that an observable
stand-alone selling price for the PCS does not exist, the entity may need to
estimate the stand-alone selling price of the PCS in accordance with ASC
606-10-32-33 through 32-35 by considering all of the information that is
reasonably available to the entity, such as the actual amounts charged for
renewals, the anticipated cost of providing the PCS, internal pricing
guidelines, and third-party prices for similar PCS (if relevant). While the
range of amounts charged for actual renewals on the basis of the stated
rates may be broad (whether priced as a fixed dollar amount or as a
percentage of the license fee), a concentration of those amounts around a
particular price may help support a stand-alone selling price.
Refer to Section 7.3.3.6 for additional information about using a
range to estimate a stand-alone selling price.
7.3.3.2 Residual Approach to Estimating Stand-Alone Selling Prices
In the software industry, certain goods or services can be sold
for a wide range of prices. This is especially true when the incremental costs
incurred to sell additional software licenses are often minimal, thus allowing
entities to sell their software at a wide range of discount prices or even
premiums. Various factors may make it challenging for an entity to determine the
stand-alone selling prices of goods and services promised in a contract with a
customer. Such factors may include, but are not limited to, (1) highly variable
or uncertain pricing, (2) lack of stand-alone sales for one or more goods or
services, and (3) pricing interdependencies such that the selling price of one
good or service is used to determine the selling price of another good or
service in the same contract. In these instances, it may be appropriate to
estimate the stand-alone selling price of a good or service (or bundle of goods
or services) by using the residual approach.
7.3.3.2.1 Appropriateness of Using the Residual Approach
ASC 606-10-32-34(c) indicates that the residual approach may be used only
if the selling price of a good or service (or bundle of goods or
services) meets either of the following conditions:
- The selling price is highly variable. This is the case when an “entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts” so that a single-point estimate of the stand-alone selling price or even a sufficiently narrow range of values representing the stand-alone selling price is “not discernible from past transactions or other observable evidence.” For example, the selling price of a software product may be highly variable if an entity has historically sold the software product for prices between $1,000 and $20,000 and there is no discernible concentration around a single price, range of prices, or other metric.
- The selling price is uncertain. This is the case when an “entity has not yet established a price for [a] good or service, and the good or service has not previously been sold on a standalone basis.”
In determining whether one of the above conditions is met, an entity
should disaggregate (i.e., stratify) its selling prices into different
populations to the extent that pricing practices differ for each
population. In doing so, the entity should take into account market
conditions, entity-specific factors, and information about the customer
or class of customer (e.g., by product, by geography, by customer size,
by distribution channel, or by contract value). However, the entity
should also consider whether there are enough data points (e.g., a
sufficient number of sales in the population) for it to determine a
meaningful stand-alone selling price.
In addition to assessing whether one of the two pricing conditions above
has been met, an entity must determine whether the resulting amount
allocated to a performance obligation under the residual approach
satisfies the allocation objective in ASC 606-10-32-28 (i.e., an
allocation that depicts the amount of consideration to which an entity
expects to be entitled in exchange for a good or service). If the
application of the residual approach to a particular contract results in
either a stand-alone selling price that is not within a range of
reasonable stand-alone selling prices or an outcome that is not aligned
with the entity’s observable evidence, use of the residual approach
would not be appropriate even if one of the conditions in ASC
606-10-32-34(c) is met. An entity should use all available information
to determine whether the stand-alone selling price is reasonable, which
may include an assessment of market conditions adjusted for
entity-specific factors. When such an analysis results in a highly
variable or broad range and the residual approach is used to estimate
the stand-alone selling price, this observable information should still
be used to support the reasonableness of the resulting residual amount.
In addition, the resulting stand-alone selling price must be substantive
and consistent with the entity’s normal pricing practices. Further, as
paragraph BC273 of ASU
2014-09 states, “if the residual approach in
paragraph 606-10-32-34(c) results in no, or very little, consideration
being allocated to a good or service or a bundle of goods or services,
the entity should consider whether that estimate is appropriate in those
circumstances.”
The residual approach is applied by subtracting
observable stand-alone selling prices from the total transaction price
and allocating the remainder (i.e., the residual) to the performance
obligation or obligations for which pricing is highly variable or
uncertain (see Example 7-4 for an
illustration of this concept). Accordingly, for an entity to apply the
residual approach to a contract containing performance obligations whose
pricing is highly variable or uncertain, that contract must include at
least one performance obligation for which the stand-alone selling price
is observable. If a contract contains multiple performance obligations
with pricing that is highly variable or uncertain, a combination of
approaches (including the residual approach) may be necessary as
described in ASC 606-10-32-35.
ASC 606 requires entities to maximize the use of observable data in
determining a stand-alone selling price. The observable data available
for a good or service may change over time. In addition, an entity’s
pricing practices may change as a result of market or entity-specific
factors. Therefore, the appropriateness of the residual approach for a
particular good or service may also change from one period to another.
For example, an entity may implement pricing policies that cause the
price of a good or service that was previously highly variable to become
consistent enough for a stand-alone selling price to be estimated (as
either a point estimate or a range).
Entities that use the residual approach to determine a stand-alone
selling price should continually assess whether its use remains
appropriate. In making this determination, entities should monitor and
consider entity-specific and market conditions. A change from the
residual approach to another method for determining a stand-alone
selling price should be accounted for prospectively, and corresponding
changes may need to be made to disclosures about the determination of
the stand-alone selling price and allocation of the transaction price
(e.g., ASC 606-10-50-17).
The examples below illustrate the application of the concepts described
above.
Example 7-1
Entity S licenses its software to customers for
terms ranging from one to five years. Along with
its software licenses, S frequently sells other
services such as PCS, professional services, or
training, and it has observable stand-alone
selling prices for such services. Taking into
account market conditions, entity-specific
factors, and information about customers or
classes of customers, S stratifies its historical
software sales data. It analyzes the pricing of
the software and determines the following:
- Fifteen percent of software transactions are priced between $150 and $1,200.
- Thirty-five percent of software transactions are priced between $1,201 and $1,800 (plus or minus 20 percent concentration around a midpoint).
- Thirty percent of software transactions are priced between $1,801 and $2,700 (plus or minus 20 percent concentration around a midpoint).
- Twenty percent of software transactions are priced above $2,700.
There are no discernible concentrations within
the above ranges.
On the basis of an analysis of the available
observable data, including appropriate
stratification of such data, S may conclude that
it sells software licenses for a broad range of
amounts and that therefore there is no discernible
stand-alone selling price. Accordingly, the
selling price of software licenses is highly
variable. In addition, there are observable
stand-alone selling prices for the other services
in S’s contracts. If the resulting allocation
under the residual approach meets the objective in
ASC 606-10-32-28, the use of that method is
acceptable.
Example 7-2
Assume the same facts as in
Example 7-1
except that in this case, the software vendor,
Entity K, determines the following:
- Fifteen percent of software transactions are priced between $150 and $1,200.
- Sixty-five percent of software transactions are priced between $1,201 and $1,800 (plus or minus 20 percent concentration around a midpoint).
- Fifteen percent of software transactions are priced between $1,801 and $2,700 (plus or minus 20 percent concentration around a midpoint).
- Five percent of software transactions are priced above $2,700.
Entity K determines that enough data points exist
for it to conclude that there is a sufficient
concentration of selling prices between $1,201 and
$1,800.
While K sells software licenses for a broad range
of amounts, there is a discernible range of
stand-alone selling prices given the sufficient
concentration of selling prices between $1,201 and
$1,800. Accordingly, K may conclude that the
selling price of its software license is not
highly variable or uncertain.
Example 7-3
Entity B licenses its
software to customers for terms ranging from one
to five years. Along with its software licenses, B
frequently sells other services such as PCS,
professional services, or training, and it has
observable stand-alone selling prices for such
services. Taking into account market conditions,
entity-specific factors, and information about the
customer or class of customer, B stratifies its
historical software sales data and analyzes the
pricing of the software. Entity B determines that
the vast majority of its software transactions are
priced between $500 and $2,400 and that there are
no discernible concentrations within that range.
Further, the selling price range is consistent
with B’s normal pricing policies and
practices.
Entity B concludes that it is appropriate to use
the residual approach to estimate the stand-alone
selling price of its software license in contracts
that contain other services. In a few of its
contracts, application of the residual approach
results in the allocation of between $0 and $50 to
the software license performance obligation.
Entity B concludes that it should not use the
residual approach to determine the stand-alone
selling price of the software license for those
contracts for which the residual approach results
in the allocation of between $0 and $50 to the
software license performance obligation.
Even though the selling price for the software
license is highly variable, the allocation
objective in ASC 606-10-32-28 is not met. This is
because the amount allocated to the software
license in a given transaction ($0 to $50) does
not faithfully depict “the amount of consideration
to which the entity expects to be entitled in
exchange for transferring the promised goods or
services to the customer.”
Since B typically prices its
software between $500 and $2,400 and has no
substantive history of selling software licenses
for a price below $50 (i.e., such pricing is not
indicative of its normal pricing policies and
practices), those amounts do not represent
substantive pricing. Accordingly, B must use
another method or methods to determine the
stand-alone selling price of its software license
performance obligations.1 This conclusion is consistent with that in
Case C in Example 34 in ASC 606-10-55-269. By
contrast, if B’s application of the residual
approach resulted in the allocation of between
$500 and $2,400 to software license performance
obligations, use of the residual may be reasonable
since these amounts appear to be within B’s normal
pricing policies and practices.
7.3.3.2.2 Allocating the Transaction Price When a Value Relationship Exists
ASC 606 does not provide guidance on estimating the
stand-alone selling price of a good or service when the price of that
good or service is dependent on the price of another good or service in
the same contract. Entities in the software industry often sell PCS to
customers in conjunction with a software license. Sometimes, PCS is
priced as a percentage of the contractually stated selling price of the
associated software license (e.g., 20 percent of the net license fee),
including upon renewal. In these circumstances, as noted in Section 7.3.3.1,
if an entity does not have observable pricing of PCS based on renewals
of PCS priced at consistent dollar amounts, it may be appropriate for
the entity to consider PCS renewals stated as a consistent percentage of
the license fee to determine the observable stand-alone selling price
for PCS. That is, even if an entity’s license pricing is highly variable
and the dollar pricing of PCS in stand-alone sales (i.e., renewals) is
therefore also highly variable, the observable stand-alone selling price
of PCS may still be established if PCS renewals are priced at a
consistent percentage of the license fee, the entity has consistent
pricing practices, and the stand-alone selling price results in an
allocation that is consistent with the overall allocation objective.
Although the revenue standard includes the residual
approach as a suitable method for estimating the stand-alone selling
price of a good or service in a contract, use of the residual approach
is intended to be limited to situations in which the selling price of
the good or service is highly variable or uncertain. Before applying the
residual approach, an entity should consider whether (1) it has an
observable stand-alone selling price for the good or service or (2) it
can estimate the stand-alone selling price by using another method
(e.g., adjusted market assessment or expected cost plus a margin
approach). When the entity cannot determine the stand-alone selling
price of the good or service by using another estimation method (e.g.,
because the stand-alone selling prices of the license and PCS,
respectively, are highly variable), it may be appropriate to apply the
residual approach. In some instances, a combination of approaches may be
needed to determine stand-alone selling prices and the resulting
transaction price allocation. On the basis of available data and
established internal pricing strategies and practices related to
licenses and PCS, an entity may determine that it has established a
“value relationship” between the license and the PCS. If this value
relationship is sufficiently consistent, the entity may use it to
estimate the stand-alone selling prices of the license and PCS,
respectively. For example, if the PCS is consistently priced and renewed
at 20 percent of the net license fee, the entity may conclude that it is
appropriate to consistently allocate 83 percent of the transaction price
to the license (1 ÷ 1.2) and 17 percent to the PCS (0.2 ÷ 1.2).
In addition, if a license is not sold separately because
it is always bundled with PCS, the entity might analyze its historical
pricing for that bundle and conclude that such pricing is highly
variable. If the bundle also includes another good or service (e.g.,
professional services) for which there is an observable stand-alone
selling price, a residual approach may be appropriate for determining
the combined stand-alone selling price for the license and PCS bundle if
the resulting estimated stand-alone selling price is reasonable.
The example below illustrates these concepts.
Example 7-4
Entity X is a software vendor
that licenses its software products to customers.
The entity has determined that its licenses are
functional IP in accordance with ASC
606-10-55-59.
Entity X enters into a contract
with a customer to provide a perpetual software
license bundled with one year of PCS and
professional services in return for $100,000.
While PCS and professional services are sold on a
stand-alone basis, the license is never sold
separately (i.e., it is always sold with PCS).
Entity X concludes that the license, PCS, and
professional services represent distinct
performance obligations.
The contractually stated selling
prices are as follows:
-
License — $70,000.
-
PCS — $14,000 (20 percent of $70,000).
-
Professional services — $16,000.
After analyzing sales of the
bundled license and PCS (the “bundle”), X
concludes that the pricing for the bundle is
highly variable and that a residual approach is
appropriate in accordance with ASC
606-10-32-34(c).
Entity X has an observable
stand-alone selling price for professional
services of $25,000. In addition, the PCS is
consistently priced (and may be renewed) at 20
percent of the net license fee stated in the
contract (for simplicity, a range is not used).
Entity X determines that it has observable data
indicating that there is a value relationship
between the perpetual license and the PCS since
the PCS is consistently priced at 20 percent of
the contractually stated selling price of the
license, including on a stand-alone basis upon
renewal. Consequently, X concludes that the
stand-alone selling price of the PCS is equal to
20 percent of the selling price of the
license.
We believe that the two
alternatives described below (“Alternative A” and
“Alternative B”) are acceptable methods for
allocating the transaction price to the
performance obligations. To determine which
alternative is more appropriate, an entity should
consider the facts and circumstances of the
arrangement. For example, we believe that when an
entity has no (or insufficient) observable data
available to determine the stand-alone selling
price for the PCS, it generally would not be
appropriate to use Alternative B.
Alternative
A
Since the pricing of the bundle
that comprises the license and the PCS is highly
variable and there is an observable stand-alone
selling price for the professional services, X may
apply the residual approach to determine the
stand-alone selling price of the bundle (step 1).
If the resulting amount allocated to the bundle is
reasonable and consistent with the allocation
objective, X may then use the value relationship
to determine how much of the transaction price
that remains after allocation to the professional
services should be allocated between the license
and the PCS (step 2).
Step 1
Under step 1, X would determine
the residual transaction price to be allocated to
the bundle as follows:
Step 2
Next, under step 2, X would
allocate the residual transaction price to the
license and PCS as follows:
The table below summarizes the
allocation of the total transaction price to the
performance obligations.
Alternative
B
Given that the pricing of the
bundle comprising the license and the PCS is
highly variable, X may determine that the pricing
of the license is also highly variable since it
has observable data indicating that there is a
consistent value relationship between the license
and the PCS. In addition, X may determine that it
has an observable stand-alone selling price for
the PCS since PCS is consistently priced at 20
percent of the contractually stated selling price
of the license. Since X has observable stand-alone
selling prices for the PCS and professional
services, respectively, it may apply the residual
approach to determine the stand-alone selling
price of the license if the resulting amount
allocated to the license is reasonable and
consistent with the allocation objective.
Entity X would allocate the
transaction price as follows:
The table below summarizes the
allocation of the total transaction price to the
performance obligations.
In selecting an appropriate alternative to determine a
stand-alone selling price in accordance with ASC 606-10-32-33, an entity
should consider “all information (including market conditions,
entity-specific factors, and information about the customer or class of
customer) that is reasonably available to the entity” and should
“maximize the use of observable inputs.” Further, any allocation
achieved through the use of the residual method should be (1) assessed
for reasonableness and (2) consistent with the allocation objective in
ASC 606-10-32-28.
While we believe that both of the alternatives discussed
in the example above are acceptable methods for allocating the
transaction price to the performance obligations, we acknowledge that
practice may evolve over time. As practice evolves, the applicability of
the alternatives described above is subject to change. Companies should
continue to monitor changes in interpretations and consider consulting
with their accounting advisers.
7.3.3.2.3 Material Right
Under ASC 606-10-55-41 through 55-45, a customer option to purchase
additional goods or services gives rise to a material right if the
option gives the entity’s customer a discount that is incremental to the
range of discounts typically given for those goods or services to that
class of customer (e.g., a customer in a particular geographic area or
market). It would not be appropriate for the entity to conclude that no
material right was conveyed to the customer simply because the selling
prices of the goods or services that are subject to the option are
highly variable or uncertain and the residual approach was therefore
applied.
7.3.3.3 Different Stand-Alone Selling Price for the Same Good or Service in a Single Contract
The example below illustrates how the stand-alone selling
price should be determined when the specified contract price for the same
product changes over the term of the arrangement.
Example 7-5
Entity A enters into a contract to
transfer 1,000 units of Product X to a customer each
year for three years. The contract requires the
customer to pay $10 for each unit delivered in year
1, $11 for each unit in year 2, and $12 for each
unit in year 3.
ASC 606-10-32-32 states, in part,
that the “best evidence of a standalone selling
price is the observable price of a good or service
when the entity sells that good or service
separately in similar circumstances and to similar
customers. A contractually stated price or a list
price for a good or service may be (but shall not be
presumed to be) the standalone selling price of that
good or service.”
If the contractually stated price is
representative of the value of each distinct good or
service for the given period (i.e., it is considered
to be the same as the stand-alone selling price), an
entity could allocate consideration to the
performance obligations on the basis of the contract
pricing. However, A should consider the specific
facts and circumstances of the arrangement as well
as the reason for the different selling prices over
the term of the contract. For example, if the
contract prices have been set to reflect how the
market price of Product X is expected to change over
the three-year period, it may be appropriate to use
the specified contract price as the stand-alone
selling price for Product X in each year of the
contract. Conversely, if there is no expectation
that the market price of Product X will change over
the three-year period, A may need to determine a
single stand-alone selling price to be applied
throughout the three-year contract term.
7.3.3.4 Different Selling Price for the Same Good or Service to Different Customers
The example below illustrates how a product’s stand-alone
selling price should be determined when the product is sold to different
customers under separate contracts that each specify a different selling
price.
Example 7-6
Entity B enters into contracts to
sell Product X to Customers C, D, and E. The
contracts are negotiated separately, and each of the
customers will pay a different unit price.
As previously noted, ASC
606-10-32-32 states, in part, that the “best
evidence of a standalone selling price is the
observable price of a good or service when the
entity sells that good or service separately in
similar circumstances and to similar customers. A
contractually stated price or a list price for a
good or service may be (but shall not be presumed to
be) the standalone selling price of that good or
service.”
The stand-alone selling price for a
performance obligation (or distinct good or service)
does not need to be a single amount. If the
contractually stated price is representative of the
value of each distinct good or service (i.e., it is
considered to be the same as the stand-alone selling
price), an entity could allocate consideration to
the performance obligations on the basis of the
contract pricing.
In the circumstances above, B should
consider the specific facts and circumstances of the
arrangement, as well as the reason for the different
selling prices for different customers. There may be
important differences between the transactions such
that the sales are not in similar circumstances and
to similar customers. For example, the transactions
may be in different geographic markets or for
different committed volumes, or the nature of the
customer may be different (e.g., distributor, end
user). If the sales are not in similar circumstances
and to similar customers, the stand-alone selling
price could be different for each customer, and it
may be appropriate to use the specified contract
price as the standalone selling price for each of
the customers.
Conversely, if the sales are
determined to be in similar circumstances and with
similar customers, B may determine that there should
be a single stand-alone selling price for all three
customers on the basis of other evidence. It would
then use that price to allocate the transaction
price of the contracts with C, D, and E between
Product X and any other performance obligations in
those contracts, including when it applies ASC
606-10-32-36 through 32-38 to any discounts given
against that stand-alone selling price.
7.3.3.5 Determining the Stand-Alone Selling Price for Multiperiod Commodity Contracts
Entities in commodities industry sectors, specifically oil
and gas, power and utilities, mining and metals, and agriculture, often
enter into multiyear contracts with their customers to provide commodities
at a fixed price per unit. For example, an entity may enter into a contract
to provide its customer 10,000 barrels of oil per month at a fixed price of
$50 per barrel. For certain types of commodities, there may be a forward
commodity pricing curve and actively traded contracts that establish pricing
for all of or a portion of the contract duration. The forward commodity
pricing curve may provide an indication of the price at which an entity
could currently buy or sell a specified commodity for delivery in a specific
month.
Sometimes, “strip” pricing may be available. In strip
pricing, a single price is used to represent a single-price “average” of the
expectations of the individual months in the strip period, which is
typically referred to as a seasonal or annual strip. Terms of the
multiperiod contracts are often derived, in part, in contemplation of the
forward commodity pricing curve.
Certain arrangements may not meet the criteria in ASC
606-10-25-15 to be accounted for as a series of distinct goods that have the
same pattern of transfer to the customer (and, therefore, as a single
performance obligation). In these situations, when each commodity delivery
is determined to be distinct, stakeholders have questioned whether entities
are required to use the forward commodity pricing curve, the spot price, or
some other value as the stand-alone selling price for allocating
consideration to multiperiod commodity contracts.
We believe that entities should consider all of the relevant
facts and circumstances, including market conditions, entity-specific
factors, and information about the customer, in determining the stand-alone
selling price of each promised good. We do not believe that entities should
use forward-curve pricing by default in determining the stand-alone selling
price; however, certain situations may indicate that the forward curve
provides the best indicator of the stand-alone selling price. In other
circumstances, the contract price may reflect the stand-alone selling price
for the commodity deliveries under a particular contract. The determination
of the contract price and the resulting allocation of the transaction price
needs to be consistent with the overall allocation objective (i.e., to
allocate the transaction price to each distinct good or service in an amount
that depicts the amount of consideration to which the entity expects to be
entitled in exchange for transferring the goods or services to the
customer). Entities will need to use significant judgment in determining the
stand-alone selling price in these types of arrangements.
7.3.3.6 Using a Range When Estimating a Stand-Alone Selling Price
Throughout ASC 606, the FASB uses the term “standalone
selling price,” which is defined in ASC 606-10-20 and the ASC master
glossary as the “price at which an entity would sell a promised good or
service separately to a customer.” In the Codification’s definition, the
FASB refers to the term in the singular rather than the plural. In ASC 606,
this word choice is further emphasized in illustrative examples in which the
stand-alone selling price is always expressed as a single-point observation
or estimate of value (e.g., in Example 33, the directly observable
stand-alone selling price of Product A is $50, and the estimated stand-alone
selling price of Product B under an adjusted market approach is $25).
As a result, some have questioned whether the singular form
of the defined term and the illustrations in the examples would preclude an
entity from using anything other than a single-point observation or estimate
as the stand-alone selling price (i.e., whether the guidance in ASC 606
precludes an entity from using a range of observations or estimates to
establish a stand-alone selling price).
We believe that the stand-alone selling price for a
performance obligation does not need to be a single amount. That is, the
stand-alone selling price can be a range of amounts if the range is
sufficiently narrow and concentrated, and the allocation of the transaction
price that results from the identified stand-alone selling price is
consistent with the general allocation objective in ASC 606-10-32-28 (i.e.,
“to allocate the transaction price to each performance obligation (or
distinct good or service) in an amount that depicts the amount of
consideration to which the entity expects to be entitled in exchange for
transferring the promised goods or services to the customer”). See Section 7.3.3.6.1 for additional information
about determining the appropriate range to estimate a stand-alone selling
price.
7.3.3.6.1 Determining the Appropriate Range
When a range is used to estimate the stand-alone selling
price, questions have arisen about how to determine whether the range is
truly indicative of the stand-alone selling price.
Some entities (e.g., companies in the software industry)
have developed a practice of estimating the stand-alone selling price as
a range by demonstrating that a certain number of observable
transactions are sufficiently clustered around a midpoint. For example,
on the basis of an analysis of historical data (i.e., observable
pricing), an entity may use a bell-shaped curve approach and determine
that 75 percent of the sales of a particular good are priced within 15
percent of $5 (the midpoint) in either direction. Therefore, the
stand-alone selling price range is $4.25 to $5.75. Both the distribution
(i.e., width) of the range and the percentage of transactions clustered
around the midpoint within that distribution (i.e., concentration) are
important factors to consider in the determination of whether a range is
truly indicative of the stand-alone selling price for a particular good
or service.2
Some entities may instead establish the stand-alone selling price by
using historical data on discounts off the list price. For example, if
an entity consistently priced a particular good or service at 40 percent
off the list price, the entity may establish the midpoint stand-alone
selling price as 60 percent of the list price (100 percent less the 40
percent discount), provided that a sufficient number of transactions
were discounted within a reasonable range of that midpoint. In such a
case, a reasonable range might be 51 percent to 69 percent of the list
price (calculated as 15 percent below and 15 percent above the midpoint
of 60 percent of the list price). Alternatively, a reasonable range
might be a discount of 34 percent to 46 percent off the list price
(calculated as 15 percent below and 15 percent above the midpoint of 40
percent off the list price). Entities should consider whether the use of
historical discounting data is sufficient and appropriate for
establishing the stand-alone selling price.
ASC 606 does not prescribe or preclude any method for
estimating the stand-alone selling price (exclusive of conditions that
must be met for an entity to use the residual method). Likewise, ASC 606
does not establish any bright lines regarding which values or ranges are
indicative of the stand-alone selling price, including the width and
concentration of a given range. Instead, ASC 606 states that the
stand-alone selling price of each distinct good or service should be a
value “that depicts the amount of consideration to which the entity
expects to be entitled in exchange for transferring the promised goods
or services.”
Since the stand-alone selling price determined by using
a range must meet the allocation objective in ASC 606-10-32-28, we
believe that a particular range may not be appropriate if the
concentration is too low, the width is too great, or both. For example,
a stand-alone selling price range in which 60 percent of transactions
fall within plus or minus 40 percent of a midpoint would most likely be
too wide to meet the allocation objective. Likewise, a stand-alone
selling price range in which 10 percent of transactions fall within plus
or minus 15 percent of a midpoint would most likely not be sufficiently
concentrated to meet the allocation objective. Entities must balance the
narrowness of distribution with the adequacy of the concentration. That
is, for an entity to establish the stand-alone selling price by using a
range, both the concentration of transactions around the midpoint and
the width thereof must be reasonable. For example, we believe that if an
entity has maximized the use of observable inputs and has considered all
reasonably available information, the entity would most likely meet the
allocation objective in ASC 606-10-32-28 when using a stand-alone
selling price range that (1) encompasses the majority of the relevant
transactions (i.e., greater than 50 percent) and (2) has a width
extending no greater than 20 percent from the midpoint in either
direction.
We also believe that if there are not enough
transactions within a reasonably narrow range, further disaggregation of
the data (e.g., by contract value and geography in addition to product
type) may be appropriate for determining reasonable stand-alone selling
price ranges.3
If the resulting range does not meet the allocation
objective after an entity has disaggregated the population of
transactions, maximized the use of observable inputs, and considered all
reasonably available information, the entity may need to apply other
methods to establish the stand-alone selling price.
7.3.3.6.2 Allocation Considerations When the Stand-Alone Selling Price Is Established as a Range
An entity that establishes the stand-alone selling price
as a range for a particular good or service will need to implement and
consistently apply a policy related to when a contractually stated price
does not represent the stand-alone selling price for any performance
obligation (e.g., the contractually stated price is not within the
established stand-alone selling price range) and reallocation is
required. If a contractually stated price falls within the established
stand-alone selling price range, it is considered “at stand-alone
selling price,” and reallocation is therefore unnecessary unless
required by other performance obligations in the contract (i.e., because
the contractually stated price of another performance obligation is not
at its stand-alone selling price). By contrast, if a contractually
stated price is outside the stand-alone selling price range,
reallocation is required. Accordingly, an entity will need to make a
policy election regarding the point in the range that it will use for
allocating the transaction price to each performance obligation on the
basis of the stand-alone selling price. The following points are
possible alternatives (not all-inclusive):
-
The midpoint in the range.
-
The outer point in the range, which would be:
-
The high point in the range when the contractually stated price is greater than the high point in the range.
-
The low point in the range when the contractually stated price is less than the low point in the range.
-
-
The low point in the range.
-
The high point in the range.
Once an entity elects a policy, the entity must ensure
that the policy is consistently applied and that the resulting
allocation meets the allocation objective in ASC 606-10-32-28.
7.3.3.7 Methods for Establishing the Stand-Alone Selling Price for Term Licenses and PCS
Questions have arisen regarding the determination of stand-alone selling
prices when observable pricing from stand-alone sales (typically the most
persuasive data point) does not exist for one or more performance
obligations. In addition, contractually stated or list prices to be used as
data points may not exist for one or more performance obligations. These
circumstances frequently exist when term licenses are sold with PCS.
Regardless of whether any of these circumstances apply, entities will
generally have to estimate the stand-alone selling price of each performance
obligation. We believe that in many such cases, there may be reasonably
available observable data from which to determine the stand-alone
selling prices.
Example 7-7
Market-Based Approach — Value Relationship
Entity A has developed a software solution similar to
solutions offered by its peers. Although A’s
solution has certain proprietary features that other
competitors do not offer, A determines that the
products are very comparable. Entity A licenses its
software on a term basis. Each license includes
coterminous PCS (i.e., PCS that begins and ends at
the same time as the license term). Entity A has
concluded that the license and PCS each constitute a
distinct performance obligation.
Entity A always sells the license with the PCS. Given
the coterminous nature of the PCS, there are no
stand-alone renewals of PCS or stand-alone sales of
term licenses. Entity A prices the license and PCS
as a bundle and does not have any entity-specific
information related to pricing for the term license
and PCS separately. Consequently, there are no
contractually stated or list prices for each
performance obligation.
Entity A obtains data related to its competitors’
historical and current pricing of similar licenses
and PCS. The data indicate that while pricing is
variable, a value relationship exists between the
pricing of licenses and the pricing of PCS.
Specifically, on average, the data indicate that PCS
for software products similar to those offered by A
is consistently priced at 22–28 percent of the net
license price.
We believe that A may use a market-based approach to
estimate the stand-alone selling prices if the data
represent reliable pricing information and the
products are sufficiently similar. ASC 606-10-32-33
includes market conditions as information that could
be used to estimate the stand-alone selling price of
a promised good or service. In addition, paragraphs
9.4.31 and 9.4.34 of the AICPA Audit and Accounting
Guide Revenue Recognition (the
“AICPA Guide”) state the following, in part,
regarding the estimation of the stand-alone selling price:
9.4.31 An entity’s estimate of the
stand-alone selling price will require judgment
and the consideration of a number of different
factors. . . . A vendor may consider the following
information when estimating the stand-alone
selling price of the distinct goods or services
included in a contract:
a. Historical selling prices for any
stand-alone sales of the good or service (for
example, stand-alone maintenance renewals), even
if limited stand-alone sales exist. An entity will
have to consider its facts and circumstances to
determine how relevant historical pricing is to
the determination of current stand-alone selling
price. For example, if an entity recently changed
its pricing strategy, historical pricing data is
likely less relevant for the current determination
of stand-alone selling price.
b. Historical selling prices for
non-stand-alone sales/bundled sales.
c.
Competitor pricing for a similar product,
especially in a competitive market or in
situations in which the entities directly compete
for customers.
d. Vendor’s pricing for similar
products, adjusting for differences in
functionality and features.
e. Industry pricing practices for
similar products.
f. Profit and pricing objectives of
the entity, including pricing practices used to
price bundled products.
g. Effect of proposed transaction on
pricing and the class of the customer (for
example, the size of the deal, the characteristics
of the targeted customer, the geography of the
customer, or the attractiveness of the market in
which the customer resides).
h. Published price lists.
i. The costs incurred to manufacture
or provide the good or service, plus a reasonable
profit margin.
j. Valuation techniques; for example,
the value of intellectual property could be
estimated based on what a reasonable royalty rate
would be for the use of intellectual
property.
9.4.34
Depending on the inherent uniqueness of a license
to proprietary software and the related vendor
maintenance, third-party or
industry pricing may or may not be useful for
determining stand-alone selling price of distinct
goods or services included in these
arrangements. When evaluating whether
third-party or industry pricing is a relevant and
reliable basis for establishing the stand-alone
selling price, the data points
should be based on information of comparable items
sold on a stand-alone basis to similar types of
customers. Products or services are
generally similar if they are largely
interchangeable and can be used in similar
situations by similar customers. For these
reasons, third-party or industry pricing for
software licenses may not be a relevant data
point. However, third-party or
industry pricing may be a relevant data point for
estimating stand-alone selling price for
maintenance, hosting, or professional services if
other vendors sell similar services on a
stand-alone basis and their pricing is known by
the vendor. For example, third-party pricing
may be a relevant data point if other vendors
provide implementation services or host the
vendor’s software products. [Emphasis added]
In accordance with the guidance above, if A’s
software solution is similar to solutions offered by
its peers and the market data are reliable, A may
use a market-based approach to estimate the
stand-alone selling prices by using the pricing data
related to its peers. Under such an approach, A may
conclude that the stand-alone selling price of the
PCS is 25 percent of the net selling price of the
license (i.e., the midpoint of the stand-alone
selling price range that A determined through its
analysis of available observable market data), which
may also be expressed as 20 percent of the bundle
price (0.25 ÷ 1.25). Consequently, A may also
conclude that the stand-alone selling price of the
license is equal to 80 percent of the bundle
price.
Example 7-8
Entity-Specific Approach — Value
Relationship
Entity B licenses its proprietary software on a term
basis for five years. There are no other similar
products4 on the market, and because any incremental
direct costs involved in the production and
distribution of copies of B’s software product are
minimal, B does not use cost as a basis for
establishing pricing. Customers are required to
purchase one year of PCS in conjunction with any
license purchase. Consequently, licenses are never
sold on a stand-alone basis. On the basis of B’s
historical experience, PCS is consistently priced at
approximately 20 percent of the contractually stated
net license fee for both the initial purchase and
any subsequent renewals. Therefore, observable
stand-alone sales of PCS exist upon renewal.
Further, B has concluded that the license and PCS
each constitute a distinct performance
obligation.
It may be reasonable for B to use the approach
described below to estimate the stand-alone selling
prices.
Since there are no similar software products on the
market, B does not use a market-based approach to
estimate the stand-alone selling price of the
license. In addition, because the incremental direct
costs involved in the production and distribution of
copies of B’s software product are minimal and such
costs are not used as a basis for establishing
pricing, B does not use a cost-based approach to
estimate the stand-alone selling price of the
license. However, B determines that observable data
and pricing practices demonstrate the existence of a
value relationship between the license and the PCS
(PCS is consistently priced at 20 percent of the net
license fee).
Paragraphs 9.4.34 and 9.4.44 of the AICPA Guide state
the following, in part, regarding the concept of a
value relationship:
9.4.34 [O]ver time, the software
industry has developed a common practice of
pricing maintenance services as a percentage of
the license fee for related software products,
indicating there may be a consistent value
relationship between those two items. . . .
9.4.44 [The] lack of history of selling
goods or services on a stand-alone basis combined
with minimal direct costs and a lack of
third-party or industry-comparable pricing may
result in some software vendors focusing on
entity-specific and market factors when estimating
stand-alone selling price of both the license or
the maintenance such as internal pricing
strategies and practices. That is, based on its
established pricing practices, an entity may
conclude that it has established a value
relationship between a software product and the
maintenance that is helpful in determining
stand-alone selling price.
In a manner consistent with the guidance above, B
determines that the value relationship between the
term license and the PCS for establishing their
respective stand-alone selling prices in a given
contract is a ratio of 83 percent (1 ÷ 1.2) to 17
percent (0.2 ÷ 1.2). Therefore, if the transaction
price for a contract is $120, B would allocate $100
to the license and $20 to the PCS.5
Example 7-9
Entity-Specific Approach — Observable Data From
Perpetual Licenses
Entity C has developed a unique proprietary software
solution. The entity licenses this software on a
perpetual basis and has determined that the economic
useful life of the software is five years. All
customers are required to purchase at least one year
of PCS when they purchase a license. Consequently,
licenses are never sold on a stand-alone basis. On
the basis of C’s historical experience, PCS is
consistently priced at approximately 20 percent of
the contractually stated net license fee for both
the initial purchase and any subsequent stand-alone
renewals. In addition, C has determined from
historical experience that customers typically
purchase a total of five years of PCS over the life
of a perpetual license.
Like Entity B in Example
7-8, C does not use a market- or
cost-based approach to estimate the stand-alone
selling price of a license. Therefore, C estimates
the stand-alone selling prices of a perpetual
license and PCS, respectively, by using the value
relationship observed between the license and PCS
(i.e., 83%/17%).
Entity C charges an up-front fee of $100 for a
perpetual license and prices PCS at 20 percent of
the license fee both initially and upon renewal. The
resulting value relationship between a perpetual
license and PCS, which varies depending on the total
years of PCS purchased, is shown in the table
below.
Entity C also licenses the same software product
discussed above on a term basis for five years. Each
sale of a term license is bundled with coterminous
PCS (i.e., PCS that begins and ends at the same time
as the license term). Entity C has concluded that
the term license and PCS each constitute a distinct
performance obligation. The term license is always
sold with PCS, and given the coterminous nature of
the PCS, there are no stand-alone renewals of PCS on
term licenses. That is, stand-alone sales of PCS and
term licenses do not occur. Entity C prices term
licenses and PCS as a bundle; consequently,
contractually stated prices for a term license and
PCS individually are unavailable. However, C
determines that its internal pricing process for a
term license (1) is similar to that for a perpetual
license and (2) takes into consideration the length
of a term license relative to renewals of PCS on a
perpetual license.
It may be reasonable for C to use the approach
described below to estimate the stand-alone selling
prices.
Entity C considers the observable entity-specific
information related to its perpetual licenses to
estimate the stand-alone selling price of a
five-year term license and that of the associated
PCS.
Paragraph 9.4.32 of the AICPA Guide states the following:
The quantity and type of
reasonably available data points used in
determining stand-alone selling price will not
only vary among software vendors but may differ
for products or services offered by the same
vendor. Furthermore, with respect to software
licenses, reasonably available
data points may vary for the same software product
that has differing attributes/licensing rights
(that is, perpetual versus term license, exclusive
versus nonexclusive). For example, a vendor may
have stand-alone observable sales of the
maintenance services in its perpetual software
license (that is, maintenance renewals).
These observable sales may be a useful data
point for similar maintenance services bundled
with other types of software licenses (for
example, term licenses). [Emphasis added]
In a manner consistent with the guidance above, an
entity may consider observable data related to the
value relationship between a perpetual license and
the associated PCS to be a relevant and useful data
point in determining the stand-alone selling prices
of term licenses for the same software and the
associated PCS, especially when other observable
data are limited or nonexistent. While the entity
should not presume such data to be determinative
when estimating the stand-alone selling prices, we
acknowledge that in certain cases in which the
observable inputs for the determination of
stand-alone selling prices for term licenses and PCS
are limited to data on the same licenses and PCS
sold on a perpetual basis, such data may represent
the best available information for making the
determination.
Legacy guidance in AICPA Technical
Q&As Section 5100.68 indicates that the value of
PCS for a term license is different from that of PCS
for the same license sold on a perpetual basis
because upgrades and enhancements associated with
the latter are retained indefinitely. AICPA
Technical Q&As Section 5100.68 states, in
part:
PCS
services for a perpetual license and PCS services
for a multi-year time-based license are two
different elements. Though the same
unspecified product upgrades or enhancements may
be provided under each PCS arrangement, the time period during which the
software vendor’s customer has the right to use
such upgrades or enhancements differs based on the
terms of the underlying licenses. Because PCS
services are bundled for the entire term of the
multi-year time-based license, those PCS services
are not sold separately. [Emphasis added]
While this guidance has been
superseded by ASC 606, we believe that the concept
that differences in value may exist between PCS for
a term license and PCS for a perpetual license
remains valid. However, we also note that AICPA
Technical Q&As Section 5100.68 goes on to state
the following:
[I]n the
rare situations in which both of the following
circumstances exist, the PCS renewal terms in a
perpetual license provide [vendor-specific
objective evidence] of the fair value of the PCS
services element included (bundled) in the
multi-year time-based software arrangement:
(1) the term of the multi-year
time-based software arrangement is substantially
the same as the estimated economic life of the
software product and related enhancements that
occur during that term; and (2) the fees charged for the
perpetual (including fees from the assumed renewal
of PCS for the estimated economic life of the
software) and multi-year time-based licenses are
substantially the same. [Emphasis added]
Similarly, pricing data from transactions involving a
perpetual license may, in certain situations, be
relevant to the determination of the stand-alone
selling prices for a term license and associated
PCS. This concept is similar to that of the
above-referenced guidance in paragraph 9.4.32 of the
AICPA Guide, but determining the stand-alone selling
price for a term license under ASC 606 on the basis
of pricing for a perpetual license is more flexible
than under legacy U.S. GAAP. Nonetheless, pricing
data for the perpetual license should not be
considered in isolation from the facts and
circumstances associated with the term license.
Paragraph 9.4.51 of the AICPA Guide states the following:
As discussed in paragraph 9.4.44, a software
vendor may have established a value relationship
between the perpetual software license and the
maintenance services for that license that
influences the vendor’s determination of
stand-alone selling price for each of those items.
Given that the underlying products (software
license) and services (technical support and
unspecified upgrades and enhancements) are similar
for both a perpetual and a term license
arrangement, FinREC believes that the renewal
pricing for the maintenance associated with one
type of license (for example, a percentage of the
license fee for a perpetual license) would be a
good starting point for establishing stand-alone
selling price for the maintenance associated with
the license without renewal pricing. Entities
would have to determine whether the stand-alone
selling price of the maintenance for one type of
license would be different from the other type of
license. Management would need to carefully
analyze its particular facts and circumstances and
the related market dynamics, but should consider
any stand-alone renewal transaction data,
adjusting as necessary for the type of license, in
formulating its stand-alone selling price. For
example, some vendors may determine that the
renewal rates would not differ based on market
dynamics. Conversely, other vendors may determine
that the ability to use the updates provided in
maintenance associated with perpetual or
longer-term licenses might cause that maintenance
to have higher pricing. [Emphasis added]
In a manner consistent with the guidance above and
C’s internal pricing process, C determines that the
value relationship observed between sales of
perpetual licenses and the associated PCS is the
best available observable information for estimating
the stand-alone selling price of the term license
and that of the associated PCS. Therefore, after
considering all of the facts and circumstances, C
estimates the stand-alone selling prices of the term
license and PCS, respectively, by using the value
relationship observed in the sale of a perpetual
license with five total years of PCS, or
50%/50%.
We believe that this example may be expanded to
include various scenarios in which the economic
useful life of the perpetual license is not
equivalent to the term of the term license. In such
cases, various factors could be considered,
including, but not limited to, the following:
- The expected term (i.e., the stated duration of the term license and PCS as well as subsequent renewals of both) of the term license as compared with the economic useful life of the perpetual license.
- The initial term of the term license as compared with the economic useful life of the perpetual license.
- Renewals of the term license and associated PCS as compared with renewals of PCS for the perpetual license.
- The internal pricing process and practices (e.g., if the internal pricing process and practices for the term license are consistent with those for the perpetual license inclusive of PCS renewals, the value relationship table for the perpetual license may be more relevant).
- The pace of technological advancement that could affect whether the customer is more likely to renew the term license (rather than upgrade to a new version or buy a license to a different software product).
Example 7-10
High Renewal Rates and Expected Term
Assume the same facts as in
Example 7-9, except that Entity C
sells (1) a term license with an initial two-year
term, (2) coterminous PCS, and (3) annual renewals
of both the term license and PCS on a bundled basis.
On the basis of historical experience, 95 percent of
C’s customers are expected to renew the license and
PCS on an annual basis for at least three additional
years.
It may be reasonable for C to use the approach
described below to estimate the stand-alone selling
prices of the two-year term license and PCS.
In a manner similar to that
discussed in Example 7-9, C
determines that the value relationship observed
between sales of perpetual licenses and the
associated PCS is the best available observable
information for estimating the stand-alone selling
price of the term license and that of the associated
PCS. Entity C considers that the expected term of
the term license and PCS (i.e., the term that is
inclusive of anticipated renewals) is greater
than the initial two-year term and approximates the
economic useful life of the perpetual license. That
is, C concludes that a two-year term license with
coterminous PCS and annual renewals is not
substantially different from a five-year term
license with coterminous PCS since the term license
and PCS are renewed annually 95 percent of the time
for an additional three years. Therefore, after
considering all facts and circumstances, C estimates
the stand-alone selling prices of the term license
and PCS, respectively, by using the value
relationship observed in the sale of a perpetual
license with five total years of PCS, or
50%/50%.
In addition to the facts outlined above, assume the following:
- The transaction price for the initial two-year term license with coterminous PCS is $100 and is paid up front.
- The transaction price for the three annual renewals of the coterminous term license and PCS is $50 per year.
The license revenue will be recognized up front ($50
in year 1 and $25 at the start of years 3, 4, and 5
as renewals occur) when the customer obtains the
right to use and benefit from the software in
accordance with ASC 606-10-55-58C. PCS revenue will
be recognized over time ($50 over the first two-year
period for the initial two-year PCS and then $25
over each subsequent one-year period as renewals
occur), typically on a straight-line (i.e., ratable)
basis because of the stand-ready nature of most PCS
offerings.
The table below summarizes the allocation of the
transaction price and associated revenue
recognition.
Example 7-11
Low Renewal
Rates and Expected Term
Assume the same facts as in
Example 7-9, except that Entity C
sells (1) a term license with an initial one-year
term, (2) coterminous PCS, and (3) annual renewals
of both the term license and PCS on a bundled basis.
On the basis of historical experience, only 10
percent of C’s customers are expected to renew the
license and PCS for one additional year. Entity C
believes that it (1) would not price its one-year
term license and PCS differently from its perpetual
license with one year of PCS and (2) does not have
any other observable information that would indicate
that the pricing of its one-year term license and
PCS would be different from the pricing of its
perpetual license with one year of PCS.
It may be reasonable for C to use
the approach described below to estimate the
stand-alone selling prices.
In a manner similar to that discussed in Example
7-9, C determines that the value
relationship observed between sales of perpetual
licenses and the associated PCS is the best
available observable information for estimating the
stand-alone selling price of the term license and
that of the associated PCS. However, C considers
that the expected term of the term license and PCS
(i.e., the term that is inclusive of anticipated
renewals) is substantially different from the
economic useful life of the perpetual license
because the term license and associated PCS are
infrequently renewed beyond the initial term. In
addition, the initial term of the term license is
only one year. However, C does not believe that it
would price the two types of licenses and PCS
differently. That is, even though the rights
associated with the software and PCS for a perpetual
license are different from those associated with the
software and PCS for a term license, C believes that
it would price the licenses and the one-year PCS in
the same manner. Therefore, after considering all of
the facts and circumstances, C estimates the
stand-alone selling prices of the term license and
PCS, respectively, by using the value relationship
observed in the sale of a perpetual license with one
year of PCS, or approximately 83%/17%. Since C does
not have any other observable information that
conflicts with the 83%/17% split, and management
asserts that it would not price term licenses
differently, the only — and, therefore, best —
observable information is the value relationship
observed in sales of perpetual licenses with one
year of PCS.
Example 7-12
Moderate Renewal
Rates and Expected Term
Assume the same facts as in
Example 7-9, except that Entity C
sells (1) a term license with an initial two-year
term, (2) coterminous PCS, and (3) annual renewals
of both the term license and PCS on a bundled basis.
On the basis of historical experience, 70 percent of
C’s customers are expected to renew the license and
PCS on an annual basis. While there is no consistent
pattern of renewals, most customers that renew do so
for one or two years. In addition, C has an internal
pricing policy that indicates that renewals of the
term license should be targeted at approximately 67
percent (per additional year) of the original
annualized transaction price, while renewals of PCS
should be targeted at approximately 33 percent (per
additional year) of the original annualized
transaction price.
It may be reasonable for C to use
the approach described below to estimate the
stand-alone selling prices.
Entity C determines that its internal pricing policy
and the value relationship observed between sales of
perpetual licenses and the associated PCS constitute
the best available information for estimating the
stand-alone selling price of the term license and
that of the associated PCS. The entity considers
that the expected term of the term license and PCS
(i.e., the term that is inclusive of anticipated
renewals) is most likely greater than the initial
two-year term given the renewal rate of 70 percent
but is most likely shorter than the economic useful
life of a perpetual license. Consequently, by using
the observable data related to the value
relationship between a perpetual license and various
durations of PCS, C determines that a value
relationship between the term license and the PCS
should be between 71%/29% (perpetual license with
two years of PCS) and 50%/50% (perpetual license
with five years of PCS). Entity C also considers its
internal pricing policy and notes that the policy
indicates a value relationship closer to 67%/33%.
Accordingly, after considering all of the facts and
circumstances, C estimates the stand-alone selling
prices of the term license and PCS, respectively, by
using the value relationship observed in the sale of
a perpetual license with three years of PCS, or
approximately 62%/38%.
Footnotes
1
One method may be to use the range of
observable pricing in other transactions for which
the stand-alone selling prices were determined to
be reasonable and in line with B’s normal pricing
policies and practices.
2
Some entities may instead apply a method similar
to a bell-shaped curve approach to determine a single-point
estimate of the stand-alone selling price of a performance
obligation (e.g., by using the midpoint within the distribution
as the stand-alone selling price). This section addresses only
circumstances in which the stand-alone selling price is
determined as a range.
3
The level of disaggregation may depend, in part,
on an entity’s pricing policies and practices.
4
Even when similar products do exist, reliable
pricing information may not be available for
determining stand-alone selling prices under a
market-based approach.
5
If B had determined that pricing for its
software product is highly variable under ASC
606-10-32-34(c)(1) and that an observable
stand-alone selling price exists for PCS, it would
have been reasonable for B to conclude that a
residual approach is appropriate. This approach
may yield an answer similar to the one resulting
from the value relationship approach described
above.
7.4 Allocation of a Discount
It is not uncommon for contracts containing multiple goods and services to
include a discounted bundled price rather than the sum of the individual goods’ or
services’ respective stand-alone selling prices (see the Codification example in
Section 7.2). In accordance
with the general allocation principle discussed in Section 7.2, the discounted transaction price
is allocated proportionately to each distinct good and service on the basis of its
relative stand-alone selling price. However, there may be instances in which the
result of this allocation approach does not faithfully depict the amount of
consideration to which the entity expects to be entitled in exchange for the
underlying goods or services. That is, the allocation approach may result in revenue
recognition that is inconsistent with the core principle in the revenue standard.
This may occur, for example, if certain goods or services are routinely sold at a
very low margin while others are routinely sold at a very high margin. An entity may
routinely discount the high-margin goods or services but not discount the low-margin
goods or services. Allocating a discount proportionately to these goods or services
may result in an allocated amount that does not accurately depict the amount of
consideration to which the entity expects to be entitled in exchange for the goods
or services. Consequently, ASC 606-10-32-37 provides an exception for allocating a
discount to one or more, but not all, distinct goods or services in a contract if
certain criteria are met.
ASC 606-10
32-36 A customer receives a discount for purchasing a bundle of goods or services if the sum of the
standalone selling prices of those promised goods or services in the contract exceeds the promised
consideration in a contract. Except when an entity has observable evidence in accordance with paragraph
606-10-32-37 that the entire discount relates to only one or more, but not all, performance obligations in a
contract, the entity shall allocate a discount proportionately to all performance obligations in the contract. The
proportionate allocation of the discount in those circumstances is a consequence of the entity allocating the
transaction price to each performance obligation on the basis of the relative standalone selling prices of the
underlying distinct goods or services.
32-37 An entity shall allocate a discount entirely to one or more, but not all, performance obligations in the
contract if all of the following criteria are met:
- The entity regularly sells each distinct good or service (or each bundle of distinct goods or services) in the contract on a standalone basis.
- The entity also regularly sells on a standalone basis a bundle (or bundles) of some of those distinct goods or services at a discount to the standalone selling prices of the goods or services in each bundle.
- The discount attributable to each bundle of goods or services described in (b) is substantially the same as the discount in the contract, and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation (or performance obligations) to which the entire discount in the contract belongs.
32-38 If a discount is allocated entirely to one or more performance obligations in the contract in accordance
with paragraph 606-10-32-37, an entity shall allocate the discount before using the residual approach to
estimate the standalone selling price of a good or service in accordance with paragraph 606-10-32-34(c).
Paragraph BC283 of ASU 2014-09 summarizes the views of the FASB and IASB on the application of ASC
606-10-32-37:
The Boards . . . noted that paragraph 606-10-32-37 would typically apply to contracts for which there are at least
three performance obligations. This is because an entity could demonstrate that a discount relates to two or
more performance obligations when it has observable information supporting the standalone selling price of a
group of those promised goods or services when they are sold together. The Boards noted it may be possible
for an entity to have sufficient evidence to be able to allocate a discount to only one performance obligation in
accordance with the criteria in paragraph 606-10-32-37, but the Boards expected that this could occur in only rare
cases.
The example below, which is reproduced from ASC 606, illustrates how an entity would
allocate a discount when there are multiple performance obligations.
ASC 606-10
Example 34 — Allocating a Discount
55-259 An entity regularly sells
Products A, B, and C individually, thereby establishing the
following standalone selling prices:
55-260 In addition, the entity
regularly sells Products B and C together for $60.
Case A — Allocating a Discount to One or
More Performance Obligations
55-261 The entity enters into a
contract with a customer to sell Products A, B, and C in
exchange for $100. The entity will satisfy the performance
obligations for each of the products at different points in
time.
55-262 The contract includes a
discount of $40 on the overall transaction, which would be
allocated proportionately to all 3 performance obligations
when allocating the transaction price using the relative
standalone selling price method (in accordance with
paragraph 606-10-32-36). However, because the entity
regularly sells Products B and C together for $60 and
Product A for $40, it has evidence that the entire discount
should be allocated to the promises to transfer Products B
and C in accordance with paragraph 606-10-32-37.
55-263 If the entity transfers
control of Products B and C at the same point in time, then
the entity could, as a practical matter, account for the
transfer of those products as a single performance
obligation. That is, the entity could allocate $60 of the
transaction price to the single performance obligation and
recognize revenue of $60 when Products B and C
simultaneously transfer to the customer.
55-264 If the contract requires the
entity to transfer control of Products B and C at different
points in time, then the allocated amount of $60 is
individually allocated to the promises to transfer Product B
(standalone selling price of $55) and Product C (standalone
selling price of $45) as follows:
Case B — Residual Approach Is
Appropriate
55-265 The entity enters into a
contract with a customer to sell Products A, B, and C as
described in Case A. The contract also includes a promise to
transfer Product D. Total consideration in the contract is
$130. The standalone selling price for Product D is highly
variable (see paragraph 606-10-32-34(c)(1)) because the
entity sells Product D to different customers for a broad
range of amounts ($15 – $45). Consequently, the entity
decides to estimate the standalone selling price of Product
D using the residual approach.
55-266 Before estimating the
standalone selling price of Product D using the residual
approach, the entity determines whether any discount should
be allocated to the other performance obligations in the
contract in accordance with paragraphs 606-10-32-37 through
32-38.
55-267 As in Case A, because the
entity regularly sells Products B and C together for $60 and
Product A for $40, it has observable evidence that $100
should be allocated to those 3 products and a $40 discount
should be allocated to the promises to transfer Products B
and C in accordance with paragraph 606-10-32-37. Using the
residual approach, the entity estimates the standalone
selling price of Product D to be $30 as follows:
55-268 The entity observes that the
resulting $30 allocated to Product D is within the range of
its observable selling prices ($15 – $45). Therefore, the
resulting allocation (see above table) is consistent with
the allocation objective in paragraph 606-10-32-28 and the
guidance in paragraph 606-10-32-33.
Case C — Residual Approach Is
Inappropriate
55-269 The same facts as in Case B
apply to Case C except the transaction price is $105 instead
of $130. Consequently, the application of the residual
approach would result in a standalone selling price of $5
for Product D ($105 transaction price less $100 allocated to
Products A, B, and C). The entity concludes that $5 would
not faithfully depict the amount of consideration to which
the entity expects to be entitled in exchange for satisfying
its performance obligation to transfer Product D because $5
does not approximate the standalone selling price of Product
D, which ranges from $15 – $45. Consequently, the entity
reviews its observable data, including sales and margin
reports, to estimate the standalone selling price of Product
D using another suitable method. The entity allocates the
transaction price of $105 to Products A, B, C, and D using
the relative standalone selling prices of those products in
accordance with paragraphs 606-10-32-28 through 32-35.
The two examples below further illustrate how an entity may allocate
a discount in a contract.
Example 7-13
Entity W regularly sells Item A, Item B, and
Item C on a stand-alone basis. The stand-alone selling price
(SSP) of each item is shown in the following table:
On January 1, 20X1, W enters into a contract
with a customer to provide the customer with one of each
item for consideration of $135 (a $15 discount) in
accordance with the following schedule:
Assume that W also sells bundles regularly
at combined prices as follows:
On the basis of the selling prices of the
bundled goods, the entity does not
have sufficient evidence to demonstrate that the discount in
the contract is related to any specific performance
obligation (i.e., the evidence does not support a
determination that the discount is anything more than a
volume-based discount attributable to a customer’s purchase
of a bundle of items).
Accordingly, the discount of $15 should be
allocated pro rata to each of the performance obligations on
the basis of their individual stand-alone selling prices as
follows:
The entity would therefore recognize revenue
as follows:
-
When Item A is transferred, recognize revenue of $27 ($30 – $3).
-
When Item B is transferred, recognize revenue of $63 ($70 – $7).
-
When Item C is transferred, recognize revenue of $45 ($50 – $5).
Thus, the total revenue recognized on the
contract is $135 ($27 + $63 + $45).
Example 7-14
Assume the same facts as in the example
above, except that the entity regularly sells bundles at
combined prices as follows:
In this scenario, the evidence based on the
selling prices of the bundled goods supports a determination
that (1) there is a discount of $15 when the entity sells a
bundle of two items that includes Item A and (2) there is a
discount of $0 for all other bundles that contain items
other than Item A. Consequently, it is reasonable to
conclude that the discount of $15 should be allocated
entirely to Item A in accordance with ASC 606-10-32-37.
The entity would recognize revenue as
follows:
-
When Item A is transferred, recognize revenue of $15 ($30 [stand-alone selling price of Item A] – $15 [full discount]).
-
When Item B is transferred, recognize revenue of $70.
-
When Item C is transferred, recognize revenue of $50.
Thus, the total revenue recognized on the
contract is $135 ($15 + $70 + $50).
7.4.1 Application of the Discount Allocation Guidance to Goods or Services Not Sold Separately
Generally, for the criterion in ASC 606-10-32-37(a) to be met,
the entity will regularly sell and therefore have observable prices for all of
the performance obligations in the contract to allocate a discount to one or
more (rather than all) of the performance obligations. However, there may be
instances in which an entity does not regularly sell each distinct good or
service, but regularly sells some of the distinct goods and services as a bundle
and regularly sells other distinct goods and services separately. In these
cases, an entity may be able to conclude that the discount is allocable to the
bundle of distinct goods and services.
This determination requires judgment. In all cases, an entity
should maximize the use of observable evidence when determining stand-alone
selling prices and allocating discounts. An entity should exercise caution when
considering whether to allocate a discount in an arrangement to a distinct good
or service that is not sold separately since the stand-alone selling price needs
to be estimated.
The example below illustrates how an entity may allocate a
discount to a bundle of distinct goods and services.
Example 7-15
Company X enters into a contract to sell
License A, Service B, and Service C. In addition, X
regularly sells, and therefore has observable evidence
of sales of, a bundle consisting only of License A and
Service B (“Bundle A + B”) for $50 and also regularly
sells Service C for $20.
The tables below show the stand-alone
selling price of each distinct good and service and each
bundle of distinct goods and services that X sells.
Scenario 1: Contract
Price = $70
As shown below, the value of the
discount (in dollars) in this scenario is the same for
(1) X’s observable and regular sales of Bundle A + B and
(2) the contract that requires X to transfer License A,
Service B, and Service C.
Since the observable sales price of
Bundle A + B plus the observable sales price of Service
C is equal to the contract price, there is no
incremental discount for purchasing Service C in
addition to Bundle A + B. Accordingly, X should
attribute to Bundle A + B the discount of $15 off the
total of License A’s and Service B’s respective
stand-alone selling prices to arrive at the observable
selling price of License A and Service B when sold
together.
If necessary (e.g., if the time at which
control of License A is transferred is different from
when control of Service B is transferred), $50 of
consideration (inclusive of the discount of $15) should
be allocated between License A and Service B on a
relative stand-alone selling price basis (step 2
allocation in the table below). In this fact pattern,
the absence of observable stand-alone sales of License A
does not prohibit the application of the guidance on
allocating discounts in ASC 606-10-32-27 to Bundle A +
B. Note, however, that the guidance could not be applied
if X lacked observable stand-alone selling prices for
either Service C or Bundle A + B.
The resulting allocations are as
follows:
Scenario 2: Contract
Price = $60
As shown below, when the contract price
for purchasing License A, Service B, and Service C is
$60, the contract includes a $25 discount in comparison
with the sum of the stand-alone selling prices of
License A, Service B, and Service C. Because the $25
discount in this contract is not the same as the $15
discount that a customer receives when purchasing
License A and Service B together, the $25 discount must
be allocated to each distinct good or service in the
contract.
Because the discount for purchasing
Bundle A + B ($15) is not substantially the same as the
discount provided in the contract ($25), the criterion
in ASC 606-10-32-37(c) is not met. Therefore, X may not
allocate the discount in the contract entirely to Bundle
A + B. Rather, the $25 discount should be allocated to
each distinct good or service on a relative stand-alone
selling price basis. The resulting allocations are as
follows:
Connecting the Dots
Entities often sell their goods and services in bundles
priced at a discount instead of selling each good or service separately.
Stakeholders have questioned whether the guidance in ASC 606-10-32-37 on
allocating discounts to one or more, but not all, of the performance
obligations is a requirement (i.e., whether an entity needs to prove
that it does not meet the criteria in ASC 606-10-32-37 to allocate a
discount proportionately to all of the performance obligations).
We believe that if the criteria in ASC 606-10-32-37 are
met, an entity should allocate a discount to one or more, but not all,
of the performance obligations in a contract. We believe that failing to
do so would result in an allocation that is inconsistent with the core
allocation principle of ASC 606 — namely, that an entity should allocate
the transaction price to each performance obligation in an amount that
depicts the amount of consideration to which the entity expects to be
entitled in exchange for transferring the promised goods or
services.
The level of effort required to determine whether the
criteria in ASC 606-10-32-37 are met will depend on the entity’s
specific facts and circumstances. Often, an entity’s established pricing
practice or customary business practices will provide sufficient
evidence that the criteria in ASC 606-10-32-37 are met (or not met).
However, in certain circumstances, it may not be evident that those
criteria are met (or not met), and an entity may therefore be required
to perform further analysis. Even so, we do not believe that an entity
must perform an exhaustive analysis to prove that the criteria in ASC
606-10-32-37 are not met before it can apply the general allocation
guidance in ASC 606-10-32-29 (i.e., allocate the discount
proportionately to the performance obligations).
However, in determining whether the criteria in ASC
606-10-32-37 are met, an entity should not ignore information that is
reasonably available without undue cost and effort. Entities may need to
document their pricing strategies for each good or service (which may be
part of the determination of stand-alone selling prices for each good or
service), including (1) how the goods or services are marketed, (2)
internally communicated pricing guidelines, (3) relative direct costs
attributed to goods or services, and (4) relevant market
information.
Entities may also need to assess their internal controls
to evaluate the manner in which they adhere to the requirement in ASC
606-10-32-37. An entity should develop a reasonable approach to
evaluating how discounts should be allocated, and it should apply that
approach consistently to similar contracts and in similar
circumstances.
7.4.2 Allocation of a Premium or Surplus
Entities often enter into arrangements for which the sum of the
stand-alone selling prices of the individual performance obligations exceeds the
transaction price. ASC 606-10-32-36 requires any discount under the contract to
be allocated proportionately to all performance obligations unless an entity has
observable evidence that the entire discount is related only to one or more, but
not all, of the performance obligations in the contract. ASC 606-10-32-37
specifies the criteria an entity must meet to conclude that the discount does
not need to be allocated proportionately to all performance obligations.
However, ASC 606 does not explicitly discuss situations in which
the transaction price exceeds the sum of the stand-alone selling prices of the
individual performance obligations, which would suggest that a customer is
paying a surplus or a premium for purchasing the goods or services.
Before assessing how to allocate a premium or surplus, given
that this scenario is expected to be relatively uncommon, an entity should
determine whether an apparent surplus indicates that an error, such as one of
the following, has been made in the analysis:
-
A significant financing component in the contract has not been identified.
-
The contract includes an incentive (i.e., performance bonus) that has not been identified or properly constrained.
-
Additional performance obligations have not been identified.
-
The stand-alone selling prices of performance obligations have not been correctly identified.
If, after further assessment, it is determined that a premium or
surplus exists, the entity should allocate that premium in a manner consistent
with the requirements of ASC 606 for allocation of a discount (i.e., on a
relative stand-alone selling price basis in accordance with ASC 606-10- 32-29,
subject to the exception in ASC 606-10-32-36 through 32-38).
7.5 Allocation of Variable Consideration
As discussed in Section 7.4, there may be instances in which applying the relative
stand-alone selling price allocation principle could result in the recognition of
revenue that does not depict the amount of consideration to which an entity expects
to be entitled in exchange for goods or services. This could occur when the criteria
for allocating a discount to one or more, but not all, performance obligations are
met. Another example is when a contract includes variable consideration and meets
certain criteria for allocating the variable consideration to one or more, but not
all, performance obligations or distinct goods or services. This additional
exception to the general allocation requirements is discussed in the following
paragraphs of ASC 606:
ASC 606-10
32-39 Variable consideration that
is promised in a contract may be attributable to the entire
contract or to a specific part of the contract, such as
either of the following:
-
One or more, but not all, performance obligations in the contract (for example, a bonus may be contingent on an entity transferring a promised good or service within a specified period of time)
-
One or more, but not all, distinct goods or services promised in a series of distinct goods or services that forms part of a single performance obligation in accordance with paragraph 606-10-25-14(b) (for example, the consideration promised for the second year of a two-year cleaning service contract will increase on the basis of movements in a specified inflation index).
32-40 An entity shall allocate a
variable amount (and subsequent changes to that amount)
entirely to a performance obligation or to a distinct good
or service that forms part of a single performance
obligation in accordance with paragraph 606-10-25-14(b) if
both of the following criteria are met:
-
The terms of a variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service).
-
Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28 when considering all of the performance obligations and payment terms in the contract.
32-41 The allocation requirements
in paragraphs 606-10-32-28 through 32-38 shall be applied to
allocate the remaining amount of the transaction price that
does not meet the criteria in paragraph 606-10-32-40.
7.5.1 Codification Example of Allocating Variable Consideration
The example below, which is reproduced from ASC 606, illustrates
how an entity would allocate variable consideration.
ASC 606-10
Example 35 — Allocation of Variable
Consideration
55-270 An entity enters into
a contract with a customer for two intellectual property
licenses (Licenses X and Y), which the entity determines
to represent two performance obligations each satisfied
at a point in time. The standalone selling prices of
Licenses X and Y are $800 and $1,000, respectively.
Case A — Variable Consideration
Allocated Entirely to One Performance
Obligation
55-271 The price stated in
the contract for License X is a fixed amount of $800,
and for License Y the consideration is 3 percent of the
customer’s future sales of products that use License Y.
For purposes of allocation, the entity estimates its
sales-based royalties (that is, the variable
consideration) to be $1,000, in accordance with
paragraph 606-10-32-8.
55-272 To allocate the
transaction price, the entity considers the criteria in
paragraph 606-10-32-40 and concludes that the variable
consideration (that is, the sales-based royalties)
should be allocated entirely to License Y. The entity
concludes that the criteria in paragraph 606-10-32-40
are met for the following reasons:
-
The variable payment relates specifically to an outcome from the performance obligation to transfer License Y (that is, the customer’s subsequent sales of products that use License Y).
-
Allocating the expected royalty amounts of $1,000 entirely to License Y is consistent with the allocation objective in paragraph 606-10-32-28. This is because the entity’s estimate of the amount of sales-based royalties ($1,000) approximates the standalone selling price of License Y and the fixed amount of $800 approximates the standalone selling price of License X. The entity allocates $800 to License X in accordance with paragraph 606-10-32-41. This is because, based on an assessment of the facts and circumstances relating to both licenses, allocating to License Y some of the fixed consideration in addition to all of the variable consideration would not meet the allocation objective in paragraph 606- 10-32-28.
55-273 The entity transfers
License Y at inception of the contract and transfers
License X one month later. Upon the transfer of License
Y, the entity does not recognize revenue because the
consideration allocated to License Y is in the form of a
sales-based royalty. Therefore, in accordance with
paragraph 606-10-55-65, the entity recognizes revenue
for the sales-based royalty when those subsequent sales
occur.
55-274 When License X is
transferred, the entity recognizes as revenue the $800
allocated to License X.
Case B — Variable Consideration
Allocated on the Basis of Standalone Selling
Prices
55-275 The price stated in
the contract for License X is a fixed amount of $300,
and for License Y the consideration is 5 percent of the
customer’s future sales of products that use License Y.
The entity’s estimate of the sales-based royalties (that
is, the variable consideration) is $1,500 in accordance
with paragraph 606-10-32-8.
55-276 To allocate the
transaction price, the entity applies the criteria in
paragraph 606-10-32-40 to determine whether to allocate
the variable consideration (that is, the sales-based
royalties) entirely to License Y. In applying the
criteria, the entity concludes that even though the
variable payments relate specifically to an outcome from
the performance obligation to transfer License Y (that
is, the customer’s subsequent sales of products that use
License Y), allocating the variable consideration
entirely to License Y would be inconsistent with the
principle for allocating the transaction price.
Allocating $300 to License X and $1,500 to License Y
does not reflect a reasonable allocation of the
transaction price on the basis of the standalone selling
prices of Licenses X and Y of $800 and $1,000,
respectively. Consequently, the entity applies the
general allocation requirements in paragraphs
606-10-32-31 through 32-35.
55-277 The entity allocates
the transaction price of $300 to Licenses X and Y on the
basis of relative standalone selling prices of $800 and
$1,000, respectively. The entity also allocates the
consideration related to the sales-based royalty on a
relative standalone selling price basis. However, in
accordance with paragraph 606-10-55-65, when an entity
licenses intellectual property in which the
consideration is in the form of a sales-based royalty,
the entity cannot recognize revenue until the later of
the following events: the subsequent sales occur or the
performance obligation is satisfied (or partially
satisfied).
55-278 License Y is
transferred to the customer at the inception of the
contract, and License X is transferred three months
later. When License Y is transferred, the entity
recognizes as revenue the $167 ($1,000 ÷ $1,800 × $300)
allocated to License Y. When License X is transferred,
the entity recognizes as revenue the $133 ($800 ÷ $1,800
× $300) allocated to License X.
55-279 In the first month,
the royalty due from the customer’s first month of sales
is $200. Consequently, in accordance with paragraph
606-10-55-65, the entity recognizes as revenue the $111
($1,000 ÷ $1,800 × $200) allocated to License Y (which
has been transferred to the customer and is therefore a
satisfied performance obligation). The entity recognizes
a contract liability for the $89 ($800 ÷ $1,800 × $200)
allocated to License X. This is because although the
subsequent sale by the entity’s customer has occurred,
the performance obligation to which the royalty has been
allocated has not been satisfied.
7.5.2 Allocating Variable Consideration and Discounts
In some circumstances, a contract may include both a discount
and variable consideration. The revenue standard includes guidance on allocating
discounts to only one or some, but not all, performance obligations, which
differs from the guidance on allocating variable consideration to one or some,
but not all, performance obligations or distinct goods or services. Because
discounts may be in the form of variable consideration (i.e., the revenue
standard cites discounts as examples of variable consideration), stakeholders
have questioned which guidance should be applied when an entity’s contract with
a customer includes a variable discount.
An entity would first determine whether a discount is variable
consideration. If the entity concludes that the discount is variable
consideration, it would apply the variable consideration allocation guidance in
ASC 606-10-32-39 through 32-41 if the related criteria are met and then apply
the allocation guidance in ASC 606-10-32-28 through 32-38 (which includes the
guidance on allocating discounts) to the remaining amount of the transaction
price. If the discount is not variable, the entity would look to the discount
allocation guidance to determine how to allocate the discount.
The above issue is addressed in Q&A 38 (compiled from
previously issued TRG Agenda Papers 31 and 34) 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.
There are several approaches to determining the amount that represents a discount
rather than variable consideration. However, an entity should ensure that the
approach selected results in an allocation that is consistent with the criteria
in ASC 606-10-32-40, including the allocation objective in ASC 606-10-32-28.
The approaches are as follows:
- Approach 1 — An entity should determine the remaining discount, if any, that is a fixed discount (i.e., the amount of the discount that is present in the contract regardless of the outcome of the uncertainties that give rise to variable consideration). In determining the fixed discount in an arrangement, the entity should compare the combined stand-alone selling prices of the performance obligations with the sum of the fixed consideration and any potential variable consideration, including variable consideration that has been specifically allocated to a performance obligation. In determining potential variable consideration (i.e., the top end of the potential consideration), the entity should not include amounts that are not realistic outcomes (i.e., there should be substance to the potential variable consideration). Accordingly, when the likelihood of receiving certain amounts of variable consideration is sufficiently low, the entity should exclude those amounts from the transaction price when determining the portion of the discount that is essentially a fixed discount.
- Approach 2 — An entity should calculate the remaining discount by comparing the combined stand-alone selling prices of the performance obligations with the transaction price. The transaction price should include the fixed element plus an estimate of the variable consideration determined in accordance with ASC 606-10-32-8; that estimate should be made before the application of the constraints under ASC 606-10-32-11 or ASC 606-10-55-65.
- Approach 3 — An entity should calculate the remaining discount by comparing the combined stand-alone selling prices of the performance obligations with the transaction price. The transaction price should include the fixed element plus an estimate of the variable consideration determined in accordance with ASC 606-10-32-8, subject to the variable consideration constraints under ASC 606-10-32-11 or ASC 606-10-55-65.
The example below illustrates the application of the above
approaches.
Example 7-16
Consider the following:
-
An entity enters into a contract with a customer that includes Product A and Product B.
-
The stand-alone selling price of Product A is $100, and the stand-alone selling price of Product B is $200.
-
The contract includes fixed consideration of $225 and a performance bonus of $50 if certain conditions are met.
-
The performance bonus is related to the productivity enhancements that Product B achieves.
As indicated above, the contract
includes both a discount and variable consideration.
Because of the performance bonus, the determination of
the transaction price will result in either of the
following possible outcomes:
When a contract includes both a discount
and variable consideration, an entity would first apply
the variable consideration allocation guidance in ASC
606-10-32-39 through 32-41 to determine whether the
criteria for allocating the variable consideration to
one or more (but not all) of the performance obligations
are met. After considering the guidance on allocating
variable consideration, the entity would look to the
discount allocation guidance to determine how to
allocate the discount. ASC 606-10-32-41 establishes a
hierarchy that requires an entity to identify and
allocate variable consideration to performance
obligations before applying other guidance (e.g., the
guidance on allocating a discount).
Because the performance bonus is related
to productivity enhancements achieved by Product B, the
entity concludes that the criterion in ASC
606-10-32-40(a) is met and allocates the variable
consideration entirely to Product B. The entity would
then apply the guidance in ASC 606-10-32-28 through
32-38 to allocate the remaining consideration to Product
A and Product B. That allocation should be consistent
with the criterion in ASC 606-10-32-40(b).
Approach 1 would result in a fixed discount of $25 (i.e.,
the total stand-alone selling price of $300 minus the
total potential consideration of $275) that would be
allocated to Product A and Product B in accordance with
the guidance in ASC 606-10-32-36 through 32-38 as
follows:
Under Approach 1, $91.67 would be
recognized when control of Product A is transferred to
the customer. If the entity concludes that it is
probable that including the performance bonus in the
transaction price will not result in a significant
revenue reversal, the entity would recognize $183.33 as
revenue when control of Product B is transferred to the
customer. Any subsequent changes in the transaction
price would be attributed entirely to Product B.
Under Approach 2, if the amounts
discussed above are used across a portfolio of
homogeneous contracts and the entity estimates that it
would be entitled to a performance bonus of $40
(determined in accordance with ASC 606-10-32-8(a)), a
remaining discount of $35 (i.e., the total stand-alone
selling price of $300 minus the expected consideration
of $265) would be allocated to Product A and Product B
in accordance with the guidance in ASC 606-10-32-36
through 32-38 as follows:
Under Approach 2, $88.33 would be
recognized when control of Product A is transferred to
the customer. If the entity concludes that it is
probable that including the performance bonus in the
transaction price will not result in a significant
revenue reversal, the entity would recognize $186.67 as
revenue when control of Product B is transferred to the
customer. Any subsequent changes in the transaction
price would be attributed entirely to Product B.
Under Approach 3, if the amounts
discussed above are used across a portfolio of
homogeneous contracts and only $30 of the performance
bonus of $50 is included in the transaction price (i.e.,
the constrained amount of variable consideration), a
remaining discount of $45 (i.e., the total stand-alone
selling price of $300 minus the constrained transaction
price of $255) would be allocated to Product A and
Product B in accordance with the guidance in ASC
606-10-32-36 through 32-38 as follows:
Under Approach 3, $85 would be
recognized when control of Product A is transferred to
the customer. If the entity concludes that it is
probable that including the performance bonus in the
transaction price will not result in a significant
revenue reversal, the entity would recognize $190 as
revenue when control of Product B is transferred to the
customer. Any subsequent changes in the transaction
price would be attributed entirely to Product B.
The revenue standard does not prescribe a method for determining
the amount of remaining consideration to allocate once variable consideration
has been allocated in accordance with ASC 606-10-32-39 through 32-41. An entity
should use judgment and consider a contract’s specific facts and circumstances
when deciding which of the above approaches would best achieve the allocation
objective, which is to allocate the transaction price to each performance
obligation in an amount that depicts the amount of consideration to which the
entity expects to be entitled in exchange for transferring the promised goods or
services.
In the determination of which approach to use, it may be
relevant to consider whether the stand-alone selling price of one or more of the
goods or services is actually a range of amounts (which may be the case if
variable consideration is appropriately allocated to one or more, but not all,
performance obligations in a contract). For instance, if the stand-alone selling
price of B in the above example was determined to be between $150 and $200,
Approach 1 may be the most appropriate approach. This is because the discount
allocated to both A and B under either outcome results in an amount of revenue
recognized for each performance obligation that is (1) consistent with the
overall allocation objective and (2) based on the relative stand-alone selling
prices of A and B. Depending on the specific facts and circumstances, different
approaches may be more or less appropriate.
It will also be important to evaluate the potential outcomes of
any resulting allocation approach. For example, in situations involving both a
fixed discount and variable consideration (i.e., the total potential transaction
price is less than the aggregated stand-alone selling prices), we do not think
that an allocation that could result in the allocation of consideration to a
performance obligation in an amount that exceeds the performance obligation’s
stand-alone selling price would be consistent with the overall allocation
objective.
7.5.3 Allocating Variable Consideration to a Series of Distinct Services
The revenue standard includes a provision that requires
an entity to identify as a performance obligation a
promise to transfer a “series of distinct goods or
services that are substantially the same and that have
the same pattern of transfer to the customer” (see Section
5.3.3). As noted above, the revenue standard
requires the allocation of variable consideration to one
or more, but not all, of the distinct goods or services
promised in a series of distinct goods or services that
forms part of a single performance obligation in
accordance with ASC 606-10-25-14(b) (the “series
guidance”) when the criteria in ASC 606-10-32-40 are
met.
|
Stakeholders have questioned whether an entity is required to
allocate variable consideration on the basis of the relative stand-alone selling
price of each distinct good or service in a series accounted for as a single
performance obligation under ASC 606-10-25-14(b). If an entity is required to do
so, applying the series guidance would not result in the relief contemplated by
the FASB and IASB, as discussed in paragraph BC114 of ASU 2014-09. Such an
outcome would largely nullify the benefits of qualifying for the series guidance
since the same amount of consideration would most likely be allocated to each
distinct good or service that is “substantially the same” (because goods or
services that are substantially the same would most likely have the same
stand-alone selling prices). However, a distinct increment of service that forms
part of a single performance obligation may be substantially the same but have
varying stand-alone selling prices (see Section 5.3.3.1 on evaluating whether
distinct goods and services accounted for under the series guidance are
substantially the same), and allocating the variable consideration (or changes
in variable consideration) entirely to this discrete increment of service may be
consistent with the allocation objective in ASC 606-10-32-28.
As stated in ASC 606-10-32-29, the general allocation principle does not apply if
the criteria in ASC 606-10-32-39 through 32-41 are met. The FASB and IASB staffs
concluded that a relative stand-alone selling price allocation is not required
to meet the allocation objective when it is related to the allocation of
variable consideration to a distinct good or service in a series.
The application of this allocation concept is further explained in paragraph
BC285 of ASU 2014-09, which states, in part:
Consider the example of a
contract to provide hotel management services for one year (that is, a
single performance obligation in accordance with paragraph 606-10-25-14(b))
in which the consideration is variable and determined based on two percent
of occupancy rates. The entity provides a daily service of management that
is distinct, and the uncertainty related to the consideration also is
resolved on a daily basis when the occupancy occurs. In those circumstances,
the Boards did not intend for an entity to allocate the variable
consideration determined on a daily basis to the entire performance
obligation (that is, the promise to provide management services over a
one-year period). Instead, the variable consideration should be allocated to
the distinct service to which the variable consideration relates, which is
the daily management service.
The above example illustrates a scenario in which the same service (hotel
management) is performed each day for varying amounts (because occupancy rates
change each day). If it was determined that each day of service should have the
same stand-alone selling price, an entity might have to estimate the total
transaction price for the contract (on the basis of the expected occupancy rates
and associated fees over the term of the arrangement) and allocate that
transaction price to each distinct increment of service. However, as explained
in paragraph BC285, this was not the boards’ intent. Rather, variability in the
actual amounts earned each day based on occupancy rates can be allocated to that
day’s service without regard to a perceived stand-alone selling price of the
service provided. In all scenarios, however, the resulting allocation would need
to meet the overall allocation objective.
The guidance in ASC 606-10-32-39 through 32-41 specifically
addresses the allocation of variable consideration to one or more, but not all,
performance obligations (or distinct goods or services promised in a series) but
is silent on whether a similar allocation of fixed consideration is acceptable.
However, Example A of Implementation Q&A 45 (compiled from previously issued
TRG Agenda Papers 39 and 44) includes a declining fixed price per unit for variable
quantities. In that example, it would be acceptable to allocate the fixed price
attributed to each variable quantity even when the fixed price per unit declines
over time. This is because such consideration represents variable consideration
and doing so would meet the allocation objective when (1) the declining price is
intended to reflect changes in market terms or (2) the changes in price are
substantive and linked to changes in either the entity’s cost of fulfilling the
obligation or the value provided to the customer.
Although Example A illustrates a situation in which there is a
declining fixed unit price for variable quantities, we believe that the same
concepts apply to the allocation of fixed elements of consideration provided
that the contract also includes elements of variable consideration that meet the
criteria to be allocated to one or more, but not all, performance obligations.
That is, we believe that an entity must consider the total transaction price
(i.e., both fixed and variable components) when performing an evaluation under
ASC 606-10-32-40(b) to determine whether its application of the variable
consideration allocation guidance described in that subparagraph is consistent
with the overall allocation objective in ASC 606-10-32-28. Specifically, if the
fixed consideration declines over time, allocating less of the fixed
consideration to each successive period of a contract could be consistent with
the objective behind allocating the total transaction price (i.e., the overall
allocation objective in ASC 606-10-32-28) when (1) declining fixed consideration
is linked to changes in the entity’s cost of providing the service or changes in
the value provided to the customer and (2) the total transaction price also
includes elements of variable consideration that meet the criteria to be
allocated to one or more, but not all, distinct goods or services in a
series.
Example 7-17
Entity L enters into a contract to
provide 10 years of management service for an apartment
complex to Customer C. In exchange for the service
provided, C pays the following fees to L:
-
Base management fee — Fixed annual fee that declines by 1 percent each year as a result of expected efficiencies and other expected cost reductions.
-
Incentive fee — Variable annual fee based on 3 percent of C’s rental revenues.
-
Reimbursement — Payment of certain fulfillment costs incurred by L.
Entity L concludes that the management
service meets the criteria in ASC 606-10-25-15 to be
accounted for as a series of distinct services.
Under these facts, L can allocate the
fixed consideration in the contract to each distinct
increment of management service. The base management fee
declines on an annual basis as a result of expected
efficiencies and other expected cost reductions. In
addition, there are variable elements of consideration
that meet the criteria to be allocated to one or more,
but not all, distinct goods or services in a series. For
these reasons, we believe that L would meet the overall
allocation objective in ASC 606-10-32-28 by allocating
each annual amount of the base management fee, in
combination with the variable consideration (the annual
incentive fee, which is further discussed below), to a
distinct annual year of service. Consequently, L will
recognize less revenue from the base management fee in
each year of the contract.
Entity L can allocate the variable
consideration in the contract (i.e., the annual
incentive fee) to each distinct increment of management
service. The variable consideration in this example
(i.e., the annual incentive fee) is similar to the
variable payments in Example C of Implementation Q&A 45. The
variability associated with the incentive fee is
directly related to the distinct increments of
management service provided by L (i.e., the rental
income generated from the management service). Because
the variability is related to each distinct increment of
management service, allocating each annual incentive fee
to a distinct annual year of service is consistent with
the allocation objective in ASC 606-10-32-28.
Further, if the reimbursement of L’s
fulfillment costs is directly related to L’s efforts to
fulfill its promise to C, L can allocate that
reimbursement to the period in which the costs were
incurred. Doing so in that case would be consistent with
the allocation objective in ASC 606-10-32-28.
Connecting the Dots
The example above illustrates a situation in which a
single performance obligation results in multiple forms of consideration
(i.e., both fixed consideration and multiple sources of variable
consideration). As a result of the allocation conclusions above, the
actual revenue recognized is likely to fluctuate during the contract
period as the uncertainties associated with the sources of variable
consideration are resolved. Consequently, revenue might be recognized in
a pattern that suggests that multiple measures of progress are being
used to determine the entity’s pattern of performance. As discussed in
Section
8.5.3, an entity should use only a single measure of
progress for each performance obligation identified in a contract.
However, the pattern of revenue recognition that results from the
allocations described in the example above is not attributable to the
selection of multiple methods of measuring progress as part of step 5
(i.e., the pattern does not reflect multiple attribution). Rather, the
pattern arises from the application of the transaction price allocation
guidance as part of step 4.
7.5.3.1 Allocating Variable Consideration in Cloud-Based or Hosted Software Arrangements
Entities that sell cloud-based or hosted software solutions
(e.g., SaaS arrangements)6 often require the customer to pay them a variable amount, usually
based on the underlying usage of the SaaS technology. ASC 606 generally
requires entities to estimate variable consideration subject to a
constraint,7 but it also provides a practical expedient and a variable
consideration allocation exception. In addition, while ASC 606 includes an
exception to the general model for variable consideration in the form of a
sales- or usage-based royalty related to licenses of IP,8 SaaS arrangements often do not qualify for the exception because a
license is typically not transferred to the customer in such cases (i.e.,
the contracts are often hosting arrangements that do not meet the criteria
in ASC 985-20-15-5 to be considered a license and are therefore accounted
for as a service).
The next sections provide interpretive guidance intended to
help entities address certain challenges associated with applying the
revenue model in ASC 606 to SaaS arrangements that include variable
consideration. All of the examples assume that (1) SaaS is the only promise
in the contract and (2) the SaaS performance obligation meets the
requirements to be recognized over time because the customer “simultaneously
receives and consumes the benefits provided by the entity’s performance as
the entity performs,” in accordance with ASC 606-10-25-27(a).
7.5.3.1.1 Applying the Invoice Practical Expedient to Stand-Ready SaaS Arrangements With Usage-Based Variable Consideration
ASC 606-10-55-18 provides the following practical expedient (the “invoice
practical expedient”), which can be applied to performance obligations
that are satisfied over time:
As a practical expedient, if an entity has a right to
consideration from a customer in an amount that corresponds
directly with the value to the customer of the entity’s
performance completed to date (for example, a service contract
in which an entity bills a fixed amount for each hour of service
provided), the entity may recognize revenue in the amount to
which the entity has a right to invoice.
The invoice practical expedient allows an entity to recognize revenue in
the amount of consideration to which the entity has the right to invoice
if such amount corresponds directly to the value transferred to the
customer. That is, the invoice practical expedient cannot be applied in
all circumstances because the amount that an entity has the right to
invoice does not always correspond to the value of the entity’s
performance to date. Therefore, an entity should demonstrate its ability
to apply the invoice practical expedient to performance obligations
satisfied over time. In addition, because the use of the invoice
practical expedient must faithfully depict the entity’s measure of
progress toward completion, the expedient can only be applied to
performance obligations satisfied over time (not at a point in
time).
We believe that if a stand-ready SaaS arrangement (1) has a pricing
structure that is solely variable on the basis of the customer’s SaaS
usage, (2) is priced at the same fixed rate per usage, and (3) gives the
entity the right to invoice the customer for its usage as the usage
occurs, the invoice practical expedient may be applied. In such cases,
the amount of revenue for which the entity has the right to invoice may
reflect the value the customer has obtained from the SaaS during the
period because it is a fixed rate based on the volume of the customer’s
SaaS usage. Accordingly, an entity with this type of arrangement is not
required to estimate the amount of variable consideration to which it
would be entitled at contract inception and instead can recognize
revenue as the customer’s usage occurs (provided that it also has the
right to invoice).
The conclusion above may not be appropriate when (1) there are fixed fees
in addition to the usage-based fees, (2) there are substantive minimum
usage requirements, (3) the usage price or rate varies during the
contract period, or (4) up-front or back-end fees are charged. In those
circumstances, it may be challenging to demonstrate that the amount the
entity has the right to invoice corresponds to the value the customer
has received to date. However, the invoice practical expedient may not
necessarily be precluded in the following scenarios (not all-inclusive):
-
The amount of fixed consideration the entity has a right to invoice does not change from period to period, and the customer’s usage is expected to be consistent from period to period.
-
The customer is expected to significantly exceed any minimum usage requirements.
-
The usage rate changes solely on the basis of the Consumer Price Index or another metric that reflects an increase or decrease in value and directly correlates to the benefits received by the customer.
-
The up-front or back-end fees are insignificant relative to the other expected consideration in the arrangement so that the amount the entity has the right to invoice is commensurate with the value the customer has received to date.
7.5.3.1.2Applying the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Usage-Based Variable Consideration
Generally, ASC 606 requires an entity to allocate the transaction price
to each performance obligation on a relative stand-alone selling price
basis. However, the guidance provides an exception to the general
allocation principle that applies specifically to variable consideration
(the “variable consideration allocation exception”). Specifically, ASC
606-10-32-39(b) states that variable consideration may be attributable
to “[o]ne or more, but not all, distinct goods or services promised in a
series of distinct goods or services that forms part of a single
performance obligation.” In addition, ASC 606-10-32-40 states the
following:
An entity shall allocate a variable amount (and subsequent
changes to that amount) entirely to a performance obligation or
to a distinct good or service that forms part of a single
performance obligation in accordance with paragraph
606-10-25-14(b) if both of the following criteria are met:
- The terms of a variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service).
- Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28 when considering all of the performance obligations and payment terms in the contract.
If an entity elects not to apply the invoice practical
expedient or is precluded from applying such expedient to its
stand-ready SaaS arrangements, it may be required to apply the variable
consideration allocation exception to usage-based fees depending on the
facts and circumstances. Because a SaaS arrangement would typically be a
series of distinct services that represent a single performance
obligation, an entity that does not apply the invoice practical
expedient would apply the variable consideration allocation exception if
the conditions in ASC 606-10-32-40 are met. An entity that receives
variable consideration based on usage would typically meet the condition
in ASC 606-10-32-40(a) because the usage is usually associated with a
specific outcome (e.g., the transaction is processed, or storage
capacity is used). However, an entity must carefully evaluate its
pricing structure to determine whether allocating variable consideration
to a distinct service (e.g., each day that SaaS is provided) is
consistent with the allocation objective.
Example 7-18
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Variable Consideration That Is
Solely Usage-Based
Entity A sells a SaaS platform
that is a stand-ready performance obligation. The
pricing structure for its SaaS is based solely on
usage (e.g., $1 for each transaction processed).
We believe that if a stand-ready SaaS arrangement
has a variable pricing structure based on the
customer’s SaaS usage and the SaaS is priced at a
fixed rate per usage, the variable consideration
allocation exception may be applied.9 This is because (1) the usage-based fees are
related to a specific outcome and (2) allocation
of the variable consideration to each distinct
service period (e.g., each day) would meet the
allocation objective (i.e., the usage-based
pricing represents the amount of consideration to
which the entity expects to be entitled upon the
transfer of each and every distinct service, which
is based on each increment of time within the
series). Accordingly, A is not required to
estimate the amount of variable consideration to
which it would be entitled at contract inception
and instead can recognize revenue as the
customer’s usage occurs.
However, the conclusion above may not be
appropriate if the usage price or rate varies
during the contract period, and an entity should
give careful consideration to variable fees that
increase or decrease on the basis of usage (e.g.,
tiered pricing). If the usage-based fees that
would be allocated to each distinct service would
not represent the amount of consideration to which
the entity expects to be entitled upon the
transfer of each distinct service (i.e., the
increase or decrease in the fee is not
commensurate with the efforts required by the
entity to satisfy each distinct service or does
not reflect the value of the specific outcome
associated with usage), it may not be appropriate
to conclude that the requirements to use the
variable consideration allocation exception are
met.
Example 7-19
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Both Fixed Consideration and
Usage-Based Variable Consideration
Entity B sells a SaaS platform
that is a stand-ready performance obligation. The
pricing structure for its SaaS includes a fixed
component that is charged regardless of usage
(e.g., a flat fee of $100,000 for an annual
subscription) and a variable component based on
usage (e.g., $1 for each transaction processed).
If B uses a ratable (i.e., time-based) measure of
progress for its stand-ready SaaS arrangements,
the fixed consideration (e.g., $100,000) would be
recognized ratably over the contractual period. In
addition, as discussed in Example
7-18, we believe that if a stand-ready
SaaS arrangement has a variable pricing structure
based on the customer’s SaaS usage and the SaaS is
priced at a fixed rate per usage, the variable
consideration allocation exception may be applied.
This is because (1) the usage-based fees are
related to a specific outcome and (2) allocation
of the variable consideration to each distinct
service period (e.g., each day) would meet the
allocation objective (i.e., the usage-based
pricing would represent the amount of
consideration to which the entity expects to be
entitled upon the transfer of each and every
distinct service, which is based on each increment
of time within the series). Accordingly, B is not
required to estimate the amount of variable
consideration to which it would be entitled at
contract inception and instead can recognize the
variable consideration as the customer’s usage
occurs (with the fixed consideration recognized
ratably).
As in Example 7-18, the conclusion above may
not be appropriate if the usage price or rate
varies during the contract period.
Example 7-20
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Reset Monthly
Entity C sells a SaaS platform that is a
stand-ready performance obligation and uses a
ratable measure of progress for the performance
obligation. The pricing structure for its SaaS
includes a fixed component that is based on a
predetermined amount of usage (i.e., a minimum
usage requirement) and a variable component that
is charged if the customer exceeds the
predetermined amount (i.e., “overage fees”). In
one of its arrangements, C sells a one-year
subscription that has a minimum usage requirement
of 100,000 transactions every month. The
subscription is priced at $100,000 per month ($1
for each transaction processed); if the number of
transactions exceeds 100,000, additional
transactions processed are also priced at $1 each.
If the customer has fewer than 100,000
transactions in any month, the shortfall is not
carried forward (e.g., if the customer only has
90,000 transactions in a particular month, it must
still pay $100,000 that month and the next month’s
minimum is still 100,000 transactions). Therefore,
the total fixed consideration is $1.2 million
($100,000 × 12 months), which is recognized
ratably over the contractual term.
An entity’s ability to apply the variable
consideration allocation exception when a fixed
component and overage fees exist depends on
whether the minimum usage requirements are the
same in each period, whether the overage fees are
a fixed rate per usage, and how often the minimum
usage requirements are “reset.” If the minimum
usage requirements are the same in each period,
overage fees are a fixed rate per usage, and
minimum usage requirements are reset frequently
throughout the entity’s reporting period (e.g.,
monthly), the overage fees incurred in such
periods typically qualify for the variable
consideration allocation exception. This is
because (1) the usage-based fees are related to a
specific outcome and (2) allocation of the
variable consideration to each distinct service
period (e.g., each month) would meet the
allocation objective (i.e., the usage-based
pricing represents the amount of consideration to
which the entity expects to be entitled upon the
transfer of each and every distinct service, which
is based on each increment of time within the
series).
In assessing the allocation objective, C
determines that any overage fees for a particular
month are solely associated with that month and
reflect the value of the specific outcome
associated with the overage. Accordingly, C is not
required to estimate the amount of variable
consideration to which it would be entitled at
contract inception and instead can recognize the
variable consideration as the customer’s usage
occurs (with the fixed consideration recognized
ratably).
Example 7-21
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and a Minimum That
Does Not Reset
Assume the same facts as in
Example 7-20
except that in one of its arrangements, Entity C
sells a one-year subscription that has an annual
minimum usage requirement of 1.2 million
transactions. The subscription is priced at a
fixed fee of $1.2 million ($1 for each transaction
processed); if the number of transactions exceeds
1.2 million, additional transactions processed are
also priced at $1 each. Therefore, the total fixed
consideration is $1.2 million, which is recognized
ratably over the contractual term ($100,000 each
month).
Because the minimum usage requirements do not
reset, the overage fees incurred in the latter
part of the year would not qualify for the
variable consideration allocation exception. While
the usage-based fees are related to a specific
outcome, allocation of the variable consideration
to each distinct service period (e.g., the latter
month or months of the year) would not meet the
allocation objective (i.e., the usage-based
pricing does not represent the amount of
consideration to which the entity expects to be
entitled upon the transfer of each and every
distinct service, which is based on each increment
of time within the series). In assessing the
allocation objective, C determines that any
overage fees for a particular month (1) would not
be solely associated with that month and (2) would
not reflect the value of the specific outcome
associated with the overage. For example, if the
customer has 110,000 transactions in each month,
total consideration would be $1.32 million
(110,000 × $1 × 12 months) and $100,000 of fixed
consideration would be recognized in each month.
The overage fees would be $120,000 ($1.32 million
– $1.2 million). However, if the overage fees were
recognized in the specific month they related to,
they would be recognized in the last 2 months of
the year ($10,000 in month 11 and $110,000 in
month 12). Therefore, even though the number of
transactions would be the same in each month
(i.e., the benefits received in the last two
months are similar to those received in the first
10 months because the usage is the same), more
revenue would be recognized in the last 2 months
($100,000 recognized in months 1–10, $110,000
recognized in month 11, and $210,000 recognized in
month 12).
Accordingly, C would generally
be required to estimate the amount of variable
consideration to which it would be entitled at
contract inception and to recognize both fixed and
variable consideration ratably over the contract
term, subject to the variable consideration
constraint.10
Example 7-22
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Reset Annually
Assume the same facts as in
Example 7-20
except that in one of its arrangements, Entity C
sells a three-year subscription that has an annual
minimum usage requirement of 1.2 million
transactions. The subscription is priced at $1.2
million per year ($1 for each transaction
processed); if the number of transactions exceeds
1.2 million, the additional transactions are also
priced at $1 each. If the customer has fewer than
1.2 million transactions in any year, the
shortfall is not carried forward (e.g., if the
customer only has 1 million transactions in a
particular year, it must still pay $1.2 million
and the next year’s minimum is still 1.2 million
transactions). Therefore, the total fixed
consideration is $3.6 million ($1.2 million × 3
years), which is recognized ratably over the
contractual term ($100,000 in each month).
Since the minimum usage requirements are the same
for each year, overage fees are a fixed rate per
usage, and minimum usage requirements are reset
each year, the overage fees incurred for a
particular annual period typically qualify for the
variable consideration allocation exception and
can therefore be allocated to that year’s service.
This is because (1) the usage-based fees are
related to a specific outcome and (2) the
allocation of variable consideration to each
distinct service period (e.g., each year) meets
the allocation objective (i.e., the usage-based
pricing represents the amount of consideration to
which the entity expects to be entitled upon the
transfer of each and every distinct service, which
is based on each annual increment of time within
the series). In assessing the allocation
objective, C determines that any overage fees for
a particular year are solely associated with that
year and reflect the value of the specific outcome
associated with the overage.
However, as in Example
7-21, because the minimum usage
requirements do not reset frequently (e.g.,
monthly), the overage fees incurred in the latter
part of each year would not qualify for the
variable consideration allocation exception for
the periods within each year (e.g., each month
within the year). While the usage-based fees are
related to a specific outcome, the allocation of
variable consideration to each distinct service
period (e.g., the latter month or months of the
year) would not meet the allocation objective
(i.e., the usage-based pricing does not represent
the amount of consideration to which the entity
expects to be entitled upon the transfer of each
and every distinct service, which is based on each
increment of time within the series). In assessing
the allocation objective, C determines that any
overage fees for a particular month (1) are not
solely associated with that month and (2) do not
reflect the value of the specific outcome
associated with the overage.
Accordingly, C would generally
be required to estimate the amount of variable
consideration to which it would be entitled in
each year and to recognize both fixed and variable
consideration ratably over each annual period,
subject to the variable consideration constraint.
However, because the allocation objective is met
on an annual basis (i.e., the overage fees for
each year (1) are solely associated with that year
and (2) reflect the value of the specific outcome
associated with the overage for that year), the
overages for a particular year can be recognized
that year. For example, if C expects $100,000 in
overage fees in the first year, $120,000 in
overage fees in the second year, and $150,000 in
overage fees in the third year, it may recognize
$1.3 million11 ratably in the first year, $1.32 million12 ratably in the second year, and $1.35
million13 ratably in the third year, subject to the
variable consideration constraint.14
Example 7-23
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Increase Monthly
Assume the same facts as in
Example 7-20 except that in one of its
arrangements, Entity C sells a one-year
subscription that has an increasing minimum usage
requirement in every month, which is priced at $1
for each transaction processed. If the number of
transactions exceeds the minimum requirement, the
additional transactions processed are also priced
at $1 each. The minimum usage starts at 100,000
transactions in the first month and increases by
10,000 in each month of the year (210,00015 in the last month). Therefore, the total
fixed consideration is $1.86 million,16 which is recognized ratably over the
contractual term.
Because the minimum usage
requirements change in each month, C must
carefully evaluate whether it would qualify for
the variable consideration allocation exception.
While the usage-based fees are related to a
specific outcome, allocation of the variable
consideration to each distinct service period
(e.g., each month) would not be likely to meet the
allocation objective (i.e., the usage-based
pricing is not likely to represent the amount of
consideration to which the entity expects to be
entitled upon the transfer of each and every
distinct service, which is based on each increment
of time within the series). In assessing the
allocation objective, C determines that any
overage fees for a particular month are not likely
to (1) be solely associated with that month or (2)
reflect the value of the specific outcome
associated with the overage. For example, fixed
consideration of $155,000 would be recognized in
each month ($1.86 million ÷ 12 months). However,
if the customer had 200,000 transactions in each
month, the amount of overage fees would be greater
in the earlier months ($100,00017 in the first month, $90,00018 in the second month, and so on). Therefore,
even though the number of transactions would be
the same in each month, more consideration would
be recognized in the earlier months (for a total
of $255,00019 recognized in the first month, $245,00020 recognized in the second month, and so
on).
Accordingly, C would generally
be required to estimate the amount of variable
consideration to which it would be entitled at
contract inception and to recognize both fixed and
variable consideration ratably over the contract
term, subject to the variable consideration
constraint.21
Example 7-24
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Carry Over
Assume the same facts as in
Example 7-20
except that in one of its arrangements, Entity C
sells a one-year subscription that specifies a
minimum usage requirement of 100,000 transactions
in every month. The subscription is priced at
$100,000 per month ($1 for each transaction
processed); if the number of transactions exceeds
100,000, the additional transactions processed are
also priced at $1 each. However, if the customer
has fewer than 100,000 transactions in any month,
the shortfall is carried over to the following
month (e.g., if the customer only has 90,000
transactions in the first month, it must still pay
$100,000 for that month but the next month’s
minimum becomes 110,000 transactions; and if in
the second month the customer only has 95,000
transactions, it must still pay $100,000 for that
month but the next month’s minimum becomes
115,000. However, if in the third month the
customer has 120,000 transactions, it will pay
$100,000 for that month and pay $5,000 for the
overage). In addition, any shortfall at the end of
the year is not carried forward upon renewal.
Therefore, the total fixed consideration is $1.2
million ($100,000 × 12 months), which is
recognized ratably over the contractual term.
Because the minimum usage
requirements could change in each month, C must
carefully evaluate whether it would qualify for
the variable consideration allocation exception.
As in Example 7-23,
while the usage-based fees are related to a
specific outcome, allocation of the variable
consideration to each distinct service period
(e.g., each month) may not meet the allocation
objective (i.e., the usage-based pricing may not
represent the amount of consideration to which the
entity expects to be entitled upon the transfer of
each and every distinct service, which is based on
each increment of time within the series).
Therefore, if the minimum usage requirements
change monthly, any overage fees for a particular
month may not (1) be solely associated with that
month or (2) reflect the value of the specific
outcome associated with the overage. Accordingly,
C may be required to estimate the amount of
variable consideration to which it would be
entitled at contract inception and to recognize
both fixed and variable consideration ratably over
the contract term, subject to the variable
consideration constraint.
However, if C expects the
customer to exceed 100,000 transactions in every
month (i.e., there is no shortfall carried over),
the arrangement may be similar to that in
Example 7-20, and any overage fees for
a particular month would (1) be solely associated
with that month and (2) reflect the value of the
specific outcome associated with the overage. In
that case, C would not be required to estimate the
amount of variable consideration to which it would
be entitled at contract inception and instead
could recognize the variable consideration as the
customer’s usage occurs (with the fixed
consideration recognized ratably).22
7.5.4 Optional Exemption From Disclosure Requirement
Stakeholders have raised concerns regarding the need to disclose
the amount of the transaction price that is allocated to remaining performance
obligations when (1) the remaining performance obligations form part of a
series, (2) the transaction price includes an amount of variable consideration,
and (3) the entity meets the criteria in ASC 606-10-32-40 for allocating the
variable amount entirely to a distinct good or service that forms part of a
single performance obligation. In these situations, an entity may be required to
estimate the amount of variable consideration to include in the transaction
price only for disclosure purposes. That is because any remaining variability in
the transaction price would be related entirely to unsatisfied portions of a
single performance obligation.
ASU
2016-20 includes the addition of an optional exemption to
the revenue standard’s guidance on required disclosures. The optional exemption
provides relief from the requirement to disclose the amount of variable
consideration included in the transaction price that is allocated to outstanding
performance obligations when either of the following conditions is met:
- The variability is related to a sales- or usage-based royalty.
- The variable consideration is allocated entirely to unsatisfied performance obligations or to a wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation for which the criteria in ASC 606-10-32-40 are met.
Entities electing the optional exemption are still required to
disclose any fixed consideration allocated to outstanding performance
obligations.
7.5.5 Application of the Variable Consideration Allocation Exception to Commodity Sales Contracts With Market- or Index-Based Pricing
Entities in commodity industries (e.g., oil and gas, power and
utilities, mining and metals, and agriculture) may enter into sales contracts to
transfer a specified quantity of commodities in exchange for market- or
index-based pricing at the time the commodities are transferred.
Commodity sales contracts with market- or index-based pricing
contain variable consideration since the ultimate amount to which entities in
such contracts are entitled is unknown at contract inception. Consequently,
entities that have entered into these contracts should evaluate the criteria in
ASC 606-10-32-40 to determine whether the variable consideration allocation
exception is met.
Generally, commodity sales contracts that contain only market-
or index-based pricing will meet the criteria in ASC 606-10-32-40, and therefore
qualify for the variable consideration allocation exception, as follows:
- The criterion in ASC 606-10-32-40(a) will generally be met because the variability is solely attributed to, and resolved as a result of, the market- or index-based price upon the transfer of each distinct commodity to the customer.
- The criterion in ASC 606-10-32-40(b) will generally be met because the market- or index-based price represents the amount of consideration to which the entity expects to be entitled upon the transfer of each distinct commodity. If the index-based price is unrelated to the commodity (e.g., oil indexed to inflation), the criterion in ASC 606-10-32-40(b) may not be met.
However, when commodity sales contracts with market- or
index-based pricing also include fixed consideration or other types of variable
consideration, entities will need to consider all of the payment terms to
determine whether both of the criteria in ASC 606-10-32-40 are met.
Example 7-25
Company T enters into a contract with a
customer to sell and deliver specified gallons of
heating oil each day over a two-year period. The price
of the heating oil is based on the New York Harbor No. 2
Heating Oil Spot Price (the “Pricing Index”) on the day
that the heating oil is delivered to the customer.
Company T concludes that each gallon of
heating oil represents a separate performance obligation
(i.e., a distinct good). That is, each gallon of heating
oil is separately identifiable and capable of benefiting
the customer on its own. In addition, control of each
gallon of heating oil is transferred at the time of
delivery (i.e., at a point in time).
Because of the variable consideration in
the contract that arises from the Pricing Index, T
evaluates whether the contract meets the criteria in ASC
606-10-32-40 and therefore qualifies for the variable
consideration allocation exception. In its evaluation, T
makes the following determinations:
-
The criterion in ASC 606-10-32-40(a) is met because the daily Pricing Index (i.e., the variable consideration) is specifically related to T’s efforts to transfer the distinct goods each day (i.e., each daily quantity of heating oil).
-
The criterion in ASC 606-10-32-40(b) is met because the Pricing Index reflects the amount of consideration to which T expects to be entitled upon the transfer of the distinct goods (i.e., each daily quantity of heating oil).
On the basis of these determinations, T
concludes that it is appropriate to recognize revenue in
an amount equal to the gallons of heating oil each day
multiplied by the Pricing Index on the day the oil is
delivered to the customer.
7.5.6 Accounting for Sponsorship Arrangements
Companies often enter into multiyear sponsorship arrangements
with venues (e.g., sports stadiums) to promote their brand. For example, a beer
company may enter into a contract with a football stadium to display its logo on
the football field. Other examples of sponsorship arrangements include
companies’ obtaining the naming rights to stadiums.
Many sponsorship arrangements are relatively long-term (e.g.,
five years or longer) and may contain stated price increases on an annual basis
(e.g., 3 percent increase in the annual fee each year of the contract). The
example below illustrates these concepts.
Example 7-26
Chi Corp. owns an arena, which is used
by a baseball team, the Streeterville Sluggers, to play
its home games from April to October each year. In
addition to baseball games, the arena holds other live
events (e.g., concerts) that occur evenly throughout the
year. The Streeterville Sluggers games constitute
approximately 40 percent of the total live events held
at the arena throughout the year. The number of other
live events is subject to the duration of the team’s
season (e.g., the team’s season will be longer if the
team makes it into the playoffs).
On January 1, 20X8, Chi Corp. enters
into a five-year noncancelable sponsorship agreement
with Beer Inc., which allows Beer Inc.’s logo to be
displayed throughout the arena. Chi Corp.’s promise to
provide the sponsorship rights meets the criteria in ASC
606-10-25-27 to be satisfied over time.
Chi Corp. has concluded that the
contract to provide sponsorship rights to Beer Inc. does
not contain a lease under ASC 842.
In exchange for the sponsorship rights
granted to Beer Inc., Beer Inc. agrees to pay Chi Corp.
a fixed fee that increases by 5 percent each year as
follows:
-
Year 1: $1,000,000
-
Year 2: $1,050,000
-
Year 3: $1,102,500
-
Year 4: $1,157,625
-
Year 5: $1,215,506
Chi Corp. has concluded that the annual
fees stated in the contract are equal to the stand-alone
selling price of the services provided in each annual
period of the sponsorship. In addition, Chi Corp. has
concluded that it does not meet the conditions in ASC
606-10-55-18 to apply the invoice practical expedient
(see Section 8.5.8.1 for further discussion
of the invoice practical expedient).
When assessing how to allocate the
annual fees and recognize revenue, Chi Corp. must first
evaluate the criteria in ASC 606-10-25-14(b) and 25-15
to determine whether the annual sponsorship rights it
promised in a long-term sponsorship arrangement
represent a series of distinct licenses (and therefore a
single performance obligation) or multiple performance
obligations (i.e., separate performance obligations for
each annual period).
ASC 606-10-25-14(b) states that a series
consists of “distinct goods or services that are
substantially the same and that have the same pattern of
transfer to the customer.” Further, ASC 606-10-25-15
provides the following two criteria that, if met, would
establish that a series of distinct goods or services
has the same pattern of transfer to the customer:
-
“Each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in paragraph 606-10-25-27 to be a performance obligation satisfied over time.”
-
The “same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.”
When assessing the criteria in ASC
606-10-25-14(b) and 25-15, Chi Corp. should evaluate the
nature of its promise in the sponsorship arrangement
and, more specifically, should consider whether the
nature of its promise varies throughout the contract
term (i.e., whether the promise in one annual period is
substantially the same as the promise in other annual
periods of the contract term).
If Chi Corp. concludes that the nature
of its promise in the sponsorship arrangement is
substantially the same in each year of the contract, the
promise to provide sponsorship rights over the contract
term would meet the criteria in ASC 606-10-25-14(b) and
25-15 to be accounted for as a series of distinct
licenses, which are accounted for as a single
performance obligation. Although the single performance
obligation would consist of a series of distinct
licenses, Chi Corp. concludes that it does not meet the
criteria in ASC 606-10-32-40 to allocate consideration
entirely to one or more, but not all, of the distinct
periods within the series because no element of variable
consideration exists. Therefore, Chi Corp. would
recognize the transaction price (i.e., $5,525,631) by
using a single measure of progress over the five-year
contract term (e.g., ratably if Chi Corp. determines
that time is an appropriate measure of progress).
Recognizing revenue by using a time-based measure of
progress would result in the creation of a contract
asset in year 1, which would increase in years 2 and 3
of the contract and subsequently reverse in years 4 and
5 of the contract.
If, on the other hand, Chi Corp.
concludes that the nature of its promise in the
sponsorship arrangement is not substantially the same in
each year of the contract, the promise to provide
sponsorship rights over the contract term would not meet
the criteria in ASC 606-10-25-14(b) and 25-15 to be
accounted for as a series of distinct licenses. Rather,
the contract would consist of five distinct performance
obligations since the events occur evenly throughout the
year (i.e., a distinct performance obligation for each
annual period of the contract). Because the annual fees
stated in the contract are equal to the stand-alone
selling price of the services provided in each annual
period of the sponsorship, Chi Corp. would allocate the
stated annual fees in the contract to each annual
period. Consequently, Chi Corp. would recognize revenue
for each annual period equal to the amount billed to
Beer Inc. for that period.
Footnotes
6
In this section, it is assumed that a SaaS
arrangement is accounted for as a service contract because the
customer does not have the ability to take possession of the
underlying software license on an on-premise basis.
7
In accordance with ASC 606-10-32-11, variable
consideration can only be included in the transaction price “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.”
8
When a sales- or usage-based royalty is related to
only a license of IP or to a license of IP that is the predominant
item in an arrangement, the royalty is recognized at the later of
the date on which (1) the subsequent sale or usage occurs or (2) the
performance obligation associated with the royalty is satisfied (or
partially satisfied).
9
This assumes that the invoice
practical expedient is not used. However, as
discussed in Section
7.5.3.1.1, the invoice practical
expedient could be used when a stand-ready SaaS
arrangement (1) has a pricing structure that is
solely variable on the basis of the customer’s
SaaS usage, (2) is priced at a fixed rate per
usage, and (3) gives the entity the right to
invoice the customer for its usage as the usage
occurs.
10
However, as discussed in
Section 7.5.3.1.1, the invoice
practical expedient could be used when a
stand-ready SaaS arrangement (1) has a pricing
structure that is solely variable on the basis of
the customer’s SaaS usage, (2) is priced at a
fixed rate per usage, and (3) gives the entity the
right to invoice the customer for its usage as the
usage occurs. While, in this example, the fees are
not solely variable, if (1) the customer is
expected to significantly exceed the minimum usage
requirements, (2) the minimum usage is priced at
the same rate as any overages, and (3) C has the
right to invoice the customer for its usage as the
usage occurs, C may be able to use the invoice
practical expedient (which would result in the
recognition of both the fixed and variable fees as
usage occurs rather than ratable recognition).
11
$1.2 million fixed
consideration plus $100,000 estimated variable
consideration.
12
$1.2 million fixed
consideration plus $120,000 estimated variable
consideration.
13
$1.2 million fixed
consideration plus $150,000 estimated variable
consideration.
14
To determine whether the
invoice practice expedient can be used, see footnote
10.
15
$100,000 plus ($10,000 × 11
months).
16
$100,000 + $110,000 + $120,000
+ $130,000 + $140,000 + $150,000 + $160,000 +
$170,000 + $180,000 + $190,000 + $200,000 +
$210,000.
17
$200,000 total fees (200,000
transactions × $1 per transaction) less $100,000
minimum in month 1.
18
$200,000 total fees (200,000
transactions × $1 per transaction) less $110,000
minimum in month 2.
19
$155,000 fixed consideration
plus $100,000 overage fees (see footnote
17).
20
$155,000 fixed consideration
plus $90,000 overage fees (see footnote
18).
21
We believe that for these
types of arrangements, the allocation objective
would only be met in limited circumstances. For
example, if the number of overages was expected to
be the same in each month (in line with the
increase in minimums), an entity may be able to
apply the variable consideration allocation
exception. However, the entity must have
sufficient historical data to substantiate that
the number of overages will be the same in each
month. In addition, to determine whether the
invoice practice expedient can be used, see footnote
10.
22
To determine whether the
invoice practice expedient can be used, see footnote
10.
7.6 Changes in the Transaction Price
7.6.1 Allocating Changes in the Transaction Price
ASC 606-10
32-42 After contract inception,
the transaction price can change for various reasons,
including the resolution of uncertain events or other
changes in circumstances that change the amount of
consideration to which an entity expects to be entitled
in exchange for the promised goods or services.
32-43 An entity shall allocate
to the performance obligations in the contract any
subsequent changes in the transaction price on the same
basis as at contract inception. Consequently, an entity
shall not reallocate the transaction price to reflect
changes in standalone selling prices after contract
inception. Amounts allocated to a satisfied performance
obligation shall be recognized as revenue, or as a
reduction of revenue, in the period in which the
transaction price changes.
32-44 An entity shall allocate
a change in the transaction price entirely to one or
more, but not all, performance obligations or distinct
goods or services promised in a series that forms part
of a single performance obligation in accordance with
paragraph 606-10-25-14(b) only if the criteria in
paragraph 606-10- 32-40 on allocating variable
consideration are met.
32-45 An entity shall account
for a change in the transaction price that arises as a
result of a contract modification in accordance with
paragraphs 606-10-25-10 through 25-13. However, for a
change in the transaction price that occurs after a
contract modification, an entity shall apply paragraphs
606-10-32-42 through 32-44 to allocate the change in the
transaction price in whichever of the following ways is
applicable:
-
An entity shall allocate the change in the transaction price to the performance obligations identified in the contract before the modification if, and to the extent that, the change in the transaction price is attributable to an amount of variable consideration promised before the modification and the modification is accounted for in accordance with paragraph 606-10-25-13(a).
-
In all other cases in which the modification was not accounted for as a separate contract in accordance with paragraph 606-10-25-12, an entity shall allocate the change in the transaction price to the performance obligations in the modified contract (that is, the performance obligations that were unsatisfied or partially unsatisfied immediately after the modification).
As discussed in Chapter 6, an entity needs to determine a contract’s transaction
price so that it can be allocated to the performance obligations in the
contract. This determination is made at contract inception. However, after
contract inception, the transaction price could change for various reasons
(e.g., changes in an estimate of variable consideration). Generally, any change
in the transaction price should be allocated to the performance obligations on
the same basis used at contract inception. For example, if the criteria for
allocating variable consideration to one or more, but not all, performance
obligations are met, changes in the amount of variable consideration to which
the entity expects to be entitled would be allocated to such performance
obligation(s) on the same basis. If the criteria for allocating variable
consideration to one or more, but not all, performance obligations are not met,
changes in the transaction price after contract inception would be allocated to
all of the performance obligations in the contract on the basis of the initial
relative stand-alone selling prices. An entity would not reallocate the
transaction price for changes in stand-alone selling prices after contract
inception.
For changes in the transaction price that arise as a result of a
contract modification, an entity should apply the guidance on contract
modifications in ASC 606-10-25-10 through 25-13 (see Section 9.4). However, if the transaction
price changes after a contract modification, an entity would allocate the change
as follows:
-
The change in the transaction price is allocated to a performance obligation that was identified before the contract modification when (1) the change in the transaction price is attributable to variable consideration related to that performance obligation and (2) the contract modification is accounted for as if the contract was terminated and a new contract was entered into (see ASC 606-10-25-13(a)).
-
In all other situations, the change in the transaction price is allocated to the unsatisfied or partially satisfied performance obligations that are identified after the contract modification.
7.6.2 Differentiating Changes in the Transaction Price From Contract Modifications
ASC 606-10-32-43 and 32-44 specify that an entity should
allocate changes in the transaction price on the same basis as at contract
inception. Application of this guidance may result in a cumulative catch-up
adjustment to revenue for amounts allocated to satisfied performance
obligations. In addition, ASC 606-10-32-45 states that an entity should account
for changes in the transaction price that are triggered by a contract
modification in accordance with the contract modification guidance in ASC
606-10-25-10 through 25-13.
An entity should consider whether the change in the price is due
to (1) the resolution of variability that existed at contract inception or (2) a
change in the scope or price (or both) of the contract that changes the parties’
rights and obligations after contract inception.
ASC 606-10-32-42 describes a change in the transaction price as
the “resolution of uncertain events or other changes in circumstances that
change the amount of consideration to which an entity expects to be entitled in
exchange for the promised goods or services.” A change in the transaction price
could result from the resolution of variable consideration (e.g., achieving a
performance bonus or qualifying for a volume rebate) that was part of the
contract at inception. However, the contract does not always have to
specifically identify forms of variable consideration for subsequent changes to
be accounted for as a change in the transaction price. The following factors
could suggest that subsequent changes in the transaction price do not constitute
a contract modification:
-
The entity has a history of granting price concessions to customers, which may or may not have been specifically negotiated.
-
The selling prices of the goods or services are highly variable, and the entity has a demonstrated history of not enforcing payment of the stated sales price (e.g., the entity has granted extended payment terms and has a history of not enforcing payment of the full contract price).
-
Changes in the transaction price result from customer satisfaction issues related to the underlying product or service.
On the other hand, a contract modification is described in ASC
606-10-25-10 as “a change in the scope or price (or both) of a contract that is
approved by the parties to the contract. . . . A contract modification exists
when the parties to a contract approve a modification that either creates new or
changes existing enforceable rights and obligations of the parties to the
contract.” Although contract modifications will usually result from negotiations
between the parties after contract inception, finalizing the amount of
concessions or other variable consideration may also require subsequent
negotiations between the parties. Therefore, the existence of negotiations is
not in itself determinative of whether a change represents a change in the
transaction price or a contract modification. Further, while contract
modifications often include the addition or removal of goods or services, they
could occasionally occur without a change in the scope of the contract (i.e.,
only as a result of a change in price). The following factors could suggest that
a change in the transaction price should be accounted for as a modification:
-
Subsequent changes in market conditions suggest that there has been a substantial change in the market price of the goods or services that was not anticipated at contract inception, which resulted in the entity’s agreeing to adjust the transaction price.
-
The entity has no history of granting price concessions, and the price concession is not related to the quality of the transferred goods or services.
-
The entity agreed to a reduction in the transaction price for remaining goods or services to induce its customer to enter into a contract for additional goods or services.
-
Technological advances and competitive pressures that did not exist at contract inception result in a significant change in the price that the entity is willing to accept for its goods or services.
An entity will need to use judgment to determine whether a
change in price is the result of a change in the transaction price or a contract
modification, especially when the entity provides the customer with a price
concession. In situations involving a price concession, an entity will need to
consider whether the price concession should have been contemplated at contract
inception and thus represents a change in the transaction price. As illustrated
in Example 5, Case B, of the revenue standard (ASC 606-10-55-114 through
55-116), this may be the case when the concession is related to product defects
or service issues associated with products or services that have already been
transferred to the customer. Had the product defects or service issues been
anticipated at contract inception, the potential price concession would have
been identified as a source of variable consideration under the contract.
Alternatively, a concession may result from a change in market
conditions that could not have been anticipated at contract inception. The
resulting change in the price of the contract changes the existing enforceable
rights and obligations of the parties under the contract and should be accounted
for as a contract modification in accordance with ASC 606-10-25-10 through
25-13.
The example below illustrates the identification of and
accounting for a change in the transaction price that results from a contract
modification.
Example 7-27
Albus Inc. enters into a contract with
Cherry Co. to deliver 120 standard widgets (each
distinct) over a 12-month period for a fixed price of
$100 per widget (total transaction price of $12,000).
After 60 widgets are transferred (for which Albus Inc.
recognizes $6,000 in revenue), a new competitor launches
a competing product that is being sold for $65 per
widget. Because of a change in the competitive landscape
and to preserve its customer relationship, Albus Inc.
agrees to lower the price for the remaining 60 widgets
to $60 per unit.
Albus Inc. concludes that (1) its rights
under the initial contract changed (having given up its
right to $100 per widget) and (2) it should account for
the change in the transaction price as a contract
modification. Consequently, Albus Inc. applies the
guidance in ASC 606-10-25-10 through 25-13. Since the
remaining widgets to be transferred under the contract
are distinct, Albus Inc. will recognize revenue of
$3,600 ($60 × 60 units) as the remaining 60 widgets are
transferred to Cherry Co.
In contrast to the example above, the example below illustrates
the identification of and accounting for a change in the transaction price that
does not result from a contract modification.
Example 7-28
Albus Inc. enters into a contract with
Cherry Co. to deliver 120 standard widgets (each
distinct) over a 12-month period for a fixed price of
$100 per widget (total transaction price of $12,000).
After 60 widgets are delivered, Cherry Co. identifies
quality issues with the first 60 units delivered that
require a small amount of rework. After negotiations,
Albus Inc. agrees to grant Cherry Co. a concession of
$20 per unit (a total concession of $2,400). Albus Inc.
and Cherry Co. agree that the concession will be
reflected in the selling price of the remaining 60
widgets (decreasing the price to $60 per widget for the
remaining 60 widgets).
Albus Inc. determines that it should
account for the concession as a change in the
transaction price since it resulted from conditions that
existed in the initial contract (quality issues in the
transferred widgets).That is, because of the quality
issue in the product (which will continue with the
remaining widgets), Albus Inc. concludes that it had a
right to consideration of only $80 per widget under the
initial contract. Consequently, Albus Inc. applies the
guidance in ASC 606-10-32-43 and 32-44. It records an
immediate adjustment to revenue of $1,200 for the $20
per widget concession granted for units already
transferred to Cherry Co. and will recognize revenue of
$4,800 ($80 per widget) as the remaining 60 widgets are
transferred to Cherry Co.
Refer to Chapter 9 for additional information about accounting for
contract modifications.
7.7 Allocation Considerations for Significant Financing Components
Under step 3 of ASC 606’s revenue recognition model, an entity may
need to adjust its transaction price for the existence of a significant financing
component (see Section 6.4).
ASC 606-10-32-15 requires an entity to adjust the transaction price for the effects
of the time value of money if the timing of payments agreed to by the parties to the
contract provides the customer or the entity with a significant benefit of financing
the transfer of goods or services to the customer (see Section 6.3). In those circumstances, the contract contains a
significant financing component.
In situations involving a contract with a customer that includes multiple performance
obligations, questions have arisen about whether an adjustment to the transaction
price resulting from a significant financing arrangement could be allocated to one
or more, but not all, performance obligations.
Generally, a significant financing component in a contract is
related to the contract as a whole rather than to the individual performance
obligations in the contract. However, it may be reasonable in some circumstances to
allocate a significant financing component to one or more, but not all, of the
performance obligations in the contract. As a practical matter, when an entity
considers the basis for such allocation, it may be appropriate for the entity to
analogize to (1) the guidance in ASC 606-10-32-36 through 32-38 on allocating a
discount or (2) the guidance in ASC 606-10-32-39 through 32-41 on allocating
variable consideration.
An entity that is considering the possibility of allocating a
significant financing component to one or more, but not all, of the performance
obligations in a contract will need to use judgment in determining whether such an
approach is reasonable in the particular circumstances of that contract.
The above issue is addressed in Implementation Q&A 37 (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.
Chapter 8 — Step 5: Determine When to Recognize Revenue
Chapter 8 — Step 5: Determine When to Recognize Revenue
8.1 Objective and Background
ASC 606-10
25-23 An entity shall recognize
revenue when (or as) the entity satisfies a performance
obligation by transferring a promised good or service (that
is, an asset) to a customer. An asset is transferred when
(or as) the customer obtains control of that asset.
8.1.1 Concept of Control
In a manner consistent with the core principle of the revenue standard — “an
entity shall recognize revenue to depict the transfer of
promised goods or services to customers in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for those
goods or services” (emphasis added) — step 5 focuses on recognition (i.e., when it is appropriate to recognize revenue). While
steps 1 and 2 (see Chapters
4 and 5) also
contain recognition concepts, step 5 is the central tenet of the recognition
principle in the standard.
The revenue standard requires an entity to assess whether the customer has
obtained control of the good or service to determine
whether the good or service has been transferred to the customer. Determining
when revenue should be recognized — that is, the timing of the
transfer of control of the good or service to the customer — is the most common
question regarding revenue recognition.
While step 5 of the standard’s revenue model acts as a gate and responds to the
question of “when to recognize,” it is preceded by the earlier steps (i.e.,
steps 1–4). The conclusions reached in the earlier steps are critical to the
determination of how much revenue to recognize in step 5 when control of a good
or service is transferred to a customer. Therefore, the revenue standard
generally requires a sequential evaluation of each of the four steps preceding
step 5.
Connecting the Dots
While the revenue standard uses a control-based approach
for determining whether and, if so, when a good or service has been
transferred to a customer, the FASB and IASB did not define “good or
service.” Instead, the boards focused on the concept of control to
determine when the good or service is transferred. The boards
decided that assessing the transfer of control would result in more
consistent decisions about when goods or services are transferred than
the risks-and-rewards approach, which requires an entity to use more
judgment when it retains risks and rewards to some extent. For example,
the boards considered contracts in which the entity sells a product but
also provides a warranty. During the development of the final standard,
this example was used to challenge the risks-and-rewards model since
some argue that in many such cases, the risks and rewards of the product
may not have been entirely transferred to the customer given that the
entity retains some risks associated with the product through the
related warranty. However, it was the boards’ expectation that under a
control-based model, the accounting would more appropriately align
recognition with performance — that is, in the fact pattern above, the
entity performs by delivering a product and then, if the warranty is
determined to be a service-type warranty (see Section 5.5), will recognize
performance under its separate promise of a warranty over the period
covered.
The revenue standard requires an entity first to
determine, at contract inception, whether control of a good or
service is transferred over time; if so, the entity would
recognize the related revenue over time in a manner consistent with the
transfer of the good or service over time to the customer. If the entity
cannot conclude that control is transferred over time (i.e., the
transfer does not meet one of three criteria described in Section 8.4), control
is considered to be transferred at a point in time. As a result, the
entity must determine at what specific point in time to recognize the
related revenue. As discussed in Section 8.6, the guidance provides
five indicators to help an entity assess when that point in time is for
a promised good or service. Even though the revenue standard shifts away
from risks and rewards, the boards noted that an entity could still look
to whether risks and rewards have been transferred to the customer as an
indicator that control has passed to the customer.
8.1.2 Performance Obligations Satisfied Over Time or at a Point in Time
ASC 606-10
25-24 For each performance
obligation identified in accordance with paragraphs
606-10-25-14 through 25-22, an entity shall determine at
contract inception whether it satisfies the performance
obligation over time (in accordance with paragraphs
606-10-25-27 through 25-29) or satisfies the performance
obligation at a point in time (in accordance with
paragraph 606-10-25-30). If an entity does not satisfy a
performance obligation over time, the performance
obligation is satisfied at a point in time.
One of the key objectives of the FASB and IASB in establishing the revenue
standard was to create a single framework for entities to apply across disparate
jurisdictions, industries, and transactions. However, there had been a
long-standing view that some promises to a customer are satisfied in an exchange
transaction at a point in time (generally, the transfer of a good), whereas
other promises to a customer are satisfied over time as the entity performs
various actions (generally, the transfer of a service). When developing the
control-based model, the boards thought that using control as the basis for
recognition allowed them to achieve that single model since control of something
could be transferred (1) at a single point in time after the completion of the
entity’s efforts or (2) over time in conjunction with the entity’s efforts
toward providing a benefit to the customer, typically through the delivery of a
service.
During the development of the revenue standard, the boards understood, and
stakeholders continued to provide feedback on, the need to outline how the
single model of control would be applied to the transfer of goods as compared
with the transfer of services.
8.1.3 Distinguishing Between “Goods” and “Services”
Despite intending to create a single framework, the boards acknowledged that
there are clear differences between the most common instances of sales of goods
and delivery of services. However, along a spectrum of revenue transactions,
there are instances of arrangements (e.g., construction-type contracts) in which
it becomes less clear whether the entity is providing a good or a service
because constructing an asset has attributes of both the sale of a good (the
final constructed asset) and the delivery of a service (benefits are being
provided throughout the development of the asset).
Therefore, the boards committed to developing a control-based model and determined that it would
be most appropriate to describe performance obligations as being transferred either over time (most
commonly in the case of services) or at a point in time (most commonly in the case of products or
goods).
During the development of the revenue standard, stakeholders questioned whether
a control-based model could be applied to service contracts given that it can be
difficult to identify the asset that is being provided to the customer in a
service contract. Such difficulty arises because the asset is often
simultaneously created and consumed by the customer, especially in the case of a
pure service contract (e.g., cleaning service). As a result, stakeholders
expressed concerns about whether a single control-based model could be applied
to all types of contracts with customers. The boards clarified that although
certain service contracts may not result in the creation of a tangible good or
work in process, there is an inherent asset being created in all service
contracts (i.e., the customer receives a future economic benefit as a result of
the entity’s performance in a service contract). In light of this, the boards
decided that a separate model should not be created for service contracts and
continued to develop a single control-based model.
Ultimately, the boards achieved their objective of creating a single framework
for revenue recognition based on control (specifically, when the customer obtains control of an asset) while still
allowing for accounting based on the disparate qualities of goods and
services.
See further discussion in Sections 8.4, 8.5, and 8.6 of performance obligations satisfied over time
and at a point in time.
Also, the boards determined that it was most operational to make the distinction between a
performance obligation satisfied at a point in time and a performance obligation satisfied over time
by using a single starting point — namely, the determination of whether the promise is a performance
obligation satisfied over time, as discussed in Sections 8.4 and 8.5. That assessment is based on
whether the performance obligation meets one of three specific criteria for recognizing revenue over
time. If the promise does not meet any of the three criteria, it is, by default, a performance obligation
satisfied at a point in time, as discussed in Section 8.6.
It is important to note that the assessment of whether a performance obligation meets the criteria for
recognizing revenue over time must be performed at contract inception. In addition, the assessment
of whether revenue should be recognized over time or at a point in time should be performed at
the individual performance obligation level rather than at the overall contract level. Accordingly, it is
important to appropriately identify the performance obligations in step 2 (refer to Chapter 5) before
evaluating whether revenue should be recognized over time or at a point in time.
The simple flowchart below illustrates the process that entities should use to
determine the appropriate pattern of revenue recognition.
8.2 Control
ASC 606-10
25-23 An entity shall recognize revenue when (or as) the entity satisfies a performance obligation
by transferring a promised good or service (that is, an asset) to a customer. An asset is transferred
when (or as) the customer obtains control of that asset.
25-25 Goods and services are
assets, even if only momentarily, when they are received and
used (as in the case of many services). Control of an asset
refers to the ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset.
Control includes the ability to prevent other entities from
directing the use of, and obtaining the benefits from, an
asset. The benefits of an asset are the potential cash flows
(inflows or savings in outflows) that can be obtained
directly or indirectly in many ways, such as by:
-
Using the asset to produce goods or provide services (including public services)
-
Using the asset to enhance the value of other assets
-
Using the asset to settle liabilities or reduce expenses
-
Selling or exchanging the asset
-
Pledging the asset to secure a loan
-
Holding the asset.
ASC 606 applies a single model (based on control) to all revenue transactions to determine when
revenue should be recognized. ASC 606-10-25-25 defines control of an asset as “the ability to direct the
use of, and obtain substantially all of the remaining benefits from, the asset.” This definition consists of
three components:
- The “ability” — For an entity to recognize revenue, its customer must have the present right to direct the use of, and obtain substantially all of the remaining benefits from, an asset. That is, the entity should not recognize revenue until the customer has in fact obtained that right.
- “[T]o direct the use of . . . the asset” — This means that the customer can (1) use the asset in its own activities, (2) allow the asset to be used in another entity’s activities, or (3) restrict another entity from using the asset.
- “[A]nd obtain substantially all of the remaining benefits [from the] asset" — To obtain control, the customer must be able to obtain substantially all of the remaining benefits from the asset (e.g., by using, consuming, disposing of, selling, exchanging, pledging, or holding the asset).
Transfer of control can be assessed from both the customer’s and the seller’s perspective; however,
the FASB and IASB decided that control should be viewed from the customer’s perspective. While
the timing of revenue recognition could often be the same from both perspectives (i.e., when the seller
surrenders control and when the customer obtains control), assessing the transfer of control from the
customer’s perspective minimizes the risk of recognizing revenue for activities that do not align with the
transfer of the goods or services to the customer.
The notion of control is a relatively simple concept when applied to the transfer of control of a good to
the customer; however, for performance obligations related to services and construction-type contracts,
the notion of control may be less straightforward. For example, in arrangements in which the customer
simultaneously consumes the asset as the asset is created, the customer never recognizes an asset;
consequently, it may be more difficult to determine when the customer obtains control.
In developing the standard, the boards received feedback that there should be separate control
guidance for goods and services; however, as discussed above, the boards ultimately decided against
this because (1) it may sometimes be difficult to clearly define a service and (2) not all service contracts
result in the transfer of resources to customers over time. Rather, the boards focused on the attribute
of the timing of when a performance obligation is satisfied to determine whether control has been
transferred. This is discussed further in Section 8.3.
Connecting the Dots
The switch from a risks-and-rewards model to a control-based model is consistent with the
FASB’s overall shift in recent years toward a control-based model in other projects (e.g.,
consolidation, leases, and derecognition of financial assets). While the notion of control may be
defined slightly differently to take into account the specifics in each of these standards, the same
general concept of a control-based standard remains.
As illustrated in Section 8.1.3, a performance obligation
satisfied at a point in time is generally a product or good, and a
performance obligation satisfied over time is generally a service. However,
certain exceptions apply, and it is important not to automatically assume
that revenue from a product or good is recognized at a point in time and
revenue from a service is recognized over time. For example, revenue from
certain deliverables of what many may commonly consider to be goods (e.g.,
some contract manufacturing) may be recognized over time as revenue from a
manufacturing “service.” Depending on the payment terms, this may be the
case when the goods being manufactured are highly customized and do not have
an alternative use to the entity, thereby implying that the customer is
receiving a benefit over the manufacturing period, as opposed to only when
the finished goods are provided to the customer. Alternatively, revenue from
certain deliverables of “services” (e.g., under some construction contracts)
may need to be recognized at a point in time if it is determined that the
customer does not control the constructed asset until the end of the
construction process. Refer to Sections 8.3.1 and 8.3.2 for
illustrations of these concepts.
8.3 Two Models for Revenue Recognition — Based on Control
At contract inception, an entity must determine whether the performance obligation meets the criteria
for revenue to be recognized over time (see Sections 8.4 and 8.5); if the performance obligation does
not meet those criteria, revenue must be recognized at a point in time (see Section 8.6). That is, the entity
must carefully evaluate how and when control is transferred to the customer. While generally speaking,
goods are transferred at a point in time and services are transferred over time, this is not the case in all
circumstances.
Connecting the Dots
Step-by-Step Approach
When entities think about
revenue recognition, it may seem natural or logical to jump directly to determining when
revenue can be recognized in step 5. However, understanding the nature of the
arrangement and identified promised goods or services in step 2 is critical to
determining when transfer of control occurs in step 5. As discussed in Section 8.1.1, applying the steps
sequentially is important because the assessment of whether revenue should be recognized
over time or at a point in time should be performed at the individual performance
obligation level rather than at the overall contract level.
For example, suppose that an
entity sells a product with a multiyear warranty to a customer. Without identifying and
assessing the nature of the promised goods and services in the contract, the entity may
incorrectly assume that it should recognize all of the revenue when the product is
transferred to the customer. However, upon assessing the nature of the promised goods
and services in the contract, the entity determines that the multiyear warranty
represents a service-type warranty (rather than an assurance-type warranty). In this
situation, the contract would include two performance obligations: (1) the product and
(2) the service-type warranty. In accordance with step 4 (see Chapter 7) revenue should be allocated to the product
and the service-type warranty. The revenue allocated to the product would generally be
recognized at the point in time when control is transferred (see Section 8.6), and the revenue allocated to the
service-type warranty should be recognized over the multiyear warranty period (see Sections 8.4 and 8.5). See Section
5.5 for additional information on determining whether a warranty represents
a distinct service in the contract.
Assessing the Nature of the Promise
Identifying the nature of the arrangement and the promised goods or
services may be challenging in many instances, such as in certain types of stand-ready
obligations or when an entity is acting as an agent. For example, in an arrangement in
which a price comparison Web site (the entity) allows its users (customers) to select
services from a wide range of providers (e.g., hotels, airlines) and make purchases
through the site, stakeholders have questioned whether revenue should be recognized
before the user executes a purchase (e.g., selects and books a hotel room or flight).
That is, when an entity acts as an agent, it could be thought of as providing a service
throughout a certain period of effort, or it could instead be viewed as performing a
single act of matching the buyer with a provider (when the agent finds a buyer). The
entity earns a commission for acting as a broker; however, the entity is also providing
a service of price comparisons and in essence is creating a lead for the provider.
Stakeholders have therefore questioned whether revenue should be recognized before the
customer makes a purchase through the site since some views indicate that value is being
transferred to the user over time before the execution of a purchase through the site.
In light of this, the entity should first assess the nature of its promise in the
contract to understand whether its promise is fulfilled at a point in time or over time
so that it can appropriately recognize revenue. For additional discussion, see Section 8.9.5.
Sections 8.3.1 through 8.3.4 illustrate
how an entity must carefully assess the terms of the arrangement and not just assess whether
it is providing a good or a service to properly determine when control is transferred to the
customer.
8.3.1 When Revenue Recognition Over Time Is Appropriate for Goods (e.g., Contract Manufacturing)
An entity that is delivering goods (e.g., a contract manufacturer)
should carefully analyze the contractual arrangement in accordance with the three criteria
in ASC 606-10-25-27 to determine whether the promise in the contract to construct and
transfer goods to the customer is a performance obligation that will be satisfied over
time or at a point in time.
If an entity’s obligation to produce a customized product meets one of
the criteria in ASC 606-10-25-27 for revenue recognition over time (e.g., the entity’s
performance does not create an asset with an alternative use, and the entity has an
enforceable right to payment for performance completed to date), revenue related to that
product would be recognized as the product is produced, not when the product is
delivered to the customer.
For example, an entity that has a contract with an original equipment
manufacturer (OEM) to produce a customized part for the OEM’s product would meet the
criteria for revenue recognition over time if the customized part has no alternative use
other than as a part for the OEM’s product and the entity has an enforceable right to
payment for performance completed to date “at all times throughout the duration of the
contract.” ASC 606-10-25-28 and 25-29 as well as ASC 606-10-55-8 through 55-15 provide
detailed guidance on whether an asset has an alternative use to the entity and whether an
entity has an enforceable right to payment for performance completed to date. An entity
would need to carefully analyze the contractual arrangements and the specific facts and
circumstances to determine whether those criteria are met.
If it concludes that revenue should be recognized over time, the entity
would then be required to select a method of recognizing revenue over time that faithfully
depicts the entity’s performance to date for producing the product. Therefore, contract
revenue should be recognized as the entity performs (i.e., as the product is produced)
rather than when the product is delivered to the customer.
8.3.2 When Revenue Recognition Over Time Is Appropriate for Services (e.g., Construction)
An entity that provides a service (e.g., under a construction contract)
cannot assume that it can recognize revenue over time. Rather, the entity needs to assess
whether the criteria outlined in ASC 606-10-25-27 are met.
Specifically, ASC 606-10-25-27 requires one of the following criteria to
be met for revenue to be recognized over time:
-
The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs . . . .
-
The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced . . . .
-
The entity’s performance does not create an asset with an alternative use to the entity . . . , and the entity has an enforceable right to payment for performance completed to date.
The assessment should be made at contract inception. If a performance
obligation does not meet any of the criteria in ASC 606-10-25-27, the entity should
recognize revenue at a point in time rather than over time.
The entity should carefully analyze the terms of the contractual
arrangement(s) in accordance with the requirements in ASC 606-10-25-27 to determine
whether the performance obligation is satisfied over time or at a particular point in
time. The criteria in ASC 606-10-25-27 are discussed in further detail in Section 8.4.
8.3.3 Whether an Entity Is Free to Choose Whether to Recognize Revenue Over Time or at a Point in Time
The decision of whether to recognize revenue over time or at a point in
time is not a free choice. At contract inception, an entity must carefully evaluate
whether the performance obligation meets any of the three criteria in ASC 606-10-25-27 for
revenue recognition over time. If one or more of the criteria are met, the performance
obligation must be recognized over time. However, if none of the criteria are met, the
entity should recognize revenue at a point in time.
Accordingly, it would not be appropriate to recognize revenue at a point
in time if one of the three criteria in ASC 606-10-15-27 is met.
8.3.4 Recognizing Revenue Over Time or at a Point in Time — Production of Customized Goods
An entity that sells products or goods cannot presume that it can
recognize revenue at a point in time since it will be required to recognize revenue over
time if one of the criteria in ASC 606-10-25-27 is met. In the FASB staff’s view, revenue
from certain contracts with customers (e.g., contracts for the production of customized
goods) may need to be recognized over time under the revenue standard because (1) the
goods or services being provided may have no alternative use to the entity and (2) the
entity may have an enforceable right to payment. To illustrate, the FASB staff cites the
following fact pattern:1
An entity has contracted with a customer to provide a
manufacturing service in which it will produce 1,000 units of a product per month for a
2-year period. The service will be performed evenly over the 2-year period with no
breaks in production. The units produced under this service arrangement are
substantially the same and are manufactured to the specifications of the customer. The
entity does not incur significant upfront costs to develop the production process.
Assume that its service of producing each unit is a distinct service in accordance with
the criteria in paragraph 606-10-25-19. Additionally, the service is accounted for as a
performance obligation satisfied over time in accordance with paragraph 606-10-25-27
because the units are manufactured specific to the customer (such that the entity’s
performance does not create an asset with alternative use to the entity), and if the
contract were to be cancelled, the entity has an enforceable right to payment (cost plus
a reasonable profit margin). Therefore, the criteria in paragraph 606-10-25-15 have both
been met.
The FASB staff cautions that while the example is not meant to
illustrate that revenue from contracts for customized goods should always be recognized
over time, an entity should not presume that it would continue to recognize revenue from
such contracts at a point in time under the revenue standard. Rather, the entity would
need to assess the criteria in ASC 606-10-25-27 to determine whether it should recognize
revenue over time. If none of those criteria are met, the entity should recognize revenue
at a point in time.
The above issue is addressed in Implementation Q&A 54 (compiled from previously issued
TRG Agenda Papers 56 and 60). For additional information and Deloitte’s summary of issues
discussed in the Implementation Q&As, see Appendix C.
Footnotes
1
Quoted from Q&A 54 of the FASB staff’s Revenue Recognition Implementation Q&As
(the “Implementation Q&As”).
8.4 Revenue Recognized Over Time
ASC 606-10
25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance
obligation and recognizes revenue over time, if one of the following criteria is met:
- The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs (see paragraphs 606-10-55-5 through 55-6).
- The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced (see paragraph 606-10-55-7).
- The entity’s performance does not create an asset with an alternative use to the entity (see paragraph 606-10-25-28), and the entity has an enforceable right to payment for performance completed to date (see paragraph 606-10-25-29).
ASC 606-10-25-27 is one of the most critical paragraphs in the standard since it effectively defines whether the entity is (1) providing the customer with a service (and revenue should be recognized as the entity is performing) or (2) providing the customer with a good (and revenue should be recognized only when the entity finishes what it was obligated to do and the good is transferred or delivered to the customer).
The criteria in ASC 606-10-25-27 were developed to provide an objective basis
for assessing whether control is transferred over time and, therefore, the
performance obligation is satisfied over time. The flowchart below summarizes the
criteria in ASC 606-10-25-27.
8.4.1 Meeting More Than One of the Criteria for Recognition of Revenue Over Time
The criteria in ASC 606-10-25-27 are not intended to be mutually
exclusive, and it is possible that an entity will meet more than one criterion.
For example, in some cases it may be determined that the “entity’s performance
creates or enhances an asset . . . that the customer controls as the asset is
created or enhanced” (ASC 606-10-25-27(b)) and that the entity also “does not
create an asset with an alternative use to the entity [and] has an enforceable
right to payment for performance completed to date” (ASC 606-10-25-27(c)).
When one or more of the criteria in ASC 606-10-25-27 are met,
revenue should be recognized over time.
8.4.2 Application of ASC 606-10-25-27 to Contracts With a Very Short Duration
For contracts with a short duration (e.g., a one-year contract
or a one-month contract), ASC 606 does not contain any practical expedient under
which entities would not be required to assess whether revenue should be
recognized over time or at a point in time but rather would simply default to
point-in-time recognition.
Entities should carefully analyze the contractual arrangement in
accordance with the requirements of ASC 606-10-25-27 to determine whether the
performance obligation is satisfied over time or at a point in time, even for
short-duration contracts. Depending on the timing of the transfer of control,
the distinction could result in different accounting outcomes when control is
transferred in multiple reporting periods. In addition, entities should consider
the different disclosure requirements related to those performance obligations
that are satisfied over time versus those that are satisfied at a point in
time.
8.4.3 Simultaneous Receipt and Consumption of Benefits of the Entity’s Performance
ASC 606-10
25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance
obligation and recognizes revenue over time, if one of the following criteria is met:
- The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs (see paragraphs 606-10-55-5 through 55-6). . . .
55-5 For some types of
performance obligations, the assessment of whether a
customer receives the benefits of an entity’s
performance as the entity performs and simultaneously
consumes those benefits as they are received will be
straightforward. Examples include routine or recurring
services (such as a cleaning service) in which the
receipt and simultaneous consumption by the customer of
the benefits of the entity’s performance can be readily
identified.
55-6 For other types of
performance obligations, an entity may not be able to
readily identify whether a customer simultaneously
receives and consumes the benefits from the entity’s
performance as the entity performs. In those
circumstances, a performance obligation is satisfied
over time if an entity determines that another entity
would not need to substantially reperform the work that
the entity has completed to date if that other entity
were to fulfill the remaining performance obligation to
the customer. In determining whether another entity
would not need to substantially reperform the work the
entity has completed to date, an entity should make both
of the following assumptions:
-
Disregard potential contractual restrictions or practical limitations that otherwise would prevent the entity from transferring the remaining performance obligation to another entity
-
Presume that another entity fulfilling the remainder of the performance obligation would not have the benefit of any asset that is presently controlled by the entity and that would remain controlled by the entity if the performance obligation were to transfer to another entity.
The first criterion for determining whether a performance obligation is
satisfied over time (ASC 606-10- 25-27(a)) is that a customer simultaneously
receives and consumes benefits as the entity performs. This criterion most
commonly applies to typical service contracts, which would generally meet the
criterion. That is, the entity’s performance momentarily creates an asset that
the customer simultaneously receives and consumes, which means that the customer
obtains control of the entity’s output as the entity performs. Typically, in
contracts that meet the criterion in ASC 606-10-25-27(a), there is no tangible
asset that is being created by the accumulation of effort of the entity as it
performs. For example, a contract to provide a cleaning service and a contract
to process transactions on behalf of a customer are arrangements in which the
customer simultaneously consumes as the entity performs. That is, in each of
those examples, there is no accumulation of the entity’s efforts to build or
create an asset (e.g., a report, completed building, or piece of specialized
equipment). However, the customer does benefit from the entity’s efforts as the
entity performs; therefore, control of an asset is transferred to the customer
over time.
The FASB and IASB observed that determining whether the customer simultaneously receives and
consumes may be difficult in service-type contracts because the notion of “benefit” can be subjective.
Paragraph BC126 of ASU 2014-09 provides a shipping example in which an entity has agreed to
transport goods from Vancouver to New York City. Stakeholders questioned whether the customer in
that example receives any benefit as the goods are transported. ASC 606-10-55-6 notes that an entity’s
customer receives benefit as the entity performs if another entity would not need to substantially
reperform the work that the entity has completed to date to fulfill the remaining performance obligation.
ASC 606-10-55-6(b) clarifies that when assessing whether another entity would
not need to substantially reperform the work completed to date, an entity should
presume that the other entity would not be able to use the asset being used by
the current entity to fulfill the performance obligation. The boards observed
that if the goods in the shipping example described above were to be transported
only part of the way (e.g., to Chicago), another entity would not need to
substantially reperform what has already been performed even though that other
entity does not have the benefit of using the original entity’s truck to
transport the goods. Therefore, even though the new entity would need to use its
own truck to complete the fulfillment of the performance obligation, the
customer does in fact benefit from the original entity’s performance as the work
is performed (i.e., transfer of the goods from Vancouver to Chicago).
Consequently, the boards observed that assessing whether another entity would
need to substantially reperform the performance completed to date can be a good
indicator of whether the customer benefits simultaneously as the entity
performs. However, the boards also decided that in making this assessment, an
entity should disregard any contractual or practical limitations since the
objective of the criterion in ASC 606-10-25-27(a) is to determine whether
control of the goods or services has already been transferred to the customer.
That is, the entity would need to hypothetically assess what another entity
would need to reperform the work if the original entity were to stop performance
and let the second entity take over, regardless of actual practical or
contractual limitations. This hypothetical assessment would only be applicable
when the customer simultaneously receives and consumes as the entity performs;
such an assessment would not be appropriate for scenarios that meet either of
the other two criteria in ASC 606-10-25-27, which are discussed further
below.
ASC 606-10
Example 13 — Customer Simultaneously Receives and Consumes the Benefits
55-159 An entity enters into a contract to provide monthly payroll processing services to a customer for one
year.
55-160 The promised payroll processing services are accounted for as a single performance obligation in
accordance with paragraph 606-10-25-14(b). The performance obligation is satisfied over time in accordance
with paragraph 606-10-25-27(a) because the customer simultaneously receives and consumes the benefits of
the entity’s performance in processing each payroll transaction as and when each transaction is processed.
The fact that another entity would not need to reperform payroll processing services for the service that the
entity has provided to date also demonstrates that the customer simultaneously receives and consumes the
benefits of the entity’s performance as the entity performs. (The entity disregards any practical limitations on
transferring the remaining performance obligation, including setup activities that would need to be undertaken
by another entity.) The entity recognizes revenue over time by measuring its progress toward complete
satisfaction of that performance obligation in accordance with paragraphs 606-10-25-31 through 25-37 and
606-10-55-16 through 55-21.
Connecting the Dots
Stakeholders have raised questions regarding the
determination of when an entity transfers control of a commodity.
Specifically, they have questioned whether revenue related to the
delivery of a commodity should be recognized (1) at a point in time for
each commodity delivery or (2) over time because the entity is providing
a commodity delivery service of which the customer simultaneously
receives and consumes the benefits. In particular, the analysis in
question has focused on ASC 606-10-25-27(a), one of the three criteria
for determining whether revenue should be recognized over time.
For the criterion in ASC 606-10-25-27(a) to be met, the
customer must simultaneously receive and consume the benefits of the
good or service (e.g., the commodity) as the entity performs. The FASB
staff discusses this issue in Implementation Q&A 50 (compiled
from TRG Agenda Papers 43 and
44), noting that the evaluation of
the criterion in ASC 606-10-25-27(a) should take into consideration “all
relevant facts and circumstances, including the inherent characteristics
of the commodity, the contract terms, and information about
infrastructure or other delivery mechanisms.” In Implementation Q&A
50, the FASB staff further notes that the evaluation should be performed
in this manner “regardless of whether the contract is for the delivery
of a commodity or a widget.”
Accounting outcomes may differ if a multiperiod
commodity supply contract is viewed as individually distinct goods or
services (i.e., each individual delivery is a performance obligation
satisfied at a point in time) or as a series of distinct goods or
services of which the customer simultaneously receives and consumes the
benefits (i.e., delivery is part of a single performance obligation
satisfied over time). If the contract is determined to be for the
delivery of individually distinct goods or services (that do not qualify
to be accounted for as a series), the entity would need to allocate the
transaction price to each distinct good or service on a relative
stand-alone selling price basis. If the goods or services in the
contract are determined to be a series (i.e., a single performance
obligation satisfied over time), the entity would need to identify a
single measure of progress to determine the pattern of revenue
recognition.
An entity may need to evaluate whether the customer’s
action or intent to immediately receive and consume a commodity or use
the commodity later will affect whether the entity is able to conclude
that it meets the criteria for recognizing revenue over time (i.e., by
meeting the criterion that the “customer simultaneously receives and
consumes the benefits provided by the entity’s performance as the entity
performs”). Customers in certain industries (e.g., oil and gas, power
and utilities) may take different actions or have different intents for
the commodity delivered by the entity.
For example, a gas utility customer of an entity that
explores for and produces natural gas may store natural gas in a pool
until demand from its own customers requires the natural gas to be used.
Conversely, those same customers of the gas utility may not have
infrastructure with which to store natural gas in their homes and
thereby immediately receive and consume any natural gas delivered by the
utility (e.g., to heat a stove).
8.4.4 Customer Controls the Asset as It Is Created or Enhanced
ASC 606-10
25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance
obligation and recognizes revenue over time, if one of the following criteria is met: . . .
b. The entity’s performance creates or enhances an asset (for example, work in process) that the customer
controls as the asset is created or enhanced (see paragraph 606-10-55-7). . . .
55-7 In determining whether a
customer controls an asset as it is created or enhanced
in accordance with paragraph 606-10-25-27(b), an entity
should apply the guidance on control in paragraphs
606-10-25-23 through 25-26 and 606-10-25-30. The asset
that is being created or enhanced (for example, a work
in process asset) could be either tangible or
intangible.
The second criterion for determining whether a performance obligation is
satisfied over time (ASC 606-10-25-27(b)) is that the entity’s performance
creates or enhances an asset that the customer controls as the asset is created
or enhanced. This criterion was intended to address situations in which the
entity is creating an asset but it is clear that the customer controls the work
in process as the asset is created. Arrangements that would meet this criterion
for recognizing revenue over time include, but are not limited to, (1) a
renovation of, or addition to, the customer’s existing property and (2) the
configuration or customization of computer hardware and software owned by the
customer. Because the customer controls the work in process, the customer is
benefiting from the entity’s performance as the entity performs.
Example 8-1
Entity B enters into a contract to
manufacture a customized part for Customer L. To
manufacture the part, B must purchase the raw materials
from the supplier designated by L (i.e., B does not have
discretion to select the supplier). Entity B places
orders directly with the supplier, and it accepts and
takes legal title to the raw materials directly from the
supplier. The acceptability of the raw materials and
work in process is B’s responsibility, and the raw
materials and work in process stay in B’s physical
possession throughout the manufacturing process. Title
to the part, as well as the significant risks and
rewards of ownership of the part, is transferred to L
upon shipment of the part to L. The part is customized
to L’s specifications and has no alternative use to B.
However, B does not have an enforceable right to payment
and therefore fails to meet the criterion in ASC
606-10-25-27(c).
Entity B’s contract with L also does not
meet the criterion in ASC 606-10-25-27(b) for
recognizing revenue over time, as supported by the
following:
- Customer L does not accept, physically possess, or have title to the raw materials or work in process because B is manufacturing the customized part.
- Entity B has the risks and rewards of ownership of the raw materials and work in process until title to, and the risks and rewards of ownership of, the finished part are transferred to L.
- Although L has discretion in selecting the supplier for the raw materials, this does not give L control over the raw materials or the subsequent work in process.
The basis for the second criterion that the entity has in effect agreed to sell
its right to the asset as it performs (i.e., it is selling the work in process
to the customer as it performs).
However, in some instances, it may be unclear whether the asset being created or enhanced is
controlled by the customer, thus making it more difficult to determine whether this criterion is met.
Therefore, the boards developed the third criterion.
8.4.5 Entity’s Performance Does Not Create an Asset With an Alternative Use, and the Entity Has an Enforceable Right to Payment
ASC 606-10
25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance
obligation and recognizes revenue over time, if one of the following criteria is met: . . .
c. The entity’s performance does not create an asset with an alternative use to the entity (see paragraph
606-10-25-28), and the entity has an enforceable right to payment for performance completed to date
(see paragraph 606-10-25-29).
The third criterion (ASC 606-10-25-27(c)) was developed because the FASB and IASB observed that
applying the first two criteria could sometimes be challenging. In addition, the boards believed that there
are other scenarios economically similar to those described in ASC 606-10-25-27(a) and (b) in which an
entity’s performance is more akin to a service than the completion and delivery of a good. Paragraph
BC132 of ASU 2014-09 states that the boards regarded the third criterion as potentially necessary not
only “for services that may be specific to a customer (for example, consulting services that ultimately
result in a professional opinion for the customer) but also for the creation of tangible (or intangible)
goods.”
The boards believed that there are two mandatory features of arrangements that meet this criterion.
As a result, this criterion involves a two-part assessment (i.e., to meet the criterion, an entity must
demonstrate compliance with two subcriteria), which includes two notions: “alternative use” and “right to
payment.”
8.4.5.1 Alternative Use
ASC 606-10
25-28 An asset created by an entity’s performance does not have an alternative use to an entity if the entity
is either restricted contractually from readily directing the asset for another use during the creation or
enhancement of that asset or limited practically from readily directing the asset in its completed state for
another use. The assessment of whether an asset has an alternative use to the entity is made at contract
inception. After contract inception, an entity shall not update the assessment of the alternative use of an asset
unless the parties to the contract approve a contract modification that substantively changes the performance
obligation. Paragraphs 606-10-55-8 through 55-10 provide guidance for assessing whether an asset has an
alternative use to an entity.
55-8 In assessing whether an
asset has an alternative use to an entity in
accordance with paragraph 606-10- 25-28, an entity
should consider the effects of contractual
restrictions and practical limitations on the
entity’s ability to readily direct that asset for
another use, such as selling it to a different
customer. The possibility of the contract with the
customer being terminated is not a relevant
consideration in assessing whether the entity would
be able to readily direct the asset for another
use.
55-9 A contractual
restriction on an entity’s ability to direct an
asset for another use must be substantive for the
asset not to have an alternative use to the entity.
A contractual restriction is substantive if a
customer could enforce its rights to the promised
asset if the entity sought to direct the asset for
another use. In contrast, a contractual restriction
is not substantive if, for example, an asset is
largely interchangeable with other assets that the
entity could transfer to another customer without
breaching the contract and without incurring
significant costs that otherwise would not have been
incurred in relation to that contract.
55-10 A practical limitation
on an entity’s ability to direct an asset for
another use exists if an entity would incur
significant economic losses to direct the asset for
another use. A significant economic loss could arise
because the entity either would incur significant
costs to rework the asset or would only be able to
sell the asset at a significant loss. For example,
an entity may be practically limited from
redirecting assets that either have design
specifications that are unique to a customer or are
located in remote areas.
The notion of alternative use was developed to distinguish circumstances in
which the entity’s performance does not represent a service and therefore
would not result in the transfer of control to the customer over time. That
is, if the asset has an alternative use, the asset could readily be
redirected to another customer, which is commonly the case for standard
inventory-type items. In the case of inventory (readily redirected assets),
the production effort is not transferring a benefit to the customer as the
entity performs. The criterion in ASC 606-10-25-27(c) was intended to apply
to circumstances in which the entity creates a highly customized or
specialized asset that would be difficult to redirect to another customer
without incurring significant costs and performing additional work.
In making this assessment, the entity needs to consider both practical
limitations and contractual restrictions on redirecting the asset for
another use. For example, if the terms of the contract indicate that the
entity is prohibited from transferring the asset to another customer and
that restriction is substantive, the entity would conclude that the asset
does not have an alternative use because the entity is contractually
prohibited from redirecting the asset for another use. This is often the
case in real estate contracts; however, it may also occur in other types of
contracts, such as those involving the construction of highly specialized
assets.
On the other hand, contractual restrictions that provide the customer with a
protective right are not sufficient to establish that there is no
alternative use for the asset. Protective rights typically allow the entity
to substitute the asset, or redirect the asset, without the customer’s
knowledge. For example, terms of the contract may indicate that the entity
cannot transfer a good because the customer has legal title to the goods in
the contract; however, these terms may act merely as protection in the event
of liquidation, and the entity can then physically substitute the asset or
redirect it to another customer for little cost. This type of contractual
restriction is a protective right and would not be viewed as transferring
control to the customer.
An entity’s assessment of alternative use should be performed at contract
inception and should not be updated unless there is a contract modification
that substantively changes the performance obligation. In performing the
assessment, the entity should consider the asset in its completed state when
determining whether the asset can practically be readily redirected.
Further, in addition to concluding that there is no alternative use, the
entity must conclude that it has a right to payment for performance
completed to date, which is further described in Section 8.4.5.2.
ASC 606-10
Example 15 — Asset Has No Alternative Use to the Entity
55-165 An entity enters into a contract with a customer, a government agency, to build a specialized satellite.
The entity builds satellites for various customers, such as governments and commercial entities. The design
and construction of each satellite differ substantially, on the basis of each customer’s needs and the type of
technology that is incorporated into the satellite.
55-166 At contract inception, the entity assesses whether its performance obligation to build the satellite is a
performance obligation satisfied over time in accordance with paragraph 606-10-25-27.
55-167 As part of that assessment, the entity considers whether the satellite in its completed state will have an
alternative use to the entity. Although the contract does not preclude the entity from directing the completed
satellite to another customer, the entity would incur significant costs to rework the design and function of the
satellite to direct that asset to another customer. Consequently, the asset has no alternative use to the entity
(see paragraphs 606-10-25-27(c), 606-10-25-28, and 606-10-55-8 through 55-10) because the customer-specific
design of the satellite limits the entity’s practical ability to readily direct the satellite to another
customer.
55-168 For the entity’s
performance obligation to be satisfied over time
when building the satellite, paragraph
606-10-25-27(c) also requires the entity to have an
enforceable right to payment for performance
completed to date. This condition is not illustrated
in this Example.
Example 8-2
A manufacturer of automobile parts
enters into a contract with a customer for the
initial production of 1,000 parts for the customer’s
new vehicle. The parts are highly customized and
only compatible with the customer’s new vehicle
(i.e., the parts would not function in other
vehicles). The contract provides the manufacturer
with an enforceable right to payment for its
performance throughout the contract period in
accordance with ASC 606-10-25-27(c). There are no
contractual restrictions preventing the manufacturer
from redirecting the finished parts to a third
party. However, since an aftermarket for the parts
does not exist at contract inception and there are
no other customers to which the part can be readily
directed, the manufacturer is limited practically
from redirecting the parts for another use.
In this example, the contract for
the initial production of parts meets the criterion
in ASC 606-10-25-27(c) for recognizing revenue over
time. In accordance with ASC 606-10-25-27(c), an
entity is required to recognize revenue over time if
the asset being produced has no alternative use and
the entity has an enforceable right to payment. ASC
606-10-25-28 further requires an entity to determine
“at contract inception” whether the asset being
produced has an alternative use. Since the
manufacturer in this fact pattern is limited
practically from redirecting the parts for another
use (because no aftermarket exists at contract
inception), the parts do not have an alternative
use. Since the parts do not have an alternative use
and, as noted above, the contract provides an
enforceable right to payment for the manufacturer’s
performance throughout the contract period, the
criterion in ASC 606-10-25-27(c) would be met.
However, once an aftermarket for the parts does
exist, the manufacturer would be able to redirect
the parts to another party, thereby creating an
alternative use. At that point, the criterion in ASC
606-10-25-27(c) for recognizing revenue over time
would no longer be met for future contracts to
manufacture and deliver the parts (including any
modifications to the original contract that
substantively change the performance
obligation).
We acknowledge that in other
situations, a manufacturer of parts may believe that
it is highly probable that an aftermarket for the
parts will exist in the future (e.g., after the
development stage). In these situations, entities
will need to apply judgment and consider all of the
relevant facts and circumstances, including, but not
limited to, (1) historical evidence, (2) the
quantity of the parts, (3) the nature of the parts,
(4) the stage of development, (5) the existence of a
contract, and (6) contract negotiations. Entities
may want to consult with their accounting advisers
in such situations.
Connecting the Dots
In Implementation Q&A 55
(compiled from TRG Agenda Papers 56 and
60), the FASB staff discusses
whether an entity should consider the completed asset or the
in-production asset when performing the “alternative use” assessment
under ASC 606-10-25-27(c). The FASB staff’s analysis of this issue
is illustrated in the following example:
An
entity enters into a contract with a customer to build
equipment. The entity is in the business of building custom
equipment for various customers. The customization of the
equipment occurs when the manufacturing process is approximately
75% complete. In other words, for approximately 75% of the
manufacturing process, the in-process asset could be redirected
to fulfill another customer’s equipment order (assuming there is
no contractual restriction to do so). However, the equipment
cannot be sold in its completed state to another customer
without incurring a significant economic loss. The design
specifications of the equipment are unique to the customer and
the entity would only be able to sell the completed equipment at
a significant loss.
The FASB staff notes in Implementation Q&A 55
that “[b]ecause the entity [in the example] cannot sell the
completed equipment to another customer without incurring a
significant economic loss, the entity has a practical limitation on
its ability to direct the equipment in its completed state and,
therefore, the asset does not have an alternative use.” Accordingly,
regardless of the timing of the customization in the production
process (i.e., when the good has no alternative use), the entity
should consider whether the completed asset could be redirected to
another customer without the need for significant rework on the
customized good. If the completed asset is deemed to have no
alternative use, that aspect of the criterion in ASC 606-10-25-27(c)
would be met.
8.4.5.2 Enforceable Right to Payment for Performance Completed to Date
ASC 606-10
25-29 An entity shall consider the terms of the contract, as well as any laws that apply to the contract, when
evaluating whether it has an enforceable right to payment for performance completed to date in accordance
with paragraph 606-10-25-27(c). The right to payment for performance completed to date does not need
to be for a fixed amount. However, at all times throughout the duration of the contract, the entity must be
entitled to an amount that at least compensates the entity for performance completed to date if the contract is
terminated by the customer or another party for reasons other than the entity’s failure to perform as promised.
Paragraphs 606-10-55-11 through 55-15 provide guidance for assessing the existence and enforceability
of a right to payment and whether an entity’s right to payment would entitle the entity to be paid for its
performance completed to date.
55-11 In accordance with
paragraph 606-10-25-29, an entity has a right to
payment for performance completed to date if the
entity would be entitled to an amount that at least
compensates the entity for its performance completed
to date in the event that the customer or another
party terminates the contract for reasons other than
the entity’s failure to perform as promised. An
amount that would compensate an entity for
performance completed to date would be an amount
that approximates the selling price of the goods or
services transferred to date (for example, recovery
of the costs incurred by an entity in satisfying the
performance obligation plus a reasonable profit
margin) rather than compensation for only the
entity’s potential loss of profit if the contract
were to be terminated. Compensation for a reasonable
profit margin need not equal the profit margin
expected if the contract was fulfilled as promised,
but an entity should be entitled to compensation for
either of the following amounts:
-
A proportion of the expected profit margin in the contract that reasonably reflects the extent of the entity’s performance under the contract before termination by the customer (or another party)
-
A reasonable return on the entity’s cost of capital for similar contracts (or the entity’s typical operating margin for similar contracts) if the contract-specific margin is higher than the return the entity usually generates from similar contracts.
55-12 An entity’s right to
payment for performance completed to date need not
be a present unconditional right to payment. In many
cases, an entity will have an unconditional right to
payment only at an agreed-upon milestone or upon
complete satisfaction of the performance obligation.
In assessing whether it has a right to payment for
performance completed to date, an entity should
consider whether it would have an enforceable right
to demand or retain payment for performance
completed to date if the contract were to be
terminated before completion for reasons other than
the entity’s failure to perform as promised.
55-13 In some contracts, a
customer may have a right to terminate the contract
only at specified times during the life of the
contract or the customer might not have any right to
terminate the contract. If a customer acts to
terminate a contract without having the right to
terminate the contract at that time (including when
a customer fails to perform its obligations as
promised), the contract (or other laws) might
entitle the entity to continue to transfer to the
customer the goods or services promised in the
contract and require the customer to pay the
consideration promised in exchange for those goods
or services. In those circumstances, an entity has a
right to payment for performance completed to date
because the entity has a right to continue to
perform its obligations in accordance with the
contract and to require the customer to perform its
obligations (which include paying the promised
consideration).
55-14 In assessing the
existence and enforceability of a right to payment
for performance completed to date, an entity should
consider the contractual terms as well as any
legislation or legal precedent that could supplement
or override those contractual terms. This would
include an assessment of whether:
-
Legislation, administrative practice, or legal precedent confers upon the entity a right to payment for performance to date even though that right is not specified in the contract with the customer.
-
Relevant legal precedent indicates that similar rights to payment for performance completed to date in similar contracts have no binding legal effect.
-
An entity’s customary business practices of choosing not to enforce a right to payment has resulted in the right being rendered unenforceable in that legal environment. However, notwithstanding that an entity may choose to waive its right to payment in similar contracts, an entity would continue to have a right to payment to date if, in the contract with the customer, its right to payment for performance to date remains enforceable.
55-15 The payment schedule
specified in a contract does not necessarily
indicate whether an entity has an enforceable right
to payment for performance completed to date.
Although the payment schedule in a contract
specifies the timing and amount of consideration
that is payable by a customer, the payment schedule
might not necessarily provide evidence of the
entity’s right to payment for performance completed
to date. This is because, for example, the contract
could specify that the consideration received from
the customer is refundable for reasons other than
the entity failing to perform as promised in the
contract.
Right to payment is the second mandatory feature in the assessment of whether the criterion in
ASC 606-10-25-27(c) is met. The boards reasoned that if an entity is creating a highly specialized or
customized asset without an alternative use (i.e., the entity meets the first subcriterion in ASC 606-10-
25-27(c)), the entity would want to be economically protected from the risk associated with doing so.
Consequently, the boards incorporated the requirement of a right to payment into the third criterion for
assessing whether the entity is transferring control of the asset to the customer over time (i.e., providing
a service). In addition, the customer’s obligation to pay for performance completed to date indicates that
the customer has received some of the benefits of the entity’s performance.
For the purpose of evaluating the guidance in ASC 606-10-25-27(c), the right to payment refers to a
payment compensating the entity for performance completed to date and does not pertain to, for
example, a deposit or payment to compensate the entity for inconvenience or loss of profit in the event
of a termination. The right to payment for performance completed to date must include compensation
for costs incurred to date plus a reasonable profit margin. A reasonable profit margin does not
necessarily mean the profit margin that the entity would earn on the entire contract once completed
(i.e., if the contract were to be terminated at any point in time, the partially completed asset may not be
proportional to the value of the contract if it was completed). Rather, a reasonable profit margin should
be (1) based on a reasonable proportion of the entity’s expected profit margin or (2) a reasonable return
on the entity’s cost of capital.
Further, the right to payment must be an enforceable right to demand or retain payment, or both.
However, it does not need to be a present unconditional right to payment in the event that the
customer terminates the contract before the asset is fully completed.
If the customer pays a nonrefundable up-front fee, this could be viewed as a
right to payment if the entity is able to retain at least an amount for
performance completed to date in the event of a contract termination.
However, payment terms by themselves do not support a determination of
whether an entity has an enforceable right to payment for performance
completed to date. Rather, the entity should evaluate whether it has an
enforceable right to payment if the contract were to be terminated for
reasons other than the entity’s failure to perform. For example, an entity
may be paid only upon contract completion or may be paid entirely up front.
In those circumstances, the entity must consider whether it has a right to
demand or retain payment for performance completed to date if the contract
were to be terminated.
The FASB and IASB clarified that there may be instances in which an entity’s
customer does not have the right to terminate the contract, or only has the
right to terminate the contract at specified times, but the entity may still
conclude that it has an enforceable right to payment. Such instances may
occur if the contract or other jurisdictional laws require completion of
obligations by both the entity and the customer. This is often referred to
as the specific performance notion. Refer to Example 8-4 for an illustration of the
specific performance notion.
While an entity may conclude that it meets the criterion in ASC 606-10-25-27(c)
for recognizing revenue over time because it is creating an asset that does
not have an alternative use and it has the right to payment for performance
completed to date, recognition of revenue may not be appropriate for
materials purchased that are not yet incorporated into the asset. For
example, an entity may purchase raw materials that will be used as inputs to
satisfy the performance obligation, but the inputs are not yet transferred
to the customer through incorporation into the asset and therefore still may
be used for other purposes. The example below illustrates this concept.
Example 8-3
Entity X enters into a contract with
Customer Y under which X will construct an asset for
Y that has no alternative use to X. To build this
machine, X acquires standard materials that it
regularly uses in other contracts and manufactures
some “generic” component parts for inclusion in the
customer’s asset. These standard materials remain
interchangeable with other items until actually
deployed in the construction of the asset for Y.
If Y cancels the contract, X will be
entitled to reimbursement for costs incurred for
work completed to date plus a margin of 10 percent
(which is considered to be a reasonable margin in
accordance with ASC 606-10-55-11). However, X will
not be reimbursed for any materials (e.g.,
subcomponent parts) that have been purchased for use
in the contract but have not yet been used and are
still controlled by X.
Under ASC 606-10-25-27(c), revenue
from a contract should be recognized over time if
the “entity’s performance does not create an asset
with an alternative use to the entity . . . , and
the entity has an enforceable right to payment for performance completed to
date” (emphasis added).
The asset that X is constructing for
Y has no alternative use to X, and the terms of the
contract reimburse X for the costs of work completed
to date plus a reasonable margin. However, materials
(e.g., subcomponent parts that may be classified as
inventory) that have not yet been used are not part
of “performance completed to date”; therefore, there
is no requirement that the entity have an
enforceable right to reimbursement for such
items.
Under the contract termination
provisions, if the customer terminates the contract
early, X is entitled to payment of costs incurred
plus a reasonable profit margin. However, the
contractual terms do not include payment for
standard materials or “generic” component parts that
were specifically acquired for the project but not
yet incorporated into the customized machine.
That is, if the raw materials or
work in process has an alternative use before being
integrated into the manufacturing process, the raw
materials or work in process would not be considered
costs of the contract until integrated into the
manufacturing process. Consequently, the materials
or work in process does not transfer to the customer
until (1) integration of the materials or work in
process into the project and (2) the entity has an
enforceable right to payment.
Therefore, the absence of a right to
payment for raw materials or work in process that
has an alternative use does not preclude an entity
from being able to conclude that a performance
obligation is satisfied over time when the entity
has an enforceable right to payment for performance
completed to date once the entity has integrated the
raw materials or work in process into the project.
Accordingly, X’s contract with Y meets the condition
in ASC 606-10-25-27(c) for recognition of revenue
over time.
Connecting the Dots
An entity that has entered into a contract to manufacture customized goods may conclude
that the goods have no alternative use. In addition, depending on the payment terms of the
contract for customized goods, the entity may be required to recognize revenue over time. In
this arrangement, the entity will need to carefully consider the contract’s payment terms to
determine the appropriate recognition of revenue. Specifically, the entity may need to consider
termination provisions in the arrangement and how they interact with the entity’s right to
payment. For example, if the entity has some rights to payment for its performance, but the
contract has a termination provision that allows the customer to cancel at any time with no
obligation to pay the entity for work performed under the contract, the entity may not meet
the criteria for recognizing revenue over time because it has not met the right to payment
requirement.
ASC 606-10
Example 14 — Assessing Alternative Use and Right to Payment
55-161 An entity enters into a contract with a customer to provide a consulting service that results in the entity
providing a professional opinion to the customer. The professional opinion relates to facts and circumstances
that are specific to the customer. If the customer were to terminate the consulting contract for reasons other
than the entity’s failure to perform as promised, the contract requires the customer to compensate the entity
for its costs incurred plus a 15 percent margin. The 15 percent margin approximates the profit margin that the
entity earns from similar contracts.
55-162 The entity considers the criterion in paragraph 606-10-25-27(a) and the guidance in paragraphs
606-10-55-5 through 55-6 to determine whether the customer simultaneously receives and consumes the
benefits of the entity’s performance. If the entity were to be unable to satisfy its obligation and the customer
hired another consulting firm to provide the opinion, the other consulting firm would need to substantially
reperform the work that the entity had completed to date because the other consulting firm would not have
the benefit of any work in progress performed by the entity. The nature of the professional opinion is such
that the customer will receive the benefits of the entity’s performance only when the customer receives the
professional opinion. Consequently, the entity concludes that the criterion in paragraph 606-10-25-27(a) is not
met.
55-163 However, the entity’s performance obligation meets the criterion in paragraph 606-10-25-27(c) and is a
performance obligation satisfied over time because of both of the following factors:
- In accordance with paragraphs 606-10-25-28 and 606-10-55-8 through 55-10, the development of the professional opinion does not create an asset with alternative use to the entity because the professional opinion relates to facts and circumstances that are specific to the customer. Therefore, there is a practical limitation on the entity’s ability to readily direct the asset to another customer.
- In accordance with paragraphs 606-10-25-29 and 606-10-55-11 through 55-15, the entity has an enforceable right to payment for its performance completed to date for its costs plus a reasonable margin, which approximates the profit margin in other contracts.
55-164 Consequently, the
entity recognizes revenue over time by measuring the
progress toward complete satisfaction of the
performance obligation in accordance with paragraphs
606-10-25-31 through 25-37 and 606-10-55-16 through
55-21.
Example 16 — Enforceable Right to
Payment for Performance Completed to Date
55-169 An entity enters into
a contract with a customer to build an item of
equipment. The payment schedule in the contract
specifies that the customer must make an advance
payment at contract inception of 10 percent of the
contract price, regular payments throughout the
construction period (amounting to 50 percent of the
contract price), and a final payment of 40 percent
of the contract price after construction is
completed and the equipment has passed the
prescribed performance tests. The payments are
nonrefundable unless the entity fails to perform as
promised. If the customer terminates the contract,
the entity is entitled only to retain any progress
payments received from the customer. The entity has
no further rights to compensation from the
customer.
55-170 At contract inception,
the entity assesses whether its performance
obligation to build the equipment is a performance
obligation satisfied over time in accordance with
paragraph 606-10-25-27.
55-171 As part of that
assessment, the entity considers whether it has an
enforceable right to payment for performance
completed to date in accordance with paragraphs
606-10-25-27(c), 606-10-25-29, and 606-10- 55-11
through 55-15 if the customer were to terminate the
contract for reasons other than the entity’s failure
to perform as promised. Even though the payments
made by the customer are nonrefundable, the
cumulative amount of those payments is not expected,
at all times throughout the contract, to at least
correspond to the amount that would be necessary to
compensate the entity for performance completed to
date. This is because at various times during
construction the cumulative amount of consideration
paid by the customer might be less than the selling
price of the partially completed item of equipment
at that time. Consequently, the entity does not have
a right to payment for performance completed to
date.
55-172 Because the entity
does not have a right to payment for performance
completed to date, the entity’s performance
obligation is not satisfied over time in accordance
with paragraph 606-10-25-27(c). Accordingly, the
entity does not need to assess whether the equipment
would have an alternative use to the entity. The
entity also concludes that it does not meet the
criteria in paragraph 606-10-25-27(a) or (b), and,
thus, the entity accounts for the construction of
the equipment as a performance obligation satisfied
at a point in time in accordance with paragraph
606-10-25-30.
Example 17 — Assessing Whether a
Performance Obligation Is Satisfied at a Point in
Time or Over Time
55-173 An entity is
developing a multi-unit residential complex. A
customer enters into a binding sales contract with
the entity for a specified unit that is under
construction. Each unit has a similar floor plan and
is of a similar size, but other attributes of the
units are different (for example, the location of
the unit within the complex).
Case A — Entity Does Not Have an
Enforceable Right to Payment for Performance
Completed to Date
55-174 The customer pays a
deposit upon entering into the contract, and the
deposit is refundable only if the entity fails to
complete construction of the unit in accordance with
the contract. The remainder of the contract price is
payable on completion of the contract when the
customer obtains physical possession of the unit. If
the customer defaults on the contract before
completion of the unit, the entity only has the
right to retain the deposit.
55-175 At contract inception,
the entity applies paragraph 606-10-25-27(c) to
determine whether its promise to construct and
transfer the unit to the customer is a performance
obligation satisfied over time. The entity
determines that it does not have an enforceable
right to payment for performance completed to date
because until construction of the unit is complete,
the entity only has a right to the deposit paid by
the customer. Because the entity does not have a
right to payment for work completed to date, the
entity’s performance obligation is not a performance
obligation satisfied over time in accordance with
paragraph 606-10-25-27(c). Instead, the entity
accounts for the sale of the unit as a performance
obligation satisfied at a point in time in
accordance with paragraph 606-10-25-30.
Case B — Entity Has an
Enforceable Right to Payment for Performance
Completed to Date
55-176 The customer pays a
nonrefundable deposit upon entering into the
contract and will make progress payments during
construction of the unit. The contract has
substantive terms that preclude the entity from
being able to direct the unit to another customer.
In addition, the customer does not have the right to
terminate the contract unless the entity fails to
perform as promised. If the customer defaults on its
obligations by failing to make the promised progress
payments as and when they are due, the entity would
have a right to all of the consideration promised in
the contract if it completes the construction of the
unit. The courts have previously upheld similar
rights that entitle developers to require the
customer to perform, subject to the entity meeting
its obligations under the contract.
55-177 At contract inception,
the entity applies paragraph 606-10-25-27(c) to
determine whether its promise to construct and
transfer the unit to the customer is a performance
obligation satisfied over time. The entity
determines that the asset (unit) created by the
entity’s performance does not have an alternative
use to the entity because the contract precludes the
entity from transferring the specified unit to
another customer. The entity does not consider the
possibility of a contract termination in assessing
whether the entity is able to direct the asset to
another customer.
55-178 The entity also has a
right to payment for performance completed to date
in accordance with paragraphs 606-10-25-29 and
606-10-55-11 through 55-15. This is because if the
customer were to default on its obligations, the
entity would have an enforceable right to all of the
consideration promised under the contract if it
continues to perform as promised.
55-179 Therefore, the terms
of the contract and the practices in the legal
jurisdiction indicate that there is a right to
payment for performance completed to date.
Consequently, the criteria in paragraph
606-10-25-27(c) are met, and the entity has a
performance obligation that it satisfies over time.
To recognize revenue for that performance obligation
satisfied over time, the entity measures its
progress toward complete satisfaction of its
performance obligation in accordance with paragraphs
606-10-25-31 through 25-37 and 606-10-55-16 through
55-21.
55-180 In the construction of
a multi-unit residential complex, the entity may
have many contracts with individual customers for
the construction of individual units within the
complex. The entity would account for each contract
separately. However, depending on the nature of the
construction, the entity’s performance in
undertaking the initial construction works (that is,
the foundation and the basic structure), as well as
the construction of common areas, may need to be
reflected when measuring its progress toward
complete satisfaction of its performance obligations
in each contract.
Case C — Entity Has an
Enforceable Right to Payment for Performance
Completed to Date
55-181 The same facts as in
Case B apply to Case C, except that in the event of
a default by the customer, either the entity can
require the customer to perform as required under
the contract or the entity can cancel the contract
in exchange for the asset under construction and an
entitlement to a penalty of a proportion of the
contract price.
55-182 Notwithstanding that
the entity could cancel the contract (in which case
the customer’s obligation to the entity would be
limited to transferring control of the partially
completed asset to the entity and paying the penalty
prescribed), the entity has a right to payment for
performance completed to date because the entity
also could choose to enforce its rights to full
payment under the contract. The fact that the entity
may choose to cancel the contract in the event the
customer defaults on its obligations would not
affect that assessment (see paragraph 606-10-55-13),
provided that the entity’s rights to require the
customer to continue to perform as required under
the contract (that is, pay the promised
consideration) are enforceable.
The example below illustrates the determination of whether
and, if so, how to recognize revenue from real estate sales and purchase
agreements entered into before the completion of a property project.
Example 8-4
Entity A, a real estate developer,
entered into sales and purchase agreements with
various buyers before the completion of a property
project. The properties are located in Country B.
The sales and purchase agreements include the
following key terms:
-
A specific unit is identified in the contract.
-
Entity A is required to complete the property in all respects in compliance with the conditions set out in the sales agreement and the related building plans within two years from the time when the sales contracts are entered into.
-
The property remains at A’s risk until delivery.
-
The buyer is not permitted at any time before delivery to sub-sell the property or transfer the benefit of the agreement. However, the buyer can at any time before the date of assignment mortgage the property to finance the acquisition of the property.
-
The agreement specifies that the sales agreement can be canceled only when both the buyer and A agree to do so — in effect, the buyer does not have the right to cancel the sales agreement.
-
If both the buyer and A agree to cancel the contract, A has the right to retain 10 percent of the total purchase price, and the buyer is required to pay for all necessary legal and transaction costs incurred by A in relation to the cancellation.
-
If A fails to complete the development of the property within the specified two-year period, the buyer has the right to rescind the sales contract and A is required to repay to the buyer all amounts paid by the buyer together with interest. Otherwise, the buyer does not have a right to cancel the contract.
-
The purchase consideration is payable as follows:
-
5 percent of the entire sale consideration upon entering into the sales agreement.
-
5 percent of the purchase consideration within one month from the date when the sales agreement is entered into.
-
5 percent of the purchase consideration within three months from the date when the sales agreement is entered into.
-
The remaining 85 percent of the purchase consideration upon delivery of the property.
-
Note that for simplicity, this
example does not address whether there is a
significant financing component.
Under ASC 606, an entity satisfies a
performance obligation over time when it transfers
control of the promised good or service over time.
ASC 606-10-25-27 states that an entity transfers
control of a good or service over time and,
consequently, satisfies a performance obligation and
recognizes revenue over time if one of the following
criteria is met:
-
The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs . . . .
-
The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced . . . .
-
The entity’s performance does not create an asset with an alternative use to the entity . . . , and the entity has an enforceable right to payment for performance completed to date.
Criterion (a) above is not relevant
in the determination of whether revenue from real
estate sales (before completion) should be
recognized over time or at a point in time. This is
because buyers generally do not consume all of the
benefits of the property as the real estate
developers construct the property; rather, those
benefits are consumed in the future.
Criterion (b) above is not directly
relevant either because, without further
consideration of criterion (c), a conclusion cannot
be reached about whether the buyers have control of
the property as A develops the property. For
example, property buyers may not obtain physical
possession of or title to the property until
construction is completed.
Entity A should focus on criterion
(c), and particularly on (1) whether an asset has
been created with an alternative use to the real
estate developer and (2) whether the real estate
developer has an enforceable right to payment for
performance completed to date.
Has an Asset
Been Created With an Alternative Use to Entity
A?
In accordance with ASC 606-10-25-28,
an asset does not have an alternative use to an
entity if the entity is either restricted
contractually from readily directing the asset for
another use during the creation or enhancement of
that asset or limited practically from readily
directing the asset in its completed state for
another use.
With regard to contract restriction,
ASC 606-10-55-8 states that the entity does not
consider the possibility of a contract termination
in assessing whether the entity is able to direct
the asset to another customer.
Since each sales contract specifies
the unit to be delivered, the property unit does not
have an alternative use to A. The contract precludes
A from transferring the specified unit to another
customer.
Does Entity A
Have an Enforceable Right to Payment for
Performance Completed to Date?
The payment schedule per the sales
and purchase agreement does not correspond to the
performance completed to date. However, in assessing
whether it has the right to payment for performance
completed to date, A should not only consider the
payment schedule but should also consider ASC
606-10-55-13, which states:
In
some contracts, a customer may have a right to
terminate the contract only at specified times
during the life of the contract or the customer
might not have any right to terminate the
contract. If a customer acts to terminate a
contract without having the right to terminate the
contract at that time (including when a customer
fails to perform its obligations as promised), the
contract (or other laws) might entitle the entity
to continue to transfer to the customer the goods
or services promised in the contract and require
the customer to pay the consideration promised in
exchange for those goods or services. In those
circumstances, an entity has a right to payment
for performance completed to date because the
entity has a right to continue to perform its
obligations in accordance with the contract and to
require the customer to perform its obligations
(which include paying the promised
consideration).
In the circumstances under
consideration, the contract specifies that the
customer cannot terminate the contract unless both
the property developer and the buyer agree to do so.
In effect, the buyer does not have the discretion to
terminate the contract as it wishes.
ASC 606-10-25-28 requires an entity
to consider the terms of the contract, as well as
any laws that apply to the contract, when evaluating
whether it has an enforceable right to payment for
performance completed to date. If, taking into
account practice and legal precedent in Country B, A
has the right to continue to perform the contract
and be entitled to all of the consideration as
promised, even if the buyer acts to terminate the
contract (as articulated in ASC 606-10-55-13 and ASC
606-10-55-88), A has the enforceable right to
payment for performance completed to date.
The same response (i.e., the
recognition of revenue over time) applies
irrespective of whether A allows buyers to choose to
pay the consideration on the basis of the
agreed-upon payment schedule or to pay all of the
consideration up front.
Should Entity A
Recognize Revenue Over Time or at a Point in
Time?
Since the asset does not have an
alternative use to A, and provided that A has an
enforceable right to payment for performance
completed to date, it should recognize revenue over
time. However, if A does not have an enforceable
right to payment for the performance completed to
date, it should recognize revenue at a point in time
(i.e., at the point when the control of the property
unit is transferred to the buyer, which would
normally be at the time of delivery).
8.4.5.2.1 How and When an Entity Should Determine Whether It Has an Enforceable Right to Payment
In Implementation Q&A 56 (compiled
from TRG Agenda Papers 56 and
60), the FASB staff discusses how
and when an entity should determine whether it has an enforceable right
to payment under ASC 606-10-25-27(c). The staff notes that under ASC
606-10-55-14, an entity should consider the following factors in
addition to assessing the terms of the contract:
-
“[L]egislation, administrative practice, or legal precedent that confers upon the entity a right to payment for performance to date even though that right is not specified in the contract with the customer.”
-
“[R]elevant legal precedent that indicates that similar rights to payment for performance completed to date in similar contracts [have] no binding legal effect.”
-
An “entity’s customary business practice of choosing not to enforce a right to payment that has resulted in the right being rendered unenforceable in that legal environment.”
The determination should be made at contract inception.
To illustrate its analysis, the FASB staff provides the following
example:
For each of the last five years, an entity has
received an order from a customer for 300 custom ice cream
machines. The specifications of the ice cream machines are
unique to the customer. In anticipation of the customer’s order
this year, the entity starts production of the custom ice cream
machines before there is a contract between the parties in the
current year. The entity is willing to take the risk of
beginning to manufacture custom units before there is a contract
because (a) the customer has predictable purchasing behavior and
(b) the entity has knowledge of the customer’s performance in
the current year and plans for growth from the customer’s public
disclosures. The entity and the customer later enter into a
contract (that meets all of the criteria in Step 1 of Topic 606)
for 300 units. The entity has a practical limitation on its
ability to direct the equipment in its completed state because
it could not do so without incurring a significant economic
loss. The entity has an enforceable right to payment beginning
when the contract is executed. Assume that each of the machines
is distinct. At the inception of the contract, the entity has
completed 50 units (that is, 50 units are in inventory awaiting
shipment to the customer), has 10 units in production (that is,
10 units are in various stages of the manufacturing process),
and has not begun manufacturing 240 units.
The staff concludes that at contract inception, the
performance obligation to transfer 300 units meets the criteria for
recognizing revenue over time because (1) the ice cream machines do not
have an alternative use to the entity (i.e., because significant rework
would be needed to redirect the assets to another customer) and (2) the
entity has an enforceable right to payment for progress completed to
date. Although the entity did not have an enforceable right to payment
when it was customizing the ice cream machines in anticipation of a
customer order, the criteria were met as soon as a valid and genuine
contract existed. Consequently, the performance obligation to transfer
300 units to the customer is satisfied over time in accordance with ASC
606-10-25-27(c).
In the staff’s example, the entity also meets the
requirements in ASC 606-10-25-14 and 25-15 to account for the transfer
of the 300 units as a series of distinct goods or services that
constitute a single performance obligation. The entity would record (1)
a cumulative catch-up adjustment to revenue to reflect its progress
toward complete satisfaction of its performance obligation to transfer
300 units to its customer and (2) revenue for 50 completed and 10
in-process ice cream machines that will be transferred to the customer
once the new contract is executed.
8.4.5.2.2 Impact of Intent and Past Practice on Enforceable Right to Payment
As discussed in ASC 606-10-25-27(c), revenue from a
contract should be recognized over time if the “entity’s performance
does not create an asset with an alternative use to the entity . . . and
the entity has an enforceable right to payment for performance completed
to date.” This concept is further discussed in ASC 606-10-55-13, which
states, in part:
If a customer acts to terminate a contract
without having the right to terminate the contract at that time
(including when a customer fails to perform its obligations as
promised), the contract (or other laws) might entitle the entity to continue to transfer to the
customer the goods or services promised in the contract and
require the customer to pay the consideration promised in
exchange for those goods or services. In those
circumstances, an entity has a right to payment for performance
completed to date because the entity has a right to continue to
perform its obligations in accordance with the contract and to
require the customer to perform its obligations (which include
paying the promised consideration). [Emphasis added]
An entity may have an established practice of not
enforcing its contractual or legal rights (e.g., not continuing to
transfer the goods or services for which it could seek payment, not
seeking a reimbursement in excess of cost, not collecting a penalty from
the customer), or it may assert that it has no intention of enforcing
its contractual or legal rights.
However, an entity generally should not consider
its intent or past practice related to the enforcement of contractual or
legal rights when performing an evaluation under ASC 606-10-25-29 to
determine whether the enforceable right to payment criterion in ASC
606-10-25-27(c) is met. The determination of whether an enforceable
right to payment exists is evaluated under the terms of the contractual
arrangement as a matter of law. An entity’s intent or past practice
related to the enforcement of contractual or legal rights should be
considered only if the intent or past practice has created a legal
precedent as a matter of law that negates the enforceable right in a
contract.
This is consistent with ASC 606-10-25-29, which states,
in part:
An entity shall consider the terms of the
contract, as well as any laws that apply to the contract, when
evaluating whether it has an enforceable right to payment for
performance completed to date in accordance with paragraph
606-10-25-27(c).
ASC 606-10-55-14 provides additional insight into the
application of ASC 606-10-25-29. It states, in part, that the assessment
of whether an entity has an enforceable right to payment should take
into account whether:
-
Legislation, administrative practice, or legal precedent confers upon the entity a right to payment for performance to date even though that right is not specified in the contract with the customer.
-
Relevant legal precedent indicates that similar rights to payment for performance completed to date in similar contracts have no binding legal effect.
-
An entity’s customary business practices of choosing not to enforce a right to payment has resulted in the right being rendered unenforceable in that legal environment.
The above issue is addressed in Implementation Q&A 56 (compiled
from TRG Agenda Papers 56 and
60). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As,
see Appendix
C.
Connecting the Dots
ASC 606-10-25-29 provides that an “entity shall
consider the terms of the contract, as well
as any laws that apply to the contract, when evaluating
whether it has an enforceable right to payment for performance
completed to date in accordance with paragraph 606-10-25-27(c)”
(emphasis added). In practice, it may be uncommon for an entity
to pursue legal action against a customer if the customer
canceled a contract, especially when there is an ongoing
customer-vendor relationship. That is, entities may elect not to
enforce their legal right to payment.
For example, suppose that Company A and Customer
M have a long-standing relationship. Although A may have a legal
right to recover its costs plus a reasonable profit margin if M
terminates a contract, A and M may intend to negotiate a
settlement to preserve the relationship in the event that a
contract is terminated. Regardless of the likelihood that A
would enforce its right to full payment from M, the criterion in
ASC 606-10-25-27(c) is met as long as A has a legally
enforceable right to payment that includes recovery of its costs
plus a reasonable profit margin.
In addition to the above, entities should
consider instances in which their past practice has rendered
their right to payment unenforceable.
8.4.5.2.3 Whether an Entity Has an Enforceable Right to Payment Upon Contract Termination When No Such Right Is Specified in the Contract
Questions about the application of ASC 606-10-55-14(a)
or (b) may arise when an entity creates a good with no alternative use
and the written terms of the contract with the entity’s customer do not
specify the entity’s right to payment upon contract termination. For
example, this situation could occur in the United States, where the
Uniform Commercial Code (UCC) or a state equivalent of the UCC is
applied upon contract termination.
We believe that when a contract’s written terms do not
specify the entity’s right to payment upon contract termination, an
enforceable right to payment for performance completed to date is
presumed not to exist.
However, if the contract with the customer does not
specify by its written terms the entity’s right to payment upon contract
termination and the entity asserts that it has an enforceable right to
payment for performance completed to date, we would expect the entity
to:
-
Support its assertion on the basis of legislation, administrative practice, or legal precedent that confers upon the entity a right to payment for performance to date, as stated in ASC 606-10-55-14(a). This analysis would need to demonstrate that an enforceable right to payment (as defined by ASC 606) exists in the relevant jurisdiction. The fact that the entity would have a basis for making a claim against the counterparty in a court of law would not be sufficient to support the existence of an enforceable right to payment.
-
Assess whether relevant legal precedent indicates that similar rights to payment for performance completed to date in similar contracts have no binding legal effect, as stated in ASC 606-10-55-14(b).
8.4.5.2.4 Impact of Shipping Terms on Revenue Recognition Over Time
Shipping terms in a contract that require a customer to
pay only at a specific point in time (e.g., “free on board” [FOB]
destination) do not preclude the contract from meeting the criterion in
ASC 606-10-25-27(c) for revenue recognition over time (specifically, the
enforceable right to payment condition).
The guidance in ASC 606-10-55-12 makes clear that an
enforceable right to payment “need not be a present unconditional right
to payment” and that an entity may have “an unconditional right to
payment only . . . upon complete satisfaction of the performance
obligation.” In these circumstances, the guidance states, “an entity
should consider whether it would have an enforceable right to demand or
retain payment for performance completed to date if the contract were to
be terminated before completion for reasons other
than the entity’s failure to perform as promised” (emphasis
added).
When a contract’s shipping terms require an entity’s
customer to pay only at a specific point in time (e.g., FOB
destination), the possibility that the entity will not be paid if the
goods are lost in shipment would represent “the entity’s failure to
perform as promised” and should be disregarded in the entity’s
assessment of whether the performance obligation meets the criterion in
ASC 606-10-25-27(c) for revenue recognition over time (i.e., when an
entity is assessing whether it has an enforceable right to payment, it
should presume that it will perform as promised and that the goods will
be delivered). Accordingly, the conclusion that the entity has an
enforceable right to payment is not precluded when the contract’s
payment terms require payment only at specific points in the production
or delivery process. Those payment terms may be overruled by contractual
rights that give the entity an enforceable right to demand or retain
payment (if the entity performs as promised). Therefore, the fact that
the customer would not be required to pay for the goods if they were
lost in transit would not, by itself, preclude the contract from meeting
the criterion in ASC 606-10-25-27(c) for revenue recognition over
time.
8.5 Measuring Progress for Revenue Recognized Over Time
ASC 606-10
25-31 For each performance
obligation satisfied over time in accordance with paragraphs
606-10-25-27 through 25-29, an entity shall recognize
revenue over time by measuring the progress toward complete
satisfaction of that performance obligation. The objective
when measuring progress is to depict an entity’s performance
in transferring control of goods or services promised to a
customer (that is, the satisfaction of an entity’s
performance obligation).
25-32 An entity shall apply a
single method of measuring progress for each performance
obligation satisfied over time, and the entity shall apply
that method consistently to similar performance obligations
and in similar circumstances. At the end of each reporting
period, an entity shall remeasure its progress toward
complete satisfaction of a performance obligation satisfied
over time.
After determining that a performance obligation is satisfied over
time, an entity must determine the appropriate method for depicting that performance
over time — that is, how far complete the entity’s progress is as of any given
reporting period. This method is described in the revenue standard as the entity’s
measure of progress.
For example, if a contract requires a calendar-year reporting entity
to perform a daily cleaning service for 12 months beginning on January 1, the entity
may, depending on the facts and circumstances, measure progress in any of the
following ways:
-
Based on days passed (i.e., time elapsed) — For example, as of March 31, 90 days have passed, so the entity’s performance is 25 percent complete.
-
Based on costs incurred — For example, as of March 31, the entity has incurred $300,000 of the expected costs of $1 million, so the entity’s performance is 30 percent complete.
-
Based on labor hours — For example, as of March 31, the entity has incurred 260 hours of cleaning of the expected 1,100 hours for the full year. As a result, the entity’s performance is 24 percent complete.
8.5.1 Methods for Measuring Progress
ASC 606-10
Methods for Measuring Progress
25-33 Appropriate methods of
measuring progress include output methods and input
methods. Paragraphs 606-10-55-16 through 55-21 provide
guidance for using output methods and input methods to
measure an entity’s progress toward complete
satisfaction of a performance obligation. In determining
the appropriate method for measuring progress, an entity
shall consider the nature of the good or service that
the entity promised to transfer to the customer.
When a performance obligation is satisfied over time, an entity
must select a measure of progress (e.g., time elapsed, labor hours, costs
incurred) to depict its progress toward complete satisfaction of that
obligation.
In accordance with ASC 606-10-25-33, appropriate methods of
measuring progress include:
-
Output methods — ASC 606-10-55-17 states that output methods “recognize revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract.” These methods include “surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed, and units produced or units delivered.” (See Section 8.5.8.)
-
Input methods — ASC 606-10-55-20 states that input methods “recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labor hours expended, costs incurred, time elapsed, or machine hours used) relative to the total expected inputs to the satisfaction of that performance obligation.” (See Section 8.5.9.)
In discussing the selection of a measure of progress, paragraph
BC164 of ASU 2014-09 states:
The [FASB and IASB] decided
that, conceptually, an output measure is the most faithful depiction of an
entity’s performance because it directly measures the value of the goods or
services transferred to the customer. However, the Boards observed that it
would be appropriate for an entity to use an input method if that method
would be less costly and would provide a reasonable proxy for measuring
progress.
The above statement from paragraph BC164 of ASU 2014-09 does
not mean that it is preferable for an entity to use an output method
when measuring progress toward complete satisfaction of a performance
obligation. As stated in paragraph BC159 of ASU 2014-09, an entity does not have
a free choice in selecting an appropriate method of measuring progress toward
complete satisfaction of a performance obligation but should exercise judgment
in identifying a method that fulfills the stated objective in ASC 606-10-25-31
of depicting an entity’s performance in transferring control of goods or
services promised to a customer (i.e., the satisfaction of the performance
obligation).
Neither an input method nor an output method is preferred since
each has benefits and disadvantages that will make it more or less appropriate
to the facts and circumstances of each contract. While an output method is, as
stated in paragraph BC164, conceptually preferable in a general sense, an
appropriate measure of output will not always be directly observable; and
sometimes, an apparent measure of output will not in fact provide an appropriate
measure of an entity’s performance. Information needed to apply an input method
is more likely to be available to an entity without undue cost, but care should
be taken to ensure that any measure of an entity’s inputs used is reflective of
the transfer of control of goods or services to the customer.
Considerations that may be relevant to the selection of a
measure of progress include the following:
-
An output method would not provide a faithful depiction of the entity’s performance if the output selected fails to measure some of the goods or services transferred to the customer. For example, a units-of-delivery or a units-of-production method may sometimes understate an entity’s performance by excluding work in progress that is controlled by the customer. (See paragraph BC165 of ASU 2014-09.)
-
An input method may better reflect progress toward complete satisfaction of a performance obligation over time when (1) the performance obligation consists of a series of distinct goods or services that meets the criteria in ASC 606-10-25-14(b) to be treated as a single performance obligation and (2) the effort required to create and deliver the first units is greater than the effort to create the subsequent units because of the effect of a “learning curve” of efficiencies realized over time. (See paragraph BC314 of ASU 2014-09.)
-
An entity applying an input method must exclude from its measure of progress the costs incurred that (1) do not contribute to the entity’s progress in satisfying a performance obligation (e.g., the costs of unexpected amounts of wasted materials) and (2) are not proportionate to the entity’s progress in satisfying the performance obligation (e.g., the cost of obtaining goods from a vendor that accounts for most of the product’s cost). (See ASC 606-10-55-21.)
8.5.2 Whether Control of a Good or Service Can Be Transferred at Discrete Points in Time When the Underlying Performance Obligation Is Satisfied Over Time
As discussed above, if the entity meets one of the three
criteria in ASC 606-10-25-27, it recognizes revenue over time by using either an
output method or an input method to measure its progress toward complete
satisfaction of the performance obligation. While the revenue standard does not
prescribe which method to use, the entity should select an approach that
faithfully depicts its performance in transferring control of goods or services
promised to a customer.
At the TRG’s April 2016 meeting, the TRG discussed two views
articulated by stakeholders on whether an entity that is performing over time
can transfer control of a good or service underlying a performance obligation at
discrete points in time:
-
View A — Satisfaction of any of the requirements for recognition over time implies that control does not transfer at discrete points in time. Therefore, an entity’s use of an appropriate measure of progress should not result in its recognition of a material asset (e.g., work in progress) for performance the entity has completed. Proponents of View A point to paragraphs BC125, BC128, BC130, BC131, BC135, and BC142 of ASU 2014-09, which clarify that control of any asset (such as work in progress) transfers to the customer as progress is made.
-
View B — Satisfaction of any of the criteria for recognition over time does not preclude transfer of control at discrete points in time. The use of an appropriate measure of progress could therefore result in the recognition of a material asset for performance under a contract. Proponents of View B emphasized that ASC 606-10-25-27(c) specifically “contemplates transfer of control at discrete points in time.” They also noted that the term “could” in paragraph BC135 of ASU 2014-09 implies that in certain circumstances, the customer may not control the asset as performance occurs. In addition, proponents of View B indicated that “if control can never transfer at discrete points in time, certain methods of progress referenced in the new revenue standard [e.g., milestones2] rarely would be permissible.”3
The FASB staff believes (as discussed in Implementation Q&A 51) that View B is
inconsistent with the revenue standard but that View A is appropriate. The staff
reiterates that paragraphs BC125, BC128, BC130, BC131, BC135, and BC142 of ASU
2014-09 clarify that when an entity satisfies any of the three criteria for
recognizing revenue over time, the entity’s performance is an asset that the
customer controls. The staff also indicates that in accordance with paragraph
BC135 of ASU 2014-09, an entity would consider whether it has a right to payment
in determining whether the customer controls an asset. Therefore, in the staff’s
view, control “does not transfer at discrete points in time,” and “an
appropriate measure of progress should not result in an entity recognizing a
material asset that results from the entity’s performance (for example, work in
process).”4
The FASB staff also notes that (1) View A does not prohibit an
entity from recognizing revenue over time if there is a period during which the
entity does not perform any activities toward satisfying its performance
obligation (i.e., if there is a break in the period of performance) and (2)
although Example 27 in the revenue standard refers to milestone payments, the
standard does not conclude that milestones are the appropriate measure of
progress. Therefore, entities must use judgment in selecting an appropriate
measure of progress.
Certain TRG members questioned the FASB staff’s view that there
could be times when an entity may recognize an immaterial asset (e.g., work in
progress) under a recognition-over-time model because the entity’s selected
measure of progress may not perfectly match its performance. Specifically, they
cited ASC 340-40-25-8, which requires an entity to recognize costs related to
satisfied and partially satisfied performance obligations as expenses when they
are incurred.
TRG members indicated that an asset could result from activities
that are not specific to the customer contract (i.e., the creation of general
inventory). They reiterated the importance of understanding the differences
between costs associated with the development of an asset that transfers to a
customer as it is created and costs to develop assets for general inventory
(i.e., before the asset undergoes modifications that are specific to the
customer). One TRG member discussed an example that involved large, complex, and
customized assets. He noted that activities can be performed to assemble parts,
for example, and that such costs may represent inventory (and thus an asset)
because the assets are interchangeable for use in more than one customer
contract.
Because control of the related good or service cannot be
transferred at discrete points in time if a performance obligation meets one of
the criteria in ASC 606-10-25-27, the measure of progress selected for such a
performance obligation should be consistent with the pattern of transfer of
control of the good or service over time and should not result in the
recognition of work in progress (or a similar asset) as the entity performs work
between discrete points of revenue recognition (see Example 13-2).
ASC 606-10-25-27 does not, however, require an entity’s
performance over time to be continuous and uninterrupted. Accordingly, a gap in
the entity’s performance (e.g., if the entity does not perform any activities
toward satisfying the performance obligation in a particular financial reporting
period) does not in itself prevent the entity from recognizing revenue over
time. In addition, as discussed in Section
13.3.3.2, it will typically be appropriate for the entity to
continue to recognize any incurred contract-fulfillment costs related to future
performance as assets, such as inventories and other assets that have not yet
been used in the contract and are still controlled by the entity.
The above issues are addressed in Implementation Q&A 51 (compiled from previously issued
TRG Agenda Papers 53 and 55). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
8.5.3 Use of a Multiple Attribution Approach (as Compared With a Single Method for Measuring Progress)
For performance obligations meeting the requirements for revenue
recognition over time, the entity must select a method for measuring progress
toward satisfaction of the performance obligation.
Although the revenue standard indicates that an entity should
apply a single method to measure progress for each performance obligation
satisfied over time, stakeholders have questioned whether an entity may apply
more than one method to measure progress toward satisfaction of a performance
obligation that contains multiple goods and services bundled and recognized over
time. Examples of such circumstances include the following:
-
A cloud computing company provides hosting services to its customers for specified periods that begin once certain up-front implementation activities are completed. The customer cannot access the services in the hosting arrangement until the implementation activities are complete (and no other vendor can perform the implementation). Therefore, the hosting services are combined with the up-front activities to be one performance obligation.
-
A license is provided to a customer at contract inception. However, there is also a service associated with the license that is not considered to be distinct. Therefore, the service is combined with the license to be one performance obligation.
-
A franchisor enters into a license agreement with a new franchisee for a specified number of years with a promise to also provide a fixed number of hours of consulting services in the first year of the agreement. The license is to be satisfied over time. Because both promises in the arrangement are highly interrelated, the license is combined with the consulting services into one performance obligation.
Stakeholders questioned whether it would be acceptable to apply
two different methods for measuring progress even though the contract has only
one performance obligation.
The FASB staff notes that the revenue standard clearly indicates
that “using multiple methods of measuring progress for the same performance
obligation would not be appropriate.”5 Accordingly, the staff concludes that an entity should use a single
measure of progress for each performance obligation identified in the
contract.
In addition, the FASB staff observes that selecting a common
measure of progress may be challenging when a single performance obligation
contains more than one good or service or has multiple payment streams, although
it emphasizes that the selection is not a free choice. Further, the staff notes
that while a common measure of progress that does not depict the economics of
the contract may indicate that the arrangement contains more than one
performance obligation, it is not determinative. However, a reexamination may
suggest that the contract includes more performance obligations than were
initially identified.
The above issues are addressed in Implementation Q&As 47 and 48 (compiled from previously
issued TRG Agenda Papers 41 and 44). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
8.5.4 Use of Different Methods of Measuring Performance to Date to Determine Whether a Performance Obligation Is Satisfied Over Time and to Measure Progress Toward Satisfaction of That Performance Obligation
In some circumstances, an entity will need to identity a
suitable method for measuring “performance completed to date” to determine
whether the criterion in ASC 606-10-25-27(c) is met (see ASC 606-10-25-29 and
ASC 606-10-55-11 for additional guidance). Further, once it has been determined
that a performance obligation is satisfied over time, ASC 606-10-25-31 requires
an entity to “recognize revenue over time by measuring the progress toward
complete satisfaction of that performance obligation.” For measuring both
performance completed to date under ASC 606-10-25-27(c) (to determine whether
revenue should be recognized over time) and progress toward complete
satisfaction of a performance obligation under ASC 606-10-25-31, the method
selected should faithfully depict an entity’s performance in transferring
control of goods or services promised to a customer. However, there is no
requirement for the same method to be used for both purposes.
But in determining an appropriate method for measuring progress
under ASC 606-10-25-31, entities should be aware that ASC 606-10-25-32 requires
them to apply the same method to all similar performance obligations in similar
circumstances.
Example 8-5
Entity A enters into a contract with
Customer B under which A will construct a large item of
specialized equipment on its own premises and then
deliver the equipment and transfer title to B after
construction is completed. The specialized equipment is
only suitable for this particular customer (i.e., it has
no alternative use). In addition, the specialized
equipment is subject to certain regulations that require
third-party appraisals to be performed throughout the
construction of the equipment. The objective of the
appraisals is to assess the entity’s construction
progress and ensure that the equipment is built in
accordance with published regulations. The results of
the periodic appraisals are provided to the customer,
and a final appraisal is performed shortly before the
equipment is delivered to the customer.
Entity A concludes that it qualifies to
recognize revenue over time under ASC 606-10-25-27(c) by
using a cost-based input method because if the customer
cancels the contract, the customer must reimburse the
costs incurred by the entity to the date of cancellation
and pay a 5 percent margin on those costs (which is
considered to be a reasonable margin).
However, in measuring the progress
toward satisfaction of similar performance obligations
in other contracts, A uses an output method based on
third-party appraisals completed to date. This method is
determined to faithfully depict progress toward
satisfaction of the performance obligation in the
contract with B. Because ASC 606-10-25-32 requires an
entity to apply the same method of measuring progress to
similar performance obligations in similar
circumstances, A uses this appraisal-based output method
to measure the revenue to be recognized in each
reporting period from its contract with B despite using
a cost-based measure of progress to determine whether it
met the criterion in ASC 606-10-25-27(c).
8.5.5 Application of the Method for Measuring Progress
ASC 606-10
25-34 When applying a method
for measuring progress, an entity shall exclude from the
measure of progress any goods or services for which the
entity does not transfer control to a customer.
Conversely, an entity shall include in the measure of
progress any goods or services for which the entity does
transfer control to a customer when satisfying that
performance obligation.
Under the control principle of the revenue standard, it would
not be appropriate for an entity to recognize revenue for any progress made or
activities performed that do not transfer control to the customer. Rather, the
entity should use judgment to determine which activities are included in the
promised goods or services to the customer and select a method for measuring
progress toward transferring the goods or services to the customer.
This concept is also aligned with principal-versus-agent
considerations in that if the entity does not transfer control to the customer
but coordinates the transfer directly to the customer from a third party (i.e.,
the entity does not control the good or service before it is transferred to the
customer), it would be inappropriate to include the component part in the
measure of progress, and revenue should therefore be adjusted accordingly. See
Chapter 10 for further
discussion of principal-versus-agent considerations.
8.5.6 Subsequent Measurement of an Entity’s Measure of Progress
ASC 606-10
25-35 As circumstances change
over time, an entity shall update its measure of
progress to reflect any changes in the outcome of the
performance obligation. Such changes to an entity’s
measure of progress shall be accounted for as a change
in accounting estimate in accordance with Subtopic
250-10 on accounting changes and error corrections.
It is common for estimates related to an entity’s level of
progress to change as the entity fulfills its promise to the customer. As a
result, such estimates of an entity’s measure of progress should be updated on
the basis of the most current information available to the entity. Consideration
should be given to subsequent measurement to the extent that there are any
changes in the outcome of the performance obligation. Such changes should be
accounted for in a manner consistent with the guidance on accounting changes in
ASC 250, which states that a “change in accounting estimate shall be accounted
for in the period of change if the change affects that period only or in the
period of change and future periods if the change affects both.” Accordingly, a
change in the entity’s estimated measure of progress should be accounted for
prospectively (i.e., prior periods are not restated, but there could be a
cumulative-effect adjustment to revenue in the current period). Because the
change represents a change in accounting estimate rather than any change in the
scope or price of the contract, the guidance in the revenue standard on contract
modifications (discussed in Chapter 9) would not apply. In addition, since this estimate is
related to an entity’s recognition of revenue rather than measurement of
revenue, the guidance on accounting for changes in the estimate of variable
consideration (discussed in Chapter 7) would not apply.
Example 8-6
Entity A enters into a contract to construct a building
in exchange for a fixed price of $2 million. Entity A
concludes that it has a single performance obligation
and that one of the criteria for recognizing revenue
over time is met. In addition, A concludes that an input
method is the most appropriate method for measuring its
progress toward complete satisfaction. Accordingly, A
measures its progress on the basis of costs incurred to
date as compared with total expected costs.
At contract inception, A estimates that it will incur
total costs of $900,000. After A incurs actual costs of
$450,000, its estimate of total costs changes from
$900,000 to $800,000. This change represents a change in
accounting estimate and should be accounted for as
follows:
-
Amount of revenue recognized to date — ($450,000 ÷ $900,000) × $2 million = $1 million.
-
Amount of revenue that should be recognized on the basis of the new estimate — ($450,000 ÷ $800,000) × $2 million = $1.125 million.
-
Amount of revenue recognized upon change in estimate — $1.125 million − $1 million = $125,000.
8.5.7 Reasonable Measure of Progress
ASC 606-10
Reasonable Measures
of Progress
25-36 An entity shall recognize
revenue for a performance obligation satisfied over time
only if the entity can reasonably measure its progress
toward complete satisfaction of the performance
obligation. An entity would not be able to reasonably
measure its progress toward complete satisfaction of a
performance obligation if it lacks reliable information
that would be required to apply an appropriate method of
measuring progress.
25-37 In some circumstances
(for example, in the early stages of a contract), an
entity may not be able to reasonably measure the outcome
of a performance obligation, but the entity expects to
recover the costs incurred in satisfying the performance
obligation. In those circumstances, the entity shall
recognize revenue only to the extent of the costs
incurred until such time that it can reasonably measure
the outcome of the performance obligation.
As discussed in Section 8.5.1, the revenue standard
requires an entity to select the method that faithfully depicts its progress
toward completion. However, in some circumstances, an entity may not be able to
reasonably measure progress toward completion.
During the development of the revenue standard, feedback
considered by the FASB and IASB suggested that recognizing revenue solely on the
basis of costs incurred (resulting in zero margin being recognized) is a widely
understood and reasonable practice. As a result, the boards agreed that this is
an important recognition practice and decided to incorporate the concept into
the revenue standard. Specifically, the boards concluded that if an entity
cannot reasonably measure progress but still expects to recover the costs
incurred to satisfy the performance obligation, the entity should recognize
revenue for its progress in satisfying the performance obligation by recognizing
revenue in the amount of the costs incurred. However, this would only be
appropriate if the entity cannot reasonably measure its progress, or until the
entity is able to reasonably measure progress. In addition, an entity may need
to evaluate whether it is required to recognize losses in its financial
statements before those losses are incurred. Refer to Chapter 13 for considerations related to
onerous performance obligations and recognition of such losses.
Importantly, this evaluation is separate from estimating and
constraining variable consideration. Therefore, in long-term contracts, there
are typically at least two key estimates made at contract inception and
reassessed during the contract: (1) the entity’s current measure of progress
and, separately, (2) the entity’s current estimate of any variable consideration
(see Chapter 6 for
further discussion).
The example below illustrates a situation in which progress
toward complete satisfaction of a performance obligation cannot be reasonably
measured.
Example 8-7
A contractor enters into a building
contract with fixed consideration of $1,000. The
contract is expected to take three years to complete and
satisfies one of the criteria in ASC 606-10-25-27 for
revenue to be recognized over time. At the end of year
1, management is unable to reasonably measure its
progress toward complete satisfaction of the performance
obligation (e.g., because it cannot reasonably measure
total costs under the contract). Taking into account the
progress to date and future expectations, management
expects that total contract costs will not exceed total
contract revenues. Costs of $100 have been incurred in
year 1.
In this example, since the contractor is
not able to reasonably measure the progress relative to
the work performed to date but expects that costs are
recoverable, only revenue of $100 should be recognized
in year 1. Therefore, in year 1, revenue and costs of
services of $100 are recognized, resulting in no profit
margin.
8.5.8 Output Methods
The revenue standard outlines two types of methods for measuring
progress: output methods and input methods. As stated in ASC 606-10-55-17,
output methods “recognize revenue on the basis of direct measurements of the
value to the customer of the goods or services transferred to date relative to
the remaining goods or services promised under the contract.” Examples of output
methods include surveys of performance completed to date, appraisals of results
achieved, milestones reached, time elapsed, and units delivered or produced.
Value to the customer should be an objective measure of the entity’s performance
(i.e., the measure is directly observable, and information needed to apply the
measure is readily available).
ASC 606-10
55-17 Output methods recognize
revenue on the basis of direct measurements of the value
to the customer of the goods or services transferred to
date relative to the remaining goods or services
promised under the contract. Output methods include
methods such as surveys of performance completed to
date, appraisals of results achieved, milestones
reached, time elapsed, and units produced or units
delivered. When an entity evaluates whether to apply an
output method to measure its progress, the entity should
consider whether the output selected would faithfully
depict the entity’s performance toward complete
satisfaction of the performance obligation. An output
method would not provide a faithful depiction of the
entity’s performance if the output selected would fail
to measure some of the goods or services for which
control has transferred to the customer. For example,
output methods based on units produced or units
delivered would not faithfully depict an entity’s
performance in satisfying a performance obligation if,
at the end of the reporting period, the entity’s
performance has produced work in process or finished
goods controlled by the customer that are not included
in the measurement of the output.
55-19 The disadvantages of
output methods are that the outputs used to measure
progress may not be directly observable and the
information required to apply them may not be available
to an entity without undue cost. Therefore, an input
method may be necessary.
Paragraph BC164 of ASU 2014-09 states that the FASB and IASB
“decided that, conceptually, an output measure is the most faithful depiction of
an entity’s performance because it directly measures the value of the goods or
services transferred to the customer.” That is, the boards did not state that an
output method is the preferred method but instead indicated that in most cases,
an output method would be the most appropriate method that is consistent with
recognizing revenue as value is transferred to the customer. Some stakeholders
argue that an output method is generally the most appropriate method. However, a
drawback of using an output method is that there may not always be a directly
observable or objectively determined output to reliably measure an entity’s
progress, and it could fail to measure progress between directly observable or
objectively determined outputs. As a result, the boards noted that there may be
instances in which it would be appropriate for an entity to use an input method
(i.e., if that method would be less costly and would provide a reasonable
measure of progress).
In redeliberations of the revenue standard, some stakeholders
requested that the boards provide more guidance on when units-of-delivery or
units-of-production methods would be appropriate. Although such methods appear
to be output methods, they do not always provide the most faithful depiction of
the entity’s performance. That is, these methods may disregard an entity’s
efforts that result in progress toward completion when performance is satisfied
over time, which could be material to the contract or even the financial
statements as a whole. In addition, units-of-production or units-of-delivery
methods may not be appropriate in contracts that provide design and production
services because the transfer of produced items may not correspond to the actual
progress made on the entire contract.
Therefore, in the selection of an output method for measuring
progress and the determination of whether a units-of-delivery or
units-of-production method is appropriate, it is important for an entity to
carefully consider (1) all of the facts and circumstances of the arrangement and
(2) how value is transferred to the customer.
8.5.8.1 Invoice Practical Expedient for Measuring Progress
ASC 606-10
55-18 As a practical
expedient, if an entity has a right to consideration
from a customer in an amount that corresponds
directly with the value to the customer of the
entity’s performance completed to date (for example,
a service contract in which an entity bills a fixed
amount for each hour of service provided), the
entity may recognize revenue in the amount to which
the entity has a right to invoice.
The revenue standard provides a practical expedient in ASC
606-10-55-18 that can be applied to performance obligations that meet the
criteria in ASC 606-10-25-27 to be satisfied over time. Most commonly
referred to as the “invoice practical expedient,” this option allows an
entity to recognize revenue in the amount of consideration to which the
entity has the right to invoice when the amount that the entity has the
right to invoice corresponds directly to the value transferred to the
customer. That is, the invoice practical expedient cannot be applied in all
circumstances because the right to invoice a certain amount does not always
correspond to the progress toward satisfying the performance obligation.
Therefore, an entity should demonstrate its ability to apply the invoice
practical expedient to performance obligations satisfied over time. Because
the purpose of the invoice practical expedient is to faithfully depict an
entity’s measure of progress toward completion, the invoice practical
expedient can only be applied to performance obligations satisfied over time
(not at a point in time).
8.5.8.1.1 Using the Invoice Practical Expedient When the Unit Price or Rate Varies During the Contract Period
The option to apply the invoice practical expedient in
ASC 606-10-55-18 is available only if the invoice amount represents the
“amount that corresponds directly with the value to the customer of the
entity’s performance completed to date (for example, a service contract
in which an entity bills a fixed amount for each hour of service
provided).”6
Stakeholders have questioned whether the invoice
practical expedient may be used for contracts in which the unit price or
rate varies during the contract period.
The FASB staff has noted that an entity must use
judgment and that conclusions are likely to vary depending on the facts
and circumstances. The staff believes that the invoice practical
expedient could be used for both a contract in which the unit price
varies during the contract period and a contract in which the rate
varies during the contract period if the contracts’ respective price and
rate changes reflect the “value to the customer of each incremental good
or service that the entity transfers to the customer.”7
Connecting the Dots
In some industries, the price charged to the customer for each
unit transferred may vary over the contract term. For example, a
contract to supply electricity for several years may specify
different unit prices each year depending on the forward market
price of electricity at contract inception.
In this example, the contract to purchase electricity at prices
that vary over the term of the contract depending on the forward
market price of electricity at contract inception would qualify
for the practical expedient because the rates per unit generally
correlate to the value to the customer of the entity’s provision
of each unit of electricity.
The above issue is addressed in Implementation Q&A 46 (compiled from previously
issued TRG Agenda Papers 40 and 44). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
8.5.8.1.2 Applying the Invoice Practical Expedient to Contracts With Up-Front Consideration or Back-End Fees
An entity is not necessarily precluded from applying the
invoice practical expedient in ASC 606-10-55-18 when a contract contains
nonrefundable up-front consideration or back-end fees. However, the
entity will need to use judgment in determining whether the amount
invoiced for goods or services reasonably represents the value to the
customer of the entity’s performance completed to date.
When the entity makes this assessment, an analysis of
the significance of the up-front or back-end fees relative to the other
consideration in the arrangement is likely to be important.
The above issue is addressed in Implementation Q&A 46 (compiled from previously
issued TRG Agenda Papers 40 and 44). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
8.5.9 Input Methods
Input methods recognize revenue on the basis of an entity’s
efforts or inputs toward satisfying a performance obligation. Examples include
resources consumed, labor hours expended, costs incurred, time elapsed, or
machine hours used.
ASC 606-10
55-20 Input methods recognize
revenue on the basis of the entity’s efforts or inputs
to the satisfaction of a performance obligation (for
example, resources consumed, labor hours expended, costs
incurred, time elapsed, or machine hours used) relative
to the total expected inputs to the satisfaction of that
performance obligation. If the entity’s efforts or
inputs are expended evenly throughout the performance
period, it may be appropriate for the entity to
recognize revenue on a straight-line basis.
A common input method is the “cost-to-cost” method, as implied
by the use of the term “costs incurred” in ASC 606-10-55-20 as an example of a
basis for measuring progress. When applying the cost-to-cost method, an entity
uses costs incurred as compared with total estimated costs. Types of costs that
an entity may consider when applying the cost-to-cost method include direct
labor, direct materials, subcontractor costs, and other costs incurred that are
related to the entity’s performance under a contract. In addition, while certain
overhead costs may be appropriate for consideration under the cost-to-cost
method, an entity should use judgment to include only allocated costs (in
measuring progress) that actually contribute to the transfer of control to the
customer of the performance obligation(s). For example, it would generally not
be appropriate for an entity to include general and administrative costs or
sales and marketing costs in measuring the progress toward satisfying a
performance obligation unless (1) those costs are directly chargeable to the
customer and (2) including such costs faithfully depicts the entity’s progress
toward satisfying the performance obligation. In making this distinction,
entities may refer to ASC 340-40-25-7, which includes types of costs that are
directly related to a contract.
8.5.9.1 Inefficiencies and Wasted Materials
ASC 606-10
55-21 A shortcoming of input
methods is that there may not be a direct
relationship between an entity’s inputs and the
transfer of control of goods or services to a
customer. Therefore, an entity should exclude from
an input method the effects of any inputs that, in
accordance with the objective of measuring progress
in paragraph 606-10-25-31, do not depict the
entity’s performance in transferring control of
goods or services to the customer. For instance,
when using a cost-based input method, an adjustment
to the measure of progress may be required in the
following circumstances:
-
When a cost incurred does not contribute to an entity’s progress in satisfying the performance obligation. For example, an entity would not recognize revenue on the basis of costs incurred that are attributable to significant inefficiencies in the entity’s performance that were not reflected in the price of the contract (for example, the costs of unexpected amounts of wasted materials, labor, or other resources that were incurred to satisfy the performance obligation). . . .
While an entity may conclude that an input method is the
most appropriate method to measure progress of a contract (e.g.,
cost-to-cost method), there may be instances or anomalies in which costs
incurred are attributable to inefficiencies or wasted materials and do not
contribute to the satisfaction of the performance obligation. In these
circumstances, an entity should exclude such factors that do not accurately
depict the entity’s progress toward satisfying the performance
obligation.
In early drafts of the revenue standard, the FASB and IASB
proposed requiring an entity to exclude inefficiencies and wasted materials
from any input measure (i.e., a cost-to-cost measure). However, many comment
letter respondents explained that often there is an “expected” level of
inefficiency or waste factored into a project from the outset and that
separately, circumstances involving “unexpected” inefficiencies or waste may
occur once a project has commenced. Those comment letter respondents
requested further clarification from the boards regarding the amounts that
should be excluded from any measure of progress. However, instead of
providing additional detailed guidance on “expected” versus “unexpected”
inefficiencies, the boards ultimately decided to emphasize the objective of
measuring progress toward complete satisfaction of the performance
obligation to depict an entity’s performance in the contract. That is, when
an input method is used, it should be adjusted if it is not truly depicting
the measure of progress.
In many construction and manufacturing contracts, some level
of wastage is normal and unavoidable as part of the construction or
manufacturing process. Expected levels of such wastage will be forecasted in
an entity’s budgets and estimates and included in contract costs. However,
there may be circumstances in which an entity experiences significant
unexpected levels of wasted materials, labor, or other resources.
ASC 606 contains specific guidance on accounting for costs
of fulfilling a contract. ASC 340-40-25- 8(b) specifies that costs of wasted
materials, labor, or other resources to fulfill a contract that are not
reflected in the price of the contract should be recognized as expenses when
incurred.
Abnormal waste costs do not represent additional progress
toward satisfaction of an entity’s performance obligation and, if revenue is
being recognized over time, should be excluded from the measurement of such
progress. If the entity is using costs incurred to date as an input method
to measure progress toward complete satisfaction of its performance
obligation, it should be careful to ensure that revenue attributed to work
carried out is not increased to offset additional costs incurred when
abnormal or excessive costs arise as a result of inefficiency or error. In
particular, ASC 606-10-55-21(a) states that when using a cost-based input
method, entities may be required to adjust the measure of progress when
costs are incurred that are “attributable to significant inefficiencies in
the entity’s performance that were not reflected in the price of the
contract.”
8.5.9.2 Uninstalled Materials
ASC 606-10
55-21 A shortcoming of input
methods is that there may not be a direct
relationship between an entity’s inputs and the
transfer of control of goods or services to a
customer. Therefore, an entity should exclude from
an input method the effects of any inputs that, in
accordance with the objective of measuring progress
in paragraph 606-10-25-31, do not depict the
entity’s performance in transferring control of
goods or services to the customer. For instance,
when using a cost-based input method, an adjustment
to the measure of progress may be required in the
following circumstances: . . .
b. When a cost incurred is not proportionate
to the entity’s progress in satisfying the
performance obligation. In those circumstances,
the best depiction of the entity’s performance may
be to adjust the input method to recognize revenue
only to the extent of that cost incurred. For
example, a faithful depiction of an entity’s
performance might be to recognize revenue at an
amount equal to the cost of a good used to satisfy
a performance obligation if the entity expects at
contract inception that all of the following
conditions would be met:
1. The good is not
distinct.
2. The customer is
expected to obtain control of the good
significantly before receiving services related to
the good.
3. The cost of the
transferred good is significant relative to the
total expected costs to completely satisfy the
performance obligation.
4. The entity procures
the good from a third party and is not
significantly involved in designing and
manufacturing the good (but the entity is acting
as a principal in accordance with paragraphs
606-10- 55-36 through 55-40).
There may be instances in which an entity is acting as a
principal and promises to deliver a good and a service that are not distinct
from each other, but the good is transferred before the service is provided.
For example, this could occur when a piece of equipment is transferred to
the customer, but the entity has also promised to install the equipment or
the piece of equipment is a component part of an overall highly customized
project being provided to the customer. In these types of circumstances, a
strict, literal interpretation of an input method to measure progress may
not be appropriate, and the entity may need to carefully consider its actual
progress toward completion. To assist in the interpretation of the revenue
standard’s general guidance on input methods in these circumstances, the
boards provided additional guidance (see ASC 606-10-55-21(b), reproduced
above) and included an example illustrating the treatment of uninstalled
materials (see Example 19, reproduced below).
Through both the additional guidance and the example, the
boards clarified that the adjustment to the input method for uninstalled
materials was to ensure that the input method is consistent with the
objective of measuring progress toward complete satisfaction of a
performance obligation.
In the scenario described above (the promised delivery and
installation of equipment), it would be inappropriate to continue
recognizing the equipment as inventory after delivery but before
installation. Rather, the entity should recognize revenue for the entity’s
performance (i.e., for the delivery of the equipment) in accordance with the
core principle of the standard. However, the boards acknowledged that an
entity may have difficulty determining the amount of revenue to recognize
for the delivery of the equipment when the delivery is not distinct from the
installation. For example, if the entity were to use a cost-to-cost method
to measure progress, resulting in recognition of a contract-wide profit
margin for the delivery of the equipment, the entity’s performance could
consequently be overstated, resulting in an overstatement of revenue.
Another option would be for the entity to estimate a profit margin (which
differs from the contract-wide profit margin); however, this approach would
be complex and could result in the recognition of too much revenue for the
transfer of goods or services that are not distinct. Ultimately, the boards
decided that in certain circumstances, an entity should only recognize
revenue in the amount of the cost of those goods that have been transferred
to the customer (and not include any amount of profit margins). This
adjustment is necessary if delivery of the uninstalled good does not depict
the entity’s performance. This adjustment to the cost-to-cost measure of
progress is most appropriate for scenarios in which the goods (e.g., the
equipment) compose a large portion of the total cost of the contract, and it
ensures that the input method meets the objective of measuring progress to
depict the entity’s performance.
In addition, the boards also clarified that if an entity
selects an input method, (e.g., the cost-to-cost method), it would need to
adjust the measure of progress if including some of the costs incurred would
not truly depict the entity’s performance in the contract.
ASC 606-10
Example 19 — Uninstalled
Materials
55-187 In November 20X2, an
entity contracts with a customer to refurbish a
3-story building and install new elevators for total
consideration of $5 million. The promised
refurbishment service, including the installation of
elevators, is a single performance obligation
satisfied over time. Total expected costs are $4
million, including $1.5 million for the elevators.
The entity determines that it acts as a principal in
accordance with paragraphs 606-10-55-36 through
55-40 because it obtains control of the elevators
before they are transferred to the customer.
55-188 A summary of the
transaction price and expected costs is as
follows:
55-189 The entity uses an
input method based on costs incurred to measure its
progress toward complete satisfaction of the
performance obligation. The entity assesses whether
the costs incurred to procure the elevators are
proportionate to the entity’s progress in satisfying
the performance obligation in accordance with
paragraph 606-10-55-21. The customer obtains control
of the elevators when they are delivered to the site
in December 20X2, although the elevators will not be
installed until June 20X3. The costs to procure the
elevators ($1.5 million) are significant relative to
the total expected costs to completely satisfy the
performance obligation ($4 million). The entity is
not involved in designing or manufacturing the
elevators.
55-190 The entity concludes
that including the costs to procure the elevators in
the measure of progress would overstate the extent
of the entity’s performance. Consequently, in
accordance with paragraph 606-10- 55-21, the entity
adjusts its measure of progress to exclude the costs
to procure the elevators from the measure of costs
incurred and from the transaction price. The entity
recognizes revenue for the transfer of the elevators
in an amount equal to the costs to procure the
elevators (that is, at a zero margin).
55-191 As of December 31,
20X2, the entity observes that:
-
Other costs incurred (excluding elevators) are $500,000.
-
Performance is 20% complete (that is, $500,000 ÷ $2,500,000).
55-192 Consequently, at
December 31, 20X2, the entity recognizes the
following:
The example below illustrates the treatment of prepaid costs
for work to be performed in the future.
Example 8-8
A contractor undertakes a three-year
contract. At the end of year 1, management estimates
that the total revenue on the contract will be
$1,000 and that total costs will be $900, of which
$300 has been incurred to date. Of the $300 incurred
to date, $50 is related to materials purchased in
year 1 that will be used in year 2. The materials
purchased in advance are generic and were not
specifically produced for the contract. The
contractor has determined that the contract is a
single performance obligation that will be satisfied
over time. To calculate the progress toward complete
satisfaction of its performance obligation, the
contractor uses an input method based on costs
incurred to date in proportion to the total
anticipated contract costs.
ASC 606-10-55-21 states, in part,
that “an entity should exclude from an input method
the effects of any inputs that . . . do not depict
the entity’s performance in transferring control of
goods or services to the customer.”
Materials purchased that have yet to
be used may not form part of the costs that
contribute to the transfer of control of goods or
services to the customer. For example, if materials
have been purchased that the contractor is merely
holding at the job site, and these materials were
not specifically produced or fabricated for any
projects, transfer of control of such materials will
generally not have passed to the customer.
Accordingly, in this example, an
adjustment is required for the purchased materials
not yet used because the materials are related to
the work to be performed in the future, and control
of the materials has not transferred to the
customer, as illustrated below.
Therefore, in year 1, contract
revenue of $280 (28% of $1,000) and contract costs
of $250 are recognized in profit or loss. Contract
costs of $50 corresponding to the purchased
materials not yet used are recognized as
inventories. See also Section 8.5.5.
8.5.9.3 Incremental Costs of Obtaining a Contract
When using an input method, an entity should exclude from
its measure of progress the costs it incurred to obtain the contract with
the customer because such costs do not depict an entity’s performance under
the contract. Chapter
13 discusses how to account for the incremental costs of
obtaining a contract with a customer.
ASC 606-10-25-31 states that an entity’s objective, when
measuring progress, is to depict its performance in transferring control of
goods or services promised to a customer. ASC 606-10-55-21 also specifies
that inputs that do not depict such performance are excluded from the
measurement of progress under an input method.
Costs of obtaining a contract are not a measure of
fulfilling it and, accordingly, are excluded from the measurement of
progress (both the measure of progress to date and the estimate of total
costs incurred to satisfy the performance obligation) irrespective of
whether they are recognized as an asset in accordance with ASC 340-40-25-1.
Such assets are amortized on a systematic basis that is consistent with the
transfer to the customer of the goods or services to which the asset is
related (see Chapter
13 for additional information). Accordingly, rather than
being used to determine the pattern of revenue recognition, capitalized
costs of obtaining a contract are amortized in accordance with the expected
pattern of transfer of goods or services. In contrast, costs of fulfilling
the contract that depict an entity’s performance would be included in the
measurement of progress.
8.5.10 Measuring Progress — Stand-Ready Obligations
As discussed in Section 5.4.3, step 2 of the revenue model (i.e., identify the
performance obligations) addresses how to assess the nature of a stand-ready
obligation on the basis of what, in fact, the entity is promising to deliver to
the customer (i.e., a discrete set of performance obligations over a fixed
period or a performance obligation that is unlimited over a fixed period). This
concept is illustrated in Example 18 of ASC 606, which is reproduced below.
ASC 606-10
Example 18 — Measuring Progress When
Making Goods or Services Available
55-184 An entity, an owner
and manager of health clubs, enters into a contract with
a customer for one year of access to any of its health
clubs. The customer has unlimited use of the health
clubs and promises to pay $100 per month.
55-185 The entity determines
that its promise to the customer is to provide a service
of making the health clubs available for the customer to
use as and when the customer wishes. This is because the
extent to which the customer uses the health clubs does
not affect the amount of the remaining goods and
services to which the customer is entitled. The entity
concludes that the customer simultaneously receives and
consumes the benefits of the entity’s performance as it
performs by making the health clubs available.
Consequently, the entity’s performance obligation is
satisfied over time in accordance with paragraph
606-10-25-27(a).
55-186 The entity also
determines that the customer benefits from the entity’s
service of making the health clubs available evenly
throughout the year. (That is, the customer benefits
from having the health clubs available, regardless of
whether the customer uses it or not.) Consequently, the
entity concludes that the best measure of progress
toward complete satisfaction of the performance
obligation over time is a time-based measure, and it
recognizes revenue on a straight-line basis throughout
the year at $100 per month.
For a stand-ready obligation that is satisfied over time, an
entity may measure progress toward complete satisfaction of the performance
obligation by using one of various methods, including input and output methods.
Although ASC 606-10-55-16 through 55-21 provide guidance on when an entity would
use an output or input method, the guidance does not prescribe the use of either
method. However, an entity does not have a “free choice” when selecting a
measure of progress. While an entity may use either type of method, the actual
method selected should be consistent with the clearly stated objective of
depicting the entity’s performance (i.e., the entity’s satisfaction of its
performance obligation in transferring control of goods or services to the
customer).
Further, although ASC 606 does not permit an entity to default
to a straight-line measure of progress on the basis of the passage of time
(because a straight-line measure of progress may not faithfully depict the
pattern of transfer), ASC 606 does not prohibit the use of a straight-line
measure of progress, and such a time-based method may be reasonable in some
cases depending on the facts and circumstances. An entity would need to use
judgment to select an appropriate measure of progress on the basis of the
arrangement’s particular facts and circumstances.
Example 18 in ASC 606-10-55-184 through 55-186 illustrates a
health club membership involving an entity’s stand-ready obligation to provide a
customer with one year of access to any of the entity’s health clubs. In the
example, the entity determines that the customer benefits from the stand-ready
obligation evenly throughout the year.
Other examples of stand-ready obligations include the
following:
-
Snow removal services — An entity promises to remove snow on an “as needed” basis (i.e., a single amount is paid irrespective of the number of times the snow removal services are performed). In this type of arrangement, the entity does not know and most likely cannot reasonably estimate whether, how often, and how much it will snow. This suggests that the entity’s promise is to stand ready to provide the snow-removal services on a when-and-if-needed basis. As a result, a time-based measure of progress may be appropriate. However, a pure straight-line recognition pattern over each month of an annual contract may not be reasonable if that would allow recognition of revenue during months (i.e., warmer months) when the entity either is not performing or is performing to a markedly reduced extent. For such a fixed-fee service contract, although the contract term is fixed (i.e., one year), the pattern of benefit of the services to the customer, as well as the entity’s efforts to fulfill the contract, would most likely vary throughout the year because there would be less expectation of snowfall during the warmer months of the year.
-
Unspecified software upgrades — An entity promises to make unspecified (i.e., when-and-if-available) software upgrades available to a customer. The nature of the entity’s promise is fundamentally one of providing the customer with assurance that any upgrades or updates developed by the entity during the period will be made available because the entity stands ready to transfer updates or upgrades when and if they become available. The customer benefits from the guarantee evenly throughout the contract period because any updates or upgrades developed by the entity during the period will be made available. As a result, a time-based measure of progress over the period during which the customer has rights to any unspecified upgrades developed by the entity would generally be appropriate unless the entity’s historical experience suggests that another method would more faithfully depict the pattern of transfer of the when-and-if-available upgrades to the customer.
The determination of an appropriate measure of progress for
a stand-ready obligation is addressed in Implementation Q&A 49 (compiled from previously issued
TRG Agenda Papers 16 and 25). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
Once an entity has determined the nature of the promise to the
customer, the entity must determine how to appropriately recognize revenue. As
discussed in Section 8.1.1,
an entity must first go through steps 1 through 4 before applying step 5 to
determine when to recognize revenue. Specifically, an entity must identify the
nature of the promised goods and services and determine whether those goods and
services are distinct (as described in Chapter 5) before determining the appropriate
pattern of revenue recognition. For example, an entity may sell products through
a third-party distributor and implicitly or explicitly promise to provide a
stand-ready service to the end customer. In these situations, the entity should
begin to recognize revenue for a stand-ready service promised to a customer’s
customer when the end customer has the ability to access, and begin to consume
and benefit from, the service. In addition, as illustrated in Examples 8-9 and 8-10, the pattern of revenue
recognition may differ depending on the nature of the promised goods and
services in the contract. Therefore, it is critical that an entity carefully
assess the promised goods and services in the contract before jumping to revenue
recognition in step 5. In some instances, an entity may be providing a service
of standing ready to provide as many goods or services as needed by a customer
when called upon (i.e., a stand-ready obligation). However, in other instances,
an entity may be available to provide goods or services when called upon by a
customer, but the customer only has a right to a specified amount of goods or
services.
In the two examples below, Entity X enters into two different
contracts, one with Customer A and the other with Customer B, to provide cloud
computing capacity. Because of the nature of X’s business, very little
incremental effort is required as X’s customers use the cloud computing
capacity.
Example 8-9
Contract With
Customer A for a Specified Quantity
Entity X enters into a three-year
contract with A, under which A receives the right to a
specified quantity of cloud computing capacity on an “as
needed” basis. Unused capacity is forfeited at the end
of the contract term. On the basis of historical usage,
X does not expect A to use the cloud computing capacity
evenly through the contract term but expects A to use
all of the agreed capacity before the end of the
contract. Once A has used the specified quantity of
capacity, A no longer has the ability to use the
service, and additional capacity must be separately
negotiated.
As discussed in Section 5.4.3.2, for an
entity to distinguish between a stand-ready obligation
and an obligation to provide a defined amount of goods
or services, it will often be helpful to focus on the
extent to which the customer’s use of a resource affects
the remaining resources to which the customer is
entitled.
In the circumstances described, the
nature of X’s promise is to provide a fixed capacity,
and its performance under the contract is demonstrated
by the actual discrete delivery of capacity. In contrast
to the example in paragraph BC160 of ASU 2014-09 (see
Section
5.4.3.2), when A uses cloud computing
capacity, A’s usage does affect the amount of the
remaining services to which A is entitled, indicating
that X’s promise is to deliver specified services rather
than to stand ready.
As a result, X should recognize revenue
in a manner that is consistent with A’s usage of the
capacity during the reporting period (i.e., by applying
a usage-based measure of progress). It would not be
appropriate for X to recognize revenue by using a
ratable or straight-line method.
Example 8-10
Contract With
Customer B for an Unlimited Quantity
In contrast to X’s contract with A, X’s
contract with B is to provide unlimited cloud computing
capacity as required over a three-year term. Because X
has agreed to provide an unlimited quantity of cloud
computing capacity, the nature of X’s promise to B is to
continuously stand ready to make unlimited cloud
computing capacity available, and B’s entitlement to
future capacity is not affected by the extent to which B
already used capacity. In such circumstances,
straight-line revenue recognition might be an
appropriate representation of X’s transfer of control
for this stand-ready obligation. However, X should
consider information from similar contracts regarding
historical patterns of performance in using judgment to
select an appropriate measure of progress based on its
service of making the cloud computing capacity available
(which is not necessarily the same as when the customers
use the capacity made available to them).
Connecting the Dots
In some arrangements — specifically, arrangements
involving software as a service (SaaS) — it may not always be clear
whether the nature of the promise is (1) an obligation to provide a
specified amount of services (e.g., 5,000 transactions processed through
software provided as a service) or (2) a stand-ready obligation to
provide services when and if called upon (e.g., to process all of the
transactions required through SaaS). Sometimes in practice, an entity
may price a SaaS arrangement on the basis of volume expectations but may
still be required to stand ready to provide the service for the entire
contractual period regardless of whether the customer exceeds the
volumes expected at contract inception. In other cases, a customer’s
right to use the service may terminate once the initial volumes are
exceeded, or the contract would be modified once the volumes are
exceeded. In all of these circumstances, an entity will need to
carefully consider the contractual rights and obligations to
appropriately identify the nature of the promise and to determine an
appropriate measure of progress toward complete satisfaction of the
performance obligation.
Footnotes
2
Footnote 1 in TRG Agenda Paper 53
notes that as used in the discussion, “milestones” refer to
measures of progress (i.e., they correlate to an entity’s
performance toward complete satisfaction of a performance
obligation) rather than the “milestone method” under legacy
U.S. GAAP.
3
Quoted from paragraph 19 of TRG Agenda Paper
53.
4
Quoted from Implementation Q&A 51.
5
Quoted from Implementation Q&A 47.
6
Quoted from ASC 606-10-55-18.
7
Quoted from paragraph BC167 of ASU 2014-09.
8.6 Revenue Recognized at a Point in Time
If a contract does not meet the criteria for recognition of revenue over time, revenue should be
recognized at a point in time. That is, an entity must first evaluate the criteria in ASC 606-10-25-27 for
recognizing revenue over time (see Section 8.4). Only after determining that none of the criteria in ASC
606-10-25-27 are met can the entity conclude that it is appropriate to recognize revenue at a point in
time. Then, the entity must determine the specific point in time at which it is appropriate to recognize
revenue for the contract (i.e., when control of the goods or services is transferred to the customer).
ASC 606-10
25-30 If a performance obligation is not satisfied over time in accordance with paragraphs 606-10-25-27
through 25-29, an entity satisfies the performance obligation at a point in time. To determine the point in time
at which a customer obtains control of a promised asset and the entity satisfies a performance obligation, the
entity shall consider the guidance on control in paragraphs 606-10-25-23 through 25-26. In addition, an entity
shall consider indicators of the transfer of control, which include, but are not limited to, the following:
- The entity has a present right to payment for the asset — If a customer presently is obliged to pay for an asset, then that may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset in exchange
- The customer has legal title to the asset — Legal title may indicate which party to a contract has the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset or to restrict the access of other entities to those benefits. Therefore, the transfer of legal title of an asset may indicate that the customer has obtained control of the asset. If an entity retains legal title solely as protection against the customer’s failure to pay, those rights of the entity would not preclude the customer from obtaining control of an asset.
- The entity has transferred physical possession of the asset — The customer’s physical possession of an asset may indicate that the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset or to restrict the access of other entities to those benefits. However, physical possession may not coincide with control of an asset. For example, in some repurchase agreements and in some consignment arrangements, a customer or consignee may have physical possession of an asset that the entity controls. Conversely, in some bill-and-hold arrangements, the entity may have physical possession of an asset that the customer controls. Paragraphs 606-10- 55-66 through 55-78, 606-10-55-79 through 55-80, and 606-10-55-81 through 55-84 provide guidance on accounting for repurchase agreements, consignment arrangements, and bill-and-hold arrangements, respectively.
- The customer has the significant risks and rewards of ownership of the asset — The transfer of the significant risks and rewards of ownership of an asset to the customer may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, when evaluating the risks and rewards of ownership of a promised asset, an entity shall exclude any risks that give rise to a separate performance obligation in addition to the performance obligation to transfer the asset. For example, an entity may have transferred control of an asset to a customer but not yet satisfied an additional performance obligation to provide maintenance services related to the transferred asset.
- The customer has accepted the asset — The customer’s acceptance of an asset may indicate that it has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. To evaluate the effect of a contractual customer acceptance clause on when control of an asset is transferred, an entity shall consider the guidance in paragraphs 606-10-55-85 through 55-88.
Connecting the Dots
As discussed in Section 8.2, an
entity must assess whether its promised goods or services are transferred over time. If
the entity determines that none of the criteria for recognizing revenue over time are
met, it should recognize revenue at a point in time. To do so, the entity must determine
the specific point in time at which control of the goods or services is transferred to
the customer. When assessing the transfer of control, the entity should evaluate the
point in time at which the customer has the ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset. Specifically, this
assessment should be performed from the customer’s perspective (i.e., the entity should
identify when the customer obtains control of the asset, not when the entity
relinquishes control of the asset).
In initial proposals of the revenue standard, some respondents disagreed with excluding
risks and rewards from the standard. Specifically, paragraph BC154 of ASU 2014-09
states, “Respondents observed that risks and rewards can be a helpful factor to consider
when determining the transfer of control, as highlighted by the IASB in IFRS 10,
Consolidated Financial Statements, and can often be a consequence of
controlling an asset.” Consequently, the boards decided to add risks and rewards as an
indicator of control. Although risks and rewards may indicate that control has been
transferred, it is important to remember that this is only an indicator and that an
entity should consider other factors when determining whether revenue should be
recognized.
Paragraph BC155 of ASU 2014-09 states that the indicators in ASC 606-10-25-30 (reproduced above)
“are not a list of conditions that must be met before an entity can conclude that control of a good or
service has transferred to a customer. Instead, the indicators are a list of factors that are often present
if a customer has control of an asset and that list is provided to assist entities in applying the principle of
control.”
The revenue standard does not require any one specific indicator or all of the
indicators listed above to be present for an entity to conclude that revenue should be
recognized at a point in time. In addition, each indicator may not in isolation be
sufficient to demonstrate the transfer of control (as noted in, for example, ASC
606-10-25-30(c) with respect to physical possession of an asset). An entity may therefore
need to perform a careful analysis when one or more indicators are not present and the
entity believes that control has been transferred.
The implementation guidance in
ASC 606-10-55 includes additional guidance on
assessing the transfer of control in certain
contexts, such as repurchase agreements,
consignment arrangements, bill-and-hold
arrangements, customer acceptance, and
trial-and-evaluation arrangements. When it is
appropriate to do so, an entity should apply this
guidance in addition to considering the indicators
in ASC 606-10-25-30.
8.6.1 Impact of Governing Laws on the Determination of When the Control of Goods Is Transferred to a Customer
Typically, an entity would
recognize revenue for the sale of goods at the
point in time when control is transferred to the
customer. As discussed in Section
8.3.1, there are some instances in
which it would be appropriate to recognize revenue
for the transfer of goods over time. However, in
instances in which the entity has concluded that
point-in-time revenue recognition is appropriate,
the timing of revenue may vary depending on the
impact of governing laws. As a result, it is
possible that the timing of revenue recognition
could differ for the sale of the same good in
different jurisdictions. The following are
examples of the impact of governing laws:
-
As indicated in ASC 606-10-25-29 and ASC 606-10-55-14, laws that apply to a contract may affect whether an entity has an enforceable right to payment for performance to date and, consequently, whether revenue should be recognized over time.
-
In some jurisdictions, legal title, which is an indicator of the transfer of control in ASC 606-10-25-30, does not transfer until the customer obtains physical possession of the goods.
-
In some jurisdictions, property transactions (often residential property transactions) and distance sale transactions (such as sales via Internet, phone, mail order, or television) must include a period during which the customer has an absolute legal right to rescind the transaction (sometimes referred to as a “cooling off” period). For such transactions, it may be appropriate for entities to consider the guidance on whether a contract has been identified under ASC 606 and when customer acceptance occurs in determining the timing of revenue recognition.
8.6.2 Timing of Revenue Recognition When a Right of Return Exists
The example below illustrates the timing of revenue recognition when
goods are sold to a distributor with a right of return and the distributor subsequently
resells the goods to a retailer.
Example 8-11
Company LH is a manufacturer of specialized products that
are each embedded with an activation chip. The products are sold through a
distribution chain before ultimately being sold to the end customer. Company
LH initially sells its products to Distributor D, an unrelated party that is
LH’s customer. Title to and physical possession of the products are
transferred to D upon delivery to its warehouse. In addition, D has the right
to pledge any products within its possession as collateral. Once the products
are delivered to D, LH no longer has the right to redirect the products (i.e.,
LH cannot require D to return the products so that LH can sell the products to
another party).
Distributor D then separately negotiates with Retailer R to
resell the products. Title to and physical possession of the products are
transferred to R upon delivery of the products to R’s location. Upon receipt
of the products, R activates the chip embedded in each of them. Once the chip
embedded in a product is activated, R is able to sell the product to an end
user.
Before activation, all parties in the distribution chain
(i.e., R and D) have a general right of return related to the products. Once R
activates the chip embedded in each product, the products may no longer be
returned to LH. That is, LH retains some of the inventory risk (i.e., back-end
inventory risk upon product returns) associated with the products until
activation occurs. In addition, LH has only a right to payment for the
products once the products are activated.
There are no specific acceptance terms in LH’s contracts to
sell the products.
On the basis of the facts and circumstances, LH should
not defer revenue recognition until the products are sold to and
activated by R (i.e., recognize revenue on a sell-through basis). Rather, LH
should recognize revenue when it transfers control of the products to its
customer (i.e., D). As stated in ASC 606-10-25-25, “[c]ontrol of an asset
refers to the ability to direct the use of, and obtain substantially all of
the remaining benefits from, the asset. Control includes the ability to
prevent other entities from directing the use of, and obtaining the benefits
from, an asset.”
To help an entity determine whether control of an asset has
been transferred to a customer, ASC 606-10-25-30 provides the following
indicators:
-
Present right to payment — As noted above, LH does not have a right to payment for the products until R activates the chip embedded in each of them. This may indicate that control of the products is not transferred until the products are sold to R and the chip is activated.
-
Legal title — Legal title of the products is transferred from LH to D upon delivery of the products to D’s warehouse. Although R does not obtain legal title to the products until it obtains physical possession, this indicator focuses on when the entity’s customer obtains legal title. In the example, LH’s customer is D. Therefore, when LH evaluates this indicator, it should focus on when D obtains legal title (i.e., when LH relinquishes legal title to the products). This indicates that control of the products is transferred before the sale to and activation by R — specifically, when the products are delivered to D’s warehouse.
-
Physical possession — Physical possession of the products is transferred to D upon delivery of the products to D’s warehouse, which occurs before the products are sold to R. Further, in accordance with ASC 606-10-55-79 and 55-80, LH has determined that the sale of the products does not represent a consignment arrangement.
-
Significant risks and rewards of ownership — As discussed above, LH retains some of the inventory risk (i.e., back-end inventory risk related to product returns) associated with the products until R activates the chip embedded in each product. This is because D and R have a general right of return related to the products before activation. However, once the products are in D’s warehouse, LH no longer has the ability to redirect the products. Rather, D has the ability to sell the products to its own customers and the right to pledge any products within its possession as collateral. Therefore, most of the risks and rewards of ownership are transferred to D, but others are retained by LH.
-
Customer acceptance — As noted above, there are no specific acceptance terms in LH’s contracts to sell the products. However, D is deemed to have accepted the products upon delivery to D’s warehouse because this is the point in time at which title to and physical possession of the products are transferred to D.
Although LH retains certain risks associated with the
products and is not entitled to payment until R activates the products,
control of the products is transferred upon sale to D because this is the
point in time at which LH no longer has the right to direct the use of the
products and D obtains the right to direct the use of the products. In
addition, LH does not have the ability to prevent D from directing the use of
the products (i.e., by reselling the products to R). Company LH’s transfer of
control is also supported by the fact that legal title to the products is
transferred to D, which is one of the indicators of control in ASC
606-10-25-30. Further, D has the right to obtain substantially all of the
benefits from the products not only through its ability to sell the products
to R (or any other customer) but also through its ability to pledge the
products as collateral. For these reasons, control of the products is
transferred upon delivery of the products to D. Therefore, it would be
inappropriate for LH to defer revenue recognition until the products are sold
to and activated by R. However, LH should estimate the number of products that
it expects will be returned to determine its transaction price in accordance
with ASC 606-10-55-22 and 55-23.
8.6.3 Present Right to Payment for the Asset
ASC 606-10
25-30 [A]n entity shall consider indicators of the transfer of control, which include, but are not limited to, the
following:
- The entity has a present right to payment for the asset — If a customer presently is obliged to pay for an asset, then that may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset in exchange. . . .
The first indicator that control has been transferred for a performance
obligation satisfied at a point in time is that
the entity has a present right to payment for the
asset (ASC 606-10-25-30(a)). If the customer is
obligated to pay for the asset, this could be an
indicator that control has been transferred to the
customer. As discussed above, this is only an
indicator and is not a requirement for an entity
to conclude that control has been transferred to
the customer and that the entity can recognize
revenue.
8.6.4 Legal Title to the Asset
ASC 606-10
25-30 [A]n entity shall consider indicators of the transfer of control, which include, but are not limited to, the
following: . . .
b. The customer has legal title to the asset — Legal title may indicate which party to a contract has the
ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset or to
restrict the access of other entities to those benefits. Therefore, the transfer of legal title of an asset
may indicate that the customer has obtained control of the asset. If an entity retains legal title solely
as protection against the customer’s failure to pay, those rights of the entity would not preclude the
customer from obtaining control of an asset. . . .
The second indicator that control has been transferred for a performance
obligation satisfied at a point in time is that the customer has legal title to the asset
(ASC 606-10-25-30(b)). The transfer of control typically coincides with the transfer of
legal title. As illustrated in Section
8.6.4.1, there may be limited instances in which the entity retains legal
title to the asset but is not precluded from recognizing revenue.
8.6.4.1 Retention of Title to Enforce Payment (Uniform Commercial Code)
In certain sales transactions,
a seller may retain legal title to an asset after
transferring physical possession of that asset to
its customer. In some countries, it is common for
a seller to retain a form of title until the
customer makes payment so that the seller can
recover the goods in the event of customer default
on payment. In these instances, the seller’s
retention of title does not affect the customer’s
ability to direct the use of, or obtain
substantially all of the remaining benefits from,
the goods. Accordingly, it is appropriate in these
circumstances for the seller to recognize revenue
when the goods are delivered.
A core principle in ASC 606
(specifically, ASC 606-10-25-23) is that revenue is recognized “when (or as) [an] entity
satisfies a performance obligation by transferring a promised good or service (that is,
an asset) to a customer. An asset is transferred when (or as) the customer obtains
control of that asset.” As stated in ASC 606-10-25-25, “[c]ontrol of an asset refers to
the ability to direct the use of, and obtain substantially all of the remaining benefits
from, the asset. Control includes the ability to prevent other entities from directing
the use of, and obtaining the benefits from, an asset.”
In the circumstances
described, control of the goods has been transferred from the seller to the customer
even though title has not. Transfer of title may indicate that control of the asset has
been transferred to the customer, but it is not determinative. ASC 606-10-25-30(b)
specifically states that “[i]f an entity retains legal title solely as protection
against the customer’s failure to pay, those rights of the entity would not preclude the
customer from obtaining control of an asset.” Consequently, as long as other indicators
demonstrate that control of the asset has been transferred to the customer, revenue
should be recognized.
This may be the case even in
the United States, where sales and other
commercial transactions are subject to the Uniform
Commercial Code (UCC). Under the UCC, the
retention of legal title results in the seller’s
retention of rights normally held by an owner of
goods (such as the legal right to directly dispose
of the goods and the right to prohibit the moving,
selling, or other use of the goods). An entity
must carefully evaluate the control indicators and
the overall control principle in these
circumstances to determine when control of a good
is transferred to a customer.
The example below illustrates
this concept.
Example 8-12
Company A is a global mining company whose products —
primarily iron ore pellets — are used in the integrated steel industry.
Company A’s contracts with its customers include a provision under which
title to, and the risk of loss, damage, or destruction of, iron ore pellets
are not transferred to the customer until receipt of payment. This clause is
intended to be protective, and its main objective is to provide additional
protection to A in the event of nonpayment. (For purposes of this example,
assume that collectibility is not in question.) Under these arrangements,
which are governed by the UCC, A will ship the iron ore pellets to the
customer’s facility before receiving payment. Upon delivery of the iron ore
pellets to the customer’s facility, A has a present right to payment (i.e.,
the customer cannot refuse or withhold payment for iron ore pellets that
have been delivered). Because of the nature of the products (tons of iron
ore), once the iron ore pellets have been delivered to the customer’s
facility, it is not practical to physically redirect them to another
location, and physical risk of loss is not substantive since the pellets are
virtually indestructible. Once delivered, the pellets are indistinguishable
from pellets at the customer’s location for which title has been transferred
(i.e., payment has been made). In addition, the contract does not prohibit
the customer from consuming the pellets before payment. That is, the
customer can direct the use of, and obtain the benefits from, the pellets
once the pellets are delivered to the customer’s location.
The table below provides an assessment of indicators that
control has been transferred to the customer.
Notwithstanding that A retains legal title, it is
appropriate for A to recognize revenue upon delivery of the iron ore
pellets. In light of the assessment of the control indicators in the table
above and an assessment of the control principle, control of the iron ore
pellets is transferred from the seller to the customer upon delivery even
though title is not transferred until payment is received. Given the nature
of the product, greater emphasis should be placed on the physical possession
and right to payment indicators because while A may retain the right to
redirect or repossess the goods in the event that the customer does not pay,
A does not have the practical ability to do so. In addition, the risk of
loss is not meaningful in this scenario since the product is virtually
indestructible. Further, the contract does not prohibit the customer from
consuming the goods before payment, and because of the pellets’ physical
location (i.e., at the customer’s location), the customer has the ability to
use the pellets in its own production facilities. Therefore, from the
customer’s perspective, the customer controls the iron ore pellets once the
pellets are delivered to the customer’s location.
8.6.4.2 Evaluating Whether Control Has Been Transferred in a Sale of Real Estate Without a Formal Closing
In certain limited cases, control of real
estate could be transferred to a customer even
though a formal closing has not occurred. For
example, if the escrow holder or trustee has
received all consideration for the sale as well as
the title to the property from the seller but the
formal closing process has not been completed, the
seller may record a sale as of the time the title
was transferred if it has determined that (1)
collectibility is probable, (2) it transferred
control of the real estate to the buyer, and (3)
it satisfied its performance obligations under the
contract.
On the other hand, the lack of a formal closing
(e.g., because of unresolved contingencies) may
indicate that the seller has not fulfilled its
performance obligations under the contract and
therefore has not transferred control of the real
estate.
Sometimes a sale of real estate will be
structured so that title does not pass to the
buyer until part or all of the consideration is
received by the seller without recourse. For
example, if the sale is structured as a “contract
for deed,” title may not be transferred until the
buyer’s obligation to the seller is paid in full.
Generally, a seller may structure a sale as a
contract for deed because of concern that the full
sales price will not be collected. Recognition of
revenue (or gains or losses on sales to
noncustomers) would be inappropriate in this case
if collectibility is not probable.
8.6.5 Transfer of Physical Possession of the Asset
ASC 606-10
25-30 [A]n entity shall consider indicators of the transfer of control, which include, but are not limited to, the
following: . . .
c. The entity has transferred physical possession of the asset — The customer’s physical possession of
an asset may indicate that the customer has the ability to direct the use of, and obtain substantially all
of the remaining benefits from, the asset or to restrict the access of other entities to those benefits.
However, physical possession may not coincide with control of an asset. For example, in some
repurchase agreements and in some consignment arrangements, a customer or consignee may have
physical possession of an asset that the entity controls. Conversely, in some bill-and-hold arrangements,
the entity may have physical possession of an asset that the customer controls. Paragraphs 606-10-
55-66 through 55-78, 606-10-55-79 through 55-80, and 606-10-55-81 through 55-84 provide guidance
on accounting for repurchase agreements, consignment arrangements, and bill-and-hold arrangements,
respectively. . . .
The third indicator that control has been transferred for a performance
obligation satisfied at a point in time is that the entity has transferred physical
possession of the asset to the customer (ASC 606-10-25-30(c)). The customer’s physical
possession of the asset may indicate that the customer has obtained control of the asset.
The standard, however, indicates that physical possession may not coincide with control of
an asset. That is, in some arrangements (e.g., a contract with a repurchase agreement, or
a consignment arrangement), the customer may have physical possession, but another aspect
of the contract indicates that the entity still controls the asset. To the contrary, in a
bill-and-hold arrangement, the entity may retain physical possession of the asset, but
otherwise, the customer has obtained control. See Sections 8.7,
8.6.8, and 8.6.9 for further discussion of repurchase
agreements, consignment arrangements, and bill-and-hold arrangements, respectively.
Connecting the Dots
Sometimes, an entity (e.g., a manufacturer) may sell goods to a
reseller (e.g., distributor or retailer) that then resells the goods to end customers
(e.g., consumers). In situations in which the reseller is the entity’s customer, the
entity should recognize revenue when control of the goods is transferred to the
reseller. However, in certain cases, the reseller may be restricted in its ability to
resell the goods. Common examples include (1) seller-imposed restrictions (e.g., the
entity contractually precludes the reseller from reselling the goods until a certain
date or other event occurs) and (2) restrictions inherent in the goods (e.g., seasonal
or other time-based restrictions not imposed by the seller).
When a reseller is restricted in its ability to resell a good
purchased from an entity, the entity should consider the nature of the restriction
when determining whether control of the good has been transferred to the reseller
(i.e., the entity’s customer). Seller-imposed restrictions that affect the reseller’s
ability to direct the use of and obtain substantially all of the remaining benefits
from the good would suggest that control of the good has not been transferred to the
reseller.
For example, if a seller transfers physical custody of a good to a
reseller but does not permit the reseller to sell that good to a third party until
some future date, and the underlying good does not have any benefit to the reseller
other than through the resale of the good, it is likely that control of the good has
not been transferred. That is, the reseller cannot direct the use of or obtain
substantially all of the remaining benefits from the good. In such a case, the entity
should not recognize revenue until the seller-imposed restriction lapses.
However, if the restriction is inherent in the good rather than
imposed by the seller, the reseller may have obtained control of the good (since the
restriction would be inherent in how and when the benefits of controlling the good are
derived).
Example 8-13
Entity P, a publisher, ships copies of a new book to
Entity R, a retailer. Entity P’s terms of sale restrict R’s right to
resell copies of the book to its customers (i.e., end customers and other
resellers) for several weeks to ensure a consistent release date across
all retailers. Further, P has the right and ability to either shorten or
extend the amount of time before R can resell copies of the book up to the
release date. Entity P is required to recognize revenue when, after
considering the indicators of control in ASC 606-10-25-30, it determines
that control of the goods has been transferred to R.
Entity P should not recognize revenue until the
time-based restriction lapses and R can resell copies of the book.
Although R has physical possession of the copies, it does not have the
ability to direct the use of and receive all of the remaining benefits
from the copies since it is unable to resell them before the release date.
Therefore, control of the copies has not been transferred to R.
Example 8-14
On January 1, Entity L, a clothing manufacturer, ships
shorts and swimwear to Entity C, a retailer. Entity L does not explicitly
restrict C from reselling the clothing until a certain date (i.e., there
are no seller-imposed restrictions on the resale of the clothing).
However, C decides not to make the clothing available for resale until
March 1 because it has determined on the basis of its experience that
consumers do not buy shorts and swimwear for the upcoming summer until
March. Entity C believes that it would be more beneficial to continue to
display jeans and sweaters during January and February.
Although C is restricted in its ability to resell the
clothing until March 1, this restriction is due to the seasonal nature of
the clothing, which is a restriction that is inherent in the good. Entity
L concludes that control of the clothing is transferred to C on January 1.
Therefore, L should recognize revenue from the sale of the clothing to C
on January 1.
8.6.6 Significant Risks and Rewards of Ownership
ASC 606-10
25-30 [A]n entity shall consider indicators of the transfer of control, which include, but are not limited to, the
following: . . .
d. The customer has the significant risks and rewards of ownership of the asset — The transfer of the
significant risks and rewards of ownership of an asset to the customer may indicate that the customer
has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits
from, the asset. However, when evaluating the risks and rewards of ownership of a promised asset,
an entity shall exclude any risks that give rise to a separate performance obligation in addition to the
performance obligation to transfer the asset. For example, an entity may have transferred control of an
asset to a customer but not yet satisfied an additional performance obligation to provide maintenance
services related to the transferred asset. . . .
The fourth indicator that control has been transferred for a performance
obligation satisfied at a point in time is that the entity has transferred the significant
risks and rewards of ownership to the customer (ASC 606-10-25-30(d)). While the revenue
standard shifts from a risks-and-rewards-based approach to a control-based approach, the
boards intentionally included the “customer has the significant risks and rewards of
ownership of the asset” as an indicator because it is still a helpful factor in the
determination of whether control has been transferred to the customer. In addition, it can
often be a consequence of controlling the asset. This indicator was intended to provide
additional guidance on determining whether control has been transferred to the customer
and does not change the principle of determining whether the goods or services have been
transferred to the customer on the basis of control.
8.6.7 Customer Acceptance
ASC 606-10
25-30 [A]n entity shall consider indicators of the transfer of control, which include, but are not limited to, the
following: . . .
e. The customer has accepted the asset — The customer’s acceptance of an asset may indicate that it has
obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the
asset. To evaluate the effect of a contractual customer acceptance clause on when control of an asset is
transferred, an entity shall consider the guidance in paragraphs 606-10-55-85 through 55-88.
The fifth and final indicator that control has been transferred for a
performance obligation satisfied at a point in time is that the customer has accepted the
asset (ASC 606-10-25-30(e)).
ASC 606-10
55-85 In accordance with paragraph 606-10-25-30(e), a customer’s acceptance of an asset may indicate
that the customer has obtained control of the asset. Customer acceptance clauses allow a customer to
cancel a contract or require an entity to take remedial action if a good or service does not meet agreed-upon
specifications. An entity should consider such clauses when evaluating when a customer obtains control of a
good or service.
55-86 If an entity can objectively determine that
control of a good or service has been transferred to the customer in
accordance with the agreed-upon specifications in the contract, then customer
acceptance is a formality that would not affect the entity’s determination of
when the customer has obtained control of the good or service. For example, if
the customer acceptance clause is based on meeting specified size and weight
characteristics, an entity would be able to determine whether those criteria
have been met before receiving confirmation of the customer’s acceptance. The
entity’s experience with contracts for similar goods or services may provide
evidence that a good or service provided to the customer is in accordance with
the agreed-upon specifications in the contract. If revenue is recognized
before customer acceptance, the entity still must consider whether there are
any remaining performance obligations (for example, installation of equipment)
and evaluate whether to account for them separately.
55-87 However, if an entity cannot objectively determine that the good or service provided to the customer
is in accordance with the agreed-upon specifications in the contract, then the entity would not be able to
conclude that the customer has obtained control until the entity receives the customer’s acceptance. That is
because, in that circumstance the entity cannot determine that the customer has the ability to direct the use of,
and obtain substantially all of the remaining benefits from, the good or service.
55-88 If an entity delivers products to a customer for trial or evaluation purposes and the customer is not
committed to pay any consideration until the trial period lapses, control of the product is not transferred to the
customer until either the customer accepts the product or the trial period lapses.
The significance of a customer acceptance clause in a contract can vary. For
example, in some cases, a customer acceptance condition can be included as a substantive
clause in a contract in which it is clear (perhaps even determinative) that without
customer acceptance, control of the asset has not been transferred to the customer. In
other circumstances, a customer acceptance provision may not be explicit in the contract,
or customer acceptance may be objectively determinable by the entity even before shipment
to the customer. Therefore, it is important for the entity to consider the facts and
circumstances of the arrangement as it considers the control indicators and, in
particular, the guidance on evaluating customer acceptance in the overall assessment of
transfer of control. Particularly in circumstances in which the entity cannot objectively
conclude that the customer has accepted the asset, the entity may not be able to conclude
that control has been transferred to the customer.
The decision tree below illustrates the considerations relevant to customer acceptance provisions.
8.6.8 Consignment Arrangements
Although physical possession is an indicator that control has been transferred
to the customer, ASC 606-10- 25-30(c) cautions that there are some arrangements in which
physical possession may not be indicative of control. One example is a consignment
arrangement.
ASC 606-10
55-79 When an entity delivers a product to another party (such as a dealer or a distributor) for sale to end
customers, the entity should evaluate whether that other party has obtained control of the product at that
point in time. A product that has been delivered to another party may be held in a consignment arrangement
if that other party has not obtained control of the product. Accordingly, an entity should not recognize revenue
upon delivery of a product to another party if the delivered product is held on consignment.
55-80 Indicators that an arrangement is a consignment arrangement include, but are not limited to, the
following:
- The product is controlled by the entity until a specified event occurs, such as the sale of the product to a customer of the dealer, or until a specified period expires.
- The entity is able to require the return of the product or transfer the product to a third party (such as another dealer).
- The dealer does not have an unconditional obligation to pay for the product (although it might be required to pay a deposit).
Under ASC 606, products delivered to a consignee in accordance with a
consignment arrangement generally are not sales and do not qualify for revenue recognition
until the consignee sells the products to a third party, at which point control of the
products is transferred from the consignor to the third party. It is not uncommon for the
consignee to obtain flash title before title is transferred to the third party. Entities
should use judgment and consider the indicators in ASC 606-10-55-80 to assess whether an
arrangement is a consignment arrangement, particularly when the seller no longer has
physical possession of goods but has retained control of such goods through its ongoing
rights, such as its right to repossess the products or redirect the products to another
party.
Connecting the Dots
The guidance in ASC 606-10-55-79 and 55-80 addresses consignment
arrangements in which control of a product is not transferred to a consignee when the
product is delivered to the consignee. However, that guidance does not address whether
the consignee is acting as a principal or as an agent in the sale of the product to
the end customer. Although it is possible that the consignee is acting as a principal,
particularly if it obtains control of the product before the product is
transferred to the end customer and is primarily responsible for the fulfillment of
the product, entities should carefully evaluate all facts and circumstances in making
that determination. See Chapter
10 for further discussion of principal-versus-agent considerations.
8.6.9 Bill-and-Hold Arrangements
Conversely to a customer in a consignment arrangement, a customer in a
bill-and-hold arrangement may obtain control of the good before obtaining physical
possession. Customers may request that arrangements be designed this way to meet certain
needs. For example, a customer may have limited storage capacity or may not be able to
immediately use the goods. Under such circumstances, the customer may request that the
vendor hold the goods for some period, but the customer is nonetheless committed to
purchase the goods.
ASC 606-10
55-81 A bill-and-hold arrangement is
a contract under which an entity bills a customer for a product but the entity
retains physical possession of the product until it is transferred to the
customer at a point in time in the future. For example, a customer may request
an entity to enter into such a contract because of the customer’s lack of
available space for the product or because of delays in the customer’s
production schedules.
55-82 An entity should determine when
it has satisfied its performance obligation to transfer a product by
evaluating when a customer obtains control of that product (see paragraph
606-10-25-30). For some contracts, control is transferred either when the
product is delivered to the customer’s site or when the product is shipped,
depending on the terms of the contract (including delivery and shipping
terms). However, for some contracts, a customer may obtain control of a
product even though that product remains in an entity’s physical possession.
In that case, the customer has the ability to direct the use of, and obtain
substantially all of the remaining benefits from, the product even though it
has decided not to exercise its right to take physical possession of that
product. Consequently, the entity does not control the product. Instead, the
entity provides custodial services to the customer over the customer’s
asset.
55-83 In addition to applying the
guidance in paragraph 606-10-25-30, for a customer to have obtained control of
a product in a bill-and-hold arrangement, all of the following criteria must
be met:
-
The reason for the bill-and-hold arrangement must be substantive (for example, the customer has requested the arrangement).
-
The product must be identified separately as belonging to the customer.
-
The product currently must be ready for physical transfer to the customer.
-
The entity cannot have the ability to use the product or to direct it to another customer.
55-84 If an entity recognizes revenue
for the sale of a product on a bill-and-hold basis, the entity should consider
whether it has remaining performance obligations (for example, for custodial
services) in accordance with paragraphs 606-10-25-14 through 25-22 to which
the entity should allocate a portion of the transaction price in accordance
with paragraphs 606-10-32-28 through 32-41.
Example 63 — Bill-and-Hold Arrangement
55-409 An entity enters into a
contract with a customer on January 1, 20X8, for the sale of a machine and
spare parts. The manufacturing lead time for the machine and spare parts is
two years.
55-410 Upon completion of
manufacturing, the entity demonstrates that the machine and spare parts meet
the agreed-upon specifications in the contract. The promises to transfer the
machine and spare parts are distinct and result in two performance obligations
that each will be satisfied at a point in time. On December 31, 20X9, the
customer pays for the machine and spare parts but only takes physical
possession of the machine. Although the customer inspects and accepts the
spare parts, the customer requests that the spare parts be stored at the
entity’s warehouse because of its close proximity to the customer’s factory.
The customer has legal title to the spare parts, and the parts can be
identified as belonging to the customer. Furthermore, the entity stores the
spare parts in a separate section of its warehouse, and the parts are ready
for immediate shipment at the customer’s request. The entity expects to hold
the spare parts for two to four years, and the entity does not have the
ability to use the spare parts or direct them to another customer.
55-411 The entity identifies the
promise to provide custodial services as a performance obligation because it
is a service provided to the customer and it is distinct from the machine and
spare parts. Consequently, the entity accounts for three performance
obligations in the contract (the promises to provide the machine, the spare
parts, and the custodial services). The transaction price is allocated to the
three performance obligations and revenue is recognized when (or as) control
transfers to the customer.
55-412 Control of the machine
transfers to the customer on December 31, 20X9, when the customer takes
physical possession. The entity assesses the indicators in paragraph
606-10-25-30 to determine the point in time at which control of the spare
parts transfers to the customer, noting that the entity has received payment,
the customer has legal title to the spare parts, and the customer has
inspected and accepted the spare parts. In addition, the entity concludes that
all of the criteria in paragraph 606-10-55-83 are met, which is necessary for
the entity to recognize revenue in a bill-and-hold arrangement. The entity
recognizes revenue for the spare parts on December 31, 20X9, when control
transfers to the customer.
55-413 The performance obligation to
provide custodial services is satisfied over time as the services are
provided. The entity considers whether the payment terms include a significant
financing component in accordance with paragraphs 606-10-32-15 through
32-20.
The example below illustrates how to determine whether it is appropriate
to recognize revenue from the sale of a product in a bill-and-hold arrangement.
Example 8-15
Company A manufactures its product only after receiving
noncancelable purchase orders. At the end of the reporting period, customers
from whom noncancelable purchase orders have been received may not yet be
ready to take delivery of the product for various reasons (e.g., insufficient
storage space, sufficient supply of the product in the customer’s distribution
channel, delays in the customer’s production schedule). Accordingly, at a
customer’s request, A arranges to store the product either segregated in A’s
own warehouse or in a third-party warehouse. While the product is in storage,
A has risk of loss or damage to the product. In addition, A retains legal
title to the product, and payment by the customer depends on delivery to a
customer-specified site.
ASC 606-10-55-83 provides that to recognize revenue from the
sale of a product in a bill-and-hold arrangement, an entity must meet the
requirements in ASC 606-10-25-30 related to the transfer of control in
addition to the bill-and-hold criteria in ASC 606-10-55-83. Indicators of the
transfer of control applicable to bill-and-hold arrangements include the
following (text quoted from ASC 606-10-25-30):
-
“The entity has a present right to payment for the asset.”
-
“The customer has legal title to the asset.”
-
“The customer has the significant risks and rewards of ownership of the asset.”
-
“The customer has accepted the asset.”
In this case, the customer is not presently obligated to pay
for the product, A retains legal title, and the customer does not have the
significant risks and rewards of ownership. Therefore, even if the entity
meets the bill-and-hold criteria in ASC 606-10-55-83, the customer does not
control the product, and revenue cannot be recognized.
8.6.10 Shipping Terms
For point-in-time revenue recognition, shipping terms may affect the point in
time at which the entity recognizes revenue. Therefore, entities should carefully assess
the indicators in ASC 606-10-25-30 to determine the point in time at which control
transfers to the customer by considering the shipping terms in the contract. In addition
to assessing step 5, entities should consider the guidance in step 2 of the revenue
standard on determining the nature of the promises (i.e., identifying performance
obligations), as outlined in Chapter
5. Specifically, step 2 addresses (1) the determination of when shipping and
handling is a performance obligation and (2) the FASB’s related practical expedient.
If it is determined that revenue should be recognized at a point in
time, an analysis of the shipping terms will form part of the assessment of when control
passes. This is because shipping terms will typically specify when title passes and will
typically also affect when the risks and rewards of ownership are transferred to the
customer; accordingly, they will be relevant in the assessment of two of the five
indicators of transfer of control listed in ASC 606-10-25-30.
When goods are shipped FOB shipping point, title passes to the buyer
when the goods are shipped, and the buyer is responsible for any loss in transit. On the
other hand, when goods are shipped FOB destination, title does not pass to the buyer until
delivery, and the seller is responsible for any loss in transit.
8.6.10.1 Impact of Unspecified Shipping Terms
If a written sales contract does not explicitly set out shipping
terms, the following should be taken into account in the determination of when control
of the goods has been transferred to the customer:
-
The standard shipping terms in the jurisdiction and in the industry.
-
The legal environment of whichever jurisdiction governs the sale transaction.
-
The entity’s customary business practices, to the extent that they would be relevant to the contractual terms.
8.6.10.2 Goods Shipped FOB Destination but Shipping Company Assumes Risk of Loss
Generally, when goods are shipped with standard FOB destination
shipping terms, control of the goods will be transferred to the customer when the goods
arrive at the point of the agreed destination. However, entities should carefully
consider both the terms of the contract and other relevant facts and circumstances to
determine when control of the goods is transferred to the customer, especially when a
contract contains other than standard shipping terms.
The example below illustrates how to determine whether it is
appropriate to recognize revenue when goods are shipped FOB destination but a
third-party shipping company assumes the risk of loss.
Example 8-16
Company A, which sells goods FOB destination (i.e., title
does not pass to the buyer until the goods reach the agreed destination), is
responsible for any loss in transit. To protect itself from loss, A
contracts with the shipping company for the shipping company to assume total
risk of loss while the goods are in transit.
Company A has not satisfied the performance obligation
when the goods are shipped; the performance obligation is to provide the
customer with the goods, whose title, risks and rewards of ownership, and
physical possession will only be passed to the customer when the goods reach
the agreed destination. Further, the fact that A has managed its risk while
the goods are in transit by having a contract with the shipping company does
not mean that it has transferred control of the goods to the customer at the
time when the goods are shipped.
After performing the above analysis, A determines that
control does not pass to the customer until the goods reach the agreed
destination. Therefore, it is not appropriate for A to recognize revenue
when the goods are shipped.
8.6.10.3 “Synthetic FOB Destination” Shipping Terms
Certain companies that ship goods use FOB shipping point terms but
have practices or arrangements with their customers that result in the seller’s
continuing to bear risk of loss or damage while the goods are in transit. If there is
damage or loss, the seller is obligated to provide (or has a practice of providing) the
buyer with replacement goods at no additional cost. The seller may insure this risk with
a third party or “self-insure” the risk (however, the seller is not acting solely as the
buyer’s agent in arranging shipping and insurance in the arrangements). These types of
shipping terms are commonly referred to as “synthetic FOB destination” shipping terms
because the seller has retained the risk of loss or damage during transit so that
all of the risks and rewards of ownership have not been substantively
transferred to the buyer.
In evaluating arrangements with synthetic FOB destination shipping
terms, a seller would first be required to determine whether control of a promised good is
transferred over time (in accordance with specific criteria provided in ASC 606); if
control is not transferred over time, the performance obligation would be deemed to be
satisfied at a point in time. Under ASC 606-10-25-30, if control of the good (promised
asset) is transferred at a point in time, the seller would consider indicators in
determining the point at which the customer obtains control of the asset. The seller would
be required to use judgment in applying the guidance to evaluate the impact of shipping
terms and practices on the determination of when control of the good is transferred to the
customer.
Under typical, unmodified FOB shipping point terms, the seller usually
has a legal right to payment upon shipment of the goods; title and risk of loss of/damage
to the shipped goods are transferred to the buyer, and the seller transfers physical
possession of the shipped goods (under the assumption that the buyer, not the seller, has
the ability to redirect or otherwise control the shipment through the shipping entity).
Shipping terms generally do not affect a customer acceptance term, which the seller would
have to evaluate separately to determine its impact on when control of a good is
transferred to the buyer. However, if the seller can objectively determine that the
shipped goods meet the agreed-upon specifications in the contract with the buyer, customer
acceptance would be deemed a formality, as noted in ASC 606-10-55-86. Therefore, under
typical unmodified FOB shipping point terms, the buyer would obtain control of the shipped
goods, and revenue (subject to the other requirements of ASC 606) would be recognized upon
shipment.
The typical FOB shipping point terms as described above may be modified
in such a way that a seller is either (1) obligated to the buyer to replace goods lost or
damaged in transit (a legal obligation) or (2) not obligated but has a history of
replacing any damaged or lost goods at no additional cost (a constructive obligation).
Such an obligation is an indicator that the seller would need to consider in determining
when the buyer has obtained control of the shipped goods. In these situations, the seller
should evaluate whether the buyer has obtained the “significant” risks and rewards of
ownership of the shipped goods even though the seller maintains the risk of loss of/damage
to the goods during shipping. Such evaluation would include (1) a determination of how the
obligation assumed by the seller affects the buyer’s ability to sell, exchange, pledge, or
otherwise use the asset (as noted in ASC 606-10-25-25) and (2) a consideration of the
likelihood and potential materiality of lost or damaged goods during shipping. The
determination of whether the significant risks and rewards have been transferred would
constitute only one indicator (not in itself determinative) of whether the buyer has
obtained control of the shipped goods and should be considered along with the other four
indicators in ASC 606-10-25-30. Recognition of revenue upon shipment (subject to the other
requirements of ASC 606) would be appropriate if the seller concludes that the buyer has
obtained “control” of the goods upon shipment (on the basis of an overall evaluation of
the indicators in ASC 606-10-25-30 and other guidance in ASC 606) even if the seller
retains some of the risks of the shipped goods.
Connecting the Dots
It is important to understand the shipping terms of an arrangement
to determine when control of the good is transferred to the customer. This is because
the shipping terms often trigger some of the key control indicators (e.g., transfer of
title and present right to payment). Therefore, a careful evaluation of shipping terms
is critical to the assessment of transfer of control.
While the fact that the customer has the significant risks and
rewards of ownership is an indicator of control, that indicator may be overcome by the
other indicators of control. As a result, it may be appropriate to recognize revenue
upon shipment when the terms are FOB shipping point, even in instances in which the
entity retains the risks associated with loss or damage of the products during
shipment.
When FOB shipping point fact patterns are reassessed and control is
determined to be transferred upon shipment, the seller should consider whether the
risk of loss or damage that it assumed during shipping gives rise to another
performance obligation (a distinct service-type obligation) that needs to be accounted
for separately in accordance with the revenue standard. For example, such risk may
represent another performance obligation if goods are frequently lost or damaged
during shipping.
Further, entities should consider the practical expedient under U.S.
GAAP (ASC 606-10- 25-18B, added by ASU 2016-10) that allows entities the option
to treat shipping and handling activities that occur after control of the good is
transferred to the customer as fulfillment activities. Entities that elect to use this
practical expedient would not need to account for the shipping and handling as a
separate performance obligation. Refer to Section 5.2.4.3 for additional information.
8.7 Repurchase Agreements
ASC 606-10
25-26 When evaluating whether a customer obtains control of an asset, an entity shall consider any agreement
to repurchase the asset (see paragraphs 606-10-55-66 through 55-78).
An entity that enters into a contract for the sale of an asset may also enter into an agreement to
repurchase the asset. The repurchased asset may be the same asset originally sold, an asset that is
substantially the same as the originally sold asset, or an asset of which the asset originally sold is a
component. The repurchase agreement may be either a part of the original contract or a separate
contract; however, the terms of the repurchase are agreed upon at inception of the initial contract.
An arrangement in which the entity subsequently decides to repurchase the asset after transferring
control would not constitute a repurchase agreement. Paragraph BC423 of ASU 2014-09 states that the FASB and IASB decided that a subsequent agreement would not constitute a repurchase agreement
because “the entity’s subsequent decision to repurchase a good without reference to any pre-existing
contractual right does not affect the customer’s ability to direct the use of, and obtain substantially all of
the remaining benefits from, the good upon initial transfer.”
The boards considered repurchase agreements in developing the guidance on
control since repurchase agreements may affect whether the entity is able to conclude that
control of the asset has been transferred to the customer. The revenue standard sets out
three ways a repurchase agreement would typically occur (forward, call option, and put
option). When the entity has an obligation or right to repurchase the asset (forward or call
option), it is precluded from concluding that control has been transferred to the customer
given the nature of these options and should account for the contract as a lease or
financing arrangement. When the arrangement includes a put option (an obligation for the
entity to repurchase the asset at the customer’s request), the entity will need to exercise
more judgment to determine whether the customer has a significant economic incentive to
exercise that right.
ASC 606-10
55-66 A repurchase agreement is a contract in which an entity sells an asset and also promises or has the
option (either in the same contract or in another contract) to repurchase the asset. The repurchased asset may
be the asset that was originally sold to the customer, an asset that is substantially the same as that asset, or
another asset of which the asset that was originally sold is a component.
55-67 Repurchase agreements generally come in three forms:
- An entity’s obligation to repurchase the asset (a forward)
- An entity’s right to repurchase the asset (a call option)
- An entity’s obligation to repurchase the asset at the customer’s request (a put option).
8.7.1 Forward or Call Option
ASC 606-10
55-68 If an entity has an obligation or a right to
repurchase the asset (a forward or a call option), a customer does not obtain
control of the asset because the customer is limited in its ability to direct
the use of, and obtain substantially all of the remaining benefits from, the
asset even though the customer may have physical possession of the asset.
Consequently, the entity should account for the contract as either of the
following:
- A lease in accordance with Topic 842 on leases, if the entity can or must repurchase the asset for an amount that is less than the original selling price of the asset unless the contract is part of a sale and leaseback transaction. If the contract is part of a sale and leaseback transaction, the entity should account for the contract as a financing arrangement and not as a sale and leaseback transaction in accordance with Subtopic 842-40.
- A financing arrangement in accordance with paragraph 606-10-55-70, if the entity can or must repurchase the asset for an amount that is equal to or more than the original selling price of the asset.
55-69 When comparing the repurchase price with the selling price, an entity should consider the time value of
money.
55-70 If the repurchase agreement is a financing arrangement, the entity should continue to recognize the
asset and also recognize a financial liability for any consideration received from the customer. The entity should
recognize the difference between the amount of consideration received from the customer and the amount
of consideration to be paid to the customer as interest and, if applicable, as processing or holding costs (for
example, insurance).
55-71 If the option lapses unexercised, an entity should derecognize the liability and recognize revenue.
The graphic below illustrates the application of this guidance to transactions
involving forward or call options that are not sale-and-leaseback transactions.
The following example in ASC 606 illustrates how a repurchase agreement that includes a call option
would be accounted for as a financing arrangement:
ASC 606-10
Example 62 — Repurchase Agreements
55-401 An entity enters into a contract with a customer for the sale of a tangible asset on January 1, 20X7, for
$1 million.
Case A — Call Option: Financing
55-402 The contract includes a call option that gives the entity the right to repurchase the asset for
$1.1 million on or before December 31, 20X7.
55-403 Control of the asset does not transfer to the customer on January 1, 20X7, because the entity has a
right to repurchase the asset and therefore the customer is limited in its ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset. Consequently, in accordance with paragraph 606-10-
55-68(b), the entity accounts for the transaction as a financing arrangement because the exercise price is more
than the original selling price. In accordance with paragraph 606-10-55-70, the entity does not derecognize
the asset and instead recognizes the cash received as a financial liability. The entity also recognizes interest
expense for the difference between the exercise price ($1.1 million) and the cash received ($1 million), which
increases the liability.
55-404 On January 1, 20X7, the option lapses unexercised; therefore, the entity derecognizes the liability and
recognizes revenue of $1.1 million.
8.7.1.1 Contingent Repurchase Agreements
ASC 606-10-55-68 states, in part, that “[i]f an entity has an
obligation or a right to repurchase the asset (a forward or a call option), a customer
does not obtain control of the asset because the customer is limited in its ability to
direct the use of, and obtain substantially all of the remaining benefits from, the
asset even though the customer may have physical possession of the asset.” In some
situations, an entity may exercise its call option (i.e., repurchase the asset) only
upon the occurrence of a future event (e.g., termination of the contract).
The presence of a right to repurchase an asset typically precludes an entity’s customer
from obtaining control of that asset and therefore typically precludes the entity from
recognizing revenue from the sale of that asset. This conclusion is based on the notion
that the customer is limited in its ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset. Therefore, it is important
for the entity to consider whether the contingency related to the call option limits the
customer’s ability to direct the use of, and obtain substantially all of the remaining
benefits from, the asset. Specifically, when determining whether the contingent call
option affects the customer’s ability to control the asset, the entity should consider
whether the triggering of the contingency is within the entity’s or the customer’s
control.
Repurchase options that are contingent on factors within the entity’s control would
generally imply that the customer has not obtained control of the asset. In such cases,
the entity should account for the contract as a lease or financing arrangement in a
manner consistent with the guidance in ASC 606-10-55-68. Alternatively, repurchase
options that are contingent on factors within the customer’s control may imply that the
customer has the ability to determine whether the call option may be exercised. For
example, if an entity can repurchase an asset sold to a customer only in the event that
the customer terminates the contract for convenience (i.e., the entity does not have a
right to terminate the contract), the triggering of the call option is within the
customer’s control. In that situation, the entity may reasonably conclude that the
customer obtains control of the asset even though there is a contingent call option.
8.7.1.2 Accounting for Contracts With a Right to Recall a Product After Its “Sell-By” Date
Certain contracts, such as those between a perishable goods supplier
(the “entity”) and its customer, include provisions permitting or obligating the entity
to remove (and sometimes replace) out-of-date products (e.g., to ensure that the end
consumers receive a certain level of product quality or freshness, or both). Under these
circumstances, the entity does not have the unconditional right or obligation to
repurchase the products at any time from the customer. Rather, the products must be past
their “sell-by date” before the entity would repurchase the goods.
A call option or forward that is dependent on the passing of an
expiration date (such as the one discussed above) does not require a transaction to be
accounted for as a lease or financing, in accordance with ASC 606-10-55-68. In the type
of scenario described above, it would be appropriate for the entity to account for such
an arrangement in a manner similar to the accounting for a sale with a right of return
(i.e., as variable consideration) rather than as a lease or a financing transaction.
In lease or financing arrangements, the customer does not have the
ability to control the asset for the asset’s economic life. This is because in these
arrangements, the customer is constrained in its ability to direct the use of, and
obtain substantially all of the remaining benefits from, the asset. For example, in a
lease arrangement, the customer may not sell the asset even though it has physical
possession of the asset. However, in the type of scenario described above, a customer is
free to sell, consume, or otherwise direct the use of the product unless the product becomes out of date. That is, the entity’s call option in such
a scenario is a protective right to recall the goods upon their expiration, which does
not prevent the customer from controlling the asset (i.e., selling it) before the
asset’s sell-by date.
8.7.1.3 Sale of a Commodity That Is Subject to an Agreement to Repurchase the Commodity at Its Prevailing Market Price on the Date of Repurchase
ASC 606-10-55-68 provides that when an entity sells an asset to a
customer but has an obligation or a right to repurchase the asset (a forward or a call
option), the customer “does not obtain control of the asset because the customer is
limited in its ability to direct the use of, and obtain substantially all of the
remaining benefits from, the asset even though the customer may have physical possession
of the asset.” Consequently, the entity should account for the contract as either (1) a
lease in accordance with ASC 842 (if the repurchase price of the forward or call option
is less than the original selling price) or (2) a financing arrangement in accordance
with ASC 606-10-55-70 (if the exercise price of the forward or call option is equal to
or greater than the original selling price). The accounting treatment of a repurchase at
market price (which could be greater than, less than, or equal to the original selling
price) is not specifically addressed.
If an entity sells a quantity of a commodity to a customer but has an
obligation or a right to repurchase an equivalent amount of that commodity (i.e., an
asset that is substantially the same as that originally sold) at the prevailing market
price for that commodity, the entity is not always precluded from recognizing a
sale for the original commodity.
Although ASC 606-10-55-68 precludes an entity from recognizing revenue
when a contract includes a forward or call option, this guidance is based on the notion
that control of the asset has not passed to the entity’s customer “because the customer
is limited in its ability to direct the use of, and obtain substantially all of the
remaining benefits from, the asset.” Similarly, paragraph BC424 of ASU 2014-09 notes
that the FASB’s and IASB’s rationale for concluding that no revenue should be recognized
when an entity holds a forward or call option to repurchase an asset is that the
entity’s customer does not obtain control of the asset.
As acknowledged in paragraph BC425 of ASU 2014-09, in circumstances in
which a substantially similar asset is readily available in the marketplace (which may
be the case for a commodity), an entity’s agreement with a customer to repurchase an
asset at the asset’s prevailing market price on the date of repurchase may not constrain
the customer’s ability to direct the use of, and obtain substantially all of the
remaining benefits from, the asset originally sold. Accordingly, it is important to
consider whether an entity’s obligation or right to repurchase a substantially similar
commodity does, in fact, limit the ability of the entity’s customer to control the
commodity originally sold. This will depend on a careful analysis of the specific facts
and circumstances.
If the entity’s customer is in any way limited in its ability to
direct the use of, and obtain substantially all of the remaining benefits from, the
asset originally sold, the entity should not account for the contract as a sale but
instead should account for the contract in accordance with the contract’s nature (e.g.,
as a lease or financing arrangement). In addition, the entity should consider whether
the contract includes any other element, such as payment for transport of the commodity,
which should be accounted for separately.
However, if there is sufficient evidence to demonstrate that the
entity’s customer is not limited in its ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset (and, therefore, that
control of the asset has clearly been transferred to the customer), the entity should
account for the contract as a sale in accordance with ASC 606. For this to be possible,
it would be necessary that (1) the customer could readily source the equivalent
commodities and the requisite quantities at the appropriate time and in the appropriate
location to satisfy the requirements of the forward or call option and (2) the
repurchase price to be paid is equivalent to the prevailing market price on the date of
repurchase.
8.7.2 Put Option
ASC 606-10
55-72 If an entity has an obligation to repurchase
the asset at the customer’s request (a put option) at a price that is lower
than the original selling price of the asset, the entity should consider at
contract inception whether the customer has a significant economic incentive
to exercise that right. The customer’s exercising of that right results in the
customer effectively paying the entity consideration for the right to use a
specified asset for a period of time. Therefore, if the customer has a
significant economic incentive to exercise that right, the entity should
account for the agreement as a lease in accordance with Topic 842 on leases
unless the contract is part of a sale and leaseback transaction. If the
contract is part of a sale and leaseback transaction, the entity should
account for the contract as a financing arrangement and not as a sale and
leaseback transaction in accordance with Subtopic 842-40.
55-73 To determine whether a customer has a significant economic incentive to exercise its right, an entity
should consider various factors, including the relationship of the repurchase price to the expected market
value of the asset at the date of the repurchase and the amount of time until the right expires. For example, if
the repurchase price is expected to significantly exceed the market value of the asset, this may indicate that the
customer has a significant economic incentive to exercise the put option.
55-74 If the customer does not have a significant economic incentive to exercise its right at a price that is lower
than the original selling price of the asset, the entity should account for the agreement as if it were the sale of a
product with a right of return as described in paragraphs 606-10-55-22 through 55-29.
55-75 If the repurchase price of the asset is equal to or greater than the original selling price and is more than
the expected market value of the asset, the contract is in effect a financing arrangement and, therefore, should
be accounted for as described in paragraph 606-10-55-70.
55-76 If the repurchase price of the asset is equal to or greater than the original selling price and is less than
or equal to the expected market value of the asset, and the customer does not have a significant economic
incentive to exercise its right, then the entity should account for the agreement as if it were the sale of a
product with a right of return as described in paragraphs 606-10-55-22 through 55-29.
55-77 When comparing the repurchase price with the selling price, an entity should consider the time value of
money.
55-78 If the option lapses unexercised, an entity should derecognize the liability and recognize revenue.
The flowchart below illustrates the application of this guidance to transactions
involving a put option held by the customer.
The following example in ASC 606 illustrates how a repurchase agreement that includes a put option
would be accounted for as a lease:
ASC 606-10
Example 62 — Repurchase Agreements
55-401 An entity enters into a contract with a customer for the sale of a tangible asset on January 1, 20X7, for
$1 million.
[Case A omitted8]
Case B — Put Option: Lease
55-405 Instead of having a call option [as in Case A], the contract includes a put option that obliges the entity
to repurchase the asset at the customer’s request for $900,000 on or before December 31, 20X7. The market
value is expected to be $750,000 on December 31, 20X7.
55-406 At the inception of the contract, the entity assesses whether the customer has a significant economic
incentive to exercise the put option, to determine the accounting for the transfer of the asset (see paragraphs
606-10-55-72 through 55-78). The entity concludes that the customer has a significant economic incentive to
exercise the put option because the repurchase price significantly exceeds the expected market value of the
asset at the date of repurchase. The entity determines there are no other relevant factors to consider when
assessing whether the customer has a significant economic incentive to exercise the put option. Consequently,
the entity concludes that control of the asset does not transfer to the customer because the customer is
limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.
55-407 In accordance with paragraphs 606-10-55-72
through 55-73, the entity accounts for the transaction as a lease in
accordance with Topic 842 on leases.
8.7.2.1 Accounting for Trade-In Rights
In certain contracts with customers, an entity may agree to provide
its customer with the right to trade in the original specified good for a fixed price if
the customer purchases the next version of the specified good once it becomes available
(the “trade-in right”).
To account for a trade-in right in its contract with a customer, an
entity will need to evaluate the specific terms of the arrangement and determine whether
the trade-in right is within the scope of ASC 460. If the entity concludes that the
trade-in right is outside the scope of ASC 460, it should apply the guidance in ASC 606
to the entire arrangement.
If the entity concludes that the trade-in right is within the scope of
ASC 460, the fixed-price trade-in right should be measured at fair value and excluded
from the transaction price. The remaining transaction price should then be allocated to
the remaining elements within the scope of ASC 606 (i.e., the product) and recognized
when control of the product is transferred to the customer (e.g., upon delivery).
If the trade-in right is outside the scope of ASC 460, the fixed-price
trade-in right should be assessed under the repurchase guidance in ASC 606. The trade-in
right is a put option since the entity is obligated to repurchase the product at the
customer’s option. If the repurchase price is less than the original selling price, the
entity must evaluate whether the customer has significant economic incentive to exercise
the right. If the entity determines that the customer has significant economic incentive
to exercise the right, it would account for the arrangement as a lease. If the entity
determines that the customer does not have a significant economic incentive to exercise
the right, it may be appropriate to account for the element as a sale with a right of
return. However, the facts and circumstances of the trade-in right should be evaluated,
and other accounting models may be appropriate.
8.7.3 Residual Value Guarantees
Throughout their discussions on repurchase agreements, the FASB and IASB
also considered whether other arrangements should be accounted for as leases, such as
those in which an entity provides its customer with a guaranteed amount to be paid on
resale (i.e., a residual value guarantee). Respondents provided feedback indicating that
such arrangements appeared to be economically similar to repurchase agreements. However,
as noted in paragraph BC431 of ASU 2014-09, the boards made the following observation:
[W]hile the cash flows [in repurchase agreements and residual value
guarantees] may be similar, the customer’s ability to control the asset in each case is
different. If the customer has a put option that it has significant economic incentive
to exercise, the customer is restricted in its ability to consume, modify, or sell the
asset. However, when the entity guarantees that the customer will receive a minimum
amount of sales proceeds, the customer is not constrained in its ability to direct the
use of, and obtain substantially all of the benefits from, the asset.
Accordingly, the boards decided that sales with a residual value
guarantee should not be accounted for under the repurchase agreement implementation
guidance in the revenue standard. Rather, such arrangements should be accounted for in
accordance with the general five-step model outlined in the standard. However, in
arrangements involving residual value guarantees, an entity should bifurcate and account
for the residual value guarantee at fair value under ASC 460 while accounting for the
remaining contract consideration under ASC 606.
ASU 2014-09 clarifies that arrangements involving residual value
guarantees do not represent repurchase agreements and should be accounted for under ASC
460 and ASC 606. This guidance is similarly reflected in ASU 2016-02. Specifically, ASC 842-10-55-32
states, in part, that “except as provided in paragraph 460-10-15-7, the
provisions of Subtopic 460-10 on guarantees apply to indemnification agreements
(contracts) that contingently require an indemnifying party (guarantor) to make payments
to an indemnified party (guaranteed party) based on changes in an underlying that is
related to an asset, a liability, or an equity security of the indemnified party.” A
residual value guarantee is generally a provision that contingently requires a seller
(guarantor) to make a payment to a purchaser (guaranteed party) based on the change in the
fair value (i.e., resale value, which is the underlying) of the asset transferred.
Accordingly, a residual value guarantee would generally be accounted for under ASC
460.
8.7.4 Right of First Refusal and Right of First Offer in Connection With a Sale
An entity should carefully consider a revenue contract’s terms related to the sale of an
asset that provide the entity with future rights to the asset sold. Two common types of
such rights are a right of first refusal (ROFR) and a right of first offer (ROFO), which
are often found in real estate transactions.
A ROFR gives the entity an option to repurchase the asset being sold to the
customer if the customer subsequently plans to accept a bona fide offer from a third party
to purchase the asset from the customer. If the entity exercises its option, the
repurchase transaction would be subject to terms and conditions that are similar to those
in the bona fide offer the customer received from the third party.
ASC 606-10-55-68 states, in part, that “[i]f an entity has an obligation
or a right to repurchase the asset (a forward or a call option), a customer does not
obtain control of the asset because the customer is limited in its ability to direct the
use of, and obtain substantially all of the remaining benefits from, the asset even though
the customer may have physical possession of the asset.” However, an entity’s ROFR would
not, on its own, prevent the customer from obtaining control of the asset (as defined in
ASC 606-10-25-25).
A ROFR as described above allows the seller to influence the
determination of the party to whom the customer subsequently sells the asset but not
whether, when, or for how much the subsequent sale is made. Consequently, the entity’s
right does not limit the customer’s ability to direct the use of the asset or to obtain
substantially all of the remaining benefits from the asset.
A ROFO may be found in sale-and-leaseback arrangements and gives the seller-lessee an
option to make a first offer to the buyer-lessor to repurchase the underlying asset that
has been leased at the end of the lease term. Sale accounting is generally not precluded
if the buyer-lessor is not required or compelled to accept the offer and the price of the
asset is not fixed. If the buyer-lessor is required or compelled to accept the offer, the
seller-lessee essentially has a repurchase option that may prevent the buyer-lessor from
obtaining control of the asset. On the other hand, if the seller-lessee is required or
compelled to make the offer, the buyer-lessor essentially has a put option, as described
in Section 8.7.2.
Example 8-17
Entity B enters into a contract to sell a building to Entity
C. The contract’s terms provide that if, after the sale, C receives a bona
fide offer from an unaffiliated third party to purchase the building and C
plans to accept the offer, B has the option to repurchase the building subject
to terms and conditions that are similar to those contained in the offer C
received from the third party.
In the assessment of whether B has transferred control of
the building to C, the ROFR, on its own, would not prevent C from obtaining
control of the building.
Footnotes
8
Case A of Example 62, on which Case B is based, is
reproduced in Section
8.7.1.
8.8 Customers’ Unexercised Rights — Breakage
ASC 606-10
55-46 In accordance with
paragraph 606-10-45-2, upon receipt of a prepayment from a
customer, an entity should recognize a contract liability in
the amount of the prepayment for its performance obligation
to transfer, or to stand ready to transfer, goods or
services in the future. An entity should derecognize that
contract liability (and recognize revenue) when it transfers
those goods or services and, therefore, satisfies its
performance obligation.
55-47 A customer’s nonrefundable prepayment to an entity gives the customer a right to receive a good or
service in the future (and obliges the entity to stand ready to transfer a good or service). However, customers
may not exercise all of their contractual rights. Those unexercised rights are often referred to as breakage.
55-48 If an entity expects to be entitled to a breakage amount in a contract liability, the entity should recognize
the expected breakage amount as revenue in proportion to the pattern of rights exercised by the customer.
If an entity does not expect to be entitled to a breakage amount, the entity should recognize the expected
breakage amount as revenue when the likelihood of the customer exercising its remaining rights becomes
remote. To determine whether an entity expects to be entitled to a breakage amount, the entity should
consider the guidance in paragraphs 606-10-32-11 through 32-13 on constraining estimates of variable
consideration.
55-49 An entity should recognize a liability (and not revenue) for any consideration received that is attributable
to a customer’s unexercised rights for which the entity is required to remit to another party, for example, a
government entity in accordance with applicable unclaimed property laws.
Paragraph BC397 of ASU 2014-09 notes that the FASB and IASB decided to include
in ASC 606-10- 55-46 through 55-49 (paragraphs B44 through B47 of IFRS 15) specific
implementation guidance on the accounting for breakage (i.e., “situations in which
the customer does not exercise all of its contractual rights” to goods or services
in the contract) in contracts for which there is only a single performance
obligation. The boards note that in other arrangements (i.e., those with multiple
performance obligations), breakage is generally addressed by the guidance on
accounting for a material right (see Chapter 11) and the allocation guidance in
step 4 (see Chapter 7 for
further discussion). In light of this, the next sections take a deeper dive into the
application of the revenue standard’s implementation guidance on breakage.
8.8.1 Accounting for Sales of Gift Certificates That May Not Be Redeemed
Gift certificates sold by a retailer can be used by the holder
to purchase goods up to the amount indicated on the gift certificate. Typically,
they represent a nonrefundable prepayment to an entity that gives the customer a
right to receive goods or services in the future (and obliges the entity to
stand ready to transfer the goods or services). Under ASC 606, revenue should be
recognized when (or as) an entity satisfies a performance obligation by
transferring a promised good or service to a customer. In this case, the
retailer satisfies its performance obligation when the customer redeems the gift
certificate and the retailer supplies the associated goods or services to the
customer. Accordingly, upon receipt of a prepayment from a customer, the
retailer should recognize a contract liability for its performance obligation to
transfer, or to stand ready to transfer, the goods or services in the future.
The entity should derecognize that contract liability (and recognize revenue)
when it transfers those goods or services and, therefore, satisfies its
performance obligation.
Customers may not exercise all of their contractual rights for
various reasons. ASC 606 states that such unexercised rights are often referred
to as breakage. Under ASC 606-10-55-46 through 55-49, breakage can be recognized
in earnings before the vendor is legally released from its obligation in certain
circumstances. For example:
- ASC 606-10-55-48 states, in part, “If an entity expects to be entitled to a breakage amount in
a contract liability, the entity should recognize the expected breakage
amount as revenue in proportion to the pattern of rights exercised by
the customer” (emphasis added). Under this approach, the estimated value
of gift certificates that an entity expects will not be redeemed would
be recognized as revenue proportionately as the remaining gift
certificates are redeemed. For example, assume that a retailer issues
$1,000 of gift certificates and, in accordance with ASC 606-10-32-11
through 32-13, expects that $200 of breakage will result on the basis of
a portfolio assessment indicating that 20 percent of the value of all
gift certificates sold will not be redeemed. Therefore, the proportion
of the value of gift certificates not expected to be redeemed compared
to the proportion expected to be redeemed is 20:80. Each time part of a
gift certificate is redeemed, a breakage amount equal to 25 percent (20
÷ 80) of the face value of the redeemed amount will be recognized as
additional revenue (e.g., if a gift certificate for $40 is redeemed, the
breakage amount released will be $10, such that the total revenue
recognized is $50).Entities should not recognize breakage as revenue immediately upon the receipt of payment, even if there is historical evidence to suggest that for a certain percentage of transactions, performance will not be required. As noted in paragraph BC400 of ASU 2014-09, the FASB and IASB “rejected an approach that would have required an entity to recognize estimated breakage as revenue immediately on the receipt of prepayment from a customer. The Boards decided that because the entity has not performed under the contract, recognizing revenue would not have been a faithful depiction of the entity’s performance and also could have understated its obligation to stand ready to provide future goods or services.”For an entity to determine whether it expects to be entitled to a breakage amount, the entity should consider the requirements in ASC 606-10-32-11 through 32-13 on constraining estimates of variable consideration. The entity should use judgment and consider all facts and circumstances when applying this guidance.
-
ASC 606-10-55-48 also states, “If an entity does not expect to be entitled to a breakage amount, the entity should recognize the expected breakage amount as revenue when the likelihood of the customer exercising its remaining rights becomes remote” (emphasis added). For example, assume that a retailer issues $1,000 of gift certificates and applies the guidance in ASC 606-10-32-11 through 32-13 but concludes that it does not expect to be entitled to a breakage amount. Each time part of a gift certificate is redeemed, revenue will be recognized that is equal to the face value of the redeemed amount. Later, after $800 has been redeemed, the entity may determine that there is only a remote possibility that any of the outstanding gift certificate balances will in due course be redeemed. If so, the entity will release the remaining contract liability of $200 and recognize revenue of $200 at that time.
8.8.2 Changes in Expectation of Breakage After Initial Allocation of Revenue
Although the breakage guidance in ASC 606-10-55-48 specifically refers to the
section on constraining estimates of variable consideration (the “constraint” in
ASC 606-10-32-11 through 32-13), breakage is not a form of variable
consideration because it does not affect the transaction price. In the absence
of variable consideration, the requirement in ASC 606-10-32-14 to reassess the
transaction price at the end of each reporting period does not apply. Therefore,
a change in the estimate of breakage will not cause the original amount
allocated to the expected breakage to be amended. However, the expected breakage
could affect the timing of recognition of revenue because an entity that expects
to be entitled to a breakage amount is required under ASC 606-10-55-48 to
“recognize the expected breakage amount as revenue in proportion to the pattern
of rights exercised by the customer.”
The example below illustrates how changes in expected breakage
could affect the timing of revenue recognition.
Example 8-18
Entity M sells a product to Customer H
and, as part of the same transaction, awards H a
specific number of loyalty points that can be redeemed
at a future date as and when the customer purchases
additional products from M. The sale is made for cash
consideration of $100, and no refund is available to the
customer for unused loyalty points.
In accordance with ASC 606, M is
required to allocate the revenue between the product
sold and the loyalty points (material rights) that can
be redeemed in the future. On the basis of a relative
stand-alone selling price method (which would include
expectations related to the level of loyalty points that
will not be redeemed [i.e., “breakage”]), M determines
that the appropriate allocation is $80 to the product
sold and $20 to the loyalty points.
Because breakage is not a form of
variable consideration (in this example, M always
remains entitled to the original cash consideration of
$100), the requirement in ASC 606-10-32-14 to reassess
the transaction price at the end of each reporting
period does not apply. Therefore, a change in the
estimate of breakage will not cause the original
allocation of $80 to the product and $20 to the points
to be amended.
The expected breakage could, however,
affect the timing of recognition of revenue with respect
to the $20 allocated to the loyalty points. This is
because M is required under ASC 606-10-55-48 to
“recognize the expected breakage amount as revenue in
proportion to the pattern of rights exercised by the
customer.”
Similarly, if M sells gift cards on a
stand-alone basis, the transaction price will be fixed
at the amount paid by the customer irrespective of the
expected breakage amount. Thus, the expected breakage
affects only the timing of revenue recognition, not the
total amount of revenue to be recognized, and therefore
is not a form of variable consideration.
See Section 8.8.1 on accounting
for sales of gift certificates that may not be redeemed.
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.
Chapter 9 — Contract Modifications
Chapter 9 — Contract Modifications
9.1 Defining a Contract Modification
9.1.1 In General
Contract modifications can frequently happen in the normal course of business.
Any time an entity and its customer agree to change what the entity promises to
deliver or the amount of consideration the customer will pay (i.e., creates or
changes the enforceable rights or obligations in a preexisting contract), there
is a contract modification.
ASC 606 defines a contract modification as follows:
ASC 606-10
25-10 A contract modification
is a change in the scope or price (or both) of a
contract that is approved by the parties to the
contract. In some industries and jurisdictions, a
contract modification may be described as a change
order, a variation, or an amendment. A contract
modification exists when the parties to a contract
approve a modification that either creates new or
changes existing enforceable rights and obligations of
the parties to the contract. A contract modification
could be approved in writing, by oral agreement, or
implied by customary business practices. If the parties
to the contract have not approved a contract
modification, an entity shall continue to apply the
guidance in this Topic to the existing contract until
the contract modification is approved.
25-11 A contract modification
may exist even though the parties to the contract have a
dispute about the scope or price (or both) of the
modification or the parties have approved a change in
the scope of the contract but have not yet determined
the corresponding change in price. In determining
whether the rights and obligations that are created or
changed by a modification are enforceable, an entity
shall consider all relevant facts and circumstances
including the terms of the contract and other evidence.
If the parties to a contract have approved a change in
the scope of the contract but have not yet determined
the corresponding change in price, an entity shall
estimate the change to the transaction price arising
from the modification in accordance with paragraphs
606-10-32-5 through 32-9 on estimating variable
consideration and paragraphs 606-10-32-11 through 32-13
on constraining estimates of variable consideration.
The purpose of the contract modification guidance in the revenue standard is to
create a single framework for accounting for modifications that will enable
entities to account for them consistently across all industries. Therefore,
claims, change orders, variations, or other terms that refer to a change in a
contract should be evaluated in accordance with the revenue standard’s contract
modification guidance.
9.1.2 Differentiating Changes in the Transaction Price From Contract Modifications
While contract modifications often result in a change in the transaction price,
not all changes in the transaction price are related to contract modifications.
An entity should consider whether a change in the price is due to (1) the
resolution of variability that existed at contract inception or (2) a change in
the scope or price (or both) of the contract that changes the parties’ rights
and obligations after contract inception. An entity will need to use judgment to
determine whether a change in price is the result of a change in the transaction
price or a contract modification, especially when the entity provides the
customer with a price concession. As noted in Section
7.6.2, this distinction is important because the resolution of
variability that existed at contract inception is accounted for in accordance
with ASC 606-10-32-43 and 32-44, whereas ASC 606-10-32-45 states that changes in
the transaction price that are related to a contract modification are accounted
for in accordance with the contract modification guidance in ASC 606-10-25-10
through 25-13.
9.1.3 Determining Whether a Contract Modification Is Approved
The first step in the identification of a contract modification is to assess
whether, for a contract accounted for under ASC 606, there has been a change in
the contract’s scope (e.g., a change in the quantity or type of goods or
services to be provided or the duration of the contract) or price, or both. The
second step is to determine whether the parties to the contract have agreed upon
the change. As defined above, contract modifications must be agreed to by both
parties (written, orally, or through customary business practices). That is,
both parties must agree to change the enforceable rights and obligations of the
contract.
However, the requirement that a contract modification must be agreed to by both
parties does not mean that the parties must be in full agreement on all details.
For example, there can be situations in which both parties agree to modify a
contract but there is discrepancy about the amount of consideration to be paid.
Instead of determining whether all of the terms of a contract modification have
been agreed to, an entity should assess whether it has the right to be
compensated for satisfying the modified contract. Making this determination will
require judgment. Further, a modification can be accounted for as either a
separate contract or a combined contract, as discussed below. Entities may need
to use judgment when determining when a contract extension has been approved
after the expiration of an existing contract, as highlighted in Section 4.3.1.
Example 9 in ASC 606, which is reproduced below, illustrates how an entity may be required to make certain judgments when determining whether a contract modification has been approved. In the example, the entity is required to assess the legal enforceability of a contract modification that the customer did not enter into voluntarily.
ASC 606-10
Example 9 — Unapproved Change in Scope and Price
55-134 An entity enters into
a contract with a customer to construct a building on
customer-owned land. The contract states that the
customer will provide the entity with access to the land
within 30 days of contract inception. However, the
entity was not provided access until 120 days after
contract inception because of storm damage to the site
that occurred after contract inception. The contract
specifically identifies any delay (including force
majeure) in the entity’s access to customer-owned land
as an event that entitles the entity to compensation
that is equal to actual costs incurred as a direct
result of the delay. The entity is able to demonstrate
that the specific direct costs were incurred as a result
of the delay in accordance with the terms of the
contract and prepares a claim. The customer initially
disagreed with the entity’s claim.
55-135 The entity assesses
the legal basis of the claim and determines, on the
basis of the underlying contractual terms, that it has
enforceable rights. Consequently, it accounts for the
claim as a contract modification in accordance with
paragraphs 606-10-25-10 through 25-13. The modification
does not result in any additional goods and services
being provided to the customer. In addition, all of the
remaining goods and services after the modification are
not distinct and form part of a single performance
obligation. Consequently, the entity accounts for the
modification in accordance with paragraph
606-10-25-13(b) by updating the transaction price and
the measure of progress toward complete satisfaction of
the performance obligation. The entity considers the
constraint on estimates of variable consideration in
paragraphs 606-10-32-11 through 32-13 when estimating
the transaction price.
There may be circumstances in which an entity and its customer
agree on what is often referred to as an “unpriced change order” (i.e., a change
in the scope of the contract before the parties have agreed on the related
change in price). In this situation, the entity should estimate the change in
the transaction price in a manner consistent with the guidance on estimating
variable consideration (see Section 6.3.2 for a discussion of that guidance). The entity
will most likely need to use judgment in this situation and consider all
relevant facts and circumstances when estimating the change in the transaction
price. For example, the entity’s prior history of working in a particular
industry or jurisdiction and with the specific customer may provide evidence of
the price that will ultimately be approved.
The example below illustrates the factors that an entity may
consider in determining whether an unpriced change order has been approved by
both parties.
Example 9-1
Entity SF designs, manufactures, and
installs custom closets and other home organization
systems. While SF is often engaged by individual
homeowners to redesign closet space, SF also works
frequently with one specific home builder, Entity PJ.
During the installation of a closet system for a home
that PJ is building, the two parties discuss additional
enhancements to be made to the closet system. Because of
time constraints on finishing the home, SF begins work
on the enhancements immediately, before the parties have
decided on the additional transaction price related to
the change in scope.
In determining whether the change in
scope has been approved and represents a contract
modification, SF considers the following factors:
-
The parties have worked together in the past, in the same geographic region, approximately 50 times.
-
All previous contracts have been negotiated without disagreement, and the parties have a history of changing the scope of the work before negotiating an updated price. There have been no disagreements on the ultimate price change related to changes in scope.
-
While the entities generally document their contracts in the form of a written contract, there has been sufficient history to enable SF to be certain that it will have an enforceable right to payment for the additional work that PJ asked it to perform.
-
Entity SF believes that PJ will agree to pay for both the incremental costs of the change in scope and a reasonable profit margin in a manner consistent with SF’s other contracts with PJ.
-
The jurisdiction in which the agreement is in effect does not have additional legal precedent or regulations that would override or affect the legal enforceability of SF’s right to payment for the additional work to be performed.
On the basis of these indicators, SF
concludes that the parties have agreed to a contract
modification. Entity SF estimates the change in the
transaction price in a manner consistent with the
guidance in ASC 606 on estimating the transaction price.
Entity SF will reassess this estimate of variable
consideration each reporting period until SF and PJ
agree on the transaction price related to the change in
scope of the modified contract.
9.1.4 Entering Into a New Contract With an Existing Customer
When an entity enters into a new contract with an existing
customer, the entity should consider whether the new contract should be
accounted for as a contract modification. There may be no economic difference
between whether an entity and its customer modify an existing contract by (1)
executing a legal contract whose extant written terms explicitly amend the scope
or price of the original contract or (2) executing a new and separate legal
contract that meets one or more of the criteria in ASC 606-10-25-9 to be
combined with one or more contracts and accounted for as a single contract.
Section 4.7
describes the factors in ASC 606-10-25-9 that an entity should consider when
determining whether multiple contracts with a single customer should be combined
and accounted for as a single contract.
At times, the determination of whether a new contract is a
modification of an existing contract may be relatively simple. For example, an
entity may be able to conclude relatively easily that a new contract does not
modify an existing contract if the promised goods and services in the original
contract are unrelated to and priced independently of those in the new contract
(i.e., the additional goods or services are distinct and priced at their
stand-alone selling prices).
However, in other circumstances, even when the new agreement is
not explicitly structured as a modification to the original contract, the entity
may need to use judgment when making this determination. In addition to the
considerations described in Section 4.7, the entity may need to assess whether
and, if so, why any of the promised goods or services are priced at a discount
in the newly negotiated contract (e.g., whether the favorable terms were offered
solely because of the existing relationship). The entity may also need to
understand the substance of the negotiations between the two parties when
executing the new agreement to faithfully depict the recognition of revenue
related to the goods or services promised to the customer. For example, the
revenue recognition pattern of a combined, modified contract, whose combined
transaction price would need to be allocated to the goods and services of the
combined contract, may be different from that of a newly negotiated contract
accounted for as a separate unrelated contract, whose independent transaction
price would be allocated to fewer goods and services.
9.2 Types of Contract Modifications
If a change in a contract qualifies as a contract modification under
ASC 606-10-25-10 and 25-11, the entity must assess the goods and services and their
selling prices. Depending on whether those goods and services are distinct or sold
at their stand-alone selling prices, a modification can be accounted for as:
-
A separate contract (see ASC 606-10-25-12).
-
One of the following (if the modification is not accounted for as a separate contract):
-
A termination of the old contract and the creation of a new contract (see ASC 606-10-25-13(a)).
-
A cumulative catch-up adjustment to the original contract (see ASC 606-10-25-13(b)).
-
A combination of the items described in ASC 606-10-25-13(a) and (b), in a way that faithfully reflects the economics of the transaction (see ASC 606-10-25-13(c)).
-
The flowchart below explains the decisions needed to (1) identify
modifications made to a contract and (2) determine how an entity should account for
each type of contract modification.
1
If the answer is “Yes” for some goods or services
and “No” for others, it may be appropriate to apply both models to a
single contract, in the manner described in ASC 606-10-25-13(c), on
the basis of an assessment at the performance obligation level. See
Section
9.2.2.
2
For illustrative examples, see Example 9-3; ASC
606-10, Examples 8 and 9; and Example
9-7.
3
For illustrative examples, see Example 9-2; ASC
606-10, Example 5, Case B; ASC 606-10, Example 7; Example 9-6; Example 9-8;
and ASC 606-10, Example 6
9.2.1 Contract Modification Accounted for as a Separate Contract
ASC
606-10
25-12 An entity shall account
for a contract modification as a separate contract if
both of the following conditions are present:
-
The scope of the contract increases because of the addition of promised goods or services that are distinct (in accordance with paragraphs 606-10-25-18 through 25-22).
-
The price of the contract increases by an amount of consideration that reflects the entity’s standalone selling prices of the additional promised goods or services and any appropriate adjustments to that price to reflect the circumstances of the particular contract. For example, an entity may adjust the standalone selling price of an additional good or service for a discount that the customer receives, because it is not necessary for the entity to incur the selling-related costs that it would incur when selling a similar good or service to a new customer.
When an entity accounts for a contract modification as a
separate contract in accordance with ASC 606-10-25-12, the entity’s accounting
for the original contract is not affected by the modification. Any revenue
recognized through the date of the modification is not adjusted, and remaining
performance obligations will continue to be accounted for under the original
contract. The new contract is accounted for separately from the original
contract and on a prospective basis.
There is no economic difference between (1) a modification of an
existing contract with a customer that includes additional distinct goods
or services at their representative stand-alone selling prices and (2) a
completely new contract entered into by the two parties for goods or services at
their representative stand-alone selling prices. Therefore, a modification of an
existing contract should be accounted for as a new contract that is separate and
apart from the existing contract when (1) there are additional distinct
goods or services promised to a customer and (2) those goods or services
are in exchange for consideration that represents the stand-alone selling prices
of the additional distinct promised goods or services. The change in scope must
be an increase rather than a decrease in the quantity of promised goods or
services because by its very nature, a new contract that decreases the quantity
of goods or services promised in the original contract is inherently modifying
the original contract (i.e., the new contract is not separate).
When considering whether the price charged to the customer
represents the stand-alone selling prices of additional distinct promised goods
or services, entities are allowed to adjust the stand-alone selling prices to
reflect a discount for costs they do not incur because they have modified a
contract with an existing customer. For example, the renewal price that an
entity charges a customer is sometimes lower than the initial price because the
entity recognizes that the expenses associated with obtaining a new customer can
be excluded from the renewal price to provide a discount to the existing
customer. This lower renewal price may reflect the stand-alone selling prices of
additional distinct goods or services provided in the renewed contract. See
Section 7.3 for
a discussion of the guidance on determining stand-alone selling prices and
Section 7.6 for
a discussion of the guidance on changes in the transaction price.
Connecting the Dots
If a modification is accounted for as a separate
contract in accordance with ASC 606-10-25-12, the original contract is
treated as unmodified for the purposes of ASC 606. However, if a
contract modification does not qualify for the accounting under ASC
606-10-25-12, determining how to account for the modification can be
more challenging.
For example, assume that Company X has entered into a
contract to provide a customer with 100 units of Product A over 10
years. Five years into the term of the original contract, the contract
is modified by agreement of the parties to provide the customer with an
additional 25 units of Product B at Product B’s stand-alone selling
price. In addition, both products are capable of being distinct and are
distinct within the context of the contract. Therefore, on the basis of
these two factors, the modification would be treated as a separate
contract.
In contrast, assume that X agrees to provide the
customer with 25 more units of Product A instead of Product B. The
additional units are the same as the previous Product A provided to the
customer. Company X would have to determine as of the date of the
modification whether it is selling the additional units of Product A at
their stand-alone selling price at the time of the modification. As
previously mentioned, five years have passed between the original
contract and the modification. Assuming that the price of Product A has
changed over this time, X has to determine the stand-alone selling price
of the additional goods to be delivered at the date of the modification
to determine how to account for the modification. Specifically, if the
additional goods are being sold at their then-current stand-alone
selling price, the modification would represent a separate contract to
be accounted for in accordance with ASC 606-10-25-12; but if the
additional goods are not being sold at their then-current stand-alone
selling price, the modification would be accounted for as a termination
of the existing contract and the creation of a new contract in
accordance with ASC 606-10-25-13(a).
The following example in ASC 606 illustrates an entity’s
assessment of whether a contract modification represents a separate
contract:
ASC
606-10
Example 5 — Modification of a Contract for Goods
55-111 An entity promises to
sell 120 products to a customer for $12,000 ($100 per
product). The products are transferred to the customer
over a six-month period. The entity transfers control of
each product at a point in time. After the entity has
transferred control of 60 products to the customer, the
contract is modified to require the delivery of an
additional 30 products (a total of 150 identical
products) to the customer. The additional 30 products
were not included in the initial contract.
Case A — Additional Products for a Price That Reflects the Standalone Selling
Price
55-112 When the contract is
modified, the price of the contract modification for the
additional 30 products is an additional $2,850 or $95
per product. The pricing for the additional products
reflects the standalone selling price of the products at
the time of the contract modification, and the
additional products are distinct (in accordance with
paragraph 606-10-25-19) from the original
products.
55-113 In accordance with
paragraph 606-10-25-12, the contract modification for
the additional 30 products is, in effect, a new and
separate contract for future products that does not
affect the accounting for the existing contract. The
entity recognizes revenue of $100 per product for the
120 products in the original contract and $95 per
product for the 30 products in the new contract.
9.2.2 Contract Modification Not Accounted for as a Separate Contract
ASC
606-10
25-13 If a contract
modification is not accounted for as a separate contract
in accordance with paragraph 606-10-25-12, an entity
shall account for the promised goods or services not yet
transferred at the date of the contract modification
(that is, the remaining promised goods or services) in
whichever of the following ways is applicable:
- An entity shall account for the contract modification as if it were a termination of the existing contract, and the creation of a new contract, if the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification. The amount of consideration to be allocated to the remaining performance obligations (or to the remaining distinct goods or services in a single performance obligation identified in accordance with paragraph 606-10-25-14(b)) is the sum of:
- The consideration promised by the customer (including amounts already received from the customer) that was included in the estimate of the transaction price and that had not been recognized as revenue and
- The consideration promised as part of the contract modification.
- An entity shall account for the contract modification as if it were a part of the existing contract if the remaining goods or services are not distinct and, therefore, form part of a single performance obligation that is partially satisfied at the date of the contract modification. The effect that the contract modification has on the transaction price, and on the entity’s measure of progress toward complete satisfaction of the performance obligation, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) at the date of the contract modification (that is, the adjustment to revenue is made on a cumulative catch-up basis).
- If the remaining goods or services are a combination of items (a) and (b), then the entity shall account for the effects of the modification on the unsatisfied (including partially unsatisfied) performance obligations in the modified contract in a manner that is consistent with the objectives of this paragraph.
A contract modification that does not meet the requirements
outlined in Section 9.2.1
is not accounted for as a separate contract. Therefore, an entity would have to
determine how to account for a blended contract that now includes one or both of
the following:
- An original agreement plus or minus other goods or services.
- A change in the amount of consideration due under the modified arrangement.
The determination of which model to use depends on whether the
remaining goods or services (the originally promised items and the newly
promised items) are distinct from the goods and services already provided
under the contract.
In accordance with ASC 606-10-25-13(a), if the remaining goods
or services are distinct from the goods or services already provided under the
original arrangement, the entity would in effect establish a “new” contract that
includes only those remaining goods and services. In this situation, the entity
would allocate to the remaining performance obligations (or distinct goods or
services) in the contract (1) consideration from the original contract that has
not yet been recognized as revenue and (2) any additional consideration from the
modification. Such a situation would arise when there is a modification to a
contract that contains (1) remaining distinct performance obligations or (2) a
single performance obligation accounted for as a series of distinct goods or
services under ASC 606-10-25-14(b) (see Section 5.3.3).
In contrast, in accordance with ASC 606-10-25-13(b), if the
contract modification results in remaining goods and services that are not
distinct, the entity should account for the modification as though the
additional goods and services were an addition to an incomplete performance
obligation. This may be the case in a situation involving a construction-type
contract to build a single complex when the original contract includes certain
specifications and, as the construction progresses, the parties modify the terms
to change certain requested features of the complex. In this instance, a measure
of progress would typically be used to recognize revenue over time. For example,
suppose that just before the modification, the entity’s performance was 30
percent complete. After the modification, the entity may determine that its
performance is only 25 percent complete because the scope of the single
performance obligation increased (or is 35 percent complete because the scope of
the single performance obligation decreased). As a result, an updated revenue
figure is calculated on the basis of the revised percentage, and the entity
would record a cumulative catch-up adjustment.
The FASB and IASB recognized that there may be contracts in
which some performance obligations include remaining goods or services that are
distinct from the goods or services already provided under the original
arrangement, while other performance obligations include remaining goods and
services that are not (i.e., a change in scope of a partially satisfied
performance obligation). The boards decided that in those circumstances, it may
be appropriate for an entity to apply both models to a single contract, in the
manner described in ASC 606-10-25-13(c), on the basis of an assessment at the
performance obligation level. An entity would do so by considering whether, for
the performance obligations that are not yet fully satisfied (including those
that are partially satisfied), the remaining goods or services to be transferred
in accordance with the promise are distinct from the goods or services
previously transferred. No change would be made to revenue recognized for fully
satisfied performance obligations.
9.2.2.1 Repetitive Versus Accumulating Performance Obligations
Contract modifications will have different accounting
implications for different types of performance obligations (i.e.,
repetitive or accumulating). An example of a repetitive performance
obligation would be an entity’s promise to deliver the same good or service
to a customer numerous times over an agreed-upon period, such as a
performance obligation that meets the definition of a series in ASC
606-10-25-14(b). An example of an accumulating performance obligation would
be a promise to perform many different procedures or activities over time to
produce the final good or service to be provided to a customer, such as a
performance obligation treated under ASC 606-10-25-14(a) as a bundle of
goods or services that is distinct.
The example below illustrates how an entity would account
for a modification of a repetitive performance obligation that meets the
requirements of ASC 606-10-25-13(a).
Example 9-2
Modification of a Repetitive
Performance Obligation
Company A has a contract with Customer B to provide 10 widgets at $10 per
widget. The $10 represents the stand-alone selling
price of the widget. Customer B pays A the full
consideration amount of $100 up front. These widgets
will be delivered to B over five years. Company A
concludes that the performance obligation to deliver
10 widgets over five years qualifies for revenue
recognition over time and meets the definition of a
series in ASC 606-10-25-14(b). Assume that the
contract does not have a significant financing
component.
After three years, 5 widgets have been delivered to B (and revenue of $50 has
been recognized), but B decides that it wants an
additional 15 widgets (a total of 25 widgets).
Company A agrees to sell the additional 15 widgets
to B for $4 per widget. This price does not
represent the stand-alone selling price of the
widgets, and it is adjusted by more than the normal
expenses that A would incur to obtain a new
customer. In addition, the widgets are produced
sequentially, and B’s request for additional widgets
occurs immediately after delivery of the 5th widget
but before production of the remaining widgets
begins.
If each of the
widgets in the original contract were determined to
be distinct (see Chapter 5 for
further analysis), A would apply the guidance in ASC
606-10-25-13(a) to this fact pattern because the
remaining widgets are also distinct goods but are
not sold at their stand-alone selling price.
Therefore, A would reallocate the remaining
consideration of both the original contract ($50)
and the modification ($60) to the remaining
performance obligations. In this example, A would
allocate $110 across the remaining 20 widgets. As
each widget is delivered, $5.50 would be recognized
as revenue for A.
In contrast to the example above, the example below
illustrates how an entity would account for a modification of an
accumulating performance obligation accounted for under ASC
606-10-25-13(b).
Example 9-3
Modification of an
Accumulating Performance Obligation
Assume that the original contract in the example above was determined to contain
a single performance obligation that included an
extensive and highly customized integration service
that in effect reworked each widget as additional
widgets were developed. Therefore, Company A
identified a single performance obligation to
deliver to Customer B a complete solution (that
includes the original 10 widgets). Also assume that
(1) revenue in the fact pattern is being recognized
over time in accordance with ASC 606-10-25-27 and
(2) as of the date of modification, but before the
contract is actually modified, A has concluded that
the contract is 40 percent complete. Company A has
determined that the additional 15 widgets are not
distinct from the original 10 widgets and that
together, both sets of widgets still form a complete
solution (a single project) that is being delivered
to the customer.
Under these
new facts, A would combine the goods and services
from the original contract and the modification to
the contract. No allocation is necessary since there
is only a single performance obligation. However, A
would need to determine the extent to which it has
completed its modified performance obligation.
Assume that A determines that the modified performance obligation is now 20
percent complete. Further assume that before the
modification, A recorded $40 of revenue ($100 ×
40%). Upon modification, A would record an entry to
reduce revenue by $8 ($160 × 20%, or $32, less $40)
to catch up on previously recognized revenue to
represent A’s performance to date on the basis of
the modified contract terms and in accordance with
ASC 606-10-25-13(b). Subsequently, A would recognize
the remaining $128 ($160 − $32) as it completely
satisfies the remaining performance obligation.
The table below lays out the facts of these two examples
side by side for comparison.
Fact Pattern 1 (Repetitive) | Fact Pattern 2 (Accumulating) | |
---|---|---|
Contract length | January 1, 2015, through December 31, 2020 | January 1, 2015, through December 31, 2020 |
Original obligation | Deliver 10 distinct widgets | Integrate 10 widgets into one complete solution
(i.e., one performance obligation) |
Consideration | $10 per widget | $100 for integration |
Modification date | January 1, 2018 | January 1, 2018 |
Performance completed to date | 5
widgets delivered | 40% integrated |
Total remaining consideration | $50 | $60 |
Additional goods and services | Deliver 15 additional distinct widgets | Integrate 15 additional widgets into one complete
solution (i.e., one performance
obligation) |
Price for additional goods and services | $4 per widget | $4 per widget |
Total additional consideration | $60 | $60 |
Are the additional goods and services both capable
of being distinct and distinct in the context of the
contract? | Yes | No |
Additional goods and services at stand-alone
selling price? | No | No |
Applicable modification guidance | ASC 606-10-25-13(a) | ASC 606-10-25-13(b) |
Cumulative catch-up? | No | Yes |
Cumulative catch-up amount | N/A | ($100 + $60) × 20% = $32
$100 × 40% = $40 Cumulative
catch-up = –$8 |
Consideration to recognize
prospectively | (5 × $10) + (15 × $4) = $110 10 – 5 + 15 = 20 Revenue per widget =
$5.50 | $128 recognized as remaining performance obligation
is satisfied |
These two examples, which each involve a single performance
obligation, demonstrate the difference in accounting for a contract
modification when that single performance obligation either (1) represents a
series of distinct goods or services that are substantially the same and
have the same pattern of transfer to the customer or (2) represents a
combined performance obligation because the bundle of goods or services
either (a) is not capable of being distinct or (b) is not distinct within
the context of the contract. When the remaining goods or services to be
transferred are distinct, the entity will, in effect, terminate the original
contract and establish a “new” contract (i.e., prospectively). When the
remaining goods or services to be transferred are not distinct, the
subsequent accounting for an identified contract modification will be, in
effect, an adjustment (through a cumulative catch-up) to the original
contract.
Contract modification accounting is heavily dependent on
whether the remaining goods or services to be transferred are distinct from
goods or services transferred before the modification. This further
highlights the importance of appropriately identifying all distinct
performance obligations in a contract, including an assessment of whether
one or more performance obligations in a contract are required to be
accounted for as a series in accordance with ASC 606-10-25-14(b). Contract
modifications are evaluated at the performance obligation level unless the
performance obligation is accounted for as a series, in which case contract
modifications are evaluated at the level of the distinct goods or services
that make up the series, as illustrated above. See Chapter 5 for a
detailed discussion of the identification of performance obligations in a
contract, including the requirement to identify as a performance obligation
each promise to transfer to a customer a series of distinct goods or
services that are substantially the same and have the same pattern of
transfer to the customer.
The following examples in ASC 606 further illustrate a
modification of a contract that contains a repetitive performance obligation
(Example 7) and a modification of a contract that contains an accumulating
performance obligation (Example 8):
ASC 606-10
Example 7 — Modification of a Services Contract
55-125 An entity enters into
a three-year contract to clean a customer’s offices
on a weekly basis. The customer promises to pay
$100,000 per year. The standalone selling price of
the services at contract inception is $100,000 per
year. The entity recognizes revenue of $100,000 per
year during the first 2 years of providing services.
At the end of the second year, the contract is
modified and the fee for the third year is reduced
to $80,000. In addition, the customer agrees to
extend the contract for 3 additional years for
consideration of $200,000 payable in 3 equal annual
installments of $66,667 at the beginning of years 4,
5, and 6. The standalone selling price of the
services for years 4 through 6 at the beginning of
the third year is $80,000 per year. The entity’s
standalone selling price at the beginning of the
third year, multiplied by the additional 3 years of
services, is $240,000, which is deemed to be an
appropriate estimate of the standalone selling price
of the multiyear contract.
55-126 At contract inception,
the entity assesses that each week of cleaning
service is distinct in accordance with paragraph
606-10-25-19. Notwithstanding that each week of
cleaning service is distinct, the entity accounts
for the cleaning contract as a single performance
obligation in accordance with paragraph 606-10-
25-14(b). This is because the weekly cleaning
services are a series of distinct services that are
substantially the same and have the same pattern of
transfer to the customer (the services transfer to
the customer over time and use the same method to
measure progress — that is, a time-based measure of
progress).
55-127 At the date of the
modification, the entity assesses the additional
services to be provided and concludes that they are
distinct. However, the price change does not reflect
the standalone selling price.
55-128 Consequently, the
entity accounts for the modification in accordance
with paragraph 606-10-25-13(a) as if it were a
termination of the original contract and the
creation of a new contract with consideration of
$280,000 for 4 years of cleaning service. The entity
recognizes revenue of $70,000 per year ($280,000 ÷ 4
years) as the services are provided over the
remaining 4 years.
Example 8 — Modification Resulting
in a Cumulative Catch-Up Adjustment to Revenue
55-129 An entity, a
construction company, enters into a contract to
construct a commercial building for a customer on
customer-owned land for promised consideration of $1
million and a bonus of $200,000 if the building is
completed within 24 months. The entity accounts for
the promised bundle of goods and services as a
single performance obligation satisfied over time in
accordance with paragraph 606-10-25-27(b) because
the customer controls the building during
construction. At the inception of the contract, the
entity expects the following:
55-130 At contract inception,
the entity excludes the $200,000 bonus from 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. Completion of the building is highly
susceptible to factors outside the entity’s
influence, including weather and regulatory
approvals. In addition, the entity has limited
experience with similar types of contracts.
55-131 The entity determines
that the input measure, on the basis of costs
incurred, provides an appropriate measure of
progress toward complete satisfaction of the
performance obligation. By the end of the first
year, the entity has satisfied 60 percent of its
performance obligation on the basis of costs
incurred to date ($420,000) relative to total
expected costs ($700,000). The entity reassesses the
variable consideration and concludes that the amount
is still constrained in accordance with paragraphs
606-10-32-11 through 32-13. Consequently, the
cumulative revenue and costs recognized for the
first year are as follows:
55-132 In the first quarter
of the second year, the parties to the contract
agree to modify the contract by changing the floor
plan of the building. As a result, the fixed
consideration and expected costs increase by
$150,000 and $120,000, respectively. Total potential
consideration after the modification is $1,350,000
($1,150,000 fixed consideration + $200,000
completion bonus). In addition, the allowable time
for achieving the $200,000 bonus is extended by 6
months to 30 months from the original contract
inception date. At the date of the modification, on
the basis of its experience and the remaining work
to be performed, which is primarily inside the
building and not subject to weather conditions, the
entity concludes that it is probable that including
the bonus in the transaction price will not result
in a significant reversal in the amount of
cumulative revenue recognized in accordance with
paragraph 606-10-32-11 and includes the $200,000 in
the transaction price. In assessing the contract
modification, the entity evaluates paragraph
606-10-25-19(b) and concludes (on the basis of the
factors in paragraph 606-10-25-21) that the
remaining goods and services to be provided using
the modified contract are not distinct from the
goods and services transferred on or before the date
of contract modification; that is, the contract
remains a single performance obligation.
55-133 Consequently, the
entity accounts for the contract modification as if
it were part of the original contract (in accordance
with paragraph 606-10-25-13(b)). The entity updates
its measure of progress and estimates that it has
satisfied 51.2 percent of its performance obligation
($420,000 actual costs incurred ÷ $820,000 total
expected costs). The entity recognizes additional
revenue of $91,200 [(51.2 percent complete ×
$1,350,000 modified transaction price) – $600,000
revenue recognized to date] at the date of the
modification as a cumulative catch-up
adjustment.
9.2.2.2 Blend-and-Extend Contract Modifications
9.2.2.2.1 Blend-and-Extend Contract Modifications in the Power and Utilities Industry
A common transaction in the power and utilities
(P&U) industry, a blend-and-extend (B&E) contract modification
refers to an agreement between an entity and a customer that are already
in a contract to change the amount of consideration to be paid and
extend the length of the contract term.
For B&E contract modifications, stakeholders have
questioned how the payment terms affect the evaluation of the contract
modification (i.e., whether the modification should be accounted for as
a separate contract or a termination of the existing contract and the
creation of a new contract). In a typical B&E modification, the
supplier and customer may renegotiate the contract to allow the customer
to take advantage of lower commodity pricing while the supplier
increases its future delivery portfolio. Under such circumstances, the
customer and supplier agree to extend the contract term and “blend” the
remaining original, higher contract rate with the lower market rate of
the extension period for the remainder of the combined term. The
supplier therefore defers the cash realization of some of the contract
fair value that it would have received under the original contract terms
until the extension period, at which time it will receive an amount that
is greater than the market price for the extension- period deliveries as
of the date of the modification.
For example, a supplier and a customer enter into a
fixed-volume, five-year forward sale of electricity at a fixed price of
$50 per unit. Years 1 through 3 have passed, and both parties have met
all of their performance and payment obligations for those years.
At the beginning of year 4, the customer approaches the
supplier and asks for a two-year contract extension, stretching the
remaining term to four years. Electricity prices have gone down since
the original agreement was executed; as a result, a fixed price for the
two-year extension period is $40 per unit based on forward market price
curves that exist at the beginning of year 4. The customer would like to
negotiate a lower rate now while agreeing to extend the term of the
original deal.
The supplier and customer agree to a B&E contract
modification. Under the modification, the $50-per-unit fixed price from
the original contract with two years remaining is blended with the
$40-per-unit fixed price for the two-year extension period. The
resulting blended rate for the four remaining delivery years is $45 per
unit.
There has been uncertainty about whether the supplier
should compare (1) the net increase in the contract consideration (i.e.,
the total increase in consideration that the entity expects to be
entitled to under the modified contract, including any changes to the
prices of the remaining goods or services in the original contract) with
the total stand-alone selling price of the goods or services added
during the extension period or (2) the revised blended price the
customer will pay for the additional goods or services (i.e., the
$45-per-unit blended price paid for the goods or services delivered
during the extension period) with the stand-alone selling price of those
goods or services. In addition, the total transaction price may need to
be reevaluated because the blending of the prices may create a
significant financing component under the view that some of the
consideration for the current goods or services is paid later as a
result of the blending of the price for the remainder of the combined
term.
The AICPA’s P&U industry task force originally added
this item to its agenda. However, it was unable to reach a consensus on
whether a B&E contract modification should be accounted for as (1) a
separate contract for the additional goods or services in accordance
with ASC 606-10- 25-12 (“View A”) or (2) the termination of an existing
contract and the creation of a new contract in accordance with ASC
606-10-25-13(a) (“View B”). The issue was discussed with the AICPA’s
revenue recognition working group but was ultimately elevated to a
discussion with the FASB staff through the staff’s technical inquiry
process.
During that process, the FASB staff indicated that both
views are acceptable but noted that View B is more consistent with the
staff’s interpretation of the contract modification guidance in the
revenue standard. The staff also indicated that entities will still need
to assess whether B&E transactions include significant financing
components; however, the staff noted that it did not think that every
B&E contract modification inherently involves a financing
component.
The application of View A or View B focuses on whether
the goods or services added during the extension period are priced at
their stand-alone selling price. However, we believe that it is also
acceptable for an entity to conclude that a B&E contract
modification is always a termination of an existing contract and the
creation of a new contract (i.e., an entity is not required to perform
an analysis of the stand-alone selling price of the additional goods or
services). The B&E contract modification is not just an increase in
a contract’s scope (e.g., an extension of the arrangement) in exchange
for an incremental fee because the pricing of the remaining goods or
services in the original contract is also adjusted. That is, if the
modification does not solely add goods or services for an incremental
fee as described in ASC 606-10-25-12 (i.e., the modification also
adjusts the pricing of the original goods or services), it would not be
accounted for as a separate contract.
9.2.2.2.2 Blend-and-Extend Contract Modifications Related to a SaaS Arrangement
An entity that sells a SaaS solution may modify its
arrangements before the end of the initial contract term by renewing the
initial contract and revising the pricing on a “blended” basis for the
remaining term, particularly if prices have decreased (i.e., a B&E
contract modification). In such circumstances, the entity and its
customer agree to extend the contract term and “blend” the remaining
original, higher contract rate with the lower rate of the extension
period for the remainder of the combined term. Consequently, when
navigating the contract modification guidance, the entity may find it
difficult to determine the appropriate accounting treatment. In a
typical B&E contract modification in the SaaS industry, the entity
would account for such a modification as either (1) a separate contract
for the added services under ASC 606-10-25-12 or (2) a termination of
the existing contract and the creation of a new contract under ASC
606-10-25-13(a).5 The determination of which model to apply may be based on whether
the additional services are priced at their stand-alone selling prices
(i.e., whether the conditions in ASC 606-10-25-12 are met).
We believe there are three alternatives for an entity to consider in
determining how to account for a B&E contract modification.
In accordance with ASC 606-10-25-12(b), to determine whether a
modification results in a separate contract, an entity must assess
whether the price of the contract increases by an amount that reflects
the stand-alone selling prices of the additional promised goods or
services. We believe that if a modification is not just an increase in a
contract’s scope (e.g., an extension of the SaaS arrangement) in
exchange for an incremental fee because the pricing of the remaining
goods or services in the original contract is also adjusted, it would be
appropriate for the entity to account for the modification as a
termination of an existing contract and the creation of a new contract.
This is because the modification does not solely add goods or services
for an incremental fee as described in ASC 606-10-25-12 (i.e., the
modification also adjusts the pricing of the original goods or
services). Under this view (hereafter referred to as “View A”), the
entity does not need to perform an analysis of the stand-alone selling
prices of the additional promised goods or services.
However, an entity may also apply one of the two views below to B&E
contract modifications. Under these views, an entity must carefully
analyze whether the additional goods or services are actually priced at
their stand-alone selling prices to determine whether they should be
accounted for as a separate contract:
- View B — This view focuses on the net increase in the contract consideration (i.e., the total increase in consideration that the entity expects to be entitled to under the modified contract, including any changes to the prices of the remaining goods or services in the original contract), compared with the stand-alone selling prices of the additional promised goods or services. In determining how to account for the modification, the entity should compare the net increase in consideration with the stand-alone selling price of the services added during the extension period.
- View C — This view focuses on the revised blended prices of the contract compared with the stand-alone selling prices of the additional promised goods or services. Therefore, the analysis focuses solely on whether the stated blended price is consistent with the stand-alone selling price of the additional services during the extension period.
An entity should consistently apply its elected method to similar
contracts.
Example 9-4
On January 1, 20X8, Company S
enters into a noncancelable contract with Customer
T for a two-year term to provide a SaaS solution
for a variable fee of $50 per usage. The
stand-alone selling price of the SaaS ranges from
$45 to $55 per usage. There are no other
performance obligations in the contract. Company S
determines that (1) it is providing a series of
distinct services and (2) it is appropriate to
recognize revenue by using a time-based measure of
progress (i.e., ratably). In considering how much
revenue to recognize in a distinct time period, S
concludes that the contract meets the variable
consideration allocation exception guidance in ASC
606-10-32-40, and therefore it recognizes revenue
as usage occurs. In 20X8, T incurs usage-based
fees for 1,000 transactions.
By January 1, 20X9, the
stand-alone selling price range of the SaaS has
decreased to $30 to $40 per usage. During
negotiations, T renews the contract for an
additional year but requests a decrease in
pricing. As a result of negotiations, S and T
agree to apply a blended rate of $43 per usage for
the remaining two years of the modified contract.
Customer T is expected to incur usage-based fees
for 1,000 transactions per year for the remaining
years.
The following three views could be applied:
-
View A — Company S accounts for the modification as a termination of the existing contract and the creation of a new contract. Therefore, it recognizes revenue at the blended transaction price of $43 per usage in both 20X9 and 20Y0.
-
View B — Company S computes the total increase in the contract consideration, which is $36,000 or $36 per usage, as follows:Company S would then compare the increase in the transaction price to the stand-alone selling price range for the SaaS that will be provided during the extension period (i.e., 20Y0). Because $36 per usage is within the stand-alone selling price range of $30 to $40 per usage, S concludes that the extension period should be accounted for as a separate contract. Therefore, S will continue to recognize revenue in 20X9 at $50 per usage, but it will recognize revenue in 20Y0 at $36 per usage. In subsequent periods, S will need to (1) monitor actual usage and the remaining estimated usage and (2) accordingly update the transaction price and associated revenue recognized.
-
View C — Company S compares the revised blended rate of $43 per usage to the stand-alone selling price range for the SaaS that will be provided during the extension period. Because $43 per usage is outside the stand-alone selling price range of $30 to $40 per usage, S concludes that the modification should be accounted for as a termination of the existing contract and the creation of a new contract. The accounting outcome would be similar to that under View A.
9.2.2.3 Modification and Discount for Low-Quality Products
ASC 606-10
Example 5 — Modification of a Contract for Goods
55-111 An entity promises to
sell 120 products to a customer for $12,000 ($100
per product). The products are transferred to the
customer over a six-month period. The entity
transfers control of each product at a point in
time. After the entity has transferred control of 60
products to the customer, the contract is modified
to require the delivery of an additional 30 products
(a total of 150 identical products) to the customer.
The additional 30 products were not included in the
initial contract.
[Case A omitted6]
Case B — Additional Products for a Price That Does Not Reflect the Standalone
Selling Price
55-114 During the process of
negotiating the purchase of an additional 30
products, the parties initially agree on a price of
$80 per product. However, the customer discovers
that the initial 60 products transferred to the
customer contained minor defects that were unique to
those delivered products. The entity promises a
partial credit of $15 per product to compensate the
customer for the poor quality of those products. The
entity and the customer agree to incorporate the
credit of $900 ($15 credit × 60 products) into the
price that the entity charges for the additional 30
products. Consequently, the contract modification
specifies that the price of the additional 30
products is $1,500 or $50 per product. That price
comprises the agreed-upon price for the additional
30 products of $2,400, or $80 per product, less the
credit of $900.
55-115 At the time of
modification, the entity recognizes the $900 as a
reduction of the transaction price and, therefore,
as a reduction of revenue for the initial 60
products transferred. In accounting for the sale of
the additional 30 products, the entity determines
that the negotiated price of $80 per product does
not reflect the standalone selling price of the
additional products. Consequently, the contract
modification does not meet the conditions in
paragraph 606-10-25-12 to be accounted for as a
separate contract. Because the remaining products to
be delivered are distinct from those already
transferred, the entity applies the guidance in
paragraph 606-10-25-13(a) and accounts for the
modification as a termination of the original
contract and the creation of a new
contract.
55-116 Consequently, the
amount recognized as revenue for each of the
remaining products is a blended price of $93.33
{[($100 × 60 products not yet transferred under the
original contract) + ($80 × 30 products to be
transferred under the contract modification)] ÷ 90
remaining products}.
Stakeholders have raised questions about Example 5, Case B,
in ASC 606 (reproduced above). The example’s facts describe a contract
modification in which an entity gives a customer a discount because goods
and services previously delivered to the customer were determined to be of
lower quality than that to which the parties had agreed. The example is
designed to illustrate how an entity would apply the guidance in ASC
606-10-25-13(a), which describes a modification that would terminate the
original contract and create a new one. In the absence of this example, a
literal interpretation of the guidance in ASC 606-10-25-13(a) would require
all of the consideration, inclusive of the discount negotiated in the
modification for the 60 flawed products already delivered, to be recognized
only when the undelivered products are delivered to the customer in the
future (i.e., the modification is solely accounted for prospectively). That
is, the allocation of the remaining consideration of $7,500 (which is the
sum of (1) the original 60 remaining products × $100 per product and (2) the
additional 30 products × $50 per product) would result in the recognition of
$83.33 for each of the remaining 90 products delivered. This is because as
of the date of the modification, the 90 products (60 in the original
contract and 30 in the modification) are distinct from the 60 products
already delivered.
Specifically, stakeholders have questioned how to determine
the appropriate accounting approach when a contract is modified and the
selling price reflects both (1) compensation for poor-quality goods or
services that have already been supplied to the customer and (2) a selling
price for the additional goods or services that does not represent the
stand-alone selling price as of the date of the contract modification.
Generally, we believe that entities should carefully consider the facts and
circumstances in a modification and appropriately consider whether there is
a price concession or discount attributable to past performance that is
similar to the price concession in the example above.
For additional discussion related to differentiating changes
in the transaction price from contract modifications, see Section 7.6.2.
9.2.2.4 Accounting for Contract Assets as Part of a Contract Modification
The revenue standard provides an overall framework for
modification accounting. For example, when a contract modification meets the
conditions in ASC 606-10-25-13(a), the modification is accounted for
prospectively as a termination of the existing contract and the creation of
a new one. The revenue standard also requires entities to record contract
assets in certain circumstances, such as when an entity has a contract with
a customer for which revenue has been recognized (i.e., goods or services
have been transferred to the customer), but customer payment is contingent
on a future event, such as the satisfaction of additional performance
obligations (see Chapter
14). These contract assets may still be recorded at the time of a
contract modification.
Stakeholders have expressed two views on how to subsequently
account for contract assets that exist before a contract is modified when a
contract modification meets the conditions in ASC 606-10-25-13(a):
-
View A — The terminated contract no longer exists. Accordingly, contract assets associated with the terminated contract should be written off to revenue (i.e., revenue should be reversed).
-
View B — Existing contract assets should be carried forward to the new contract and realized as receivables are recognized (i.e., revenue is not reversed, leading to prospective accounting for the effects of the contract assets).
View B is generally appropriate for three reasons. First, it
better reflects the objective of ASC 606-10-25-13. Second, ASC
606-10-25-13(a) “explicitly states that the starting point for the
determination [of the allocation in a modification] is the transaction price
in the original contract less what had already been recognized as
revenue.”7 Third, it is consistent with paragraph BC78 of ASU 2014-09, which
notes that the intent of ASC 606-10-25-13(a) is to avoid adjusting revenue
for performance obligations that have been satisfied (i.e., such
modifications would be accounted for prospectively).
The above issue is addressed in Implementation Q&A 81 (compiled
from previously issued TRG Agenda Papers 51 and 55). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix
C.
The example below illustrates the accounting for a contract asset as part of
a contract modification.
Example 9-5
Entity M enters into a contract with
Customer R to sell a product and one year of
service. The product and service are separate
performance obligations. The one year of service is
considered to be a series of distinct services that
meet the criteria in ASC 606-10-25-14(b) to be
accounted for as a single performance obligation
satisfied over time. Entity M’s performance
obligation related to the product is satisfied at
the point in time that the product is shipped to R,
which occurs at the beginning of the first
month.
The transaction price of the
contract is $7,500, which is paid by R in 12 equal
installments of $625 at the end of each month. Under
these payment terms, the customer does not make an
up-front payment when the product is shipped. The
stand-alone selling price of the product is $2,700,
and the stand-alone selling price of the services is
$4,800 ($400 per month). Because the sum of the
stand-alone selling prices equals the transaction
price, the amount allocated to each performance
obligation is the stand-alone selling price of that
performance obligation.
At the end of six months, the
contract is modified to include one additional year
of service beyond the initial one-year service term.
Customer R is current with all payments, and the
modification does not affect the amounts due for the
remaining six months of service under the initial
one-year service term (i.e., R continues to pay $625
each month for the remaining six months of the
initial one-year service term). The price for the
additional one year of services is $100 per month,
which does not represent the stand-alone selling
price of the services. Because the remaining
services to be provided are distinct from the
product and services already delivered to R, the
modification is accounted for prospectively under
ASC 606-10-25-13(a).
The journal entries below illustrate
how M should recognize revenue at contract inception
and in the months leading up to the contract
modification. For simplicity, the journal entries
ignore any effect of a significant financing
component.
At contract inception, to
recognize revenue for the product shipped to
R:
At the end of each of months 1
through 6, to recognize revenue for the monthly
services:
After six months, immediately before
the modification, M has recognized revenue of $5,100
($2,700 for the product and $2,400 for the services)
and has a cumulative contract asset balance of
$1,350.
Entity M would retain the original
contract asset of $1,350 on the modification date.
The remaining consideration to be allocated consists
of two components:
-
$2,400 for the transaction price not yet recognized as revenue under the initial contract ($625 per month × 6 months remaining, less $1,350 contract asset balance).
-
$1,200 for the additional one year of services ($100 per month × 12 months).
The total transaction price for the
modified contract of $3,600 ($2,400 + $1,200) is
allocated to the remaining months of service under
the modified contract term; as a result, M
recognizes revenue of $200 per month for the
remaining 18-month contract term. The contract asset
that existed on the modification date will be
reduced as amounts received or receivable exceed
revenue recognized; once the contract asset is
recovered, amounts received or receivable in excess
of revenue recognized will be reflected as a
contract liability. This is reflected in the journal
entries below.
At the end of each of months 7
through 9:
At the end of month 10:
Before revenue is recognized at the
end of month 10, the cumulative contract asset
balance is only $75, or $1,350 – ($425 × 3). When a
contract asset is fully recovered (i.e., is reduced
to zero), consideration received in excess of
revenue recognized is reflected as a contract
liability. Consequently, a contract liability is
recorded for the remaining amounts that are received
or receivable in excess of revenue recognized.
For each of months 11 and 12, the
contract liability will be recorded in the manner
shown in the journal entry below.
At the end of each of months 11
and 12:
As of the end of month 12, the
cumulative contract liability balance is $1,200; and
beginning with month 13, amounts due under the
modified contract are reduced to $100 per month.
Revenue recognized for each month of service
continues to be $200. This is reflected in the
journal entry below for each of months 13 through
24.
At the end of each of months 13
through 24:
The results of this model are
summarized in the table below.
9.2.2.5 Accounting for Capitalized Costs of Obtaining a Contract When a Contract Is Modified
ASC 340-40-25-1 requires entities to capitalize incremental
costs incurred to obtain a contract with a customer when such costs are
expected to be recovered. ASC 340-40-35-1 requires entities to amortize such
capitalized costs “on a systematic basis that is consistent with the
transfer to the customer of the goods or services to which the asset
relates.” The asset may be related to goods or services to be transferred
under specific anticipated contracts. See Section 13.4.1.3 for a discussion of
how to account for capitalized costs incurred to obtain a contract that are
still recorded at the time of a contract modification.
9.2.2.6 Customer’s Exercise of a Material Right
As noted in Section
11.7, the TRG discussed questions raised by stakeholders
about the accounting for a customer’s exercise of a material right.
Specifically, stakeholders questioned whether an entity should account for a
customer’s exercise of a material right in one of the following ways:
-
Alternative A — As a change in the contract’s transaction price such that the additional consideration, along with the consideration from the original contract that was allocated to the material right, would be allocated to the performance obligation underlying the material right and would be recognized when or as the performance obligation underlying the material right is satisfied.
-
Alternative B — As a contract modification, which may require reallocation of consideration between existing and future performance obligations.
Although most TRG members thought that both Alternatives A
and B could be supported by the revenue standard, most TRG members leaned
toward Alternative A. Accordingly, we believe that while the guidance in ASC
606 supports the two alternatives outlined above, it is generally preferable
to account for a customer’s subsequent exercise of a material right as if it
were a separate contract (Alternative A) rather than as if it were the
modification of an existing contract (Alternative B). See Section 11.7 for
further discussion.
Connecting the Dots
A customer’s exercise of an option to purchase
additional goods or services that was accounted for as a “marketing
offer” is different from a customer’s exercise of a material right
contained within the original contract. We generally would not
consider it appropriate for an entity to analogize to the
alternatives outlined above on the basis of the TRG discussion when
accounting for a marketing offer. Example 50 in ASC 606 (reproduced
in Section 11.2) illustrates a
contract with an option for additional services that is akin to a
marketing offer rather than a material right because the prices of
the additional services under the option represent the stand-alone
selling prices of those services. Because a marketing offer in an
original contract is not accounted for as a material right and
therefore is not treated as part of the original contract, the
exercise of the marketing offer at a subsequent date should be
accounted for as a new contract (i.e., the exercise of the marketing
offer is a separate contract because the additional goods or
services are distinct and priced at their stand-alone selling
prices).
9.2.2.7 Contract Modifications That Reduce the Scope of a Contract
The revenue standard specifically states that a contract
modification is a change in the scope or price of a contract. Therefore, a
contract modification can be one that adds or removes promised goods or
services or changes the contract price. There can be situations in which
part of a contract is terminated and the change would be a contract
modification.
Depending on whether the remaining goods or services in the
existing contract are distinct from those transferred before the
modification, ASC 606-10-25-13 requires an entity to account for a contract
modification that results in a decrease in scope
(i.e., the removal from the contract of promised goods or services) as
either (1) the termination of the existing contract and the creation of a
new contract or (2) a cumulative catch-up adjustment to the existing
contract. The modification cannot be accounted for as a separate contract
because the criterion in ASC 606-10-25-12(a) specifying an increase in the scope of the contract is not met
(i.e., by its very nature, a new contract that decreases the quantity of
goods or services promised in the original contract is inherently modifying
the original contract and is not separate).
Example 9-6
Application of
ASC 606-10-25-13(a) to a Modification Resulting in
a Reduction in the Scope of a Contract That
Provides for a Series of Distinct Goods or
Services Accounted for Under ASC
606-10-25-14(b)
Entity Y enters into a contract with
a customer to provide Product X and 12 months of
services to be used in conjunction with Product X in
return for consideration of $140; the services
portion of the contract qualifies as a series in
accordance with ASC 606-10-25-14(b). Product X and
the services are each determined to be distinct,
with consideration of $40 allocated to Product X
(recognized on transfer of control of Product X) and
consideration of $100 allocated to the services
portion of the contract (recognized over the
12-month service period).
Six months after the start of the
contract, the customer modifies the contract to
reduce the level of service required. By the time of
this modification, Y has already (1) recognized
revenue of $40 for delivery of Product X, (2)
recognized revenue of $50 for services provided to
date, and (3) received payment from the customer of
$110, creating a contract liability of $20. Entity Y
agrees to a reduction in price such that the
customer will pay only $10 in addition to the
payments already made.
Given that the remaining six months
of service are distinct from both the delivery of
Product X and those services provided in the first
six months of the contract, this decrease in scope
(and price) should be accounted for as a termination
of the existing contract and the creation of a new
contract as required by ASC 606-10-25-13(a), with
$30 allocated to the services still to be provided
(i.e., the $20 previously collected from the
customer but not recognized as revenue plus the
remaining $10 due under the modified contract).
Entity Y could alternatively
calculate the $30 allocated to the services still to
be provided by considering the $50 of the original
transaction price yet to be recognized ($140
transaction price, less the $40 recognized as
revenue for delivery of Product X and the $50
recognized as revenue for services provided to
date), less the $20 reduction of the total
transaction price since the customer agrees to pay
only an additional $10. As a result, Y would
allocate $30 ($50 in remaining revenue to be
recognized under the original contract less the $20
reduction of the transaction price) to the services
still to be provided.
Example 9-7
Application of
ASC 606-10-25-13(b) to a Modification Resulting in
a Reduction in the Scope of a Contract That
Contains a Single Combined Performance Obligation
Accounted for Under ASC 606-10-25-14(a)
Entity X enters into a contract to
produce a single large item of specialized machinery
for a customer. Multiple components are used in the
production of the specialized machinery, but they
are significantly integrated so that X is using the
goods as inputs to produce the combined output of
the specialized machinery. Therefore, X concludes
that the contract contains a single combined
performance obligation in accordance with ASC
606-10-25-14(a). In addition, X concludes that the
performance obligation should be recognized over
time in accordance with ASC 606-10-25-27. Four
months into the contract term, the customer decides
to purchase a component of the project from an
alternative source; X agrees to this contract
modification, which reduces the contract scope.
Since the remaining goods or
services to be provided are not distinct from those
already provided, ASC 606-10-25-13(b) requires X to
(1) account for the contract modification as part of
the existing contract and (2) recognize a cumulative
catch-up adjustment to revenue at the time the
modification occurs.
Refer to Example 8 in ASC
606-10-55-129 through 55-133 for an example of the
calculation of a cumulative catch-up adjustment
under ASC 606-10-25-13(b).
Example 9-8
Application of
ASC 606-10-25-13(a) to a Partial Termination of a
Contract That Provides for a Series of Distinct
Goods or Services Accounted for Under ASC
606-10-25-14(b)
Provider P has entered into an
enforceable contract to deliver 25 hours of routine
and recurring cleaning services every month to
Customer C for five years at a fixed price of $1,000
per month (total transaction price of $60,000),
which represents the stand-alone selling price for
cleaning services at contract inception.
At the end of year 1 (i.e., year 1
has passed and both parties have met all of their
performance and payment obligations during that
period), the market for cleaning services has
declined and the customer’s need for cleaning
services has changed. Customer C and P agree to
reduce the remaining term of the contract to two
years (i.e., terminate years 4 and 5 of the
contract). The stand-alone selling price of the
cleaning services is $750 per month on the date of
the contract modification.
To compensate P for its lost value
on years 4 and 5 of the contract when C would have
to pay P at above-market rates, C agrees to pay a
$6,000 penalty (i.e., 24 months in years 4 and 5 ×
$250 per month, the excess of the contract rate of
$1,000 over the stand-alone selling price of $750 on
the date of modification).
Provider P accounts for the contract
as a series of distinct services with the same
pattern of transfer to C in accordance with ASC
606-10-25-15 and, therefore, as a single performance
obligation satisfied over time in accordance with
ASC 606-10-25-27(a) (and ASC 606-10-55-5 and 55-6).
Provider P uses an output method based on time
elapsed to measure its progress toward complete
satisfaction of its performance obligation.
Provider P should account for the
partial termination as a contract modification in
accordance with ASC 606-10-25-10 through 25-13. The
criteria for accounting for a contract modification
as a separate contract in ASC 606-10-25-12 are not
met because the scope of the contract does not
increase. Consequently, P should account for the
modification in accordance with the guidance in ASC
606-10-25-13(a), the application of which would
result in accounting for the modification as a
termination of the old agreement and the creation of
a new agreement.
Provider P should therefore account
for the modification prospectively and recognize
$30,000 (i.e., $12,000 per year under the original
terms for years 2 and 3 plus the $6,000 compensation
payment) over the remaining revised contract period
of two years.
Footnotes
1
If the answer is “Yes” for some goods or services
and “No” for others, it may be appropriate to apply both models to a
single contract, in the manner described in ASC 606-10-25-13(c), on
the basis of an assessment at the performance obligation level. See
Section
9.2.2.
2
For illustrative examples, see Example 9-3; ASC
606-10, Examples 8 and 9; and Example
9-7.
3
For illustrative examples, see Example 9-2; ASC
606-10, Example 5, Case B; ASC 606-10, Example 7; Example 9-6; Example 9-8;
and ASC 606-10, Example 6
5
Cumulative adjustments to revenue under ASC 606-10-25-13(b) are
not common for these types of modifications of SaaS arrangements
because the services provided after the modification are
typically distinct from those transferred before the
modification. Therefore, this discussion does not focus on
modifications that would result in an adjustment to revenue.
6
Case A of Example 5 is
reproduced in Section 9.2.1.
7
Quoted from Q&A 81 of the FASB staff’s
Revenue Recognition Implementation
Q&As (the “Implementation
Q&As”).
9.3 Reassessing Step 1 Upon a Contract Modification
Contract modifications tend to occur because despite all of the planning that an
entity and its customer can do, unforeseen challenges can cause business needs to
change. A modification could change the terms of a contract so significantly that
the modified contract does not resemble the original contract. Once a contract is
modified, a company might question whether the contract still meets the contract
existence criteria in step 1 (see Chapter 4).
ASC 606-10-25-5 states that an entity should reassess the criteria
in ASC 606-10-25-1 for identifying a contract with a customer only if “there is an
indication of a significant change in facts and circumstances.” The nature of a
contract modification and the circumstances in which it is made will determine
whether it should be deemed to reflect a significant change in facts and
circumstances as contemplated in ASC 606-10-25-5. For example, a contract
modification may sometimes be caused by a significant deterioration in the
customer’s ability to pay (i.e., a significant change in the expectation of
collectibility since contract inception), which is included in ASC 606-10-25-5 as an
example of a circumstance necessitating reassessment of the ASC 606-10-25-1
criteria.
If a reassessment is deemed necessary and leads to a conclusion that
one or more of the criteria in ASC 606-10-25-1 are not met (e.g., if it is no longer
probable that the entity will collect the consideration to which it will be
entitled), the contract should subsequently be accounted for in accordance with ASC
606-10-25-7.
The required accounting for modifications of contracts that continue
to meet the criteria in ASC 606-10-25-1 is described in ASC 606-10-25-10 through
25-13.
9.4 Change in Transaction Price After a Contract Modification
The previous sections address situations involving a contract modification and a
change in the amount of consideration in the
contract. In those situations, the change in the
amount of consideration occurred at the time of
the modification and was a result of the
modification. However, a contract’s consideration
could also change when an entity reassesses the
variable consideration of a contract at the end of
a reporting period in accordance with ASC
606-10-32-14. This reassessment is required in all
reporting periods for all contracts, including
those that have been modified.
For example, suppose that an entity, on the basis of its initial judgment,
determines that it is constrained from recognizing variable consideration as revenue
at the beginning of a contract. Further assume that after a modification occurs, the
entity performs a reassessment of the variable consideration and determines that it
is no longer constrained. As a result of this reassessment, the entity needs to
determine how to allocate the variable consideration to performance obligations that
have not been satisfied and possibly even to those that were satisfied before the
modification.
To address a change in variable consideration after a modification, the FASB provides the following guidance, which is intended to align with the guidance on a change in the variable consideration of a contract that has not been modified:
ASC 606-10
32-45 An entity shall account for a change in the transaction price that arises as a result of a contract modification in accordance with paragraphs 606-10-25-10 through 25-13. However, for a change in the transaction price that occurs after a contract modification, an entity shall apply paragraphs 606-10-32-42 through 32-44 to allocate the change in the transaction price in whichever of the following ways is applicable:
- An entity shall allocate the change in the transaction price to the performance obligations identified in the contract before the modification if, and to the extent that, the change in the transaction price is attributable to an amount of variable consideration promised before the modification and the modification is accounted for in accordance with paragraph 606-10-25-13(a).
- In all other cases in which the modification was not accounted for as a separate contract in accordance with paragraph 606-10-25-12, an entity shall allocate the change in the transaction price to the performance obligations in the modified contract (that is, the performance obligations that were unsatisfied or partially unsatisfied immediately after the modification).
The example below, which is reproduced from ASC 606, illustrates this
concept.
ASC 606-10
Example 6 — Change in the Transaction Price After a Contract Modification
55-117 On July 1, 20X0, an entity promises to transfer two distinct products to a customer. Product X transfers to the customer at contract inception and Product Y transfers on March 31, 20X1. The consideration promised by the customer includes fixed consideration of $1,000 and variable consideration that is estimated to be $200. The entity includes its estimate of variable consideration in the transaction price because it concludes that it is probable that a significant reversal in cumulative revenue recognized will not occur when the uncertainty is resolved.
55-118 The transaction price of $1,200 is allocated equally to the performance obligation for Product X and the performance obligation for Product Y. This is because both products have the same standalone selling prices and the variable consideration does not meet the criteria in paragraph 606-10-32-40 that requires allocation of the variable consideration to one but not both of the performance obligations.
55-119 When Product X transfers to the customer at contract inception, the entity recognizes revenue of $600.
55-120 On November 30, 20X0, the scope of the contract is modified to include the promise to transfer Product Z (in addition to the undelivered Product Y) to the customer on June 30, 20X1, and the price of the contract is increased by $300 (fixed consideration), which does not represent the standalone selling price of Product Z. The standalone selling price of Product Z is the same as the standalone selling prices of Products X and Y.
55-121 The entity accounts for the modification as if it were the termination of the existing contract and the creation of a new contract. This is because the remaining Products Y and Z are distinct from Product X, which had transferred to the customer before the modification, and the promised consideration for the additional Product Z does not represent its standalone selling price. Consequently, in accordance with paragraph 606-10-25-13(a), the consideration to be allocated to the remaining performance obligations comprises the consideration that had been allocated to the performance obligation for Product Y (which is measured at an allocated transaction price amount of $600) and the consideration promised in the modification (fixed consideration of $300). The transaction price for the modified contract is $900, and that amount is allocated equally to the performance obligation for Product Y and the performance obligation for Product Z (that is, $450 is allocated to each performance obligation).
55-122 After the modification but before the delivery of Products Y and Z, the entity revises its estimate of the amount of variable consideration to which it expects to be entitled to $240 (rather than the previous estimate of $200). The entity concludes that the change in estimate of the variable consideration can be included in the transaction price because it is probable that a significant reversal in cumulative revenue recognized will not occur when the uncertainty is resolved. Even though the modification was accounted for as if it were the termination of the existing contract and the creation of a new contract in accordance with paragraph 606-10-25-13(a), the increase in the transaction price of $40 is attributable to variable consideration promised before the modification. Therefore, in accordance with paragraph 606-10-32-45, the change in the transaction price is allocated to the performance obligations for Product X and Product Y on the same basis as at contract inception. Consequently, the entity recognizes revenue of $20 for Product X in the period in which the change in the transaction price occurs. Because Product Y had not transferred to the customer before the contract modification, the change in the transaction price that is attributable to Product Y is allocated to the remaining performance obligations at the time of the contract modification. This is consistent with the accounting that would have been required by paragraph 606-10-25-13(a) if that amount of variable consideration had been estimated and included in the transaction price at the time of the contract modification.
55-123 The entity also allocates the $20 increase in the transaction price for the modified contract equally to the performance obligations for Product Y and Product Z. This is because the products have the same standalone selling prices and the variable consideration does not meet the criteria in paragraph 606-10-32-40 that require allocation of the variable consideration to one but not both of the performance obligations. Consequently, the amount of the transaction price allocated to the performance obligations for Product Y and Product Z increases by $10 to $460 each.
55-124 On March 31, 20X1, Product Y is transferred to the customer, and the entity recognizes revenue of $460. On June 30, 20X1, Product Z is transferred to the customer, and the entity recognizes revenue of $460.
Chapter 10 — Principal-Versus-Agent Considerations
Chapter 10 — Principal-Versus-Agent Considerations
10.1 General Considerations
For an entity, deciding whether the nature of its promise is to transfer goods
or services to the customer itself (as a principal) or to arrange for goods or
services to be provided by another party (as an agent) is an important determination
because the conclusion the entity reaches can significantly affect the amount of
revenue recognized. Whereas a principal of a performance obligation will recognize
revenue at the gross amount it is entitled to from its customer, an agent will
present revenue at the net amount retained. An entity must use judgment when
assessing whether it is acting as a principal or as an agent.
The revenue standard focuses on recognizing revenue as an entity
transfers control of a good or service. Therefore, an entity is a principal in a
transaction if it controls the specified goods or services before they are
transferred to the customer. The revenue standard provides some indicators to help
an entity (1) determine whether it is a principal and (2) assess whether it controls
the underlying goods or services before they are transferred to the customer. See
Section 10.1.2 for further
details.
10.1.1 Identifying the Specified Goods or Services
ASC 606-10
55-36 When another party is
involved in providing goods or services to a customer,
the entity should determine whether the nature of its
promise is a performance obligation to provide the
specified goods or services itself (that is, the entity
is a principal) or to arrange for those goods or
services to be provided by the other party (that is, the
entity is an agent). An entity determines whether it is
a principal or an agent for each specified good or
service promised to the customer. A specified good or
service is a distinct good or service (or a distinct
bundle of goods or services) to be provided to the
customer (see paragraphs 606-10-25-19 through 25-22). If
a contract with a customer includes more than one
specified good or service, an entity could be a
principal for some specified goods or services and an
agent for others.
55-36A To determine the nature of its promise (as described in paragraph 606-10-55-36), the entity should:
- Identify the specified goods or services to be provided to the customer (which, for example, could be a right to a good or service to be provided by another party [see paragraph 606-10-25-18])
- Assess whether it controls (as described in paragraph 606-10-25-25) each specified good or service before that good or service is transferred to the customer.
The first step in the evaluation of whether an entity is acting as a principal
or as an agent when another party is involved in providing goods or services to
a customer is to identify the goods or services that will be transferred to the
customer (i.e., the “specified goods or services” referred to in ASC
606-10-55-36A). In the amendments in ASU
2016-08, the FASB confirmed that the unit of account for
evaluating whether an entity is acting as a principal or as an agent is not at
the contract level. Rather, the principal-versus-agent analysis is performed for
each specified distinct good or service (or distinct bundle of goods or
services) that will be transferred to the customer. Accordingly, an entity could
be a principal for certain aspects of a contract with a customer and an agent
for others.
The unit of account to be used in the first step of the principal-versus-agent
analysis could be described as being at the performance obligation level.
Consequently, this part of the analysis could be performed as part of step 2 of
ASC 606’s revenue model. However, the revenue standard does not refer to the
analysis as being conducted at the performance obligation level because the
performance obligation of an agent is to arrange for another entity to transfer
the specified goods or services to the customer. For an entity to determine
whether it controls promised goods or services before they are transferred to a
customer, it must first identify the specified goods or services that will be
transferred to the customer. However, the notion of aggregating goods or
services that are not distinct into performance obligations (i.e., a distinct
bundle of goods or services) will apply to identifying the unit of account used
in the evaluation of whether an entity is acting as a principal or as an agent.
That is, the same guidance that an entity applies to identify performance
obligations (ASC 606-10-25-19 through 25-22) will be used to determine the
specified goods or services.
10.1.2 Determining Whether the Entity Controls the Goods or Services Before They Are Transferred to the Customer
An entity is a principal in providing a specified good or
service if the entity controls that specified good or service before it is
transferred to the customer. Control is defined in ASC 606-10-25-25 as “the
ability to direct the use of, and obtain substantially all of the remaining
benefits from, the asset. Control includes the ability to prevent other entities
from directing the use of, and obtaining the benefits from, an asset.” Paragraph
BC120 of ASU 2014-09 describes
the components of control as follows:
-
Ability — A customer must have the present right to direct the use of, and obtain substantially all of the remaining benefits from, an asset for an entity to recognize revenue. For example, in a contract that requires a manufacturer to produce an asset for a particular customer, it might be clear that the customer will ultimately have the right to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, the entity should not recognize revenue until the customer has actually obtained that right (which, depending on the contract, might occur during production or afterwards).
-
Direct the use of — A customer’s ability to direct the use of an asset refers to the customer’s right to deploy that asset in its activities, to allow another entity to deploy that asset in its activities, or to restrict another entity from deploying that asset.
-
Obtain the benefits from — The customer must have the ability to obtain substantially all of the remaining benefits from an asset for the customer to obtain control of it. Conceptually, the benefits from a good or service are potential cash flows (either an increase in cash inflows or a decrease in cash outflows). A customer can obtain the benefits directly or indirectly in many ways, such as by using, consuming, disposing of, selling, exchanging, pledging, or holding an asset.
In addition, ASC 606-10-55-39 provides indicators to support an entity’s
evaluation of control.
Connecting the Dots
In the determination of whether an entity controls a
specified good or service before the good or service is transferred to a
customer, the control principle should be considered before the
indicators of control are analyzed. As noted in paragraph BC16 of ASU
2016-08, “the indicators in paragraph 606-10-55-39 were included to
support an entity’s assessment of whether it controls a specified good
or service before it is transferred to the customer. The indicators (a)
do not override the assessment of control, (b) should not be viewed in
isolation, (c) do not constitute a separate or additional evaluation,
and (d) should not be considered a checklist of criteria to be met in
all scenarios.” Further, paragraph BC18(e) of ASU 2016-08 states, in
part, that “the indicators are not an exhaustive list and merely support
the assessment of control. They do not replace or override that
assessment.”
At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB
Developments, Jonathan Wiggins, senior associate chief accountant in the
SEC’s Office of the Chief Accountant (OCA), cautioned that the
indicators of control in the principal-versus-agent analysis as outlined
in ASC 606-10-55-39 are neither a checklist nor a substitute for an
entity’s assessment of control; rather, an entity should consider
whether these indicators support its control assessment.
10.2 Determining Whether an Entity Is Acting as a Principal
The revenue standard’s core principle focuses on the transfer of control of
goods or services to a customer. When developing the framework for evaluating
whether an entity’s performance obligation is to transfer goods or services to a
customer or to arrange for another party to provide those goods or services to a
customer, the FASB and IASB observed that an entity would be a principal if it
controlled those goods or services before they were transferred to the customer.
This observation is reflected in the following guidance:
ASC 606-10
55-37 An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. However, an entity does not necessarily control a specified good if the entity obtains legal title to that good only momentarily before legal title is transferred to a customer. An entity that is a principal may satisfy its performance obligation to provide the specified good or service itself or it may engage another party (for example, a subcontractor) to satisfy some or all of the performance obligation on its behalf.
55-37A When another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of any one of the following:
- A good or another asset from the other party that it then transfers to the customer.
- A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf.
- A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer. For example, if an entity provides a significant service of integrating goods or services (see paragraph 606-10-25-21(a)) provided by another party into the specified good or service for which the customer has contracted, the entity controls the specified good or service before that good or service is transferred to the customer. This is because the entity first obtains control of the inputs to the specified good or service (which include goods or services from other parties) and directs their use to create the combined output that is the specified good or service.
10.2.1 Controlling a Good Before Transferring It to a Customer
Often, it will be clear that an entity controls a good before it is transferred to a customer because the
entity acquired the good (i.e., obtained control) from a third party before transfer of the good to the
customer. These situations will often involve an element of inventory risk that is assumed while the good
is in the entity’s control.
For example, an online clothing retailer obtains physical possession of goods (inventory) from its
designers and stores the goods in its warehouse. The retailer separately enters into contracts
with customers to sell goods held in its warehouse. In this example, it is clear that the retailer controls
the goods before transferring them to the customer.
However, other scenarios may not be as clear. Consider a situation in which an
online retailer holds some goods (inventory) in its warehouse but also has
arrangements with some of its suppliers that allow it to direct the supplier to
ship certain goods directly from the supplier’s warehouse to the end customer
(i.e., it does not have inventory risk for all goods). This sort of an
arrangement would have to be evaluated more carefully, as illustrated below.
Example 10-1
An electronics retailer has physical locations but also sells goods to its customers through its Web site.
Customers can choose to purchase goods at the retailer’s physical location but can purchase the same goods
online. The retailer has full discretion in determining the price of the goods and generally offers the same price
in stores as it does online. Customers who choose to buy electronics online enter into a contract with the
retailer to purchase one or more specified goods. The retailer can satisfy its obligation to transfer a specified
good to a customer either by shipping the good from one of its physical locations or by directing its supplier to
ship the good from the supplier’s warehouse. If the retailer directs its supplier to ship the good directly to the
customer, the retailer will take title to the specific good only momentarily before title passes to the customer
upon shipment. The retailer is required to pay the supplier for the good even if it does not receive payment
from the customer. If the customer is not satisfied with the good or there is a defect, the customer can return
the good to one of the retailer’s physical locations.
In this case, because the retailer takes title to the good only momentarily
before passing title on to the customer, it may not be
clear whether the retailer controls the specified good
before the good is transferred to the customer. That is,
further consideration is required. However, the retailer
may conclude that it controls the good before the good
is transferred to the customer because it has the
ability to direct the use of, and obtain substantially
all of the remaining benefits from, the good (i.e., it
directs the supplier to ship the good to the retailer’s
customer). In addition, after considering the control
indicators discussed below, the retailer concludes that
it is the principal because it is primarily responsible
for satisfying the performance obligation, it has some
inventory risk upon product return, and it has latitude
to establish pricing — factors that further indicate
that it controls the good before the good is transferred
to the customer. Therefore, the retailer concludes that
it should record revenue on a gross basis.
The example above is similar to a fact pattern discussed in a speech at the 2018 AICPA Conference on Current SEC and
PCAOB Developments by Sheri York, then professional accounting fellow in the
OCA. In her speech, Ms. York made the following observations related to the
determination of whether an entity is a principal or an agent when the entity
never obtains physical possession of the specified good:
Application of the principal versus agent guidance can be especially
challenging when an entity never obtains physical possession of a good (for
example, when goods are shipped directly from a manufacturer to the third
party). Over the past year OCA has received questions regarding the
principal versus agent determination in these types of fact patterns,
including fact patterns where the company concluded it was acting as a
principal and others where the company concluded it was acting as an agent.
I would like to share one of the consultations that OCA received on this
topic.
In this consultation, the registrant
distributed a wide variety of healthcare-related goods to retailers. The
registrant maintained inventory for the majority of the goods sold; however,
for certain specialized goods, the manufacturer shipped the goods directly
to the retailer. The registrant managed the return process with the
retailer; however, due to regulatory reasons, certain returned goods were
returned directly to the manufacturer.
The
registrant concluded that it was acting as a principal in the arrangement
because it controlled the specified good before it was transferred to the
customer. That is, the registrant had the ability to direct the use of, and
obtain substantially all of the remaining benefits from, the goods. As part
of its assessment of control, the registrant considered the indicators of
control and concluded that it was primarily responsible for fulfillment and
had discretion in establishing the price at which the goods were sold to the
retailer. The registrant believed that it was primarily responsible for
fulfillment based on the terms of the agreement and marketing materials
communicated to the customer. In this fact pattern, the registrant was the
primary point of contract with the retailer, and was contractually
responsible for ensuring that products were acceptable to the retailer,
including responsibility for issues related to delivery, quantity, and
spoilage.
In this fact pattern, the staff did not
object to the registrant’s conclusion that it was the principal in the
transaction. Based on my experience, I think it is important to remember
that the conclusion as to whether or not an entity is a principal or an
agent requires a consideration of the definition of control, often including
consideration of the indicators of control, of which inventory risk is only
one of the possible indicators. In some circumstances, physical possession
will not coincide with control of a specified good. [Footnotes
omitted]
Typically, the principal in a transaction to sell goods to its
customer will have legal title to the goods before they are transferred to the
customer. However, ASC 606-10-55-37 states, in part, that “an entity does not
necessarily control a specified good if the entity obtains legal title to that
good only momentarily before legal title is transferred to a customer.”
Nevertheless, we do not believe that having legal title only momentarily (e.g.,
flash title) automatically precludes the entity from having control of the goods
before they are transferred to the customer. Accordingly, the entity will need
to perform a thorough analysis of the overall definition of control and the
other indicators in ASC 606-10-25-30 and ASC 606-10-55-39 to determine whether
it has the ability to control the goods before they are transferred to the
customer.
The example below considers whether an entity’s momentary legal
title to goods that the entity sells to an end customer automatically precludes
a determination that the entity (1) has control of the goods before selling them
to the end customer and (2) is therefore the principal in the transaction.
Example 10-2
Company L, the owner and operator of
retail stores that sell clothing and accessories to
customers, enters into contracts with clothing
manufacturers to purchase clothing that is based on L’s
specifications. Upon receiving a purchase order from L,
a manufacturer produces the clothing and ships it to L’s
warehouse. Company L subsequently delivers the clothing
to its individual retail stores for sale to end
consumers. At its own discretion, L will direct the use
of the clothing by specifying the stores to which the
clothing is to be delivered.
The manufacturer retains legal title to
the clothing until L sells the clothing to an end
consumer. Upon L’s sale of the clothing to the end
consumer, legal title is transferred only momentarily to
L and then is immediately transferred from L to the end
consumer (i.e., flash title transfer). Consequently, L
has physical possession of the clothing but has legal
title to the clothing only momentarily before selling it
to the end consumer. However, L can obtain the economic
benefits of the clothing because it has the unilateral
ability to sell the clothing to an end consumer despite
having legal title to the clothing only momentarily
before the sale. In addition, the manufacturer does not
have the ability to recall the clothing or direct it to
another retailer once it has been shipped to L. Further,
L is not obligated to pay the manufacturer for any
clothing purchased until such clothing is sold to the
end consumer.
We do not believe that having legal
title to the clothing only momentarily automatically
precludes L from having control of the clothing. To be
considered a principal in a transaction, an entity must
have control of the specified good or service before
transferring that good or service to a customer, as
stated in ASC 606-10-55-37. Legal title is one of the
indicators of control in ASC 606-10-25-30, but that
indicator alone is not determinative of whether an
entity has control of an asset. As indicated in ASC
606-10-25-30(b) and discussed in Section 8.6.4.1, there
are circumstances in which control of an asset can be
transferred to the customer even though the seller
retains legal title to the asset until the asset is sold
to the end consumer. In the fact pattern outlined above,
L must consider the overall definition of control and
the other indicators in ASC 606-10-25-30 and ASC
606-10-55-39 to determine whether it obtains control of
the clothing without taking legal title to the
clothing.
ASC 606-10-25-25 states, in part:
Control of an asset refers to the
ability to direct the use of, and obtain
substantially all of the remaining benefits from,
the asset. Control includes the ability to prevent
other entities from directing the use of, and
obtaining the benefits from, an asset.
Under the facts of this example, L has
the ability to direct the use of the clothing by
delivering the clothing to L’s individual retail stores
for resale to end consumers. Further, L can obtain the
remaining benefits from the clothing by selling it to
end consumers. Although the manufacturer retains legal
title to the clothing until it is sold, the manufacturer
does not have the ability to prevent L from directing
the clothing to L’s retail stores and selling the
clothing to end consumers. Therefore, notwithstanding
that L has legal title to the clothing only momentarily
and is not obligated to pay the manufacturer for the
clothing until the clothing is sold to the end consumer,
L controls the clothing as the principal in the
transaction in the absence of any indicators under ASC
606-10-55-39 to the contrary.
The definition of control also includes the ability to “obtain substantially all
of the remaining benefits from” the asset. However, even if an entity earns a
fixed commission upon reselling a good, the entity can still control the good
before it is transferred to a customer. In a speech at the 2020 AICPA Conference on Current SEC and
PCAOB Developments, Jillian Pearce, then professional accounting fellow in the
OCA, discussed a fact pattern in which a commodity reseller was a principal in
its arrangements to sell commodity produced by a related party. In her speech,
Ms. Pearce commented as follows on the determination of whether an entity is a
principal or an agent when the entity earns a fixed percentage
commission:
I would like to share observations on a fact pattern
involving a registrant that produces and sells a commodity to its
customers. In this fact pattern, the registrant had the contractual
right to market and sell 100 percent of the commodity produced by a
related party.
The registrant determined how to source the
commodity to fulfill its contracts with customers — either from its own
production, from production from the related party facility, or from a
third party. This raises the issue of whether the registrant was acting
as a principal or an agent in selling the commodity produced by the
related party. If the registrant sourced the product from the related
party facility, the registrant took possession and legal title of the
product and transported it to the customer. The registrant had the right
to redirect the product to different customers during transportation,
subject to certain geographic restrictions, but the registrant believed
inventory risk was mitigated by an insurance policy that covered risk of
damage or loss. The selling price of the commodity was generally
determined based on the market price of the product at the time of
delivery. For product sourced from the related party facility, the
registrant received payment from the end customer and remitted payment
to the producer, less a fixed percentage commission that the registrant
retained.
The registrant proposed to account for the commodity
sales from this producer on a net basis, as it determined it was acting
as an agent in the sale of the commodity from the producer and did not
believe it controlled the product. The registrant evaluated the
indicators of control outlined within the revenue standard. While it did
not believe any of the indicators were determinative, the registrant
ultimately concluded it was an agent in the transaction as it did not
receive substantially all of the benefits from the sale of the commodity
as a result of its fixed percentage commission.
OCA staff objected
to the registrant’s conclusion that it did not have the right to direct the
use of and obtain substantially all of the remaining benefits of the product
from the producer, and therefore concluded the registrant was the principal
in the transaction based on the total mix of information presented.
[Footnote omitted]10.2.2 Controlling the Right to a Service
There may also be instances in which an entity controls a right to a service
(e.g., a voucher or ticket) and passes it on to a customer. In these instances,
the entity is not providing the service to which the voucher entitles a
customer, but the entity may control the right to the service by controlling the
voucher (e.g., prepurchasing the voucher) before it is transferred to the
customer. The entity can redeem the voucher for the service, or it can transfer
the right to the service to a customer by transferring the voucher. In addition,
an entity may control the right to a service if it directs the service provider
to perform the service on the entity’s behalf for any of the entity’s
customers.
Example 10-3
Entity A enters into a management agreement with Customer B to provide lawn maintenance services,
including fertilization, mowing and trimming, and periodic seeding. Entity A does not provide lawn maintenance
services itself; rather, it contracts with third-party service providers for each aspect of the lawn maintenance
service. Entity A and Customer B have agreed on a single price for the lawn maintenance service.
Entity A separately enters into contracts with third-party service providers and
directs those service providers to perform each aspect
of the lawn maintenance services. Once A enters into
contracts with the third-party service providers, it can
direct those service providers to perform services on
A’s behalf for any number of its customers.
Even though A is not performing the services, it controls the right to the services by directing specific lawn
maintenance service providers to perform each aspect of the lawn maintenance services. Because A controls
the right to the services, A concludes that it is acting as the principal.
The example above has similarities to a fact pattern discussed
by Lauren Alexander, professional accounting fellow in the OCA, in a
speech at the 2019 AICPA Conference on Current SEC and
PCAOB Developments. In her speech, Ms. Alexander made the following observations
related to the determination of whether an entity is a principal or an agent in
a contract to provide specified services to a customer:
Determining whether an entity is a principal or an agent
in a revenue transaction can be particularly challenging when two
parties are involved in providing services to a customer, especially if
some of the services can only be provided by a specific service
provider.
In the consultation that I will discuss today, the
registrant entered into contracts with customers to provide several
related services in exchange for a fee. The contracts acknowledged that
another service provider would provide some of the services, and the
services were marketed to customers using the brand names of both the
registrant and the other service provider. The registrant sought the
staff’s view on whether it was a principal or an agent in the revenue
transaction.
The registrant noted that some of the services promised
in the contract were based on its proprietary content, and that it was
heavily involved in providing those services to the customer, with
limited involvement from the other service provider. However, due to
certain regulatory restrictions, the registrant could not legally
provide some of the services promised in the contract and therefore had
to rely entirely on the other service provider to deliver those
services.
The registrant concluded that it was the principal in
the transaction for each of the specified services and should record
revenue on a gross basis because it controlled the services before
transferring them to the customer. In reaching this conclusion, the
registrant stated that it had the contractual ability to direct the
other service provider to provide services to customers on its behalf,
and customers did not have contractual relationships with the other
service provider. The registrant asserted that it was primarily
responsible for fulfilling the promise to provide the specified
services.
However, the registrant noted that it only had the right
to dictate certain general parameters about the services to be provided
by the other service provider, and that the other service provider had
discretion in determining exactly how to fulfill its obligation. The
registrant said that it controlled when the other service provider
delivered the services, and that contractually the other service
provider did not have the right to deny services to customers. Finally,
the registrant was responsible for handling most customer concerns that
arose from the services provided by the other service provider.
In this fact pattern, the staff did not object to the
registrant’s conclusion that it was the principal in the transaction and
should record revenue on a gross basis. The staff observed that the
registrant could control the specified services by entering into a
contract with another service provider in which the registrant defined
the scope of services to be performed on its behalf, even if the
registrant could not fulfill the contract using its own resources (that
is, it could not legally provide certain of the services promised in the
contract).
As discussed in previous staff speeches, we continue to
observe that applying the principal versus agent guidance may require
significant judgment, especially in the case of emerging business
models. We encourage registrants to carefully consider their specific
facts and circumstances and contractual terms, and any changes to these
terms over time, when applying this guidance. [Footnotes omitted]
10.2.2.1 Control Over Employees — Professional Services Organizations and Employers of Record
Professional services organizations (PSOs) may provide temporary workforce or
recruiting services. Sometimes, it may be clear that the nature of the
entity’s promise is to provide a workforce (e.g., a customer contracts with
the entity for temporary labor, and the entity is primarily responsible for
providing the workforce). In these instances, the entity (1) will make all
hiring and firing decisions, (2) will determine employee wages and benefits,
(3) will supervise and manage employees, and (4) can redeploy employees at
its discretion. Under these circumstances, an entity may reasonably conclude
that it is the principal in the arrangement (i.e., it controls the
employees) and that it should therefore report any consideration received
from the customer (including the consideration related to the employees’
wages) as revenue on a gross basis. However, in other situations, the nature
of the entity’s promise might be to arrange for employees to provide
services to a customer (e.g., the entity is the legal employer of record
[EOR] but does not control the employees).1
Example 10-4
Entity JW is a PSO that provides EOR
services, which allow its customers to hire and
deploy professionals without having a legal
footprint in the jurisdiction(s) in which the
professionals are working. Customers identify
specific professionals to be employed; determine the
professionals’ salaries, bonuses, and benefits;
supervise and manage the professionals; and
determine when and what work the professionals will
perform. As the legal EOR, JW performs all payroll
processes and payment services as well as tax
compliance filings and remittances. Entity JW is
required to pay the professionals’ salaries,
bonuses, and benefits (in amounts determined by the
customers), and JW is entitled to recover from its
customers any amounts paid to professionals. If a
professional who is performing work for a customer
quits or is fired, JW is not responsible for
identifying and employing a different professional.
Rather, the customer, at its sole discretion, will
identify another professional to be employed by JW.
In addition, JW is not responsible for the quality
of the services provided by professionals. In
exchange for providing the EOR services, JW charges
customers a fee based on a percentage of the
employees’ salaries and bonuses.
Entity JW concludes that the nature
of its promise is to arrange for each professional
to provide services directly to a customer of JW.
Although JW is the legal employer of the
professional, JW concludes that it does not obtain
control of the professional’s services before they
are transferred to the customer because the customer
makes all decisions regarding (1) which professional
to hire and fire; (2) the professional’s salary,
bonus, and benefits; (3) supervision and management;
and (4) the day-to-day activities of the
professional. Further, JW concludes that it is not
primarily responsible for providing the
professional’s services because JW is not
responsible for the quality of the services provided
and, if the professional quits, JW is not obligated
to identify an alternative professional who can
provide the services. JW also does not have
discretion in determining the price because the
customer sets the salary and bonus. Therefore, JW
concludes that it should report revenue net of
amounts paid to the professional.
A similar outcome would result if JW
treated the amounts paid to the professional as
“consideration payable to a customer” within the
scope of the guidance in ASC 606-10-32-25 through
32-27 (see Section 6.6.2).
Because the nature of JW’s promise is to arrange for
the professional to provide services to the customer
(and not to provide the professional’s services
itself) and the customer is, in substance, employing
the professional, any payments made to the
professional are being made on behalf of the
customer. Entity JW is not receiving a distinct good
or service in connection with the payments.
Consequently, any payments made to the professional
would reduce the transaction price and, therefore,
revenue.
10.2.2.2 Principal-Versus-Agent Considerations Related to Payment Processing Arrangements
For entities involved in payment processing arrangements, performing the
principal-versus-agent analysis presents unique challenges. Specifically,
entities have grappled with the issue of how to present revenue and the
various fees related to payment processing in a manner consistent with the
revenue standard. A careful evaluation of the relevant guidance is critical
since the payments ecosystem — as well as the players — continues to evolve.
Consideration must be given to the delivery model of the services, the
parties involved in the payment transactions, and the various components in
each fee arrangement. Whether an offering is integrated or independent can
have a significant effect on the accounting analysis.
ASC 606-10-55-36 states, in part, that “[i]f a contract with a customer
includes more than one specified good or service, an entity could be a
principal for some specified goods or services and an agent for others.”
Accordingly, for each specified good or service identified , an entity must
determine whether it controls the specified good or service before
transferring that good or service to the customer. Therefore, an entity in a
payment processing arrangement must determine whether it has the ability to
direct the use of, and obtain substantially all the benefits from, the
services provided by other parties in the payment processing ecosystem
before those services are transferred to the customer.
Determining which party controls the services provided by the other parties
in the payment processing ecosystem requires significant judgment.
Therefore, an entity may also evaluate the control indicators in ASC 606 to
support its conclusion.
Factors to consider as part of this determination may include:
-
The nature of the entity’s contractual arrangements, relationships, and promises with the customer and other parties and the entity’s potential risks of loss (e.g., chargebacks, fees due to other parties) arising from the transaction. As part of this analysis, the entity may consider whether it acts as the “merchant of record” for the transactions that it processes.
-
Any contractual arrangements or relationships between the customer and the other parties in the payment processing ecosystem.
-
The ability of the entity to direct other parties in the payment processing ecosystem to provide payment processing services on its behalf. As part of this analysis, the entity may consider whether it establishes underwriting guidelines, has the ability to decline transactions or withhold funds, approves customer contracts, provides customer support, and has responsibility over the resolution of customer service issues.
-
Whether the customer views the entity to be primarily responsible for the payment processing services, including their acceptability.
-
The ability of the entity to enhance, modify, or discontinue payment processing services.
-
The ability of the entity to determine and subsequently change the parties that will be used to perform the various payment processing services.
-
The ability to set the overall price paid by the customer.
-
Whether the entity provides a significant service of integrating all of the services transferred to the customer.
-
The entity’s obligation to maintain payment processing information on behalf of the merchant, perform preauthorization services, and determine what payment processing information is provided to the other parties in the payment processing ecosystem.
10.2.3 Integrating a Good or Service From a Third Party With a Good or Service Controlled by the Entity
An entity would also be a principal when it integrates a good or service
provided by a third party with other goods or services controlled by the entity.
The entity’s performance obligation may be to transfer to the customer a
distinct bundle of goods or services, a component of which is provided by the
third party. The entity would need to obtain control of the third party’s good
or service to integrate the good or service with the other goods or services
promised to the customer. For example, a general contractor may enter into a
contract with a customer to construct a house. The general contractor will most
likely need to combine goods or services provided by third parties (e.g.,
subcontractors) to transfer the promised goods or services to its customer.
Example 10-5
Contractor A enters into a contract with Customer B to construct a house. Customer B requests that a specific
brand of air-conditioning unit be included in the finished house. The contractor buys the air-conditioning unit
from a third party (either the contractor is reimbursed by the customer or the contract price includes the price
of the air-conditioning unit), completes the installation, and performs tests to ensure that the air-conditioning
unit is working. That is, as part of its obligation to construct the house for the customer, A performs a significant
service of integrating the air-conditioning unit into the house, which forms part of a single performance
obligation. Contractor A therefore concludes that it controls the air-conditioning unit before the unit is
transferred to the customer as part of the completed house.
Connecting the Dots
We believe that an entity should evaluate the level of integration
between the various inputs in identifying its performance obligations
when it uses third-party goods or services as inputs to produce or
deliver a combined output. In addition, the entity should consider
whether it has sufficient control over those inputs to significantly
integrate them into its offering.
At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB
Developments, Mr. Wiggins discussed situations in which an entity may
conclude that it is a principal because it takes a good or service from
a third party and integrates that good or service into its own offering.
In his discussion of entities’ contracts with customers involving a good
or service from a third party, Mr. Wiggins highlighted the importance of
determining (1) whether the entity is performing an integration service,
(2) the nature of the integration service, (3) the significance of the
integration service, and (4) whether the entity controls the third
party’s good or service. He noted that if an entity does not control a
promised good or service from a third party, it would be unclear how the
entity can significantly integrate that promised good or service with
its own offering.
10.2.4 Indicators That an Entity Is Acting as a Principal
In situations such as those described in
Examples 10-3 and 10-5, an entity controls specified goods
or services before they are transferred to the customer.
This may be the case even if the entity does not fulfill
the promise itself but directs a third party to fulfill
the obligation on its behalf. In other situations,
however, it may not be clear whether the entity does in
fact obtain control of the goods or services provided by
a third party before they are transferred to the
customer, as illustrated in Example 10-1. In
these circumstances, the entity will need to consider
the indicators in ASC 606-10-55-39 and 55-39A when
evaluating whether it is acting as a principal. Those
indicators are listed and explained as follows:
|
ASC 606-10
55-39 Indicators that an entity
controls the specified good or service before it is
transferred to the customer (and is therefore a
principal [see paragraph 606-10-55-37]) include, but are
not limited to, the following:
-
The entity is primarily responsible for fulfilling the promise to provide the specified good or service. This typically includes responsibility for the acceptability of the specified good or service (for example, primary responsibility for the good or service meeting customer specifications). If the entity is primarily responsible for fulfilling the promise to provide the specified good or service, this may indicate that the other party involved in providing the specified good or service is acting on the entity’s behalf.
-
The entity has inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer (for example, if the customer has a right of return). For example, if the entity obtains, or commits to obtain, the specified good or service before obtaining a contract with a customer, that may indicate that the entity has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the good or service before it is transferred to the customer.
-
The entity has discretion in establishing the price for the specified good or service. Establishing the price that the customer pays for the specified good or service may indicate that the entity has the ability to direct the use of that good or service and obtain substantially all of the remaining benefits. However, an agent can have discretion in establishing prices in some cases. For example, an agent may have some flexibility in setting prices in order to generate additional revenue from its service of arranging for goods or services to be provided by other parties to customers.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
55-39A The indicators in
paragraph 606-10-55-39 may be more or less relevant to
the assessment of control depending on the nature of the
specified good or service and the terms and conditions
of the contract. In addition, different indicators may
provide more persuasive evidence in different
contracts.
We have observed that primary responsibility and inventory risk
tend to be important indicators in the overall principal-versus-agent analysis
under the revenue standard. However, the relevance of particular control
indicators may vary depending on the fact pattern. Consequently, an entity will
need to determine whether it controls the underlying goods or services before
they are transferred to the customer by considering how the control indicators
should be evaluated under the facts and circumstances of the entity’s
arrangements.
As discussed in ASU 2016-08, the FASB and IASB acknowledge that
the indicators under the revenue standard are similar to indicators used under
legacy U.S. GAAP. Specifically, paragraphs BC16 through BC18 state, in part:
BC16. The Boards’ considerations (explained in paragraph
BC382 of Update 2014-09) highlight that the indicators in paragraph
606-10-55-39 were included to support an entity’s assessment of whether
it controls a specified good or service before it is transferred to the
customer. The indicators (a) do not override the assessment of control,
(b) should not be viewed in isolation, (c) do not constitute a separate
or additional evaluation, and (d) should not be considered a checklist
of criteria to be met in all scenarios. Considering one or more of the
indicators often will be helpful, and, depending on the facts and
circumstances, individual indicators will be more or less relevant or
persuasive to the assessment of control.
BC17. [T]he Boards decided to carry over some of the
indicators in previous revenue recognition standards even though those
indicators have a different purpose in the new standard. In the new
standard, the indicators support the concepts of identifying performance
obligations and the transfer of control of goods or services.
Accordingly, the Boards had expected that the conclusions about
principal versus agent under Topic 606 could be different in some
scenarios from those reached under the previous revenue recognition
standards. Furthermore, the Boards observed that although exposure to
risks and rewards alone does not give an entity control, exposure to
risks and rewards can be a helpful factor to consider in determining
whether an entity has obtained control (see paragraph 606-10-25-30).
BC18. The Boards decided to amend the indicators in
paragraph 606-10-55-39 to more clearly establish a link between the
control principle and the indicators by:
-
Reframing the indicators as indicators of when an entity controls a specified good or service before transfer, rather than as indicators that an entity does not control the specified good or service before transfer.
-
Adding guidance to explain how each indicator supports the assessment of control as defined in paragraph 606-10-55-39. This should help entities apply indicators that are similar to those in the previous revenue recognition guidance but within the context of the control principle in Topic 606.
-
Removing the indicator relating to the form of the consideration. Although that indicator might sometimes be helpful in assessing whether an entity is an agent, the Boards concluded that it would not be helpful in assessing whether an entity is a principal.
-
Removing the indicator relating to exposure to credit risk. The feedback on the proposed Update highlighted that exposure to credit risk is generally not a helpful indicator when assessing whether an entity controls the specified good or service. Stakeholders observed that the credit risk indicator in the previous revenue guidance has been problematic from the perspective of entities trying to use exposure to credit risk to override stronger evidence of agency. The Boards concluded that removing the credit risk indicator should reduce some of the complexity in the principal versus agent evaluation because the credit risk indicator typically will be less (or not) relevant to the evaluation for contracts with customers within the scope of Topic 606.
-
Clarifying that the indicators are not an exhaustive list and merely support the assessment of control. They do not replace or override that assessment. The Boards decided to explicitly state that one or more of the indicators might provide more persuasive evidence to support the assessment of control in different scenarios.
As noted above, the indicators are intended to support the
conclusion that the entity controls the specified goods or services before they
are transferred to the customer. Typically, the principal that controls the
specified goods or services will exhibit some or all of the control indicators.
The indicators also help an entity evaluate whether it is exposed to significant
risks and rewards associated with the contract with the customer. As also noted
above, considering whether an entity has exposure to risks and rewards can be
helpful (although this indicator alone would not confirm that the entity has
control). Since the principal in a transaction is typically exposed to
significant risks and rewards associated with the contract with a customer, the
indicators help confirm whether an entity controls specified goods or services
before they are transferred to a customer (and is therefore deemed to be the
principal).
In a speech at the 2017 AICPA Conference on Current SEC and
PCAOB Developments, Barry Kanczuker, associate chief accountant in the OCA,
provided the following guidance on determining whether an entity is a principal
or an agent:
I have observed that applying [the guidance in ASC 606 on determining
whether an entity is a principal or an agent] can be challenging in some
fact patterns. I believe that some of the challenges are amplified in
certain industries, such as the digital advertising industry or other
industries in the technology space, where there are often multiple
parties involved in providing the good or service, and transactions
often take place within the blink of an eye.
Last year at this conference, [then OCA Professional Accounting Fellow]
Ruth Uejio made remarks that principal versus agent considerations in
evolving business models may create “unique challenges that will require
sound judgment.” I would like to continue this discussion. For example,
I believe determining whether an entity controls a specified good or
service immediately prior to the good or service being transferred to
the customer may be especially challenging in certain types of service
transactions, such as when enforceable contracts only exist among the
parties once the service is being provided, or in transactions that take
place in an instant. Topic 606 does provide indicators to support an
entity’s assessment of whether it controls a specified good or service
before it is transferred to the customer. However, these indicators of
control should not be considered a checklist of criteria. The indicators
may be more or less relevant to the assessment of control depending on
the nature of the specified good or service and the terms and conditions
of the contract. I believe that determining the relevance of an
indicator to the assessment of control in certain types of transactions
will require reasonable judgment.
As an example of the application of this guidance, I would like to share
a recent pre-filing consultation that OCA received in the digital
advertising space. In this consultation, the registrant’s customer, an
advertiser, provided the registrant with specifications of the target
audience it wished to reach through its digital advertising efforts. The
advertiser’s specifications also included limited pricing information,
such as the total advertising budget over a period of time. The
registrant’s technology enabled it to identify and purchase advertising
space that met the advertiser’s specifications on a real-time basis, as
internet users in the advertiser’s target audience were browsing a
website or viewing an app with available advertising space. The
registrant had the ultimate discretion, including pricing discretion,
for individual purchases of advertising space. The advertiser held the
registrant responsible for reaching the advertiser’s target audience and
otherwise meeting the advertiser’s specifications, and typically did not
receive any information from the registrant that identified the specific
websites or apps from which the registrant purchased the advertising
space.
The registrant concluded that it was acting as a principal in the
arrangement because it controlled the specified good or service before
it was transferred to the customer. As part of its assessment of
control, the registrant considered the indicators of control and noted
that it was primarily responsible for fulfillment and had discretion in
establishing the price. The staff views principal versus agent
considerations to be an area that requires reasonable judgment — in this
case, based on the facts and circumstances and the Topic 606 guidance,
the staff did not object to the registrant’s conclusion that it was the
principal in the transaction.
I want to be clear: an area of significant judgment does not mean that
the standard permits optionality. In order to make these reasonable
judgments, I believe that registrants need to “roll up their sleeves” to
understand the nuances of the transactions and faithfully apply the
Topic 606 model to their specific set of facts and circumstances.
[Footnotes omitted]
As discussed in Mr. Kanczuker’s speech above, determining
whether an entity is a principal or an agent can be challenging in certain
industries, particularly the digital advertising industry. In a speech at the 2020 AICPA Conference on
Current SEC and PCAOB Developments, Geoff Griffin, then professional accounting
fellow in the OCA, discussed another similar fact pattern. In his speech, Mr.
Griffin made the following observations related to the determination of whether
an entity is a principal or an agent in a contract to provide a customer with
access to the entity’s advertising platform:
Significant judgment is often required when determining
whether an entity is a principal or an agent in a revenue transaction.
As discussed in previous staff speeches, assessing whether an entity is
a principal or agent under the applicable revenue guidance can be
particularly challenging in certain industries, such as the digital
advertising industry or other industries in the technology space, where
arrangements often involve multiple parties providing the good or
service. I would like to share a fact pattern that illustrates such an
arrangement.
In this fact pattern, the registrant operated a platform
that facilitated an advertiser’s purchase of advertising space from a
publisher. The registrant identified a specific advertiser’s digital
advertisement (“ad”) before bidding on potential advertising space in an
auction process. Upon winning an auction, the registrant obtained an
exclusive right to the potential advertising space and immediately
pre-loaded the identified advertiser’s ad to the publisher’s site. If a
valid user reaches the stage in the publisher’s app where the potential
advertising space is to be displayed, the pre-loaded ad is displayed in
the advertising space on the publisher’s site and a revenue transaction
occurs.
The registrant concluded it was an agent in the
transaction, despite the fact that it obtained momentary title to the
advertising space, stating that it did not obtain control of the
advertising space prior to transferring it to the customer. That is, the
registrant concluded that it did not have the ability to direct the use
of, and obtain substantially all the remaining benefits from, the
publisher’s advertising space. Due to certain constraints, the
registrant concluded it was unable to direct the use of the potential
advertising space to an ad other than the predetermined ad in the
seconds between winning the auction and the time the ad was displayed on
the publisher’s site.
As part of its assessment, the registrant considered the
indicators of control set forth in the revenue recognition guidance,
determining that it was not primarily responsible for fulfillment and
did not have inventory risk; however, the registrant determined that it
did have pricing discretion as the publisher had no ability to set or
influence the price charged to advertisers. In reaching its conclusion,
the registrant stated that it was not primarily responsible for
fulfillment based on the terms and conditions of its contract with the
advertiser. The registrant believed that the terms and conditions of its
contract only obligated it to provide an advertiser with access to the
platform that facilitated the customer’s purchase of advertising space
from publishers. Finally, the registrant stated that it did not promise
its customer, explicitly or implicitly, the delivery of advertising
space, nor did the customer have recourse against the registrant if its
ad was not properly displayed in the advertising space or a valid user
did not view the ad.
Based on the facts and circumstances presented to OCA staff, the staff
did not object to the registrant’s conclusion that it was an agent in
the transaction and should recognize revenue on a net basis. [Footnotes
omitted]
Each of the indicators in ASC 606 that an entity is acting as a principal is
further discussed below.
10.2.4.1 Primary Responsibility
The entity that has primary responsibility for fulfilling
the obligation to the customer is often the entity that is most visible to
the customer and the entity from which the customer believes it is acquiring
goods or services. Often, the entity that has primary responsibility for
fulfilling the promise to transfer goods or services to the customer will
assume fulfillment risk (i.e., risk that the performance obligation will not
be satisfied) and risks related to the acceptability of specified goods or
services. That is, such an entity will typically address customer questions
and complaints, rectify service issues, accept product returns, or be
primarily responsible for exchanges or refunds. For example, when a customer
purchases a flight on a Web site operated by a company that aggregates
flight information and facilitates payment (e.g., a travel site), the
airline rather than the travel site has the primary responsibility to
provide the transportation service to the customer. If the flight were to be
canceled or if baggage were to be lost, the customer would contact the
airline to address the issue. Although the customer initially interacted
with the travel site to arrange for the flight, the airline is primarily
responsible for fulfilling the obligation to provide transportation services
to the customer.
Similarly, in Example 10-1, when a customer
purchases a good from an online retailer’s Web site that is shipped directly
to the customer from the supplier, the customer would contact the retailer
if there are quality issues or would return the good to the retailer if
there is a defect. That is, even though the good was actually shipped
directly from the supplier to the customer, the customer views the retailer
as being primarily responsible for fulfilling the promise to transfer the
specified good, and the retailer assumes significant risk related to
fulfillment of that promise.
In some cases, it can be difficult to establish whether an
entity has primary responsibility for fulfilling a promise to provide a
specified good or service, and doing so may require significant judgment.
For example, when two parties are involved in providing a specified good or
service to a customer, both parties may have contact with the customer.
Conversely, in other cases, it may be clear that an entity has primary
responsibility. If it is clear that an entity has primary responsibility for
fulfilling a promise to provide a specified good or service to a customer,
we believe that this would typically mean that the entity is deemed to be
the principal. Although ASC 606-10-55-39 lists primary responsibility as
only an indicator, ASC 606-10-55-36 makes clear that when the
principal-versus-agent analysis is performed, it is key to identify which
party is promising to provide the specified good or service to the customer.
If an entity has primary responsibility to the customer for providing a
specified good or service, it will usually follow that the entity is the
party that is promising to provide the good or service to the customer
(i.e., the entity is a principal, not an agent), even if the entity has
engaged another party (e.g., a subcontractor) to satisfy some or all of the
performance obligation on its behalf.
10.2.4.2 Inventory Risk
When an entity has inventory risk, it is exposed to economic
risk associated with either (1) holding the inventory before a customer is
identified or (2) accepting product returns and being required to mitigate
any resulting losses by reselling the product or negotiating returns with
the supplier.
While holding the inventory, the entity bears the risk of loss as a result of
obsolescence or destruction of inventory. This risk is generally referred to
as front-end inventory risk. In the case of a service, the entity may commit
to pay for a service before it identifies a customer for the service. This
is also a form of inventory risk.
Another type of inventory risk is back-end inventory risk,
which is economic risk assumed upon product return (when there is a general
right of return). If an entity is willing to assume economic risk upon
product return (and there is a general right of return), it is assuming some
risk that is assumed by a principal in a transaction. However, in some
instances, an entity may be willing to accept a return only if it can return
the product to the supplier, in which case back-end inventory risk may be
mitigated. When combined with other factors, the existence of back-end
inventory risk may lead to a conclusion that the entity controls the
specified good or service before it is transferred to the customer even if
another party transfers the product or service directly to the customer. In
Example
10-1, the online retailer does not have inventory risk before
entering into a contract with a customer because the online retailer takes
title to a good only momentarily before the supplier ships the good to a
customer. However, if the customer were to be dissatisfied with the good,
the customer would return it to the online retailer rather than the
supplier. The online retailer would then have back-end inventory risk since
it would have to determine whether it can resell the good to another
customer or return the good to the supplier.
10.2.4.3 Discretion in Establishing Pricing
When an entity has control over the establishment of
pricing, it generally assumes substantial risks and rewards related to the
demand of the specified product or service, especially when the price it is
required to pay a third party for the specified good or service is fixed. In
contrast, when an entity acts as an agent in a transaction, the amount that
the entity earns may be fixed (either in absolute dollars per transaction or
as a fixed percentage of the sales price).
When combined with other factors, pricing discretion could
indicate that the entity controls the specified good or service before it is
transferred to the customer. However, ASC 606-10-55-39(c) states, in part,
that “an agent can have discretion in establishing prices in some cases. For
example, an agent may have some flexibility in setting prices in order to
generate additional revenue from its service of arranging for goods or
services to be provided by other parties to customers.”
Example 10-6
A food delivery service offers
delivery of meals from restaurants to consumers
within a certain radius from a specific location in
a city. Via its Web site or app, the food delivery
service connects a consumer with a restaurant and
also delivers ordered food from the restaurant to
the consumer. Each restaurant indicates its prices
on the food delivery service’s platform and has the
ability to change those prices daily. The food
delivery service earns a 5 percent commission on
sales from each restaurant order.
In this example, each restaurant has
discretion in establishing pricing rather than the
food delivery service. In addition, the restaurant
is responsible for fulfilling the ordered food. This
would suggest that the restaurant controls the
specified good or service (i.e., the food ordered by
the consumer) at all times before the food is
transferred to the consumer.
Note, however, that the food
delivery service may be the principal for the
delivery service, particularly if it is primarily
responsible for the delivery service, in which case
it would be an agent for part of the transaction and
a principal for another part. Refer to Section
10.4 for further discussion of
contracts in which an entity is both a principal and
an agent.
10.2.5 Codification Examples of Promised Goods or Services for Which an Entity Is a Principal (ASC 606-10-55-320 Through 55-329)
The following implementation guidance from the revenue standard
will help an entity determine whether it is acting as a principal in a
contract:
ASC 606-10
Example 46 — Promise to Provide Goods or
Services (Entity Is a Principal)
55-320 An entity enters into
a contract with a customer for equipment with unique
specifications. The entity and the customer develop the
specifications for the equipment, which the entity
communicates to a supplier that the entity contracts
with to manufacture the equipment. The entity also
arranges to have the supplier deliver the equipment
directly to the customer. Upon delivery of the equipment
to the customer, the terms of the contract require the
entity to pay the supplier the price agreed to by the
entity and the supplier for manufacturing the
equipment.
55-321 The entity and the
customer negotiate the selling price, and the entity
invoices the customer for the agreed-upon price with
30-day payment terms. The entity’s profit is based on
the difference between the sales price negotiated with
the customer and the price charged by the supplier.
55-322 The contract between
the entity and the customer requires the customer to
seek remedies for defects in the equipment from the
supplier under the supplier’s warranty. However, the
entity is responsible for any corrections to the
equipment required resulting from errors in
specifications.
55-323 To determine whether
the entity’s performance obligation is to provide the
specified goods or services itself (that is, the entity
is a principal) or to arrange for those goods or
services to be provided by another party (that is, the
entity is an agent), the entity identifies the specified
good or service to be provided to the customer and
assesses whether it controls that good or service before
the good or service is transferred to the customer.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
55-323A The entity concludes
that it has promised to provide the customer with
specialized equipment designed by the entity. Although
the entity has subcontracted the manufacturing of the
equipment to the supplier, the entity concludes that the
design and manufacturing of the equipment are not
distinct because they are not separately identifiable
(that is, there is a single performance obligation). The
entity is responsible for the overall management of the
contract (for example, by ensuring that the
manufacturing service conforms to the specifications)
and thus provides a significant service of integrating
those items into the combined output — the specialized
equipment — for which the customer has contracted. In
addition, those activities are highly interrelated. If
necessary modifications to the specifications are
identified as the equipment is manufactured, the entity
is responsible for developing and communicating
revisions to the supplier and for ensuring that any
associated rework required conforms with the revised
specifications. Accordingly, the entity identifies the
specified good to be provided to the customer as the
specialized equipment.
55-323B The entity concludes
that it controls the specialized equipment before that
equipment is transferred to the customer (see paragraph
606-10-55-37A(c)). The entity provides the significant
integration service necessary to produce the specialized
equipment and, therefore, controls the specialized
equipment before it is transferred to the customer. The
entity directs the use of the supplier’s manufacturing
service as an input in creating the combined output that
is the specialized equipment. In reaching the conclusion
that it controls the specialized equipment before that
equipment is transferred to the customer, the entity
also observes that even though the supplier delivers the
specialized equipment to the customer, the supplier has
no ability to direct its use (that is, the terms of the
contract between the entity and the supplier preclude
the supplier from using the specialized equipment for
another purpose or directing that equipment to another
customer). The entity also obtains the remaining
benefits from the specialized equipment by being
entitled to the consideration in the contract from the
customer.
55-324 Thus, the entity
concludes that it is a principal in the transaction. The
entity does not consider the indicators in paragraph
606-10-55-39 because the evaluation above is conclusive
without consideration of the indicators. The entity
recognizes revenue in the gross amount of consideration
to which it is entitled from the customer in exchange
for the specialized equipment.
Example 46A — Promise to Provide Goods
or Services (Entity Is a Principal)
55-324A An entity enters into
a contract with a customer to provide office maintenance
services. The entity and the customer define and agree
on the scope of the services and negotiate the price.
The entity is responsible for ensuring that the services
are performed in accordance with the terms and
conditions in the contract. The entity invoices the
customer for the agreed-upon price on a monthly basis
with 10-day payment terms.
55-324B The entity regularly
engages third-party service providers to provide office
maintenance services to its customers. When the entity
obtains a contract from a customer, the entity enters
into a contract with one of those service providers,
directing the service provider to perform office
maintenance services for the customer. The payment terms
in the contracts with the service providers generally
are aligned with the payment terms in the entity’s
contracts with customers. However, the entity is obliged
to pay the service provider even if the customer fails
to pay.
55-324C To determine whether
the entity is a principal or an agent, the entity
identifies the specified good or service to be provided
to the customer and assesses whether it controls that
good or service before the good or service is
transferred to the customer.
55-324D The entity observes
that the specified services to be provided to the
customer are the office maintenance services for which
the customer contracted and that no other goods or
services are promised to the customer. While the entity
obtains a right to office maintenance services from the
service provider after entering into the contract with
the customer, that right is not transferred to the
customer. That is, the entity retains the ability to
direct the use of, and obtain substantially all the
remaining benefits from, that right. For example, the
entity can decide whether to direct the service provider
to provide the office maintenance services for that
customer, or for another customer, or at its own
facilities. The customer does not have a right to direct
the service provider to perform services that the entity
has not agreed to provide. Therefore, the right to
office maintenance services obtained by the entity from
the service provider is not the specified good or
service in its contract with the customer.
55-324E The entity concludes
that it controls the specified services before they are
provided to the customer. The entity obtains control of
a right to office maintenance services after entering
into the contract with the customer but before those
services are provided to the customer. The terms of the
entity’s contract with the service provider give the
entity the ability to direct the service provider to
provide the specified services on the entity’s behalf
(see paragraph 606-10-55-37A(b)). In addition, the
entity concludes that the following indicators in
paragraph 606-10-55-39 provide further evidence that the
entity controls the office maintenance services before
they are provided to the customer:
-
The entity is primarily responsible for fulfilling the promise to provide office maintenance services. Although the entity has hired a service provider to perform the services promised to the customer, it is the entity itself that is responsible for ensuring that the services are performed and are acceptable to the customer (that is, the entity is responsible for fulfilment of the promise in the contract, regardless of whether the entity performs the services itself or engages a third-party service provider to perform the services).
-
The entity has discretion in setting the price for the services to the customer.
55-324F The entity observes
that it does not commit itself to obtain the services
from the service provider before obtaining the contract
with the customer. Thus, the entity has mitigated its
inventory risk with respect to the office maintenance
services. Nonetheless, the entity concludes that it
controls the office maintenance services before they are
provided to the customer on the basis of the evidence in
paragraph 606-10-55-324E.
55-324G Thus, the entity is a
principal in the transaction and recognizes revenue in
the amount of consideration to which it is entitled from
the customer in exchange for the office maintenance
services.
Example 47 — Promise to Provide Goods or
Services (Entity Is a Principal)
55-325 An entity
negotiates with major airlines to purchase tickets at
reduced rates compared with the price of tickets sold
directly by the airlines to the public. The entity
agrees to buy a specific number of tickets and must pay
for those tickets regardless of whether it is able to
resell them. The reduced rate paid by the entity for
each ticket purchased is negotiated and agreed in
advance.
55-326 The entity determines
the prices at which the airline tickets will be sold to
its customers. The entity sells the tickets and collects
the consideration from customers when the tickets are
purchased.
55-327 The entity also
assists the customers in resolving complaints with the
service provided by the airlines. However, each airline
is responsible for fulfilling obligations associated
with the ticket, including remedies to a customer for
dissatisfaction with the service.
55-328 To determine whether
the entity’s performance obligation is to provide the
specified goods or services itself (that is, the entity
is a principal) or to arrange for those goods or
services to be provided by another party (that is, the
entity is an agent), the entity identifies the specified
good or service to be provided to the customer and
assesses whether it controls that good or service before
the good or service is transferred to the customer.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
55-328A The entity concludes
that with each ticket that it commits itself to purchase
from the airline, it obtains control of a right to fly
on a specified flight (in the form of a ticket) that the
entity then transfers to one of its customers (see
paragraph 606-10-55-37A(a)). Consequently, the entity
determines that the specified good or service to be
provided to its customer is that right (to a seat on a
specific flight) that the entity controls. The entity
observes that no other goods or services are promised to
the customer.
55-328B The entity controls
the right to each flight before it transfers that
specified right to one of its customers because the
entity has the ability to direct the use of that right
by deciding whether to use the ticket to fulfill a
contract with a customer and, if so, which contract it
will fulfill. The entity also has the ability to obtain
the remaining benefits from that right by either
reselling the ticket and obtaining all of the proceeds
from the sale or, alternatively, using the ticket
itself.
55-328C The indicators in
paragraph 606-10-55-39(b) through (c) also provide
relevant evidence that the entity controls each
specified right (ticket) before it is transferred to the
customer. The entity has inventory risk with respect to
the ticket because the entity committed itself to obtain
the ticket from the airline before obtaining a contract
with a customer to purchase the ticket. This is because
the entity is obliged to pay the airline for that right
regardless of whether it is able to obtain a customer to
resell the ticket to or whether it can obtain a
favorable price for the ticket. The entity also
establishes the price that the customer will pay for the
specified ticket.
55-329 Thus, the entity
concludes that it is a principal in the transactions
with customers. The entity recognizes revenue in the
gross amount of consideration to which it is entitled in
exchange for the tickets transferred to the
customers.
Footnotes
1
Similarly, a professional employer organization (PEO) may provide
services under a co-employment model in which it does not control
the employees but serves as the EOR for payroll purposes. In this
circumstance, the nature of the PEO’s promise may be solely to
provide payroll services.
10.3 Determining Whether an Entity Is Acting as an Agent
If an entity concludes that it does not obtain control of a good or service
before that good or service is transferred to a customer, the entity is acting as an
agent. That is, the entity’s performance obligation is to arrange for another party
to transfer the good or service to the customer. As an agent, the entity will
recognize as revenue the commission or fee it earns (i.e., the net amount of
consideration retained) when or as it satisfies its performance obligation of
arranging for the specified goods or services to be provided by another party. This
guidance is articulated in ASC 606-10-55-38 as follows:
ASC 606-10
55-38 An entity is an agent if the entity’s performance obligation is to arrange for the provision of the specified good or service by another party. An entity that is an agent does not control the specified good or service provided by another party before that good or service is transferred to the customer. When (or as) an entity that is an agent satisfies a performance obligation, the entity recognizes revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging for the specified goods or services to be provided by the other party. An entity’s fee or commission might be the net amount of consideration that the entity retains after paying the other party the consideration received in exchange for the goods or services to be provided by that party.
10.3.1 Codification Examples of Promised Goods or Services for Which an Entity Is an Agent (ASC 606-10-55-317 Through 55-319 and ASC 606-10-55-330 Through 55-334)
The following implementation guidance from the revenue standard
will help an entity determine whether it is acting as an agent in a
contract:
ASC 606-10
Example 45 — Arranging for the Provision
of Goods or Services (Entity Is an Agent)
55-317 An entity operates a
website that enables customers to purchase goods from a
range of suppliers who deliver the goods directly to the
customers. Under the terms of the entity’s contracts
with suppliers, when a good is purchased via the
website, the entity is entitled to a commission that is
equal to 10 percent of the sales price. The entity’s
website facilitates payment between the supplier and the
customer at prices that are set by the supplier. The
entity requires payment from customers before orders are
processed, and all orders are nonrefundable. The entity
has no further obligations to the customer after
arranging for the products to be provided to the
customer.
55-318 To determine whether
the entity’s performance obligation is to provide the
specified goods itself (that is, the entity is a
principal) or to arrange for those goods to be provided
by the supplier (that is, the entity is an agent), the
entity identifies the specified good or service to be
provided to the customer and assesses whether it
controls that good or service before the good or service
is transferred to the customer.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
55-318A The website operated
by the entity is a marketplace in which suppliers offer
their goods and customers purchase the goods that are
offered by the suppliers. Accordingly, the entity
observes that the specified goods to be provided to
customers that use the website are the goods provided by
the suppliers, and no other goods or services are
promised to customers by the entity.
55-318B The entity concludes
that it does not control the specified goods before they
are transferred to customers that order goods using the
website. The entity does not at any time have the
ability to direct the use of the goods transferred to
customers. For example, it cannot direct the goods to
parties other than the customer or prevent the supplier
from transferring those goods to the customer. The
entity does not control the suppliers’ inventory of
goods used to fulfill the orders placed by customers
using the website.
55-318C As part of reaching
that conclusion, the entity considers the following
indicators in paragraph 606-10- 55-39. The entity
concludes that these indicators provide further evidence
that it does not control the specified goods before they
are transferred to the customers.
-
The supplier is primarily responsible for fulfilling the promise to provide the goods to the customer. The entity is neither obliged to provide the goods if the supplier fails to transfer the goods to the customer nor responsible for the acceptability of the goods.
-
The entity does not take inventory risk at any time before or after the goods are transferred to the customer. The entity does not commit to obtain the goods from the supplier before the goods are purchased by the customer and does not accept responsibility for any damaged or returned goods.
-
The entity does not have discretion in establishing prices for the supplier’s goods. The sales price is set by the supplier.
55-319 Consequently, the
entity concludes that it is an agent and its performance
obligation is to arrange for the provision of goods by
the supplier. When 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.
Example 48 — Arranging for the Provision
of Goods or Services (Entity Is an Agent)
55-330 An entity sells
vouchers that entitle customers to future meals at
specified restaurants, and the sales price of the
voucher provides the customer with a significant
discount when compared with the normal selling prices of
the meals (for example, a customer pays $100 for a
voucher that entitles the customer to a meal at a
restaurant that would otherwise cost $200). The entity
does not purchase or commit itself to purchase vouchers
in advance of the sale of a voucher to a customer;
instead, it purchases vouchers only as they are
requested by the customers. The entity sells the
vouchers through its website, and the vouchers are
nonrefundable.
55-331 The entity and the
restaurants jointly determine the prices at which the
vouchers will be sold to customers. Under the terms of
its contracts with the restaurants, the entity is
entitled to 30 percent of the voucher price when it
sells the voucher.
55-332 The entity also
assists the customers in resolving complaints about the
meals and has a buyer satisfaction program. However, the
restaurant is responsible for fulfilling obligations
associated with the voucher, including remedies to a
customer for dissatisfaction with the service.
55-333 To determine whether
the entity is a principal or an agent, the entity
identifies the specified good or service to be provided
to the customer and assesses whether it controls the
specified good or service before that good or service is
transferred to the customer.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
-
Subparagraph superseded by Accounting Standards Update No. 2016-08.
55-333A A customer obtains a
voucher for the restaurant that it selects. The entity
does not engage the restaurants to provide meals to
customers on the entity’s behalf as described in the
indicator in paragraph 606-10-55-39(a). Therefore, the
entity observes that the specified good or service to be
provided to the customer is the right to a meal (in the
form of a voucher) at a specified restaurant or
restaurants, which the customer purchases and then can
use itself or transfer to another person. The entity
also observes that no other goods or services (other
than the vouchers) are promised to the customers.
55-333B The entity concludes
that it does not control the voucher (right to a meal)
at any time. In reaching this conclusion, the entity
principally considers the following:
-
The vouchers are created only at the time that they are transferred to the customers and, thus, do not exist before that transfer. Therefore, the entity does not at any time have the ability to direct the use of the vouchers or obtain substantially all of the remaining benefits from the vouchers before they are transferred to customers.
-
The entity neither purchases nor commits itself to purchase vouchers before they are sold to customers. The entity also has no responsibility to accept any returned vouchers. Therefore, the entity does not have inventory risk with respect to the vouchers as described in the indicator in paragraph 606-10- 55-39(b).
55-334 Thus, the entity
concludes that it is an agent in the arrangement with
respect to the vouchers. The entity recognizes revenue
in the net amount of consideration to which the entity
will be entitled in exchange for arranging for the
restaurants to provide vouchers to customers for the
restaurants’ meals, which is the 30 percent commission
it is entitled to upon the sale of each voucher.
10.3.2 Timing of Revenue Recognition When the Entity Is an Agent
The timing of when an agent satisfies its performance obligation
may not be the same as the timing of when the principal in the arrangement
transfers control of the specified good or service to the end customer. As noted
in Section 8.2, ASC
606-10-25-23 states that (1) an entity should “recognize revenue when (or as)
the entity satisfies a performance obligation by transferring a promised good or
service . . . to a customer” and (2) an “asset is transferred when (or as) the
customer obtains control of that asset.” Accordingly, when an entity determines
that it is acting as an agent with respect to the specified good or service, the
entity must use judgment and consider all of the relevant facts and
circumstances to determine when it has satisfied its performance obligation to
arrange for the provision of a specified good or service by another party.
When the nature of an entity’s promise is to arrange for goods
or services to be provided by another party, it is often important to determine
whether the entity is an agent for the buyer, the seller, or both to assess (1)
to whom the entity is obligated to satisfy its performance obligation of
arranging for the provision of goods or services and (2) when the entity
satisfies such performance obligation. Further, if there is a difference in
timing between when the agent arranges for goods or services to be provided by a
seller and when the specified goods or services are transferred from the seller
to the buyer, it is important to determine whether the entity’s promise of
arranging for goods or services to be transferred by the seller is satisfied
when the arrangement is made or when the specified goods or services are
transferred by the seller to the buyer.
Example 10-7
Entity A operates a travel booking Web site that arranges
for airlines to provide transportation services to end
customers. Entity A partners with various airlines and
offers their flights on its platform. End customers will
purchase specific flights on A’s platform and pay A the
nonrefundable airfare price at the time of purchase.
Flights can be sold up to 12 months before the scheduled
departure date. Within seven days of an end customer’s
purchase, A remits to the airline the airfare price less
A’s commission. After the initial booking on A’s
platform, any changes requested by the end customer are
handled directly by the airline. Therefore, A has no
further involvement with the end customer or the airline
related to the flight purchased after the initial
booking.
Entity A concludes that the nature of its promise is to
arrange for airlines to provide transportation services
to end customers. Entity A’s customer is the end
customer, and A’s performance obligation is satisfied at
the time of the initial booking. This is because A has
no further obligations after the initial booking.
Specifically, A has no further involvement with the end
customer or the airline after the initial booking, any
changes requested by the end customer must be handled
directly by the airline, and the amount A collects is
nonrefundable. Accordingly, A may conclude that it
should recognize revenue at the point in time when the
initial booking is successfully made.
Example 10-8
Entity B operates a travel booking Web site that arranges
for various travel services (e.g., hotels, rental cars,
experiences) to be provided by third parties. Entity B
partners with these third parties and offers their
services on its platform. End customers will reserve the
travel services on B’s platform, but B does not collect
payment from end customers until the travel services are
provided. This is because B allows end customers to
change or cancel their travel arrangements at any time
before when the underlying travel services are scheduled
to be transferred to the end customers. Entity B also
promises to provide assistance to end customers in
modifying or canceling the arranged travel services and
to coordinate with the travel service providers until
the underlying services are provided. Within seven days
of payment by the end customer, B remits to the travel
service provider the price of the travel service less
B’s commission.
Entity B concludes that the nature of its promise is to
identify paying end customers for its travel service
provider partners. Entity B’s customer is the travel
service provider, and B’s performance obligation is not
satisfied until the travel service provider begins to
provide travel services to the end customer. This is
because B remains obligated to identify paying end
customers after booking and before the travel service
provider begins providing travel services. Specifically,
end customers can cancel or modify their travel
arrangements at any time before when the underlying
travel services are scheduled to be provided, B
continues to be involved with the end customers and the
travel service providers by helping end customers modify
or cancel their arrangements until such services are
provided, and end customers are not required to pay
until the travel services are provided. That is, a
paying end customer is not identified for the travel
service provider until the travel services are provided.
Accordingly, B may conclude that it should recognize
revenue at the point in time when the travel services
provided to the end customer commence.
10.4 Contracts in Which the Entity Is a Principal and an Agent
As discussed in Section
10.1.1, an entity must determine whether it is a principal or an
agent at what can effectively be described as the performance obligation level
(i.e., the specified good or service that is distinct), not the contract level.
Therefore, in some contracts, an entity could have both performance obligations to
arrange for goods or services to be provided by another entity (i.e., the entity is
acting as an agent) and performance obligations to transfer goods or services to the
customer itself (i.e., the entity is acting as a principal).
10.4.1 Illustrative Examples of Contracts in Which an Entity Is Both a Principal and an Agent
The following implementation guidance from the revenue standard
illustrates a situation in which an entity is a principal and an agent in the
same contract:
ASC 606-10
Example 48A — Entity Is a Principal and
an Agent in the Same Contract
55-334A An entity sells
services to assist its customers in more effectively
targeting potential recruits for open job positions. The
entity performs several services itself, such as
interviewing candidates and performing background
checks. As part of the contract with a customer, the
customer agrees to obtain a license to access a third
party’s database of information on potential recruits.
The entity arranges for this license with the third
party, but the customer contracts directly with the
database provider for the license. The entity collects
payment on behalf of the third-party database provider
as part of its overall invoicing to the customer. The
database provider sets the price charged to the customer
for the license and is responsible for providing
technical support and credits to which the customer may
be entitled for service down-time or other technical
issues.
55-334B To determine whether
the entity is a principal or an agent, the entity
identifies the specified goods or services to be
provided to the customer and assesses whether it
controls those goods or services before they are
transferred to the customer.
55-334C For the purpose of
this Example, it is assumed that the entity concludes
that its recruitment services and the database access
license are each distinct on the basis of its assessment
of the guidance in paragraphs 606-10-25-19 through
25-22. Accordingly, there are two specified goods or
services to be provided to the customer — access to the
third-party’s database and recruitment services.
55-334D The entity concludes
that it does not control the access to the database
before it is provided to the customer. The entity does
not at any time have the ability to direct the use of
the license because the customer contracts for the
license directly with the database provider. The entity
does not control access to the provider’s database — it
cannot, for example, grant access to the database to a
party other than the customer or prevent the database
provider from providing access to the customer.
55-334E As part of reaching
that conclusion, the entity also considers the
indicators in paragraph 606-10- 55-39. The entity
concludes that these indicators provide further evidence
that it does not control access to the database before
that access is provided to the customer.
-
The entity is not responsible for fulfilling the promise to provide the database access service. The customer contracts for the license directly with the third-party database provider, and the database provider is responsible for the acceptability of the database access (for example, by providing technical support or service credits).
-
The entity does not have inventory risk because it does not purchase or commit to purchase the database access before the customer contracts for database access directly with the database provider.
-
The entity does not have discretion in setting the price for the database access with the customer because the database provider sets that price.
55-334F Thus, the entity
concludes that it is an agent in relation to the
third-party’s database service. In contrast, the entity
concludes that it is the principal in relation to the
recruitment services because the entity performs those
services itself and no other party is involved in
providing those services to the customer.
In the example above, an important part of the fact pattern is
that the entity has no further obligations to the customer after arranging for
the database access to be provided to the customer. If this is not the case
(e.g., because the entity would be responsible for the acceptability of the
database access), the analysis could be different.
Example 10-9
Company X, a food delivery service,
offers delivery of meals from restaurants to consumers
within a certain radius from a specific location in a
city. Via its Web site and app, the food delivery
service connects a consumer with a restaurant, processes
food orders, and provides a service of delivering food
to the consumer. Each restaurant has full discretion to
establish the price for its food ordered through X. The
food delivery service earns a 5 percent commission on
sales from each restaurant order and charges a flat
delivery fee of $10 per order. The restaurant is
responsible for fulfilling the ordered food and
addressing all consumer complaints regarding the quality
of the food or an incorrect order. If the food is
compromised while in transit, X is liable.
Company X is responsible for delivering the food and can
change the delivery fee at its discretion. Company X
takes custody of the food ordered from a restaurant, but
it can deliver the food only to the consumer’s location.
Company X uses independent contractors (ICs) to perform
the delivery service, and such ICs commit to being
available to provide the delivery service at set
schedules. When an IC is presented with a delivery
request, that IC can decide whether to accept or reject
the request. If an IC accepts a request, X will direct
the IC to pick up the food at a specific restaurant and
deliver the good to a specific consumer. If, instead, an
IC rejects a request, X is still obligated to provide
the delivery service and will attempt to find another IC
to perform the delivery. In some cases, X will take a
loss on the delivery service by paying an IC a rate
higher than the delivery fee to fulfill the
delivery.
Assume that the food and the delivery service are each
capable of being distinct and distinct within the
context of the contract (see Chapter 5).
In this example, X does not obtain
control of the food (one of the specified goods or
services) before it is transferred to the consumer.
Although X takes custody of the food, it cannot redirect
the food to another consumer or consume the good (the
food) as a resource. Further, X is not responsible for
fulfilling the food order or addressing consumer
complaints, does not purchase the food before the food
is transferred to the consumer, and does not have
discretion to establish the price of the food. Company X
is acting as an agent and arranging for the restaurant
to fulfill the promise to transfer food to the
consumer.
However, X is primarily responsible for
providing the service of delivering the food to the
consumer. If the food is compromised while in transit, X
is liable to the customer. Although ICs are used to
perform the delivery service and an individual IC can
reject a particular delivery, X is still obligated to
provide the delivery service and is required to identify
another IC to complete the delivery service even if
doing so results in a loss to X. Further, X has full
discretion to establish the price of the delivery
service. Consequently, X is the principal for the
delivery service.
10.4.2 Allocating the Transaction Price When an Entity Is a Principal for Some Performance Obligations and an Agent for Other Performance Obligations
In a single contract, an entity may promise to (1) arrange for
goods or services to be provided by another entity (i.e., the entity is acting
as an agent) and (2) transfer goods or services to the customer itself (i.e.,
the entity is acting as a principal). As a result, the entity may identify one
or more performance obligations for which it is acting as an agent and one or
more performance obligations for which it is acting as a principal in the same
contract. In such a situation, an entity must consider how to allocate the
contract transaction price to those separate performance obligations.
ASC 606-10-32-28 states the objective of allocating the
transaction price:
The objective when allocating the
transaction price is for an entity to allocate the transaction price to each
performance obligation (or distinct good or service) in an amount that
depicts the amount of consideration to which the entity expects to be
entitled in exchange for transferring the promised goods or services to the
customer.
ASC 606-10-32-29 explains how to meet this objective:
To meet the allocation objective, an entity shall allocate
the transaction price to each performance obligation identified in the
contract on a relative standalone selling price basis in accordance with
paragraphs 606-10-32-31 through 32-35, except as specified in paragraphs
606-10-32-36 through 32-38 (for allocating discounts) and paragraphs
606-10-32-39 through 32-41 (for allocating consideration that includes
variable amounts).
Further, ASC 606-10-32-36 states:
A
customer receives a discount for purchasing a bundle of goods or services if
the sum of the standalone selling prices of those promised goods or services
in the contract exceeds the promised consideration in a contract. Except
when an entity has observable evidence in accordance with paragraph
606-10-32-37 that the entire discount relates to only one or more, but not
all, performance obligations in a contract, the entity shall allocate a
discount proportionately to all performance obligations in the contract. The
proportionate allocation of the discount in those circumstances is a
consequence of the entity allocating the transaction price to each
performance obligation on the basis of the relative standalone selling
prices of the underlying distinct goods or services.
In light of the guidance above, we believe that an entity should
generally allocate the transaction price to all of the performance obligations
(i.e., those for which the entity is acting as a principal as well as those for
which the entity is acting as an agent) on a relative stand-alone selling price
basis. When allocating the transaction price, the entity should also consider
the guidance on allocating discounts and variable consideration to individual
performance obligations. In addition, given the guidance above, we believe that
there are two acceptable models (“Alternative A” and “Alternative B”) for
allocating a contract transaction price when the entity is a principal for some
performance obligations and an agent for other performance obligations. Those
models are illustrated in the example below.
Example 10-10
Entity X sells two distinct products,
Item 1 and Item 2, and provides a distinct service to
Customer Z for a total contract price of $180,000. The
products and the service are all transferred to the
customer at different times. The stand-alone selling
prices are as follows:
Entity X determines that it is the
principal for the sale of Item 1 and Item 2 but that it
is an agent for the service. Entity X agrees to sell the
service for $60,000 on behalf of a third-party service
provider for a 25 percent commission and bundles the
service with its products. Thus, $45,000 is remitted to
the third-party service provider, and X retains a
$15,000 commission. Assume that the criteria for
allocating a discount to one or more, but not all,
performance obligations in accordance with ASC
606-10-32-37 are not met.
Alternative
A
Entity X determines that the stand-alone
selling price of the service provided as an agent is
$15,000 (and that therefore, the total stand-alone price
of the performance obligations is $165,000). Because X
must remit $45,000 back to the third-party service
provider and retains only a $15,000 commission, X
determines that the total consideration it is entitled
to receive is $135,000 rather than the contract price of
$180,000. Therefore, X allocates the $135,000
transaction price to Item 1, Item 2, and the service on
a relative stand-alone selling price basis, as shown in
the table below.
Alternative B
The facts and circumstances in this
example may suggest that X’s performance obligations are
provided to two separate customers (i.e., the facts and
circumstances may support a determination that those
performance obligations for which X acts as a principal
(Item 1 and Item 2) are transferred to the end customer,
and the performance obligation for which X acts as an
agent (arranging for the service to be provided by the
third party) is performed on behalf of the third party).
If so, we believe that it is acceptable for X to (1)
allocate $120,000 ($180,000 contract price – $60,000
stand-alone selling price of the service) to Item 1 and
Item 2 on a relative stand-alone selling price basis and
(2) allocate the $15,000 commission received from the
third-party service provider directly to the service.
The allocations are shown in the table below.
While both alternatives described in the example above are
acceptable, we believe that for an entity to fairly depict the substance of the
transaction, one alternative may be preferable to the other depending on the
facts and circumstances of the particular arrangement. To determine which
alternative is preferable, an entity should understand and evaluate the
relationship of all of the parties involved in the particular arrangement.
Specifically, Alternative A would most likely be preferable if (1) the facts and
circumstances indicate that the entity has only one customer in the arrangement
or (2) the economic substance of the arrangement is such that there is a single
bundled discount provided to the end customer. In contrast, Alternative B would
most likely be preferable if the facts and circumstances indicate that (1) the
entity’s performance obligations in the contract (or contracts) are provided to
two separate customers (i.e., those performance obligations for which the entity
acts as a principal are transferred to the end customer, and those performance
obligations for which the entity acts as an agent are performed on behalf of a
third party) and (2) the pricing of the performance obligations provided to the
separate customers is not interdependent. Judgment is often needed in these
types of arrangements to assess whether an entity has one customer or two
customers.
10.5 Other Considerations
10.5.1 Change in the Nature of the Customer and Vendor Relationship
Sometimes, an entity may contractually and legally transfer its
obligations to satisfy some or all of its promises under a contract with a
customer. This situation is discussed in ASC 606-10-55-40.
ASC
606-10
55-40 If another entity assumes
the entity’s performance obligations and contractual
rights in the contract so that the entity is no longer
obliged to satisfy the performance obligation to
transfer the specified good or service to the customer
(that is, the entity is no longer acting as the
principal), the entity should not recognize revenue for
that performance obligation. Instead, the entity should
evaluate whether to recognize revenue for satisfying a
performance obligation to obtain a contract for the
other party (that is, whether the entity is acting as an
agent).
An entity that was initially the principal in a transaction
should perform a careful analysis of its performance obligation before
concluding that it is no longer primarily responsible for fulfilling its promise
under the contract. A customer would most likely need to agree to ceding the
contract to another party and would look to that third party as the entity that
is primarily responsible for the fulfillment of the contract.
10.5.2 Presentation of Sales Taxes and Similar Taxes Collected From Customers
Under step 3 of the revenue standard (see Chapter 6), 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.” 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 gross or net within revenue. The
analysis is further complicated by the sales tax regulations 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.
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.
The FASB decided to provide in ASU 2016-122 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. See Chapter 15 on
disclosure.
Further, an entity that does not elect to present all sales
taxes on a net basis would be required to assess, 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. For more information on making this
assessment, see Section
6.7.
10.5.3 Income Tax Withholdings
The example below illustrates how an entity that acts as a
principal to provide services to a customer would account for income tax that
the customer withholds and remits to the customer’s local government on behalf
of the entity providing the services.
Example 10-11
Company X performs consulting services
for Company C, which is located in a country other than
that of X. Company C owes a $100 fee to X for performing
the consulting services and withholds 20 percent of the
fee as a local income tax withholding. Company C
transmits this amount to its local government on behalf
of X (X retains the primary responsibility to pay the
tax in C’s tax jurisdiction). Company C pays the
remaining 80 percent balance to X. The countries do not
have a tax treaty, and X is not required to file a tax
return in C’s country. Company X was fully aware that
the 20 percent income tax would be withheld in C’s
country when it agreed to perform the consulting
services for C.
Company X is the principal in providing
the consulting services to C (i.e., there are no third
parties involved in providing the services). Company X
also has the primary responsibility to pay the tax in
C’s tax jurisdiction, and C is simply paying the tax on
X’s behalf (acting as a collection agent). Consequently,
X should recognize revenue in the gross amount of
consideration to which it expects to be entitled in
exchange for those services and should therefore report
revenue of $100 and income tax expense of $20 (i.e., X
should not report net revenue of $80).
Company X is not eligible for the
practical expedient in ASC 606-10-32-2A in this instance
because the amount being withheld is income tax, not
sales tax. See Section 10.5.2 for
further discussion of the sales tax practical expedient
in ASC 606-10-32-2A.
10.5.4 Presentation of Shipping and Handling Costs Billed to Customers
Many vendors charge customers for shipping and handling of
goods. Shipping costs include costs incurred to move the product from the
seller’s place of business to the buyer’s designated location and include
payments to third-party shippers. Shipping costs may also be costs incurred
directly by the seller (e.g., salaries and overhead related to the activities
needed to prepare the goods for shipment). Handling costs include costs incurred
to store, move, and prepare the products for shipment. Generally, handling costs
are incurred from when the product is removed from finished-goods inventory to
when the product is provided to the shipper and may include an allocation of
internal overhead.
Some vendors charge customers a separate fee for shipping and
handling costs. Alternatively, shipping and handling might be included in the
price of the product. In some cases, the separate fee may be a standard amount
that does not necessarily correlate directly with the costs incurred for the
specific shipment. In other cases, the separate fee may be a direct
reimbursement for shipping and any direct incremental handling costs incurred or
may include a margin on top of those costs.
ASU
2016-10 provides a practical expedient that permits shipping
and handling costs that occur after control of the promised goods or services is
transferred to the customer to be presented as fulfillment costs. That is,
shipping and handling does not need to be identified as a promised good or
service and a potential performance obligation. ASC 606-10-25-18B (added by ASU
2016-10) states:
If shipping and handling activities are performed after a customer
obtains control of the good, then the entity may elect to account for
shipping and handling as activities to fulfill the promise to transfer
the good. The entity shall apply this accounting policy election
consistently to similar types of transactions. An entity that makes this
election would not evaluate whether shipping and handling activities are
promised services to its customers. If revenue is recognized for the
related good before the shipping and handling activities occur, the
related costs of those shipping and handling activities shall be
accrued. An entity that applies this accounting policy election shall
comply with the accounting policy disclosure requirements in paragraphs
235-10-50-1 through 50-6.
If an entity does not avail itself of the aforementioned
practical expedient, the appropriate presentation of amounts billed to a
customer for shipping and handling will depend on an analysis of the
principal-versus-agent considerations in ASC 606 related to shipping and
handling services. If control of the goods is transferred on receipt by the
customer (e.g., on “free on board” destination), the vendor will generally be
considered to be the principal with respect to the shipping and handling
services. If, however, control of the goods is transferred when the goods are
shipped, the vendor will need to determine whether it is the principal or the
agent with respect to the shipping service.
If, after consideration of the requirements in ASC 606-10-55-36
through 55-40, the vendor determines that it is responsible for shipping and
handling as a principal, all amounts billed to a customer in a sale transaction
related to shipping and handling represent revenues earned for the goods
provided (and the shipping services rendered, if the shipping service represents
a distinct performance obligation) and will be presented as revenue.
However, if the vendor considers the requirements of ASC
606-10-55-36 through 55-40 and determines that it is not responsible to the
customer for shipping but is instead acting merely as the buyer’s agent in
arranging for a third party to provide shipping services to the buyer, the
vendor should not report the amount charged by that third party for shipping as
its own revenue. Instead, the vendor should report as revenue only the
commission it has received (if any) for arranging shipping, which is the excess
of (1) any amounts the vendor charged the customer for shipping services over
(2) any amounts paid to the third party for those services.
10.5.5 Revenue Equal to Costs
An entity may determine, in accordance with ASC 606-10-55-36
through 55-40, that it provides goods, services, or both as a principal. In
addition, the entity may sell some goods and services to third parties at an
amount equal to the cost of the goods and services.
In these circumstances, the entity is not permitted to
present the associated revenues and expenses on a net basis. When an entity has
determined that it acts as a principal in the sale of goods, services, or both,
it should recognize revenue in the gross amount to which it is entitled. The
practice of selling goods or providing services at an amount equal to cost does
not mean that the revenue should be presented as a cost reimbursement. Revenue
and expenses should, therefore, be presented gross.
For additional information, see Section 10.5.7.
10.5.6 Royalty Considerations
The example below considers whether an entity that acts as a
principal should (1) offset the royalties it pays a third party to fulfill a
contract with a customer against revenue received from the customer or (2)
recognize the royalty payments as a cost of fulfilling the contract with the
customer.
Example 10-12
Entity A has agreed to pay a royalty to
Entity B for the use of the intellectual property rights
that A requires to make sales to its customers. The
royalty is specified as a percentage of gross proceeds
from A’s sales to its customers less certain
contractually defined costs. Entity A is the principal
in sales transactions with its customers (i.e., it must
provide the goods and services itself and does not act
as an agent for B).
Because A is the principal in sales
transactions with its customers, it should recognize its
revenue on a gross basis and the royalty as a cost of
fulfilling the contract.
For guidance on accounting for the costs of fulfilling a
contract, including whether such costs should be capitalized or expensed, see
ASC 340-40, as discussed in Chapter 13.
10.5.7 Shared Commissions
The example below considers whether an entity may offset
expenses against revenue from shared commissions.
Example 10-13
Company A has signed a contract with an insurance company
under which it receives a commission for every policy it
sells on behalf of the insurance company. Company A
contracts with individual financial advisers to sell
these insurance policies and agrees to split the
commission evenly with the financial advisers. Company A
provides administrative facilities and office space to
the financial advisers. The insurance company is aware
of the arrangements between A and the financial
advisers, but its contractual relationship is with A,
and A is responsible for providing the service to the
insurance company. The insurance company pays the full
commission to A, which then pays half of the commission
to the financial adviser that sold the policy.
Company A has determined that it is
acting as a principal in this arrangement in accordance
with ASC 606-10-55-36 through 55-40.
Company A is not permitted to offset the amount it
pays to the financial advisers against the commission
revenue it receives from the insurance company. Because
A is acting as a principal in providing services to the
insurance company and not as an agent for the financial
advisers, it is required to present the revenue it
receives for those services as a gross amount.
10.5.8 Estimating Gross Revenue as a Principal
In deliberating ASU 2016-08 and Clarifications to IFRS
15, the FASB and IASB were informed of facts and circumstances under which
an entity is determined to be a principal in a contract with a customer when
there is uncertainty in the transaction price that is unlikely to be resolved.
Such uncertainty may arise because the entity does not have, and will not
obtain, sufficient transparency into the intermediary’s pricing.
As noted in paragraph BC38 of ASU 2016-08, the FASB
contemplated, but ultimately rejected, amendments to ASC 606 to address these
types of transactions. Rather, the Board found the guidance in step 3 of the
revenue model to be helpful in the determination of what amounts are variable
consideration and thus should be included in the transaction price.
Specifically, paragraph BC38(c) states, in part:
A key tenet
of variable consideration is that at some point the uncertainty in the
transaction price ultimately will be resolved. When the uncertainty is not
expected to ultimately be resolved, the guidance indicates that the
difference between the amount to which the entity is entitled from the
intermediary and the amount charged by the intermediary to the end customer
is not variable consideration and, therefore, is not part of the entity’s
transaction price.
Accordingly, for the transactions contemplated above, the Board found it
reasonable for the principal to include in its transaction price the amounts
known (i.e., the amounts to which the entity expects to be entitled from the
intermediary).
Footnotes
2
The IASB did not amend IFRS 15 for this practical
expedient. For a summary of differences between U.S. GAAP and IFRS
Accounting Standards, see Appendix A.
Chapter 11 — Customer Options for Additional Goods or Services (Material Rights)
Chapter 11 — Customer Options for Additional Goods or Services (Material Rights)
11.1 In General
ASC 606-10
55-41 Customer options to acquire
additional goods or services for free or at a discount come
in many forms, including sales incentives, customer award
credits (or points), contract renewal options, or other
discounts on future goods or services.
55-42 If, in a contract, an entity
grants a customer the option to acquire additional goods or
services, that option gives rise to a performance obligation
in the contract only if the option provides a material right
to the customer that it would not receive without entering
into that contract (for example, a discount that is
incremental to the range of discounts typically given for
those goods or services to that class of customer in that
geographical area or market). If the option provides a
material right to the customer, the customer in effect pays
the entity in advance for future goods or services, and the
entity recognizes revenue when those future goods or
services are transferred or when the option expires.
55-43 If a customer has the option
to acquire an additional good or service at a price that
would reflect the standalone selling price for that good or
service, that option does not provide the customer with a
material right even if the option can be exercised only by
entering into a previous contract. In those cases, the
entity has made a marketing offer that it should account for
in accordance with the guidance in this Topic only when the
customer exercises the option to purchase the additional
goods or services.
An entity’s contract with a customer may give the customer a choice
of whether to purchase additional goods or services; such a choice is typically
referred to as an option for additional goods or services. Options for additional
goods or services may include, but are not limited to:
- Loyalty programs in which customers accumulate points that may be used to acquire future goods or services.
- Discount vouchers.
- Renewal options.
- Contracts that include (1) a customer’s payment of a nonrefundable up-front fee and (2) renewal options.
In some cases, such options are marketing or promotional efforts to
gain future contracts with customers. However, in other cases, such options are
purchased (often implicitly) in conjunction with a present customer contract.
Entities are required to identify options for additional goods or
services because in certain circumstances, such options can lead to performance
obligations. As explained in paragraph BC386 of ASU
2014-09, the FASB and IASB realized that it could be difficult
to differentiate between (1) an option for additional goods or services that was
paid for by the customer and (2) a marketing or promotional offer for which the
customer did not pay. The first type of option for additional goods or services
would be identified as a performance obligation to which consideration must be
allocated in accordance with step 4 (see Chapter 7) of the revenue standard.
To help entities determine whether an option for additional goods or
services is a performance obligation, the boards included the concept of a material
right in the revenue standard. If an entity determines that an option for additional
goods and services is a material right, the option should be considered a
performance obligation. However, an entity will need to use judgment to determine
whether a material right exists.
A material right in a contract is provided to a customer only if the
customer would not have received it without entering into that contract. The
guidance in the revenue standard describes an example of a material right as an
option that provides the customer an incremental discount beyond the discounts that
are typically given (considering the class of customer).
11.2 Determining Whether an Option for Additional Goods or Services Represents a Material Right
The example below, which is reproduced from ASC 606, illustrates a
contract with an option for additional goods or services that is akin to a marketing
offer and thus does not represent a material right.
ASC 606-10
Example 50 — Option That Does Not Provide
the Customer With a Material Right (Additional Goods or
Services)
55-340 An entity in the
telecommunications industry enters into a contract with a
customer to provide a handset and monthly network service
for two years. The network service includes up to 1,000 call
minutes and 1,500 text messages each month for a fixed
monthly fee. The contract specifies the price for any
additional call minutes or texts that the customer may
choose to purchase in any month. The prices for those
services are equal to their standalone selling prices.
55-341 The entity determines that
the promises to provide the handset and network service are
each separate performance obligations. This is because the
customer can benefit from the handset and network service
either on their own or together with other resources that
are readily available to the customer in accordance with the
criterion in paragraph 606-10-25-19(a). In addition, the
handset and network service are separately identifiable in
accordance with the criterion in paragraph 606-10-25-19(b)
(on the basis of the factors in paragraph 606-10-25-21).
55-342 The entity determines that
the option to purchase the additional call minutes and texts
does not provide a material right that the customer would
not receive without entering into the contract (see
paragraph 606-10-55-43). This is because the prices of the
additional call minutes and texts reflect the standalone
selling prices for those services. Because the option for
additional call minutes and texts does not grant the
customer a material right, the entity concludes it is not a
performance obligation in the contract. Consequently, the
entity does not allocate any of the transaction price to the
option for additional call minutes or texts. The entity will
recognize revenue for the additional call minutes or texts
if and when the entity provides those services.
Once a material right is identified, it must be accounted for as a
performance obligation. However, the identification of material rights has been the
focus of many questions from stakeholders.
In determining whether an option for future goods or services is a
material right, an entity should (1) consider factors outside the current
transaction (e.g., the current class of customer1) and (2) assess both quantitative and qualitative factors. Further, an entity
should also evaluate incentives and programs to understand whether they are customer
options designed to influence customer behavior (i.e., an entity should consider
incentives and programs from the customer’s perspective) because this could be an
indicator that an option is a material right.
For example, regarding certain offers, such as “Buy three, get one
free,” the quantities involved are less important than the fact that an entity would
be “giving away” future sales in such cases. While not determinative, such an
indicator may lead an entity to conclude that a customer option is a material
right.
When determining whether a contract option provides a material
right, entities should consider not only the quantitative significance of the option
(i.e., the quantitative value of the benefit) but also previous and future
transactions with the customer as well as qualitative factors. Specifically,
qualitative features such as whether the rights accumulate (e.g., loyalty points)
are likely to provide a qualitative benefit that may give rise to a material right.
In accordance with ASC 606-10-25-16B, entities should not apply the guidance in ASC
606-10-25-16A on assessing whether promises for immaterial goods or services are
performance obligations to the assessment of whether a contract option provides a
material right (i.e., an optional good offered for free or at a discount, such as
that provided through loyalty point programs, may not be material for an individual
contract but could be material in the aggregate and accounted for as a material
right).
An entity should consider its customer’s reasonable expectations
when identifying promised goods or services. A customer’s perspective on what
constitutes a material right might consider qualitative factors (e.g., whether the
right accumulates). Therefore, a numeric threshold alone might not determine whether
a material right is provided by a customer option in a contract.
Refer to Examples 49 (Section 11.8), 50 (Section 11.2), 51 (Section 11.9), and 52 (Section 11.2.2) in ASC 606-10-55-336 through
55-356 for illustrations of how an entity would determine whether an option provides
a customer with a material right. In addition, some industries, such as the software
industry, more commonly provide customers with options to purchase additional goods
or services. Refer to Sections
12.3.3.1 and 12.6.3.2 for examples of how an entity would assess whether options
to purchase additional copies of software or options to renew postcontract customer
support (PCS) provide a customer with a material right.
The above issue is addressed in Q&As 12 through 14 (compiled
from previously issued TRG Agenda Papers 6, 11, 54, and 55) 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.
11.2.1 Need for Assessing Whether a Material Right Exists When the Residual Approach Was Used to Establish the Stand-Alone Selling Price of the Additional Goods or Services
Determining the stand-alone selling price of goods or services
offered to a customer under a contract option is a necessary step in the
assessment of whether a material right exists. The ability to sell certain goods
or services for a wide range of prices may make it difficult to establish the
stand-alone selling price of goods or services offered to a customer under a
contract option (e.g., a renewal option). This is especially true in the
software industry, in which the incremental costs incurred to sell additional
software licenses are often minimal and therefore allow software entities to
sell their software at prices spanning a wide range of discounts or even
premiums. Consequently, the FASB included the residual approach in ASC 606 as a
“suitable” method for establishing the stand-alone selling price.
If an entity applied the residual approach to establish the
stand-alone selling price of goods or services because the stand-alone selling
price of those goods or services is highly variable or uncertain, the entity is
required to assess whether an option (e.g., a renewal option) to acquire more of
those goods or services conveys a material right to the customer. Under ASC
606-10-55-41 through 55-45, a customer option to purchase additional goods or
services gives rise to a material right if the option provides the entity’s
customer with a discount that is incremental to the range of discounts typically
given for those goods or services to that class of customer (e.g., a customer in
a particular geographic area or market). It would not be appropriate for the
entity to conclude that no material right was conveyed to the customer simply
because the stand-alone selling price of the goods or services that are subject
to the option is highly variable or uncertain and the residual approach was
therefore applied.
When the residual approach is used to determine the stand-alone
selling price of a good or service because pricing is highly variable or
uncertain, assessing whether option pricing for that good or service provides a
material right may require significant judgment because of the lack of a point
estimate or sufficiently consistent range representing the stand-alone selling
price. While we believe that entities are likely to identify fewer material
rights in such cases, they are nonetheless required to base their determination
of whether a material right was provided on all reasonably available
information. Although the presence of highly variable or uncertain pricing
complicates the identification of material rights, we believe that when doing
so, an entity should consider (1) the definition of a material right2 and (2) the allocation objective in ASC 606-10-32-28. In other words, an
entity must determine whether the pricing of the optional good or service (1)
indicates that preferential pricing would not have been received “but for” the
initial contract or (2) reflects the amount to which the entity expects to be
entitled in exchange for transferring that good or service to the customer. If
the pricing does not meet the allocation objective (i.e., it is a discount that
is incremental to what other similar customers would receive), a material right
should be identified. We believe that an entity might find the following factors
useful in determining whether a material right is present when the pricing of
optional future purchases is highly variable or uncertain:
-
How the pricing of the optional future purchase aligns with current pricing policies and practices — For example, if a good or service is not typically sold below a certain amount because it is a premium offering, an option to buy the good or service at an amount below that floor would be at odds with standard pricing practices and may therefore convey a material right to the customer.
-
How the pricing of the optional future purchase compares to historical amounts allocated to the good or service in similar situations — Such a comparison is likely to require an entity to look to historical data and stand-alone selling prices that were derived by using the residual approach. Accordingly, while there will not be an established point estimate or narrow range of stand-alone selling prices against which to compare the pricing of the optional future purchase, ASC 606-10-32-34(c) indicates that the residual approach is a method of establishing a stand-alone selling price. Therefore, the amounts determined under that approach represent the stand-alone selling price for that good or service. Consequently, we believe that in assessing whether a customer has been given a material right, an entity may obtain useful information by comparing the pricing of an optional future purchase with historical stand-alone selling prices that were determined as a result of applying the residual approach. In addition, to determine which range of historical stand-alone selling prices to compare with the pricing of the optional future purchase, entities should consider only those transactions that are similar to the transaction in question. For example, an entity might disaggregate historical stand-alone selling price data by one or more of the following characteristics: class of customer, geography, distribution channel, or contract value.
-
How the pricing of the optional future purchase compares to historical contractually stated pricing (if any) of the good or service in similar situations — While the contractually stated pricing may not necessarily represent the stand-alone selling price (see ASC 606-10-32-32), the historical price across a range of different contracts may nevertheless be relevant evidence of an entity’s pricing practices and discounts it may offer on future purchases.
-
Whether the pricing of the optional future purchase is intended to incorporate a discount — If the intent during negotiations was to give the customer a discount on future purchases, a material right may exist since the allocation objective is less likely to be met in such cases. For example, a customer may only have agreed to enter into an initial contract if the vendor offered discounted pricing on future purchases.
-
Whether the pricing of the optional future purchase is discounted relative to (1) the price of similar goods or services sold under the initial contract or (2) the list price when compared with the discounted list prices of all goods or services (whether similar or not) sold under the initial contract — We acknowledge that this factor conflicts with the FASB’s reasons for departing from its definition of a significant incremental discount in legacy GAAP under ASC 985-605. In paragraph BC387 of ASU 2014-09, the Board indicates its rationale for defining “incremental” solely by reference to other comparable transactions:[T]he Boards observed that even if the offered discount is not incremental to other discounts in the contract, it nonetheless could, in some cases, give rise to a material right to the customer. Consequently, the Boards decided not to carry forward that part of the previous revenue recognition guidance from U.S. GAAP into Topic 606.However, we believe that when evaluated in conjunction with all other available evidence, a comparison of the pricing of the optional future purchase with any discounts offered in the initial contract may provide insight into an entity’s pricing practices and discounting intentions. Pricing of the optional future purchase at an amount that is lower than the price under the original contract may indicate the presence of a material right. Conversely, pricing of the optional future purchase at an amount that is lower than the list price but is nevertheless consistent with the discounted price charged under the original contract may be evidence to support a conclusion that the discounted price represents the stand-alone selling price.
-
How the pricing of the optional future purchase aligns with any intended future pricing for similar goods or services — For example, an option to buy add-on software at a set price may not give the customer a material right if that price approximates the amount at which management intends to sell that software on a stand-alone basis in the near future.
-
The relative negotiating power of the entity and the customer — In certain situations, customers may have a greater ability to demand discounted pricing on optional future purchases if the customers represent significantly larger, well-known brands that are dominant in their markets, are more mature, or are otherwise better positioned than the entity selling the goods or services.
The above factors are not intended to be all-inclusive or prescriptive, and each
factor on its own may not be determinative. Entities may need to use significant
judgment when determining whether a material right has been granted. Entities
with highly variable or uncertain pricing should establish a policy for
evaluating material rights and apply that policy consistently in similar
situations.
The examples below demonstrate the application of some of the concepts described
above.
Example 11-1
Entity J, an early-stage software developer, enters into
an arrangement with Customer T, a large U.S.-based
company, to license its software on a term basis and
provide PCS for one year. The arrangement also includes
hardware and professional services. The total
transaction price is $2 million, and J has established
that the license, PCS, hardware, and professional
services each represent a distinct performance
obligation.
Entity J has concluded that the pricing of software
licenses is highly variable and uses the residual
approach to determine the stand-alone selling price. The
observable stand-alone selling prices of the other
performance obligations are as follows:
- PCS — $200,000.
- Professional services — $500,000.
- Hardware — $300,000.
Under the residual approach, $1 million is allocated to
the software license, which J determines is consistent
with the allocation objective. The contract also
indicates that the customer may renew the software
license for $250,000 per additional year and that the
pricing for other products and services will be at their
stand-alone selling prices.
Entity J reviews historical transaction data for sales of
software licenses to large customers in the United
States to determine the amounts that have been allocated
to the software license under the residual approach.
Over the past year, a range of $500,000 to $3 million
has been allocated to the software license, which is
consistent with J’s pricing policies. While J did not
initially intend to give T a discount, it was willing to
negotiate on renewal pricing because it wanted to secure
the large contract and is able to enhance the
marketability of its products by obtaining T as a
customer (T is a well-known brand and dominant in its
market). Therefore, J concludes that the pricing of the
optional future purchase has given T a material
right.
We believe that the following factors indicate that T has
received a material right:
- A comparison of (1) the price T must pay if it exercises its option to renew the license in the future ($250,000) and (2) the range of stand-alone selling prices determined under the residual approach in similar historical transactions ($500,000 to $3 million) indicates that the pricing offered to T does not meet the allocation objective because T is receiving a significant discount that is incremental to the range of discounts offered to other similar customers.
- Although J did not initially intend to give T a discount on future purchases, other facts and circumstances indicate that J nonetheless offered T preferential pricing.
Example 11-2
Entity A enters into an arrangement with
Customer C, a midsized company based in Europe, to
license its software on a term basis and provide PCS for
one year. The arrangement also includes hardware and
professional services. The total transaction price is
$20,000, and A has established that the license, PCS,
hardware, and professional services each represent a
distinct performance obligation.
Entity A has concluded that the pricing of software
licenses is highly variable and uses the residual
approach to determine the stand-alone selling price. It
has observable stand-alone selling prices for its other
products and services. The list price, contractually
stated price, discount from list price, and stand-alone
selling price of each performance obligation are as
follows:
The contract also indicates that the customer may renew
the software license for $3,000 per additional year,
which represents a 60 percent discount from the list
price, and that the pricing for other products and
services remains at the same contractually stated
prices.
Entity A reviews historical transaction
data for sales of software licenses to midsized
customers in Europe to determine the contractually
stated prices and related discounts from list price for
the software license. Over the past year, the software
license has been priced between $1,000 to $20,000, thus
ranging from a discount of 87 percent to a premium of
167 percent relative to the list price. Entity A’s
internal pricing policies require that discounts of over
50 percent must undergo an extensive approval process.
Further, A intended to give C a discount on renewals of
the software license because A is in a highly
competitive market in which customer retention is
difficult. In addition, C indicated that it would
purchase large additional amounts of hardware.
Therefore, A concludes that the pricing of the optional
future purchase(s) gives C a material right.
We believe that the following factors indicate that C has
received a material right:
- It is not especially meaningful to compare (1) the discount to the list price C receives if it exercises its option to renew the license in the future (60 percent) with (2) the range of discounts and premiums in similar historical transactions (87 percent discount to 167 percent premium) given the significant pricing variation observed in the data. However, A’s internal pricing policies require any discounts of over 50 percent undergo an extensive approval process.
- On the basis of a comparison of (1) the discount from list price for the renewal pricing (60 percent) with (2) the other discounts offered in the same contract (0 percent to 38 percent for other goods and services and 40 percent for the same software license), A determines that the optional future purchase pricing conveys an incremental discount to C that it did not receive under the initial contract.
- Entity A’s intention to give C a discount to secure its future business in a competitive market supports a conclusion that “but for the initial contract,” C would not have received favorable pricing on future software license renewals.
- Customer C’s indication that it would make many additional purchases of hardware supports A’s decision to provide preferential pricing.
11.2.2 Loyalty Programs and Accumulation Features
ASC 606-10
Example 52 — Customer Loyalty
Program
55-353 An entity has a
customer loyalty program that rewards a customer with 1
customer loyalty point for every $10 of purchases. Each
point is redeemable for a $1 discount on any future
purchases of the entity’s products. During a reporting
period, customers purchase products for $100,000 and
earn 10,000 points that are redeemable for future
purchases. The consideration is fixed, and the
standalone selling price of the purchased products is
$100,000. The entity expects 9,500 points to be
redeemed. The entity estimates a standalone selling
price of $0.95 per point (totalling $9,500) on the basis
of the likelihood of redemption in accordance with
paragraph 606-10-55-44.
55-354 The points provide a
material right to customers that they would not receive
without entering into a contract. Consequently, the
entity concludes that the promise to provide points to
the customer is a performance obligation. The entity
allocates the transaction price ($100,000) to the
product and the points on a relative standalone selling
price basis as follows:
Product $91,324 [$100,000 × ($100,000
standalone selling price ÷ $109,500)]
Points $8,676 [$100,000 × ($9,500 standalone
selling price ÷ $109,500)]
55-355 At the end of the
first reporting period, 4,500 points have been redeemed,
and the entity continues to expect 9,500 points to be
redeemed in total. The entity recognizes revenue for the
loyalty points of $4,110 [(4,500 points ÷ 9,500 points)
× $8,676] and recognizes a contract liability of $4,566
($8,676 – $ 4,110) for the unredeemed points at the end
of the first reporting period.
55-356 At the end of the
second reporting period, 8,500 points have been redeemed
cumulatively. The entity updates its estimate of the
points that will be redeemed and now expects that 9,700
points will be redeemed. The entity recognizes revenue
for the loyalty points of $3,493 {[(8,500 total points
redeemed ÷ 9,700 total points expected to be redeemed) ×
$8,676 initial allocation] – $4,110 recognized in the
first reporting period}. The contract liability balance
is $1,073 ($8,676 initial allocation – $7,603 of
cumulative revenue recognized).
Loyalty programs allow customers to accumulate points upon each
purchase of goods or services; the points accumulated may then be redeemed to
obtain future goods or services from the same vendor. That is, the customer is
granted an option to purchase additional goods or services by redeeming the
points. Accordingly, ASC 606-10-25-18(j) requires the option to be recognized as
a distinct performance obligation when the option provides the customer with a
material right as defined in ASC 606-10-55-41 through 55-45.
We believe that the existence of an accumulation feature in a
loyalty program is a strong indicator of a material right, to which an entity
would need to allocate a portion of the current contract’s transaction price. We
expect it to be a rare conclusion that loyalty programs with accumulation
features are not material rights.
In circumstances in which a customer’s loyalty points accumulate
with each transaction, the entity should evaluate the current, past, and future
transactions made by the customer in evaluating whether the loyalty program
provides the customer with a material right. In addition, the entity should
consider both qualitative and quantitative factors and, in particular, should
consider whether the material right accumulates over time (after multiple
transactions). That is, the entity should consider factors related to both the
current transaction and the loyalty program in its entirety when analyzing
whether an option provides a material right (and should therefore be accounted
for as a distinct performance obligation in accordance with ASC 606-10-25-18(j)
and ASC 606-10-55-41 through 55-45).
For example, in any given transaction, the number of loyalty points awarded may
not be quantitatively material; however, the structure of the loyalty program
could be designed to influence customer behavior and therefore be a qualitative
indicator that the option provides a material right.
The above issue is addressed in Implementation Q&A 12 (compiled from
previously issued TRG Agenda Papers 6 and 11). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix C.
Note that the above discussion focuses on loyalty programs in which points that a
customer has earned by purchasing goods or services from a vendor are redeemed
for future goods or services from the same vendor. For loyalty programs in which
accumulated points can be redeemed for goods or services from a third party or
for goods or services from the original vendor that meet the requirement to be a
separate performance obligation, the original vendor should evaluate upon
redemption whether it is acting as a principal or as an agent in the transaction
associated with the deferred recognition of revenue. (See Chapter 10 for additional considerations related
to the assessment of whether an entity is a principal or an agent.) For example,
suppose that Company X, an airline, offers one point for every $100 a customer
spends. The accumulated points can be redeemed for either future flights
provided by X or future hotel stays with Hotel Y, a vendor with which X has
partnered. Since X has determined that its loyalty programs offer a material
right that is a performance obligation, X defers a portion of revenue for the
redemption of the loyalty points. Upon a customer’s redemption of points for
either a flight or a hotel stay, X evaluates whether it is acting as a principal
or as an agent in that transaction.
Further, any changes to an entity’s incentives (e.g., loyalty programs, rebates,
method of redeeming points, amounts for which points are earned) should be
evaluated under the contract modification guidance discussed in Chapter 9.
11.2.3 Considering the Class of Customer in the Evaluation of Whether a Customer Option Gives Rise to a Material Right
As noted in Section
11.2.2, when determining whether a material right exists, an entity
should take into account past, current, and future transactions as well as both
qualitative and quantitative factors (including whether the right
accumulates).
ASC 606-10-55-42 states, in part, that an “option gives rise to
a performance obligation in the contract only if the option provides a material
right to the customer that it would not receive without entering into that
contract (for example, a discount that is incremental to the range of discounts
typically given for those goods or services to that class of customer in that
geographic area or market).”
Stakeholder views have differed regarding how the class of
customer should be considered in an entity’s evaluation of whether a customer
option gives rise to a material right. Implementation Q&A 14 (compiled from
previously issued TRG Agenda Papers 54 and 55) and TRG Agenda Paper 54 provide the
following examples of the FASB staff’s views on this topic:
Example
|
Facts
|
FASB Staff Analysis and Views
|
---|---|---|
Volume discounts
|
|
Company A will need to consider all
relevant facts and circumstances (including the price
charged to other high-volume customers) to determine
whether the price offered in year 2 represents the
stand-alone selling price for the part. Said
differently, A would need to determine whether the
discount (1) is incremental to the discount that would
be offered to other similar customers (such as that
offered to C) and (2) would be offered to a similar
customer independently of any prior contract the
customer had with A. Company A would not consider
pricing offered to other customers that is contingent on
prior-year volume purchases.
Pricing offered to B that is comparable
to pricing offered to other similar customers (and is
offered independently of prior contracts with A) may be
an indication that there is no incremental discount and
therefore no material right. However, pricing that is
not comparable may be an indication that a material
right has been given to B because B has prepaid for
parts in year 2.
|
Tier status
|
|
The airline needs to evaluate whether
the ticket purchase (the contract) includes a material
right by determining whether the customer’s option to
receive discounted goods (e.g., a free checked bag) is
independent of the current contract with the customer.
In other words, the airline would need to consider
whether the benefits (e.g., discounts) given under a
tier status program are incremental to discounts given
to a similar class of customer who did not enter into a
prior contract with the airline. In performing the
evaluation, the company could:
The airline would not consider the price
charged to other customers who received status benefits
through prior contracts with the airline since doing so
would not help it determine whether such discounted
pricing is offered independently of the current
contract.
|
The FASB staff noted that an entity will be required to use
significant judgment to determine whether a material right is provided to the
entity’s customers. Further, the staff noted that it “is not in a position to
reach broad conclusions about these types of fact patterns because there are
many variations of contracts and variations in facts and circumstances that can
affect the conclusion in each fact pattern.”3 However, the staff emphasized the following:
-
The relative importance placed on the considerations discussed in the examples (or other considerations) will vary on the basis of an entity’s facts and circumstances.
-
The objective of the guidance in ASC 606-10-55-42 and 55-43 is to determine whether a customer option to receive discounted goods is independent of an existing contract with a customer.
TRG members debated the application of concepts in the framework
the staff used to analyze the examples in Implementation Q&A 14 and TRG
Agenda Paper 54 but did not reach general agreement on (1) how or when to
consider past transactions in determining the class of customer and (2) how the
class of customer should be evaluated in the determination of the stand-alone
selling price of an optional good or service.
A few TRG members maintained that discounts or status achieved
through past transactions is akin to accumulating features in loyalty programs
(and that such features therefore represent material rights). However, others
indicated that these programs represent marketing inducements (i.e., discounts)
for future transactions that should be evaluated in relation to those offered to
other similar customers or potential customers (e.g., other high-volume
customers or potential high-volume customers). The TRG members who viewed the
programs as marketing inducements believed that considering a customer’s past
transactions, among other factors, is appropriate in the evaluation of whether a
good or service being offered to the customer reflects the stand-alone selling
price for that class of customer in accordance with ASC 606-10-55-42
(particularly for entities that have limited alternative sources of information
available upon which to establish a customer’s class). Further, these TRG
members focused on the facts that (1) similar discounts on future transactions
(like those provided in the form of benefits and other offers in status programs
for no additional fees) may be given to other customers who did not make or have
the same level of prior purchases with the entity and (2) such discounts may be
provided at the stand-alone selling price for that class of customer (i.e., the
good or service is not priced at a discount that is incremental to the range of
discounts typically offered to that class of customer and therefore do not
represent a material right).
Following its stakeholder outreach, the FASB staff indicated
that an entity should evaluate whether tier status programs contain material
rights or represent a marketing incentive. In making this evaluation, the FASB
staff indicated that entities should consider whether discounts offered on
future goods or services to customers within a given tier of a status program
are incremental to the range of discounts typically given to that class of
customer. If an entity never provides customers with tier status other than
through past purchases, the discounts provided to customers under the program
are likely to be material rights. However, if an entity sometimes provides tier
status to customers for reasons other than past purchases, the discounts may be
marketing incentives provided to a particular class of customer. The
determination of whether discounts under a tier status program are material
rights or marketing incentives will require judgment based on an evaluation of
the specific facts and circumstances of the specific program.
Footnotes
1
ASC 606-10-25-2 and ASC 606-10-55-42.
2
A material right arises from pricing on an option to
acquire additional goods or services in the future that would not have
been received if the initial contract had not been entered into. In such
cases, the customer with the option has essentially prepaid for the
future purchase.
3
Quoted from Implementation Q&A 14.
11.3 Optional Purchases Versus Variable Consideration
When an entity enters into a contract to deliver a variable volume
of goods or services, the entity should first determine whether the nature of its
promise is to provide an option to purchase additional goods or services. However,
in some contracts with customers, it may be difficult to differentiate between an
option to purchase additional goods or services (which the entity would need to
evaluate to determine whether a material right — and, therefore, a separate
performance obligation — exists) and variable consideration in the transaction price
that is driven by variable volumes (i.e., the additional volumes are part of a
single performance obligation). When determining the nature of its promise in such
arrangements, an entity should consider the following:
-
If the customer can make a separate purchasing decision to buy additional distinct goods or services (or change the goods or services to be delivered) and the entity is not presently obligated to provide those goods or services before the customer exercises its rights, the customer’s ability to make that separate purchasing decision would be indicative of an option for additional goods or services.
-
Conversely, if future events (which may include the customer’s own actions) will not obligate the vendor to provide additional distinct goods or services (or change the goods or services to be delivered), any additional consideration triggered by those events would instead be variable consideration.
Section 6.3.5.4.1 discusses
considerations related to an entity’s determination of whether a contract contains
optional purchases or variable consideration. Further, Section 12.3.3 discusses optional purchases in
a licensing scenario.
11.4 Likelihood That an Option for Additional Goods or Services Will Be Exercised
Stakeholders have raised various issues related to whether an entity
should assess optional purchases provided to customers to determine whether the
customer is economically compelled — or highly likely — to exercise its option(s).
Some business models include arrangements under which a vendor will
sell an up-front good or service and also provide the customer with an option to
purchase other distinct goods or services in the future that are related to the
up-front good or service (e.g., a specialized piece of equipment and an option to
buy specialized consumables that will be needed for its operation). Such
arrangements may include features that result in a degree of economic compulsion
such that there is a very high level of confidence that the customer will exercise
its option.
In such circumstances, when it is highly probable, or even virtually
certain, that the customer will exercise its option, the additional goods or
services should not be treated as performance obligations under the contract.
The treatment of customer options is explained in paragraph BC186 of ASU 2014-09, in
which the FASB and IASB clarified that “the transaction price does not include
estimates of consideration from the future exercise of options for additional goods
or services,” making no reference to the probability that those options will be
exercised.
Accordingly, irrespective of how likely it is that a customer will
choose to purchase additional goods or services, the entity should not treat those
goods or services as performance obligations under the initial contract. Instead,
the entity should evaluate the customer option (in accordance with ASC 606-10-55-41
through 55-45) to determine whether it gives rise to a material right.
The above issue is addressed in Implementation Q&A 21 (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.
11.5 Allocation of Consideration to Material Rights
ASC 606-10
55-44 Paragraph 606-10-32-29
requires an entity to allocate the transaction price to
performance obligations on a relative standalone selling
price basis. If the standalone selling price for a
customer’s option to acquire additional goods or services is
not directly observable, an entity should estimate it. That
estimate should reflect the discount that the customer would
obtain when exercising the option, adjusted for both of the
following:
-
Any discount that the customer could receive without exercising the option
-
The likelihood that the option will be exercised.
55-45 If a customer has a material
right to acquire future goods or services and those goods or
services are similar to the original goods or services in
the contract and are provided in accordance with the terms
of the original contract, then an entity may, as a practical
alternative to estimating the standalone selling price of
the option, allocate the transaction price to the optional
goods or services by reference to the goods or services
expected to be provided and the corresponding expected
consideration. Typically, those types of options are for
contract renewals.
If an entity’s contract with a customer includes a material right in
the form of an option to acquire additional goods or services, ASC 606-10-55-41
through 55-45 require the entity to allocate part of the transaction price to that
right and recognize the associated revenue when those future goods or services are
transferred or when the option expires. The allocation of consideration to all of
the performance obligations in a contract as required in step 4 is performed on the
basis of stand-alone selling prices. As explained in paragraph BC390 of ASU 2014-09,
option pricing models can be used to estimate an option’s stand-alone selling price.
In addition, ASC 606-10-55-45 provides an alternative to estimating the stand-alone
selling price of a customer option when certain criteria are met (discussed in
Section 11.9).
Allocation of the transaction price in step 4 is discussed comprehensively in
Chapter 7.
11.6 Whether There Can Be a Significant Financing Component as a Result of a Material Right
If an entity’s contract with a customer includes a material right in
the form of a customer option for additional goods or services, the entity should
evaluate whether there is a significant financing component as a result of the
option in accordance with ASC 606-10-32-17 and 32-18. A significant financing
component would not exist if, for example, the timing of transfer of additional
goods or services is at the customer’s discretion. In some circumstances, the
practical expedient in ASC 606-10-32-18 may be available.
Example 11-3
Entity C enters into a contract with a
customer under which the customer will receive Product W
immediately and will have the option to purchase Product X
five years later. The customer does not have the discretion
to choose when to exercise the option; rather, the customer
can exercise the option only at the point in time that is
five years after its purchase of Product W. Under the
contract, the customer is required to pay $340 at the outset
and an additional $300 five years later if it chooses to
exercise the option.
The stand-alone selling prices of Product W
and Product X are $200 and $600, respectively. Entity C
concludes that the option to purchase Product X provides the
customer with a material right. However, because the
customer pays for the material right at the outset but can
exercise the option only five years later, C also concludes
that the contract includes a financing component, which it
judges to be significant. Assume C determines that the
present value of the stand-alone selling price of the option
is $155, which it calculates by using a 10 percent interest
rate based on the rate that would be used in a separate
financing transaction between C and the customer and an
approximate 85 percent likelihood that the option will be
exercised.
The entity allocates the $340 transaction
price between Product W and the option as follows:
Accordingly, the entity (1) recognizes
revenue of $192 when Product W is delivered and (2)
recognizes a contract liability of $148 related to the
material right.
Each year, the entity records interest
expense related to the financing component of the material
right at the rate of 10 percent as follows:
Accordingly, over the five-year period, the
entity recognizes total interest expense of $91. This is
added to the price initially allocated to the option of
$148, resulting in a closing balance of $239 at the end of
year 5.
At the end of year 5, the customer exercises
the option and pays an additional $300. The entity applies
the “Alternative A” approach described in Section 11.7 and allocates to Product X the
balance of the material right ($239) and the additional $300
paid. Therefore, it recognizes revenue of $539 when Product
X is delivered.
Accordingly, C records the following journal
entries in each year of the contract:
At contract inception, to recognize
revenue for the transfer of Product W and establish the
contract liability for the customer’s option to purchase
Product X in five years:
At the end of year 1, to recognize
interest expense related to the financing component of
the material right:
At the end of year 2, to recognize
interest expense related to the financing component of
the material right:
At the end of year 3, to recognize
interest expense related to the financing component of
the material right:
At the end of year 4, to recognize
interest expense related to the financing component of
the material right:
At the end of year 5, to recognize
interest expense related to the financing component of
the material right:
At the end of year 5, to recognize
revenue upon the customer’s exercise of the option to
purchase Product X:
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.
11.7 Customer’s Exercise of a Material Right
When a contract with a customer includes a material right in the
form of an option to acquire additional goods or services, an entity may account for
the customer’s subsequent exercise of the material right either as if it were a
separate contract (“Alternative A,” which we generally believe is preferable) or as
if it were the modification of an existing contract (“Alternative B,” which we
believe is acceptable). Those alternatives may be summarized as follows:
-
Alternative A (preferred) — At the time a customer exercises a material right, an entity treats the exercise as a continuation of the original contract such that the additional consideration is allocated only to the additional performance obligation underlying the material right. In effect, therefore, the entity is treating the exercise as if it were a separate contract altogether. Under this alternative, an entity should determine the transaction price of the “new” contract and include any additional consideration to which the entity expects to be entitled as a result of the exercise. This additional consideration, along with the consideration from the original contract that was allocated to the material right, should be allocated to the performance obligation underlying the material right and recognized as revenue when or as this performance obligation is satisfied. That is, the amount allocated to the material right as part of the original contract is added to any additional amounts due (under the “new” contract) as a consequence of the customer’s exercise of the material right, and that total is allocated to the additional goods or services under the “new” contract. The amounts previously allocated to the other goods and services in the original contract are not revised.
-
Alternative B (acceptable) — It is also acceptable to account for the exercise of a material right as a contract modification since it results in a change in the scope and the price of the original contract. An entity should apply the modification guidance in ASC 606-10-25-10 through 25-13.Since we believe that the application of Alternative B may be complex, we recommend that entities consider consulting with their accounting advisers before electing to use this method.
The TRG discussed questions raised by stakeholders about the accounting for a
customer’s exercise of a material right. TRG members generally preferred the view
that an entity would account for the exercise of a material right as a change in the
contract’s transaction price4 such that the additional consideration would be allocated to the performance
obligation underlying the material right and would be recognized when or as the
performance obligation underlying the material right is satisfied. This, in effect,
results in accounting for the exercise of a material right as a separate contract.
However, the TRG also believed that it would be acceptable for an entity to account
for the exercise of a material right as a contract modification5 (which may require reallocation of consideration between existing and future
performance obligations). Contract modifications are discussed in Chapter 9.
The method used should be applied consistently by an entity to
similar types of material rights and under similar facts and circumstances.
The above issue is addressed in Implementation Q&A 15 (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.
Example 11-4
An entity enters into a contract with a
customer to provide Product X for $200 and Service Y for
$100. The contract also includes an option for the customer
to purchase Service Z for $300. The stand-alone selling
prices (SSPs) of Product X, Service Y, and Service Z are
$200, $100, and $450, respectively. The entity concludes
that the option to purchase Service Z at a discount provides
the customer with a material right. The entity’s estimate of
the stand-alone selling price of the material right is
$100.
The entity allocates the $300 transaction
price ($200 for Product X plus $100 for Service Y) to each
performance obligation under the contract as follows:
Subsequently, when the entity has delivered
Product X and has delivered 60 percent of Service Y, the
customer exercises its option to purchase Service Z for
$300.
Alternative A
(Preferred)
The entity updates the transaction price to
reflect the additional consideration receivable from the
customer. The additional $300 payable after the exercise of
the option is added to the amount of $75 that was previously
allocated to the option to purchase Service Z, resulting in
a total of $375. The amount of $375 is recognized as revenue
over the period during which Service Z is transferred.
No change is made to the amount of revenue
allocated to Product X and Service Y. The revenue not yet
recognized with respect to Service Y (40% × $75 = $30) is
recognized as revenue over the remaining period during which
Service Y is transferred to the customer.
Alternative B
(Acceptable)
The entity accounts for the customer’s
exercise of its option to purchase Service Z as a contract
modification. The appropriate accounting will be different
depending on whether the remaining services to be provided
after the modification (i.e., Service Z and the rest of
Service Y) are distinct from those transferred to the
customer before the modification.
Accounting if the
Remaining Services Are Distinct
If the entity determines that the remaining
services to be provided after the modification are distinct
from those transferred to the customer before the
modification, the guidance in ASC 606-10-25-13(a) should be
applied. The revenue already recognized with respect to
Product X ($150) and 60 percent of Service Y ($75 × 60% =
$45) is not adjusted.
After the modification, the revenue not yet
recognized is determined as follows:
The revenue not yet recognized is then
allocated to the remaining performance obligations as
follows:
Therefore, $33 is recognized as the
remaining 40 percent of Service Y is delivered, and $372 is
recognized as Service Z is delivered.
Accounting if the
Remaining Services Are Not Distinct
If the entity determines that the remaining
goods or services are not distinct, the guidance in ASC
606-10-25-13(b) should be applied and a cumulative catch-up
adjustment to revenue for performance obligations satisfied
over time should be recognized on the date of the
modification (no adjustment is made for fully satisfied
performance obligations). The updated transaction price is
allocated between the two performance obligations that are
satisfied over time as if the modification had been in place
at the start of the contract.
The cumulative catch-up adjustment is
recorded because the remaining 40 percent of Service Y is
not distinct from the previously delivered 60 percent of
Service Y (Service Y is distinct from Service Z) and is
determined as follows:
Therefore, the remaining $33 ($82 – $49) is
recognized as the entity performs the remaining 40 percent
of Service Y, and $368 is recognized as Service Z is
delivered.
Footnotes
11.8 Vouchers, Discounts, and Coupons
Some of the more common scenarios in which an entity may provide
options to purchase additional goods or services involve options in the form of
vouchers, discounts, and coupons. The Codification example and sections below
discuss how entities would apply the revenue standard’s guidance on optional
purchases in those scenarios.
ASC 606-10
Example 49 — Option That Provides the
Customer With a Material Right (Discount Voucher)
55-336 An entity enters into a
contract for the sale of Product A for $100. As part of the
contract, the entity gives the customer a 40 percent
discount voucher for any future purchases up to $100 in the
next 30 days. The entity intends to offer a 10 percent
discount on all sales during the next 30 days as part of a
seasonal promotion. The 10 percent discount cannot be used
in addition to the 40 percent discount voucher.
55-337 Because all customers will
receive a 10 percent discount on purchases during the next
30 days, the only discount that provides the customer with a
material right is the discount that is incremental to that
10 percent (that is, the additional 30 percent discount).
The entity accounts for the promise to provide the
incremental discount as a performance obligation in the
contract for the sale of Product A.
55-338 To estimate the standalone
selling price of the discount voucher in accordance with
paragraph 606-10-55-44, the entity estimates an 80 percent
likelihood that a customer will redeem the voucher and that
a customer will, on average, purchase $50 of additional
products. Consequently, the entity’s estimated standalone
selling price of the discount voucher is $12 ($50 average
purchase price of additional products × 30 percent
incremental discount × 80 percent likelihood of exercising
the option). The standalone selling prices of Product A and
the discount voucher and the resulting allocation of the
$100 transaction price are as follows:
55-339 The entity allocates $89 to
Product A and recognizes revenue for Product A when control
transfers. The entity allocates $11 to the discount voucher
and recognizes revenue for the voucher when the customer
redeems it for goods or services or when it expires.
11.8.1 Options to Purchase Goods at a Discount — Vouchers Available With or Without the Requirement to Make an Initial Purchase
The example below illustrates how the accounting for the use of a voucher that
provides a customer with a discount could vary depending on whether the customer
is required to make a purchase before receiving the voucher.
Example 11-5
In an effort to increase sales,
Supermarket B offers two separate marketing programs to
its customers:
-
Program 1 — All visitors to B, irrespective of whether they make any other purchases, can pick up a voucher entitling them to a reduction of $1 from the usual $10 selling price of Product X.
-
Program 2 — Customers who purchase Product W for its normal selling price of $7 will receive a voucher entitling them to a reduction of $5 from Product X’s selling price.
Only one voucher can be used for any
purchase of Product X. It has been determined that the
option granted to purchasers of Product W to purchase
Product X for $5 instead of $9 (i.e., the purchase price
when the $1 voucher is redeemed) gives those customers a
material right.
The $1 vouchers issued under Program 1
are not within the scope of ASC 606. Because the
customer does not enter into any enforceable commitment
by picking up a $1 voucher, no contract arises from the
$1 vouchers.
As a result, B should simply treat the
$1 vouchers as a price reduction when customers use the
$1 vouchers to purchase Product X. Therefore, if a
customer uses a $1 voucher to purchase Product X for $9,
the revenue recognized will be $9 since this is the
consideration to which B is entitled in exchange for
Product X (when the $1 vouchers are taken into
account).
However, the $5 voucher issued under
Program 2 is within the scope of ASC 606 because
customers are entitled to the $5 vouchers as part of a
sales transaction (i.e., the contract to purchase
Product W).
Therefore, in accounting for the $5
vouchers, B should consider the guidance in ASC
606-10-55-41 through 55-45 on customer options for
additional goods or services. According to this
guidance, because the option gives the customer a
material right that it would not receive without
entering into the contract, a separate performance
obligation is established.
ASC 606-10-55-44 specifies that entities
should measure this obligation, if it is not directly
observable, by applying an estimate that reflects “the
discount that the customer would obtain when exercising
the option, adjusted for both of the following:
- Any discount that the customer could receive without exercising the option
- The likelihood that the option will be exercised.”
In assessing the stand-alone selling
price of the $5 vouchers, B should consider (1) that
customers not making a purchase could still have claimed
a $1 voucher (i.e., the incremental value of the $5
voucher to the customer would therefore be $4) and (2)
the likelihood that the $5 voucher will be redeemed.
Accordingly, the stand-alone selling
price of the $5 vouchers that will be used to allocate
the transaction price to the performance obligation for
the discount voucher will not exceed the additional
discount of $4, and it may be lower depending on the
proportion of vouchers expected to be redeemed. The
entity recognizes revenue related to the $5 vouchers
when Product X is transferred to a customer, taking into
account the guidance in ASC 606-10-55-46 through 55-49
(discussed in Section
6.4.2.3) on vouchers not expected to be
redeemed.
11.8.2 Stand-Alone Selling Price for Gift Cards That Can Be Purchased Individually or in Combination With Other Goods or Services
The example below illustrates how the stand-alone selling price for gift cards
could vary depending on whether the gift cards are purchased individually or are
bundled with other goods or services.
Example 11-6
Entity T gives away a $10 gift card to
customers if they purchase a particular brand of
headphones. These gift cards are also sold on a
stand-alone basis at face value. Regardless of whether
they are given away or sold, these gift cards are only
redeemable against future music downloads made by
customers from T’s Web site to the value of $10.
Entity T has consistent historical
experience as follows:
-
When sold on a stand-alone basis, the gift cards have a 95 percent redemption rate.
-
When given away to customers who purchase headphones, the gift cards have a 40 percent redemption rate.
Entity T has determined that the gift
cards given to the customers who purchase headphones
provide those customers with a material right.
Accordingly, they give rise to a performance obligation
under the contract to sell the headphones to which part
of the transaction price should be allocated (see ASC
606-10-55-41 through 55-45 for details).
In allocating the transaction price for
purchases of headphones that include a gift card, T
should use a stand-alone selling price for the gift card
that is different from the cash price charged to
customers buying only a gift card. As discussed in
Section 7.3.3.4, different stand-alone
selling prices can arise for the same item when the
sales are in dissimilar circumstances or to dissimilar
customers.
In the scenarios described above, the
circumstances of the purchase of the gift cards can be
seen to be dissimilar. In particular, customers who
purchase the bundle are receiving gift cards regardless
of whether they want the cards, in contrast with
customers who make a conscious decision to purchase a
gift card; and these different circumstances are
reflected in the markedly different redemption
rates.
Accordingly, the stand-alone selling
price of a gift card given away with headphones is not
directly observable; it cannot be assumed to be the same
as the price of a gift card purchased in isolation
because the sales occur in dissimilar circumstances.
When a stand-alone selling price is not directly
observable, it should be estimated in accordance with
ASC 606-10-55-44, with that estimate reflecting both the
discount that the customer will receive on exercising
the option ($10 in the circumstances described above)
and the likelihood that the option will be
exercised.
Consequently, in the circumstances under
consideration and under the assumption that a customer
could not receive any other discount on downloading
music from T (which would also be reflected in the
estimate required by ASC 606-10-55-44), the stand-alone
selling price of a gift card purchased together with a
set of headphones might be assessed as $4 (40 percent of
$10).
11.8.3 Retailer-Sponsored Coupons Provided Immediately After a Purchase Transaction
Retail stores sometimes provide retailer-sponsored coupons to
customers immediately after a customer transaction (sometimes referred to as
“Catalina” coupons). These coupons are printed at the register on the basis of
an automated program and handed to the customer after a purchase is completed.
An automated program connected to the register determines whether to provide
targeted coupons to the customer as a result of various factors, such as items
purchased by the customer or the amount spent. The coupons given to the customer
can be used only in future purchases, often of specified products.
Sometimes, a customer may be capable of knowing in advance that
he or she will be entitled to receive a particular coupon upon making a
purchase. For example, a retailer may have advertised that it is running a
price-matching campaign under which a customer will receive a coupon that
represents the difference between the price paid for the goods purchased and the
price that would have been paid for those same goods if bought from a
competitor. This coupon can then be redeemed against future purchases the
customer makes from the retailer.
Often, however, when a customer makes a purchase, he or she may
have little or no expectation of either receiving a coupon from the retailer or
being able to obtain particular goods by using such a coupon.
In accordance with ASC 606-10-55-42, the coupon would give rise
to a performance obligation only if it provides a material right that the
customer would not receive without entering into the transaction. This implies
that the discount on the future good or service typically should be part of the
negotiated exchange under the existing contract with the customer. To determine
whether the offer is part of the negotiated exchange under the existing
contract, the retailer would look to ASC 606-10-25-16, which states, in part:
[T]he promised goods and services identified in a contract
with a customer may not be limited to the goods or services that are
explicitly stated in that contract. This is because a contract with a
customer also may include promises that are implied by an entity’s customary
business practices, published policies, or specific statements if, at the
time of entering into the contract, those promises create a reasonable
expectation of the customer that the entity will transfer a good or service
to the customer.
An entity will therefore need to use judgment under the
particular facts and circumstances to ascertain whether it has made a promise
(e.g., through advertising campaigns or its customary business practices) that
has created a reasonable expectation on the part of a customer that he or she
will receive a particular coupon upon making a purchase. An entity may also wish
to consider the historical data on how many customers use the coupon for
discounts on future purchases as part of its assessment of whether the coupon
has a significant value to the customer and might therefore provide a material
right.
In the price-matching campaign example described above, it is
possible that the coupon to be redeemed against future purchases may give rise
to a material right as part of the initial sale (see ASC 606-10-55-42 and 55-43
and Section 11.2
for guidance on making this determination) if the price-matching campaign has
created a valid expectation on the part of the customer that he or she will
receive a coupon for any excess amount paid as part of the current
transaction.
However, if the customer has little or no expectation regarding
any coupons that he or she might receive from the retailer, it is unlikely that
a material right exists as part of the initial sale. In particular, the
possibility that the customer will receive a coupon for a discount on future
purchases when making a purchase is unlikely to have influenced the customer’s
buying decision to any meaningful extent. In such cases, the coupon is instead
similar to a targeted coupon distribution based on customer purchasing habits.
Such a coupon should be accounted for at the time of redemption in accordance
with ASC 606-10-32-27, which states:
[I]f 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.
11.9 Renewal Options
Paragraph BC391 of ASU 2014-09 explains that contracts could
describe renewal options as either (1) renewal options, which are basically
extensions of the current contract, or (2) early cancellations, which are the option
for a customer to end a long contract earlier than planned. A customer option to
renew could be considered an option for additional goods or services, which then
opens the door for the entity to consider whether the option is a material right
(i.e., a performance obligation).
When options for additional goods or services are considered
material rights, an entity is required to estimate the options’ stand-alone selling
price so that consideration from the contract can be allocated to the options. Since
renewal options are similar to options for additional goods or services, an entity
would have to determine an estimate of the options’ stand-alone selling price for
each renewal period, which may be complex.
However, as explained in paragraphs BC392 through BC395 of ASU
2014-09, the FASB and IASB decided to provide a practical alternative for renewal
options that allows an entity to “include the optional goods or services that it
expects to provide (and corresponding expected customer consideration) in the
initial measurement of the transaction price.” This practical alternative is
included in ASC 606-10-55-45, which states:
If a customer has a material right to
acquire future goods or services and those goods or services are similar to the
original goods or services in the contract and are provided in accordance with
the terms of the original contract, then an entity may, as a practical
alternative to estimating the standalone selling price of the option, allocate
the transaction price to the optional goods or services by reference to the
goods or services expected to be provided and the corresponding expected
consideration. Typically, those types of options are for contract renewals.
To differentiate contract renewal options from other types of options for additional
goods or services (the latter of which are not eligible for the practical
alternative if the optional goods or services are not similar to the original goods
or services in the contract), the boards developed two criteria that must be met for
an entity to apply the practical alternative:
-
The additional goods or services in the renewal options are similar to those provided in the initial contract.
-
The renewal options’ terms and conditions related to goods or services are the same as those of the original contract.
These concepts are illustrated by Example 51 in ASC 606.
ASC 606-10
Example 51 — Option That Provides the
Customer With a Material Right (Renewal Option)
55-343 An entity enters into 100
separate contracts with customers to provide 1 year of
maintenance services for $1,000 per contract. The terms of
the contracts specify that at the end of the year, each
customer has the option to renew the maintenance contract
for a second year by paying an additional $1,000. Customers
who renew for a second year also are granted the option to
renew for a third year for $1,000. The entity charges
significantly higher prices for maintenance services to
customers that do not sign up for the maintenance services
initially (that is, when the products are new). That is, the
entity charges $3,000 in Year 2 and $5,000 in Year 3 for
annual maintenance services if a customer does not initially
purchase the service or allows the service to lapse.
55-344 The entity concludes that
the renewal option provides a material right to the customer
that it would not receive without entering into the contract
because the price for maintenance services are significantly
higher if the customer elects to purchase the services only
in Year 2 or 3. Part of each customer’s payment of $1,000 in
the first year is, in effect, a nonrefundable prepayment of
the services to be provided in a subsequent year.
Consequently, the entity concludes that the promise to
provide the option is a performance obligation.
55-345 The renewal option is for a
continuation of maintenance services, and those services are
provided in accordance with the terms of the existing
contract. Instead of determining the standalone selling
prices for the renewal options directly, the entity
allocates the transaction price by determining the
consideration that it expects to receive in exchange for all
the services that it expects to provide in accordance with
paragraph 606-10-55-45.
55-346 The entity expects 90
customers to renew at the end of Year 1 (90 percent of
contracts sold) and 81 customers to renew at the end of Year
2 (90 percent of the 90 customers that renewed at the end of
Year 1 will also renew at the end of Year 2, that is 81
percent of contracts sold).
55-347 At contract inception, the
entity determines the expected consideration for each
contract is $2,710 [$1,000 + (90 percent × $1,000) + (81
percent × $1,000)]. The entity also determines that
recognizing revenue on the basis of costs incurred relative
to the total expected costs depicts the transfer of services
to the customer. Estimated costs for a three-year contract
are as follows:
55-348 Accordingly, the pattern of
revenue recognition expected at contract inception for each
contract is as follows:
55-349 Consequently, at contract
inception, the entity allocates to the option to renew at
the end of Year 1 $22,000 of the consideration received to
date [cash of $100,000 – revenue to be recognized in Year 1
of $78,000 ($780 × 100)].
55-350 Assuming there is no change
in the entity’s expectations and the 90 customers renew as
expected, at the end of the first year, the entity has
collected cash of $190,000 [(100 × $1,000) + (90 × $1,000)],
has recognized revenue of $78,000 ($780 × 100), and has
recognized a contract liability of $112,000.
55-351 Consequently, upon renewal
at the end of the first year, the entity allocates $24,300
to the option to renew at the end of Year 2 [cumulative cash
of $190,000 – cumulative revenue recognized in Year 1 and to
be recognized in Year 2 of $165,700 ($78,000 + $877 ×
100)].
55-352 If the actual number of
contract renewals was different than what the entity
expected, the entity would update the transaction price and
the revenue recognized accordingly.
The example below further illustrates how to allocate consideration
to renewal options that provide material rights to a customer.
Example 11-7
ABC Company enters into 100 separate
contracts with customers to provide a perpetual software
license for $10,000 and one year of PCS for $1,000. The
contracts include a customer option to renew PCS for an
additional year for $500. ABC Company concluded that the
renewal option represents a material right and the license
and PCS are distinct performance obligations. ABC Company
also determined that both the perpetual license and PCS were
sold at stand-alone selling prices and estimated that the
customer has a 75 percent probability of renewing at the end
of year 1, 50 percent at the end of year 2, 25 percent at
the end of year 3, and 0 percent at the end of year 4.
Stand-Alone Selling
Price Approach
Year 1 renewal = $375, or ($1,000 − $500) ×
75%
Year 2 renewal = $250, or ($1,000 − $500) ×
50%
Year 3 renewal = $125, or ($1,000 − $500) ×
25%
As a result of applying the stand-alone
selling price approach, ABC Company would allocate $702
($351 + $234 + $117) to the material right. In addition, ABC
Company would recognize $10,298 ($9,362 + $936) in year
1.
“Look Through” Approach
If ABC Company chose to apply the practical
alternative or “look through” approach,6 the company would estimate a hypothetical transaction
price in one of two ways. The first approach is to determine
the best estimate of the number of years that a customer
would renew. Assume in this case that the company’s best
estimate is that the customer will exercise the renewal
option for two years.
This would result in recognition of $10,154
in revenue in year 1 ($9,231 + $923) and a deferral of $846
($11,000 − $10,154) related to the material right.
However, in a manner consistent with Example
51 in ASC 606,7 an entity could also use a portfolio approach to
estimate the hypothetical transaction price in the “look
through” model. Under this approach, the entity would use
the same probabilities applied in the stand-alone selling
price model to determine the hypothetical transaction price.
The following table illustrates this approach:
This would result in recognition of $9,233
in revenue in year 1 ($8,394 + $839) and a deferral of
$1,767 ($11,000 − $9,233) related to the material right.
Note, however, that when a portfolio
approach is applied, individual cancellations would not
necessarily result in an immediate adjustment. This is
because the overall estimates would incorporate a level of
cancellations each period. It is only when the cancellation
pattern of the overall portfolio changes that an entity
would assess a potential change in estimate.
Connecting the Dots
Television studios often enter into contracts with
broadcasters for the broadcast of the first season of a new television show,
with an exclusive pickup option for the broadcaster to license any
subsequent seasons of the show for a fixed fee per season. After contract
inception, the value of this option may change depending on the success of
the first season.
In accordance with ASC 606-10-55-42, a material right exists
if the fixed fee for the option reflects a discount that would not have been
offered if the broadcaster had not purchased the license for the first
season. Conversely, in accordance with ASC 606-10-55-43, a material right
does not exist if the fixed fee for the option represents the option’s
stand-alone selling price at contract inception.
In the circumstances described, it may be difficult to
estimate the stand-alone selling price of the option (because options of
this type are not typically sold separately and their value is affected by
the likelihood of success of the initial season, which may be unknown at
contract inception). Consequently, entities will need to use judgment in
making this evaluation. Although the value of such an option may
subsequently increase if a show is successful, whether there is a material
right should be assessed only by reference to the value of that option at
contract inception.
Footnotes
6
ABC Company is eligible to apply the practical
alternative since the optional purchase is for
additional goods or services that are similar to the
original goods or services in the contract.
Specifically, the PCS subject to the renewal option
is the same PCS included in the original
contract.
7
ASC 606-10-55-343 through
55-352.
11.10 Recognition of Revenue Related to Options That Do Not Expire
In accordance with ASC 606-10-55-41 through 55-45, when an entity provides a customer
with an option to acquire additional goods or services that results in a performance
obligation because the option provides a material right to the customer, the entity
should (1) allocate a portion of the transaction price to the material right and (2)
recognize the related revenue either when the entity transfers control of the future
goods or services or when the option expires.
When a customer’s option to acquire additional goods is a material right and does not
expire, recognition of revenue related to the option will depend on whether the
material right is (1) included in a portfolio of similar rights provided by the
entity or (2) accounted for as an individual right. If the material right is
included in a portfolio of similar rights, revenue related to expected unexercised
options should be recognized in proportion to the pattern of rights exercised by the
customers in the portfolio. If the customer option is an individual right, the
entity would recognize revenue attributed to the material right when the likelihood
that the customer will exercise the option is remote.
The guidance on options requires an entity to estimate the stand-alone selling price
of the option at contract inception by considering the likelihood that the option
will be exercised. 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 expects to be entitled to revenue related to unexercised options.
An entity would estimate the amount of revenue related to options that the entity
expects the customer will not exercise by applying the guidance on unexercised
rights in ASC 606-10-55-46 through 55-49. If there are any changes in the likelihood
of exercising the option, the entity should recognize such changes as it measures
progress toward satisfaction of the performance obligation. Accordingly, the entity
should recognize revenue as follows:
- Recognize revenue for the portion of the transaction price allocated to the option when the option is exercised.
- If the option has not been exercised, recognize revenue either (1) in proportion to the pattern of rights exercised by customers (for material rights included in a portfolio of similar rights) or (2) at the point in time when the entity determines that the likelihood that the customer will exercise the option becomes remote (when accounting for a single material right).
Example 52 in the revenue standard (ASC 606-10-55-353 through
55-356) demonstrates the allocation and recognition of changes in the expected
redemption of loyalty program points (i.e., options). See Section 11.2.2 for further discussion.
Example 11-8
Loyalty Points
An entity has a loyalty rewards program that offers customers
1 loyalty point per dollar spent; points awarded to the
customers do not expire. The redemption rate is 10 points
for $1 off future purchases of the entity’s products.
During a reporting period, customers purchase products for
$100,000 (which reflects the stand-alone selling price of
the products) and earn 100,000 points that are redeemable
for future purchases. The entity expects 95,000 points to be
redeemed.
The entity estimates the stand-alone selling price to be
$0.095 per point (totaling $9,500) on the basis of the
likelihood of redemption in accordance with ASC
606-10-55-44. The points provide a material right to the
customers that they would not receive without entering into
a contract. Therefore, the entity concludes that the promise
to provide points to the customers is a performance
obligation.
The entity therefore allocates, at contract
inception, the transaction price of $100,000 as follows:
- Products — $100,000 × ($100,000 stand-alone selling price ÷ $109,500) = $91,324.
- Loyalty points — $100,000 × ($9,500 stand-alone selling price ÷ $109,500) = $8,676.
End of Year 1
After one year, 20,000 points have been
redeemed, and the entity continues to expect a total of
95,000 points to be redeemed. Therefore, the entity
recognizes $1,827 in revenue for the 20,000 points redeemed,
or (20,000 points redeemed ÷ 95,000 total points expected to
be redeemed) × $8,676. The entity also recognizes a contract
liability of $6,849 ($8,676 − $1,827) for the unredeemed
points at the end of year 1.
End of Year 2
After two years, only 50,000 points in total
have been redeemed. The entity then reassesses the total
number of points that it expects the customers to redeem.
Its new expectation is that 70,000 (i.e., no longer 95,000)
points will be redeemed. Therefore, the entity recognizes
$4,370 in revenue in year 2. To calculate this amount, the
entity determines what portion of the $8,676 is to be
recognized in year 2, adjusting the total expected points to
be redeemed from 95,000 to 70,000:8
$4,370 = [(50,000 total points redeemed ÷ 70,000
total points expected to be redeemed) × $8,676] –
$1,827 recognized in year 1.
The contract liability balance is $2,479 ($6,849 −
$4,370).
End of Year 3
After three years, 55,000 points in total have been redeemed,
and the entity continues to expect that the customers will
redeem 70,000 points in total. Therefore, the entity
recognizes $620 in revenue in year 3. To calculate this
amount, the entity determines what portion of the $8,676 is
to be recognized in year 3 while maintaining the assumption
that the total expected points to be redeemed is 70,000:
$620 = [(55,000 total points redeemed ÷ 70,000
total points expected to be redeemed) × $8,676] –
$1,827 (recognized in year 1) – $4,370 (recognized
in year 2).
The contract liability balance is $1,859 ($2,479 – $620).
End of Year 4
After four years, no additional points have been redeemed,
and the entity concludes that the likelihood that customers
will redeem the remaining points is remote. The total
revenue recognized with respect to the material right in
year 4 would be the remaining contract liability balance of
$1,859.
Example 11-9
Single Customer Option
An entity enters into a contract with a customer for the sale
of Product A for $100. As part of the negotiated
transaction, the customer also receives a coupon for 50
percent off the sale of Product B; the coupon does not
expire. Similar coupons have not been offered to other
customers.
The stand-alone selling price of Product B is $60. The entity
estimates a 70 percent likelihood that the customer will
redeem the coupon. On the basis of the likelihood of
redemption, the stand-alone selling price of the coupon is
concluded to be $21 ($60 sales price of Product B × 50%
discount × 70% likelihood of redemption) in accordance with
ASC 606-10-55-44.
The entity concludes that the option to purchase Product B at
a discount of 50 percent provides the customer with a
material right. Therefore, the entity concludes that (1)
this option is a performance obligation and (2) a portion of
the transaction price for Product A should be allocated to
this option.
The entity therefore allocates, at contract
inception, the $100 transaction price as follows:
- Product A — $100 × ($100 stand-alone selling price ÷ $121) = $83.
- Product B material right — $100 × ($21 stand-alone selling price ÷ $121) = $17.
The option is not exercised during the first four years after
its issuance. As a result, the entity determines that no
revenue should be recognized during this period by applying
the guidance in ASC 606-10-55-48, which allows revenue to be
recognized “in proportion to the pattern of rights exercised
by the customer.” At the end of year 4, the entity
determines that the likelihood that the customer will redeem
the coupon has become remote and therefore recognizes the
$17 in accordance with ASC 606-10-55-48.
Footnotes
8
As a result, the impact of the
change in estimated points that will be redeemed is
recorded as a cumulative adjustment in year 2.
Alternatively, we believe that it may be acceptable
to recognize changes in estimate prospectively.
11.11 Amortization Period of Material Rights
In certain service contracts (e.g., month-to-month contracts), customers are required
to pay a one-time “activation fee” upon initially signing up for the service. Often,
the activities associated with the activation fee do not transfer a promised good or
service to the customer. In these situations, the activation fee is attributed to
the future services to be provided under the contract with the customer, as required
under ASC 606-10-55-51, and generally would give rise to a material right if the
customer can renew the service each month without incurring an additional activation
fee (i.e., the renewal is offered at a significant discount). ASC 606-10-55-42 and
ASC 606-10-55-51 provide the following limited guidance on how and over what period
such a material right should be recognized:
55-42 . . . If the option provides a material right to the customer,
the customer in effect pays the entity in advance for future goods or
services, and the entity recognizes revenue when those future goods or
services are transferred or when the option expires.
55-51 . . . The revenue recognition period would extend beyond the
initial contractual period if the entity grants the customer the option to
renew the contract and that option provides the customer with a material
right as described in paragraph 606-10-55-42.
Often in these circumstances, the option to renew services without incurring an
additional activation fee is indefinite (i.e., the right to renew without paying an
activation fee may exist for the entire customer relationship).
Activation fees that give rise to a material right should not
necessarily be recognized over the entire customer life since the material right is
not always related to all goods or services that will be provided to the customer
under all anticipated contracts. Rather, an entity should determine the period over
which the right to renew a contract without incurring an additional activation fee
provides a material right to the customer. When making this assessment, an entity
should consider both qualitative and quantitative factors. Examples of these factors
include historical and projected customer behavior and the significance of the
activation fee in relation to the monthly contract price. In addition to evaluating
qualitative factors, one way to make the assessment is to compare the renewal rate
with the average monthly rate paid by the customer for the prior months’ services.
Under this approach, the discount provided upon renewal diminishes with each
successive renewal as the activation fee is attributed to additional months of
service, as illustrated in the example below.
Example 11-10
Entity A charges customers a monthly fee to obtain a bundle
of services on a month-to-month basis (i.e., the contract
period is one month, but customers have the right to renew
the services at a consistent monthly rate). In addition, all
new customers are required to pay a one-time activation fee
to initiate the service, but this fee is not required upon
renewal. No promised goods or services are transferred to
customers in connection with activation activities. Entity A
determines that the ability to renew a month of services
without having to pay an additional activation fee creates a
material right.
Assume the following additional facts:
- Each new customer pays a $30 activation fee that represents the stand-alone selling price of the material right.
- The customer can renew the monthly services for $140 per month indefinitely.
- Entity A has determined that its average customer life is seven years.
Although the customer can renew the monthly services
indefinitely without incurring an additional activation fee,
the period over which the right to do so represents a
material right to the customer is likely to be less than
seven years. While the option that exists in month 1 to
renew services for month 2 provides the customer with a
discount of approximately 17.6 percent as compared with the
first month of services, the option to renew in month 8
provides only a 2.6 percent discount as compared with the
average monthly amount paid to date. This is illustrated in
the following table:
In these circumstances, it is likely that the right to renew
the contract without incurring an additional activation fee
would not be material to the customer after a relatively
short period. As a result, recognizing the activation fee
over the entire customer life might not be required.
Accordingly, A will need to use judgment to determine when
the right to renew the contract without incurring an
additional activation fee no longer provides a material
right to the customer.
Chapter 12 — Licensing
Chapter 12 — Licensing
12.1 Overview
Under the revenue standard, the framework used to account for licensing of
intellectual property (IP) is essentially the same as the framework used to account
for a sale of goods or services. That is, the five-step model is generally applied
to licensing transactions as well. However, licensing of IP can take many forms, and
the economics and substance of such transactions can often be difficult to identify.
Determining how to account for licensing transactions will often depend on the
specific facts and circumstances and will require professional judgment. To help
preparers exercise such judgment, the revenue standard provides supplemental
guidance on recognizing revenue from contracts related to the licensing of IP to
customers. The scope of the guidance includes all licenses that provide a customer
with rights to IP, except for certain software hosting arrangements that are
accounted for as a service (see Section
12.2.1).
In the evaluation of how to account for a licensing transaction under the
revenue standard, it is important for an entity to consider each of the five steps
in the model (although, as discussed below, certain exceptions are provided for
licensing transactions). Specifically, an entity will need to do each of the
following:
-
Step 1: Identify the contract with the customer — This step includes identifying the counterparty that is the customer, evaluating the enforceable rights and obligations (including implicit rights) of each party to the contract, and determining whether amounts under the contract are collectible.1
-
Step 2: Identify the performance obligations under the contract — This includes determining whether the entity’s obligation to transfer a license to a customer results in (1) a single promise that will be satisfied (i.e., a single performance obligation) or (2) multiple performance obligations. This step could also involve determining whether the license of IP is the predominant element in the arrangement.
-
Step 3: Determine the transaction price — This includes identifying and, potentially, measuring and constraining variable consideration.
-
Step 4: Allocate the transaction price— This includes considering whether the residual approach could be used for determining the stand-alone selling price of one (or a bundle) of the performance obligations.2
-
Step 5: Determining when control of the license is transferred to the customer — This includes determining whether the license is transferred at a point in time (for a right to use IP) or over time (for a right to access IP).
Some of the key judgments an entity will need to make are likely to be in
connection with step 2 (identify the performance obligations), step 4 (allocate the
transaction price), and step 5 (recognize revenue) of the model. As part of step 2,
an entity will need to evaluate license restrictions (and changes in any such
restrictions) when determining whether the restrictions merely define the licenses
(which may be the case when the restrictions are related to time or geography) or,
in effect, give rise to multiple performance obligations (which may be the case when
the restrictions change over the license period and require the entity to transfer
additional rights to the customer).
As part of step 5, when an entity is determining whether it has granted a
customer a right to use or a right to access its IP, it will need to assess the
nature of the promised license to determine whether the license has significant
stand-alone functionality. For licenses with significant stand-alone functionality,
ongoing activities3 of the entity providing the license do not significantly affect the license’s
functionality (i.e., its utility). However, certain licenses do not have significant
stand-alone functionality and require ongoing activities from the entity to support
or maintain the license’s utility to the customer. The nature of an entity’s license
of IP will determine the pattern of transfer of control to the customer, which is
either at a point in time (if the customer is granted a right to use the IP) or over
time (if the customer is granted a right to access the IP).
For licensing transactions in which consideration is tied to the subsequent sale
or usage of IP, the revenue standard provides an exception to the recognition
principle that is part of step 5 (i.e., recognize revenue when or as control of the
goods or services is transferred to the customer). Under this sales- or usage-based
royalty exception, an entity would generally not be required to estimate the
variable consideration from sales- or usage-based royalties. Instead, the entity
would wait until the subsequent sale or usage occurs to determine the amount of
revenue to recognize.
As a result of implementation concerns raised by various stakeholders after the
issuance of ASU
2014-09, the TRG discussed several licensing issues. After
debating these issues, the TRG requested that the FASB issue clarifying guidance to
help stakeholders apply the revenue standard to licensing arrangements. In April
2016, the FASB issued ASU
2016-10, which was intended to improve the operability and
understandability of the standard’s licensing guidance on (1) determining the nature
of the arrangement, (2) applying the sales- or usage-based royalty constraint, and
(3) clarifying how contractual provisions affect licenses of IP.
Footnotes
1
Refer to Section 4.4.1 for (1)
guidance on determining the contract term for certain licensing
arrangements and (2) a discussion of challenges associated with
applying the revenue standard to licensing arrangements that
involve termination rights.
2
Refer to Section
7.3.3.7 for more information about estimating
stand-alone selling prices for term licenses and postcontract
customer support and Section 7.3.3.2 for more
information about the residual approach to estimating
stand-alone selling prices and allocating the transaction price
when a value relationship exists.
3
These do not include activities that transfer one or more
goods or services to the customer (e.g., maintenance activities), which an
entity must assess to determine whether they constitute separate performance
obligations.
12.2 Scope of the Licensing Guidance
ASC 606-10
55-54 A license establishes a
customer’s rights to the intellectual property of an entity.
Licenses of intellectual property may include, but are not
limited to, licenses of any of the following:
-
Software (other than software subject to a hosting arrangement that does not meet the criteria in paragraph 985-20-15-5) and technology
-
Motion pictures, music, and other forms of media and entertainment
-
Franchises
-
Patents, trademarks, and copyrights.
Although the guidance above provides examples of licenses of IP, the
term “intellectual property” is not formally defined in U.S. GAAP. However,
paragraph BC51 of ASU 2016-10 states that “intellectual property is inherently
different from other goods or services because of its uniquely divisible nature,”
noting that “intellectual property can be licensed to multiple customers at the same
time . . . and can continue to be used by the entity during the license period for
its own benefit.” Identification of IP will require judgment.
Connecting the Dots
The licensing guidance in the revenue standard applies to
licenses of IP that are an output of an entity’s ordinary activities (and,
therefore, contracts to provide licenses of IP to customers). In some
instances, an entity whose ordinary activities do not involve the licensing
of IP may enter into a contract to provide a license of IP to a third party.
Because the contract is not with a customer, the licensing guidance in the
revenue standard is not directly applicable. Further, because a
derecognition event does not occur in a licensing transaction (i.e., there
is no sale of the IP itself), the guidance in ASC 610-20 on accounting for
gains and losses on the derecognition of nonfinancial assets is also not
directly applicable. That is, a license of IP is outside the scope of ASC
610-20 since the license does not result in the transfer of the underlying
IP when the entity still controls the IP (see Section 12.2.2 for more information
about distinguishing between a license and an in-substance sale of IP).
We believe that an entity could apply the licensing guidance
in the revenue standard by analogy to account for the measurement and
recognition of licenses of IP that are outside the scope of ASC 606 (i.e.,
licenses of IP that are not an output of the entity’s ordinary activities).
For example, an entity could apply ASC 606 to determine whether a license of
IP to a noncustomer represents a license to functional or symbolic IP. In
addition, a license of IP to a noncustomer could include sales- or
usage-based royalties, in which case an entity could apply the sales- or
usage-based royalty exception in ASC 606. However, while an entity could
apply aspects of ASC 606 by analogy, any gain or loss should not be
presented or disclosed as revenue from contracts with customers.
If an entity entered into an agreement with a noncustomer to
sell the underlying IP instead of licensing the IP (i.e., the entity
transferred control of the IP and derecognized it), the sale would be within
the scope of ASC 610-20. In that case, the sales- or usage-based royalty
exception would not apply (because the exception applies only to
licenses of IP). Rather, the entity would need to estimate and
constrain royalties when determining the gain or loss it should record on
the transfer of control of the IP.
12.2.1 Software in a Hosting Arrangement
Software in a hosting arrangement is excluded from the scope of
the licensing guidance in the revenue standard unless both of the following
criteria in ASC 985-20-15-5 are met:
-
The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
-
It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.
Connecting the Dots
Some may question whether “at any time” during the hosting period means
at every point in time during the hosting period. We do not
believe that to be the case. For example, an entity’s arrangements may
specify that the customer will automatically obtain the software at the
end of the hosting period. We believe that as long as the customer can
take possession of the software at that point without significant
penalty and it is feasible for the customer to run the software (either
on its own or with a third-party vendor), the software license is a
separate promise in the hosting arrangement and would therefore meet the
criteria in ASC 985-20-15-5(a) and (b).
Many software hosting arrangements include a “license” to
software but allow the customer to use the software only in the entity’s (rather
than the customer’s) hosted environment (because of contractual or practical
limitations, or both). Although these arrangements may include a contractual
license, since the customer is unable to take possession of the software subject
to the license without significant penalty, the customer is required to make a
separate buying decision before control of any software is truly transferred to
the customer (the separate buying decision would be the customer’s election to
incur the penalty to take possession of the software). These transactions are
accounted for as service transactions (rather than licensing transactions) since
the entity is providing the functionality of the software through a hosting
arrangement (service) rather than through an actual software license that is
controlled by the customer.
Connecting the Dots
It is common for software to be hosted on the platform
or infrastructure of a third party rather than that of the vendor or
customer. In these circumstances, it is important to determine who has
the contract with the third party (i.e., whether it is the vendor’s or
customer’s cloud instance4 of the third-party platform or infrastructure). If the software is
hosted on the customer’s cloud instance, the customer has possession of
the software, and the arrangement would be subject to the licensing
guidance in the revenue standard. By contrast, if the software is hosted
on the vendor’s cloud instance and the customer cannot otherwise obtain
possession of the software without significant penalty, the software is
provided in a hosting arrangement and is excluded from the licensing
guidance in the revenue standard.
Example 12-1
Entity L, a software vendor, offers its
office productivity package in an online format whereby
a user accesses a Web site and stores files on a secure
server. The applications will always be maintained at
the most up-to-date version available, and customers
have rights to online and telephone support. The
customer will pay a fee of $200 for a one-year “right to
use” license for software. Renewal fees are $200 for
each subsequent year renewed. The customer does not have
the ability to take possession of the software.
The license cannot be unbundled from the
hosting service because the customer is not permitted to
take possession and may only use the software together
with L’s hosting service. Therefore, the criteria in ASC
985-20-15-5 are not met, and the arrangement
consequently does not contain a license as described in
ASC 606-10-55-54. Entity L should recognize the $200
over the one-year term of the arrangement once the
customer has access to the hosted software.
As noted above, to determine whether a right to use software in
a hosted environment includes a license within the scope of the revenue
standard’s licensing guidance, entities need to consider whether the software
license is within the scope of ASC 985-20. For the software subject to a hosting
arrangement to be within the scope of ASC 985-20 (and, therefore, within the
scope of the licensing guidance in the revenue standard), the criteria in ASC
985-20-15-5(a) and (b) must both be met.
ASC 985-20-15-6 states that the term “significant penalty” as used in ASC
985-20-15-5(a) contains the following two distinct concepts:
- The ability to take delivery of the software without incurring significant cost
- The ability to use the software separately without a significant diminution in utility or value.
The analysis for determining whether a significant penalty exists depends on the
facts and circumstances of the arrangement and requires judgment. An entity may
consider the following factors (not all-inclusive) in making this assessment:
- Contractual cancellation fees associated with the hosting arrangement.
- Other contractual penalties for taking possession of the software (e.g., the requirement that the customer continue to pay the hosting fees for the remainder of the hosting term even though hosting services are terminated).
- Costs of transitioning to (1) use of the software on the customer’s own servers or (2) hosting of the software by the customer’s third-party vendor.
- Whether the utility and value of the software can be maintained upon transition (e.g., whether (1) the customer will continue to receive updates, upgrades, and enhancements and (2) the software will be capable of providing the same functionality in another environment).
- Whether the software (1) has stand-alone functionality (on its own or with readily available resources) or (2) is significantly tied to other products or services that can be provided only by the entity and will no longer be provided if the customer takes possession of the software.
Significance can be evaluated both quantitatively and qualitatively. The
accounting literature does not contain specific guidance on (1) which elements
of the contract should be included in the measurement of the amount of the
penalty or (2) the benchmark against which the entity should measure the amount
of the penalty when determining whether the penalty is quantitatively
significant. An entity may have an established policy for determining whether
the penalty is significant. For example, in a manner consistent with other
Codification subtopics, the entity may reasonably conclude that amounts above 10
percent of a given benchmark are significant. Establishing a method of
determining both the elements of the contract to include in the measurement of
the penalty and the benchmark against which to measure the penalty is an
accounting policy decision that the entity should apply consistently.
Example 12-2
Company E is developing a customer
relationship management (CRM) software solution to be
marketed and sold to customers. The software will be
provided to customers on a hosted basis (i.e., the
software will be accessed by using an Internet
connection) and will connect to E’s proprietary data
analytics platform, which has already been developed and
is housed on E’s own servers (i.e., it is a software as
a service [SaaS] solution that is accessed only online).
Company E’s data analytics platform will be a
significant part of the overall solution sold to its
customers and will be significantly integrated with the
CRM software solution being developed. Company E plans
to provide its customers with the contractual ability to
take possession of the CRM software on an on-premise
basis, when requested at any point during the hosting
period, without paying E a penalty or cancellation fee.
However, customers will not have the contractual ability
to take possession of E’s data analytics platform. In
addition, cancellation of the hosting service for the
CRM software will also result in the cancellation of the
SaaS for E’s data analytics platform, which cannot be
easily replicated by the customer or third-party
vendors. Further, customers would incur significant
costs to integrate the CRM software with other
third-party data analytics platforms.
While a customer will have “the
contractual right to take possession of the software at
any time during the hosting period” without paying E a
penalty or cancellation fee, it cannot do so without
incurring a significant penalty (i.e., significant
diminution in utility or value of the CRM software
without E’s data analytics platform). Therefore, E
concludes that arrangements with customers for the CRM
software solution do not meet the criteria to be
accounted for as licensing arrangements.
12.2.2 License Versus In-Substance Sale of IP
Other scope-related questions may require judgment. For example,
stakeholders have raised concerns regarding the evaluation of whether certain
licensing arrangements that are in-substance sales of IP should be accounted for
as sales of IP (under either the guidance in ASC 606 unrelated to licenses if
the sales arise from contracts with customers [see Chapter 4] or the guidance in ASC 610-20
on sales of nonfinancial assets if the sales are transactions with noncustomers
[see Chapter 17])
or as licenses of IP. For example, an entity may license IP to a customer under
an arrangement that gives the customer exclusive use of the IP for either a
perpetual term or a period that is substantially the same as the IP’s useful
life.
Stakeholders have questioned whether these arrangements would be
within the scope of (1) the licensing implementation guidance discussed in this
chapter or (2) the general recognition and measurement model in the revenue
standard, which could result in a different pattern of revenue recognition.
Specifically, concerns have been raised about the application of the sales- or
usage-based royalty exception (see Section 12.7). The FASB considered, but
rejected, expanding the scope of the royalty recognition constraint because of
complexities in legal differences between a sale of IP and a license of IP. More
specifically, the FASB noted in the Background Information and Basis for
Conclusions of ASU 2016-10 that an entity should not distinguish between
licenses and in-substance sales in deciding whether the royalty exception
applies. We generally believe that the legal form of the transaction will
determine which revenue accounting guidance (i.e., the guidance on estimating
royalties or the guidance on applying the royalty recognition constraint) is
applicable. For discussion of the scope of the sales- or usage-based royalty
exception, see Section
12.7.3.
12.2.3 Sales of Books, Recorded Music, and Similar Items
In many industries, it is common for an entity to sell a
tangible product (e.g., a DVD, CD, or hard-copy book) that contains IP such as a
movie, music, or a novel (a “copyrighted work”).
The “first sale doctrine”5 provides that an individual who purchases a copy of a copyrighted work
from the copyright holder is the owner of that individual copy and receives the
right to sell, lease, or otherwise dispose of that particular copy without the
permission of the copyright owner. Therefore, the owner of an individual copy of
IP controls the economic benefits of that copy of the copyrighted work. However,
the owner of the copy has no right to the underlying copyright in the work and
has only purchased use of that specific instance of the copyrighted work. While
the term “first sale doctrine” is specific to U.S. law, many other jurisdictions
have similar regulations related to copyrighted work.
An entity should not apply the implementation guidance on
licenses in ASC 606-10-55-54 through 55-65B to sales of goods subject to the
first sale doctrine or other similar jurisdictional regulations. Rather, such
transactions should be considered sales of goods rather than licenses of IP.
Although there is a license to the IP incorporated in the good,
the contract with the customer is an arrangement for the sale of a good (e.g., a
single, physical copy of a book) rather than the IP. That is, sales of goods
subject to the first sale doctrine should be evaluated as sales of tangible
goods rather than licenses of IP since the original purchaser of the goods
relinquishes all rights to the underlying IP if it sells or otherwise transfers
the associated goods to another party. As a result, the general guidance in ASC
606 should be applied to such sales in the same way it is applied to other sales
of goods.
In instances in which the entity also promises to provide the
customer with the right to download a digital copy of the IP (e.g., a movie or
song) that may be installed on a mobile device and this digital copy is subject
to certain restrictive licensing terms and conditions that result in the
inability to transfer the downloaded content to another party (i.e., the digital
copy is not subject to the first sale doctrine), the entity should assess
whether the promise to provide the download right is distinct. If the promise is
distinct, the entity should apply the implementation guidance on licenses in ASC
606-10-55-58 through 55-65B.
Footnotes
4
When used in the context of cloud capacity, the
term “cloud instance” refers to the cloud environment in which
the software operates.
5
The first sale doctrine, codified in 17 U.S.C. Section
109, provides that an individual who knowingly purchases a copy of a
copyrighted work from the copyright holder receives the right to sell,
display, or otherwise dispose of that particular copy notwithstanding
the interests of the copyright owner. However, the right to distribute
ends once the owner has sold that particular copy (see 17 U.S.C.
Sections 109(a) and 109(c)). Since the first sale doctrine never
protects a defendant who makes unauthorized reproductions of a
copyrighted work, the first sale doctrine cannot be a successful defense
in cases that allege infringing reproduction. Further, 17 U.S.C. Section
109(d) provides that the privileges created by the first sale principle
do not “extend to any person who has acquired possession of the copy or
phonorecord from the copyright owner, by rental, lease, loan, or
otherwise, without acquiring ownership of it.” Most computer software is
distributed through the use of licensing agreements. Under this
distribution system, the copyright holder remains the “owner” of all
distributed copies. For this reason, alleged infringers should not be
able to establish that any copies of these works have been the subject
of a first sale. That is, sales of software will typically not be
subject to the first sale doctrine.
12.3 Identifying Performance Obligations
Licenses are often included with other goods or services in a
contract. An entity will need to use judgment in determining whether a license (1)
is distinct or (2) should be combined with other promised goods and services in the
contract as a single performance obligation. An entity would apply the guidance in
ASC 606-10-25-14 through 25-22 in identifying the performance obligations in the
contract. The licensing implementation guidance is applicable to arrangements with
customers that contain (1) a distinct license or (2) a license that is the
predominant promised item in a performance obligation involving multiple goods or
services.
ASC
606-10
55-55 In addition to a promise
to grant a license (or licenses) to a customer, an entity
may also promise to transfer other goods or services to the
customer. Those promises may be explicitly stated in the
contract or implied by an entity’s customary business
practices, published policies, or specific statements (see
paragraph 606-10-25-16). As with other types of contracts,
when a contract with a customer includes a promise to grant
a license (or licenses) in addition to other promised goods
or services, an entity applies paragraphs 606-10-25-14
through 25-22 to identify each of the performance
obligations in the contract.
55-56 If
the promise to grant a license is not distinct from other
promised goods or services in the contract in accordance
with paragraphs 606-10-25-18 through 25-22, an entity should
account for the promise to grant a license and those other
promised goods or services together as a single performance
obligation. Examples of licenses that are not distinct from
other goods or services promised in the contract include the
following:
- A license that forms a component of a tangible good and that is integral to the functionality of the good
- A license that the customer can benefit from only in conjunction with a related service (such as an online service provided by the entity that enables, by granting a license, the customer to access content).
55-57 When
a single performance obligation includes a license (or
licenses) of intellectual property and one or more other
goods or services, the entity considers the nature of the
combined good or service for which the customer has
contracted (including whether the license that is part of
the single performance obligation provides the customer with
a right to use or a right to access intellectual property in
accordance with paragraphs 606-10-55-59 through 55-60 and
606-10-55-62 through 55-64A) in determining whether that
combined good or service is satisfied over time or at a
point in time in accordance with paragraphs 606-10-25-23
through 25-30 and, if over time, in selecting an appropriate
method for measuring progress in accordance with paragraphs
606-10-25-31 through 25-37.
When a license is included in an arrangement to provide additional
goods or services, determining whether the license is distinct may require
significant judgment. An entity would need to carefully evaluate whether the license
is both capable of being distinct and distinct in the context of the contract. See
Chapter 5 for
additional considerations related to identifying performance obligations.
The Codification examples below illustrate how an entity would apply
the guidance on determining whether multiple goods and services promised in the
entity’s contract, including a license, are distinct.
ASC
606-10
Example 10 — Goods and Services Are Not Distinct
[Cases A and B omitted6]
Case C — Combined Item
55-140D An
entity grants a customer a three-year term license to
anti-virus software and promises to provide the customer
with when-and-if available updates to that software during
the license period. The entity frequently provides updates
that are critical to the continued utility of the software.
Without the updates, the customer’s ability to benefit from
the software would decline significantly during the
three-year arrangement.
55-140E The
entity concludes that the software and the updates are each
promised goods or services in the contract and are each
capable of being distinct in accordance with paragraph
606-10-25-19(a). The software and the updates are capable of
being distinct because the customer can derive economic
benefit from the software on its own throughout the license
period (that is, without the updates the software would
still provide its original functionality to the customer),
while the customer can benefit from the updates together
with the software license transferred at the outset of the
contract.
55-140F The
entity concludes that its promises to transfer the software
license and to provide the updates, when-and-if available,
are not separately identifiable (in accordance with
paragraph 606-10-25-19(b)) because the license and the
updates are, in effect, inputs to a combined item
(anti-virus protection) in the contract. The updates
significantly modify the functionality of the software (that
is, they permit the software to protect the customer from a
significant number of additional viruses that the software
did not protect against previously) and are integral to
maintaining the utility of the software license to the
customer. Consequently, the license and updates fulfill a
single promise to the customer in the contract (a promise to
provide protection from computer viruses for three years).
Therefore, in this Example, the entity accounts for the
software license and the when-and-if available updates as a
single performance obligation. In accordance with paragraph
606-10-25-33, the entity concludes that the nature of the
combined good or service it promised to transfer to the
customer in this Example is computer virus protection for
three years. The entity considers the nature of the combined
good or service (that is, to provide anti-virus protection
for three years) in determining whether the performance
obligation is satisfied over time or at a point in time in
accordance with paragraphs 606-10-25-23 through 25-30 and in
determining the appropriate method for measuring progress
toward complete satisfaction of the performance obligation
in accordance with paragraphs 606-10-25-31 through
25-37.
Example 11 — Determining Whether Goods or
Services Are Distinct
Case A — Distinct Goods or
Services
55-141 An entity, a software
developer, enters into a contract with a customer to
transfer a software license, perform an installation
service, and provide unspecified software updates and
technical support (online and telephone) for a two-year
period. The entity sells the license, installation service,
and technical support separately. The installation service
includes changing the web screen for each type of user (for
example, marketing, inventory management, and information
technology). The installation service is routinely performed
by other entities and does not significantly modify the
software. The software remains functional without the
updates and the technical support.
55-142 The entity assesses the
goods and services promised to the customer to determine
which goods and services are distinct in accordance with
paragraph 606-10-25-19. The entity observes that the
software is delivered before the other goods and services
and remains functional without the updates and the technical
support. The customer can benefit from the updates together
with the software license transferred at the outset of the
contract. Thus, the entity concludes that the customer can
benefit from each of the goods and services either on their
own or together with the other goods and services that are
readily available and the criterion in paragraph
606-10-25-19(a) is met.
55-143 The entity also
considers the principle and the factors in paragraph
606-10-25-21 and determines that the promise to transfer
each good and service to the customer is separately
identifiable from each of the other promises (thus, the
criterion in paragraph 606-10-25-19(b) is met). In reaching
this determination the entity considers that although it
integrates the software into the customer’s system, the
installation services do not significantly affect the
customer’s ability to use and benefit from the software
license because the installation services are routine and
can be obtained from alternate providers. The software
updates do not significantly affect the customer’s ability
to use and benefit from the software license because, in
contrast with Example 10 (Case C), the software updates in
this contract are not necessary to ensure that the software
maintains a high level of utility to the customer during the
license period. The entity further observes that none of the
promised goods or services significantly modify or customize
one another and the entity is not providing a significant
service of integrating the software and the services into a
combined output. Lastly, the entity concludes that the
software and the services do not significantly affect each
other and, therefore, are not highly interdependent or
highly interrelated because the entity would be able to
fulfill its promise to transfer the initial software license
independent from its promise to subsequently provide the
installation service, software updates, or technical
support.
55-144 On the basis of this
assessment, the entity identifies four performance
obligations in the contract for the following goods or
services:
-
The software license
-
An installation service
-
Software updates
-
Technical support.
55-145 The entity applies
paragraphs 606-10-25-23 through 25-30 to determine whether
each of the performance obligations for the installation
service, software updates, and technical support are
satisfied at a point in time or over time. The entity also
assesses the nature of the entity’s promise to transfer the
software license in accordance with paragraphs 606-10-55-59
through 55-60 and 606-10-55-62 through 55-64A (see Example
54 in paragraphs 606-10-55-362 through 55-363B).
Case B — Significant
Customization
55-146 The promised goods and
services are the same as in Case A, except that the contract
specifies that, as part of the installation service, the
software is to be substantially customized to add
significant new functionality to enable the software to
interface with other customized software applications used
by the customer. The customized installation service can be
provided by other entities.
55-147 The entity assesses the
goods and services promised to the customer to determine
which goods and services are distinct in accordance with
paragraph 606-10-25-19. The entity first assesses whether
the criterion in paragraph 606-10-25-19(a) has been met. For
the same reasons as in Case A, the entity determines that
the software license, installation, software updates, and
technical support each meet that criterion. The entity next
assesses whether the criterion in paragraph 606-10-25-19(b)
has been met by evaluating the principle and the factors in
paragraph 606-10-25-21. The entity observes that the terms
of the contract result in a promise to provide a significant
service of integrating the licensed software into the
existing software system by performing a customized
installation service as specified in the contract. In other
words, the entity is using the license and the customized
installation service as inputs to produce the combined
output (that is, a functional and integrated software
system) specified in the contract (see paragraph
606-10-25-21(a)). The software is significantly modified and
customized by the service (see paragraph 606-10-25-21(b)).
Consequently, the entity determines that the promise to
transfer the license is not separately identifiable from the
customized installation service and, therefore, the
criterion in paragraph 606-10-25-19(b) is not met. Thus, the
software license and the customized installation service are
not distinct.
55-148 On the basis of the same
analysis as in Case A, the entity concludes that the
software updates and technical support are distinct from the
other promises in the contract.
55-149 On the basis of this
assessment, the entity identifies three performance
obligations in the contract for the following goods or
services:
-
Software customization which is comprised of the license to the software and the customized installation service
-
Software updates
-
Technical support.
55-150 The entity applies
paragraphs 606-10-25-23 through 25-30 to determine whether
each performance obligation is satisfied at a point in time
or over time and paragraphs 606-10-25-31 through 25-37 to
measure progress toward complete satisfaction of those
performance obligations determined to be satisfied over
time. In applying those paragraphs to the software
customization, the entity considers that the customized
software to which the customer will have rights is
functional intellectual property and that the functionality
of that software will not change during the license period
as a result of activities that do not transfer a good or
service to the customer. Therefore, the entity is providing
a right to use the customized software. Consequently, the
software customization performance obligation is completely
satisfied upon completion of the customized installation
service. The entity considers the other specific facts and
circumstances of the contract in the context of the guidance
in paragraphs 606-10-25-23 through 25-30 in determining
whether it should recognize revenue related to the single
software customization performance obligation as it performs
the customized installation service or at the point in time
the customized software is transferred to the customer.
Example 55 — License of Intellectual
Property
55-364 An entity enters into a
contract with a customer to license (for a period of three
years) intellectual property related to the design and
production processes for a good. The contract also specifies
that the customer will obtain any updates to that
intellectual property for new designs or production
processes that may be developed by the entity. The updates
are integral to the customer’s ability to derive benefit
from the license during the license period because the
intellectual property is used in an industry in which
technologies change rapidly.
55-365 The entity assesses the
goods and services promised to the customer to determine
which goods and services are distinct in accordance with
paragraph 606-10-25-19. The entity determines that the
customer can benefit from (a) the license on its own without
the updates and (b) the updates together with the initial
license. Although the benefit the customer can derive from
the license on its own (that is, without the updates) is
limited because the updates are integral to the customer’s
ability to continue to use the intellectual property in an
industry in which technologies change rapidly, the license
can be used in a way that generates some economic benefits.
Therefore, the criterion in paragraph 606-10-25-19(a) is met
for the license and the updates.
55-365A The fact that the
benefit the customer can derive from the license on its own
(that is, without the updates) is limited (because the
updates are integral to the customer’s ability to continue
to use the license in the rapidly changing technological
environment) also is considered in assessing whether the
criterion in paragraph 606-10-25-19(b) is met. Because the
benefit that the customer could obtain from the license over
the three-year term without the updates would be
significantly limited, the entity’s promises to grant the
license and to provide the expected updates are, in effect,
inputs that, together fulfill a single promise to deliver a
combined item to the customer. That is, the nature of the
entity’s promise in the contract is to provide ongoing
access to the entity’s intellectual property related to the
design and production processes for a good for the
three-year term of the contract. The promises within that
combined item (that is, to grant the license and to provide
when-and-if available updates) are therefore not separately
identifiable in accordance with the criterion in paragraph
606-10-25-19(b).
55-366 The nature of the
combined good or service that the entity promised to
transfer to the customer is ongoing access to the entity’s
intellectual property related to the design and production
processes for a good for the three-year term of the
contract. Based on this conclusion, the entity applies
paragraphs 606-10-25-23 through 25-30 to determine whether
the single performance obligation is satisfied at a point in
time or over time and paragraphs 606-10-25-31 through 25-37
to determine the appropriate method for measuring progress
toward complete satisfaction of the performance obligation.
The entity concludes that because the customer
simultaneously receives and consumes the benefits of the
entity’s performance as it occurs, the performance
obligation is satisfied over time in accordance with
paragraph 606-10-25-27(a) and that a time-based input
measure of progress is appropriate because the entity
expects, on the basis of its relevant history with similar
contracts, to expend efforts to develop and transfer updates
to the customer on a generally even basis throughout the
three-year term.
Example 56 — Identifying a Distinct
License
55-367 An entity, a pharmaceutical
company, licenses to a customer its patent rights to an
approved drug compound for 10 years and also promises to
manufacture the drug for the customer for 5 years, while the
customer develops its own manufacturing capability. The drug
is a mature product; therefore, there is no expectation that
the entity will undertake activities to change the drug (for
example, to alter its chemical composition). There are no
other promised goods or services in the contract.
Case A — License Is Not Distinct
55-368 In this case, no other
entity can manufacture this drug while the customer learns
the manufacturing process and builds its own manufacturing
capability because of the highly specialized nature of the
manufacturing process. As a result, the license cannot be
purchased separately from the manufacturing service.
55-369 The entity assesses the
goods and services promised to the customer to determine
which goods and services are distinct in accordance with
paragraph 606-10-25-19. The entity determines that the
customer cannot benefit from the license without the
manufacturing service; therefore, the criterion in paragraph
606-10-25-19(a) is not met. Consequently, the license and
the manufacturing service are not distinct, and the entity
accounts for the license and the manufacturing service as a
single performance obligation.
55-370 The nature of the combined
good or service for which the customer contracted is a sole
sourced supply of the drug for the first five years; the
customer benefits from the license only as a result of
having access to a supply of the drug. After the first five
years, the customer retains solely the right to use the
entity’s functional intellectual property (see Case B,
paragraph 606-10-55-373), and no further performance is
required of the entity during Years 6–10. The entity applies
paragraphs 606-10-25-23 through 25-30 to determine whether
the single performance obligation (that is, the bundle of
the license and the manufacturing service) is a performance
obligation satisfied at a point in time or over time.
Regardless of the determination reached in accordance with
paragraphs 606-10-25-23 through 25-30, the entity’s
performance under the contract will be complete at the end
of Year 5.
Case B — License Is Distinct
55-371 In this case, the
manufacturing process used to produce the drug is not unique
or specialized, and several other entities also can
manufacture the drug for the customer.
55-372 The entity assesses the
goods and services promised to the customer to determine
which goods and services are distinct, and it concludes that
the criteria in paragraph 606-10-25-19 are met for each of
the license and the manufacturing service. The entity
concludes that the criterion in paragraph 606-10-25-19(a) is
met because the customer can benefit from the license
together with readily available resources other than the
entity’s manufacturing service (that is, because there are
other entities that can provide the manufacturing service)
and can benefit from the manufacturing service together with
the license transferred to the customer at the start of the
contract.
55-372A The entity also concludes
that its promises to grant the license and to provide the
manufacturing service are separately identifiable (that is,
the criterion in paragraph 606-10-25-19(b) is met). The
entity concludes that the license and the manufacturing
service are not inputs to a combined item in this contract
on the basis of the principle and the factors in paragraph
606-10-25-21. In reaching this conclusion, the entity
considers that the customer could separately purchase the
license without significantly affecting its ability to
benefit from the license. Neither the license nor the
manufacturing service is significantly modified or
customized by the other, and the entity is not providing a
significant service of integrating those items into a
combined output. The entity further considers that the
license and the manufacturing service are not highly
interdependent or highly interrelated because the entity
would be able to fulfill its promise to transfer the license
independent of fulfilling its promise to subsequently
manufacture the drug for the customer. Similarly, the entity
would be able to manufacture the drug for the customer even
if the customer had previously obtained the license and
initially utilized a different manufacturer. Thus, although
the manufacturing service necessarily depends on the license
in this contract (that is, the entity would not contract for
the manufacturing service without the customer having
obtained the license), the license and the manufacturing
service do not significantly affect each other.
Consequently, the entity concludes that its promises to
grant the license and to provide the manufacturing service
are distinct and that there are two performance
obligations:
-
License of patent rights
-
Manufacturing service.
55-373 The entity assesses the
nature of its promise to grant the license. The entity
concludes that the patented drug formula is functional
intellectual property (that is, it has significant
standalone functionality in the form of its ability to treat
a disease or condition). There is no expectation that the
entity will undertake activities to change the functionality
of the drug formula during the license period. Because the
intellectual property has significant standalone
functionality, any other activities the entity might
undertake (for example, promotional activities like
advertising or activities to develop other drug products)
would not significantly affect the utility of the licensed
intellectual property. Consequently, the nature of the
entity’s promise in transferring the license is to provide a
right to use the entity’s functional intellectual property,
and it accounts for the license as a performance obligation
satisfied at a point in time. The entity recognizes revenue
for the license performance obligation in accordance with
paragraphs 606-10-55-58B through 55-58C.
55-374 In its assessment of the
nature of the license, the entity does not consider the
manufacturing service because it is an additional promised
service in the contract. The entity applies paragraphs
606-10-25-23 through 25-30 to determine whether the
manufacturing service is a performance obligation satisfied
at a point in time or over time.
Example 57 — Franchise Rights
55-375 An
entity enters into a contract with a customer and promises
to grant a franchise license that provides the customer with
the right to use the entity’s trade name and sell the
entity’s products for 10 years. In addition to the license,
the entity also promises to provide the equipment necessary
to operate a franchise store. In exchange for granting the
license, the entity receives a fixed fee of $1 million, as
well as a sales-based royalty of 5 percent of the customer’s
sales for the term of the license. The fixed consideration
for the equipment is $150,000 payable when the equipment is
delivered.
Identifying Performance
Obligations
55-376 The entity assesses the
goods and services promised to the customer to determine
which goods and services are distinct in accordance with
paragraph 606-10-25-19. The entity observes that the entity,
as a franchisor, has developed a customary business practice
to undertake activities such as analyzing the consumers’
changing preferences and implementing product improvements,
pricing strategies, marketing campaigns, and operational
efficiencies to support the franchise name. However, the
entity concludes that these activities do not directly
transfer goods or services to the customer.
55-377 The entity determines
that it has two promises to transfer goods or services: a
promise to grant a license and a promise to transfer
equipment. In addition, the entity concludes that the
promise to grant the license and the promise to transfer the
equipment are each distinct. This is because the customer
can benefit from each good or service (that is, the license
and the equipment) on its own or together with other
resources that are readily available (see paragraph
606-10-25-19(a)). The customer can benefit from the license
together with the equipment that is delivered before the
opening of the franchise, and the equipment can be used in
the franchise or sold for an amount other than scrap value.
The entity also determines that the promises to grant the
franchise license and to transfer the equipment are
separately identifiable in accordance with the criterion in
paragraph 606-10-25-19(b). The entity concludes that the
license and the equipment are not inputs to a combined item
(that is, they are not fulfilling what is, in effect, a
single promise to the customer). In reaching this
conclusion, the entity considers that it is not providing a
significant service of integrating the license and the
equipment into a combined item (that is, the licensed
intellectual property is not a component of, and does not
significantly modify, the equipment). Additionally, the
license and the equipment are not highly interdependent or
highly interrelated because the entity would be able to
fulfill each promise (that is, to license the franchise or
to transfer the equipment) independently of the other.
Consequently, the entity has two performance obligations:
-
The franchise license
-
The equipment.
Allocating the Transaction Price
55-378 The entity determines
that the transaction price includes fixed consideration of
$1,150,000 and variable consideration (5 percent of the
customer’s sales from the franchise store). The standalone
selling price of the equipment is $150,000 and the entity
regularly licenses franchises in exchange for 5 percent of
customer sales and a similar upfront fee.
55-379 The entity applies
paragraph 606-10-32-40 to determine whether the variable
consideration should be allocated entirely to the
performance obligation to transfer the franchise license.
The entity concludes that the variable consideration (that
is, the sales-based royalty) should be allocated entirely to
the franchise license because the variable consideration
relates entirely to the entity’s promise to grant the
franchise license. In addition, the entity observes that
allocating $150,000 to the equipment and allocating the
sales-based royalty (as well as the additional $1 million in
fixed consideration) to the franchise license would be
consistent with an allocation based on the entity’s relative
standalone selling prices in similar contracts.
Consequently, the entity concludes that the variable
consideration (that is, the sales-based royalty) should be
allocated entirely to the performance obligation to grant
the franchise license.
Licensing
55-380 The entity assesses the
nature of the entity’s promise to grant the franchise
license. The entity concludes that the nature of its promise
is to provide a right to access the entity’s symbolic
intellectual property. The trade name and logo have limited
standalone functionality; the utility of the products
developed by the entity is derived largely from the
products’ association with the franchise brand.
Substantially all of the utility inherent in the trade name,
logo, and product rights granted under the license stems
from the entity’s past and ongoing activities of
establishing, building, and maintaining the franchise brand.
The utility of the license is its association with the
franchise brand and the related demand for its products.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
55-381 The entity is granting a
license to symbolic intellectual property. Consequently, the
license provides the customer with a right to access the
entity’s intellectual property and the entity’s performance
obligation to transfer the license is satisfied over time in
accordance with paragraph 606-10-55-58A. The entity
recognizes the fixed consideration allocable to the license
performance obligation in accordance with paragraph
606-10-55-58A and paragraph 606-10-55-58C. This includes
applying paragraphs 606-10-25-31 through 25-37 to identify
the method that best depicts the entity’s performance in
satisfying the license (see paragraph 606-10-55-382).
55-382 Because the consideration
that is in the form of a sales-based royalty relates
specifically to the franchise license (see paragraph
606-10-55-379), the entity applies paragraph 606-10-55-65 in
recognizing that consideration as revenue. Consequently, the
entity recognizes revenue from the sales-based royalty as
and when the sales occur. The entity concludes that
recognizing revenue resulting from the sales-based royalty
when the customer’s subsequent sales occur is consistent
with the guidance in paragraph 606-10-55-65(b). That is, the
entity concludes that ratable recognition of the fixed $1
million franchise fee plus recognition of the periodic
royalty fees as the customer’s subsequent sales occur
reasonably depict the entity’s performance toward complete
satisfaction of the franchise license performance obligation
to which the sales-based royalty has been allocated.
Example 61A — Right to Use Intellectual
Property
55-399A An entity, a television
production company, licenses all of the existing episodes of
a television show (which consists of the first four seasons)
to a customer. The show is presently in its fifth season,
and the television production company is producing episodes
for that fifth season at the time the contract is entered
into, as well as promoting the show to attract further
viewership. The Season 5 episodes in production are still
subject to change before airing.
Case B — Contract Includes Two
Promises
55-399F Consistent with Case A,
the contract provides the customer with the right to
broadcast the existing episodes, in sequential order, over a
period of two years. The contract also grants the customer
the right to broadcast the episodes being produced for
Season 5 once all of those episodes are completed.
55-399G The entity assesses the
goods and services promised to the customer. The entity
concludes that there are two promised goods or services in
the contract:
-
The license to the existing episodes (see paragraph 606-10-55-399C)
-
The license to the episodes comprising Season 5, when all of those episodes are completed.
55-399H The entity then
evaluates whether the license to the existing content is
distinct from the license to the Season 5 episodes when they
are completed. The entity concludes that the two licenses
are distinct from each other and, therefore, separate
performance obligations. This conclusion is based on the
following analysis:
- Each license is capable of being distinct because the customer can benefit from its right to air the existing completed episodes on their own and can benefit from the right to air the episodes comprising Season 5, when they are all completed, on their own and together with the right to air the existing completed content.
- Each of the two promises to transfer a license in the contract also is separately identifiable; they do not, together, constitute a single overall promise to the customer. The existing episodes do not modify or customize the Season 5 episodes in production, and the existing episodes do not, together with the pending Season 5 episodes, result in a combined functionality or changed content. The right to air the existing content and the right to air the Season 5 content, when available, are not highly interdependent or highly interrelated because the entity’s ability to fulfill its promise to transfer either license is unaffected by its promise to transfer the other. In addition, whether the customer or another licensee had rights to air the future episodes would not be expected to significantly affect the customer’s license to air the existing, completed episodes (for example, viewers’ desire to watch existing episodes from Seasons 1–4 on the customer’s network generally would not be significantly affected by whether the customer, or another network, had the right to broadcast the episodes that will comprise Season 5).
55-399I The entity assesses the
nature of the two separate performance obligations (that is,
the license to the existing, completed episodes of the
series and the license to episodes that will comprise Season
5 when completed). To determine whether the licenses provide
the customer with rights to use the entity’s intellectual
property or rights to access the entity’s intellectual
property, the entity considers the following:
-
The licensed intellectual property (that is, the completed episodes in Seasons 1–4 and the episodes in Season 5, when completed) has significant standalone functionality separate from the entity’s ongoing business activities, such as in producing additional intellectual property (for example, future seasons) or in promoting the show, and completed episodes can be aired without the entity’s further involvement.
-
There is no expectation that the entity will substantively change any of the content once it is made available to the customer for broadcast (that is, the criteria in paragraph 606-10-55-62 are not met).
-
The activities expected to be undertaken by the entity to produce Season 5 and transfer the right to air those episodes constitute an additional promised good (license) in the contract and, therefore, do not affect the nature of the entity’s promise in granting the license to Seasons 1–4.
55-399J Therefore, the entity
concludes that both the license to the existing episodes in
the series and the license to the episodes that will
comprise Season 5 provide the customer with the right to use
its functional intellectual property as it exists at the
point in time the license is granted. As a result, the
entity recognizes the portion of the transaction price
allocated to each license at a point in time in accordance
with paragraphs 606-10-55-58B through 55-58C. That is, the
entity recognizes the revenue attributable to each license
on the date that the customer is first permitted to first
air the content included in each performance obligation.
That date is the beginning of the period during which the
customer is able to use and benefit from its right to use
the licensed intellectual property.
The application of the revenue standard to arrangements that include
a license of IP may be challenging. In particular, the determination of whether
rights promised to a customer in a licensing arrangement should be combined or
separated is often complex and may require significant judgment. In the Background
Information and Basis for Conclusions of ASU 2016-10, the FASB acknowledged such
challenges as follows:
BC41 The Board previously observed
that all contracts require an assessment of the promised goods and services
in the contract and the criteria for identifying performance obligations
(see paragraphs 606-10-25-14 through 25-22). This includes an assessment of
whether a customer can benefit from the license on its own or together with
other resources that are readily available to the customer (see paragraph
606-10-25-19(a)) and whether the entity’s promise to transfer the license is
separately identifiable from other goods or services in the contract (see
paragraph 606-10-25-19(b)). The Boards observed that
this assessment might sometimes be challenging.
BC42
Identifying separate deliverables (or elements) in
licensing arrangements often is challenging under previous GAAP (for
example, in many software or biotechnology arrangements), and it was
never the Board’s intention to eliminate judgment in this area.
While stakeholders in industries that engage in significant licensing
activities have questioned this, the Board concluded that no additional
guidance on identifying performance obligations specifically tailored to
entities that license intellectual property is necessary. The Board expects
that the improvements in this Update will assist all entities in applying
the general identifying performance obligations guidance in paragraphs
606-10-25-14 through 25-22, including entities that license intellectual
property. [Emphasis added]
The Background Information and Basis for Conclusions of
ASU
2014-09 and that of ASU 2016-10 both emphasize the need for an
entity to use judgment when assessing whether promised goods or services are
distinct within the context of the contract. Paragraphs BC27 and BC28 of ASU 2016-10
state the following:
BC27
The criterion in paragraph 606-10-25-19(b) as well as
the principle and the factors in paragraph 606-10-25-21 were developed
with the understanding that application will require the exercise of
judgment. This was in direct response to stakeholders’ feedback
received during the development of Topic 606. Stakeholders expressed
concerns that the proposed separation guidance in the 2010 and 2011 proposed
Updates did not appropriately address the wide variety of revenue
arrangements that existed in practice across all industries. Stakeholders
asserted that the separation guidance might have resulted in the
identification of performance obligations that do not appropriately reflect
the arrangement with a customer.
BC28 Stakeholders requested, and the Board decided to establish, guidance that permits
judgment in this area. The Board observed that identifying separate
deliverables or separate elements under existing revenue guidance also is
challenging and judgmental, especially in particular industries. Although
judgment is required, the Board has observed different interpretations of
the criterion in paragraph 606-10-25-19(b) and the guidance in paragraph
606-10-25-21. For those reasons, the Board decided to clarify that guidance
by better articulating the separately identifiable principle. Although the
language describing the principle has been expanded, the amendments merely
better describe the Board’s intentions and are not a change to the
underlying principle. Even with the improvements in this Update, the Board
recognizes that judgment will be needed to determine whether promised goods
or services are distinct. [Emphasis added]
ASU 2016-10’s Background Information and Basis for Conclusions
expands on the separately identifiable principle described in ASC 606-10-25-21 and
the FASB’s intent regarding application of that principle as follows:
-
Focusing on the principle; inputs to a combined output — Paragraph BC29 notes that the separately identifiable principle requires an entity to consider “whether the multiple promised goods or services in the contract are outputs or, instead, are inputs to a combined item (or items).” The paragraph goes on to explain that the “combined item . . . is greater than (or substantively different from) the sum of those promised (component) goods and services.” In addition, paragraph BC31 explains that the factors listed in ASC 606-10-25-21 are intended to support the principle and should not be viewed as criteria to be evaluated independently. If multiple promised goods or services represent inputs rather than individual outputs, such goods or services would not be separately identifiable.Level of integration, interrelation, or interdependence — Paragraph BC32 of ASU 2016-10 states, in part:The separately identifiable principle is intended to consider the level of integration, interrelation, or interdependence among promises to transfer goods or services. That is, the separately identifiable principle is intended to evaluate when an entity’s performance in transferring a bundle of goods or services in a contract is, in substance, fulfilling a single promise to a customer. Therefore, the entity should evaluate whether two or more promised goods or services (for example, a delivered item and an undelivered item) each significantly affect the other (and, therefore, are highly interdependent or highly interrelated) in the contract. The entity should not merely evaluate whether one item, by its nature, depends on the other (for example, an undelivered item that would never be obtained by a customer absent the presence of the delivered item in the contract or the customer having obtained that item in a different contract).The greater the level of integration, interrelation, or interdependence, the less likely it is that the promised goods or services are separately identifiable (i.e., the more likely it is that those goods or services should be combined into a single performance obligation). In a discussion not included in ASC 606 about how an entity should evaluate the level of integration, interrelation, or interdependence of multiple promised goods or services, paragraph BC116K of IFRS 15 states that “rather than considering whether one item, by its nature, depends on the other (ie whether two items have a functional relationship), an entity evaluates whether there is a transformative relationship between the two items in the process of fulfilling the contract.”
-
Diminution of utility — As indicated below, paragraph BC33(b) of ASU 2016-10 discusses how the utility of a license may depend on updates to the license and therefore should be considered in the evaluation of whether multiple promised goods or services are separately identifiable:[I]n Example 10, Case C [ASC 606-10-55-140D through 55-140F], or in Example 55 [ASC 606-10-55-364 through 55-366], the entity’s ability to transfer the initial license is not affected by its promise to transfer the updates or vice versa, but the provision (or not) of the updates will significantly affect the utility of the licensed intellectual property to the customer such that the license and the updates are not separately identifiable. They are, in effect, inputs to the combined solution for which the customer contracted. The “capable of being distinct” criterion also considers the utility of the promised good or service, but merely establishes the baseline level of economic substance a good or service must have to be “capable of being distinct.” Therefore, utility also is relevant in evaluating whether two or more promises in a contract are separately identifiable because even if two or more goods or services are capable of being distinct because the customer can derive some economic benefit from each one, the customer’s ability to derive its intended benefit from the contract may depend on the entity transferring each of those goods or services. [Emphasis added]When the utility of one promised good or service significantly depends on another promised good or service, it is less likely that those goods or services are separately identifiable. Specifically, an entity should consider (1) how quickly the utility of the initial license diminishes and, therefore, (2) how quickly the customer needs to incorporate any updates or upgrades to the licensed IP to continue to benefit and derive utility from the originally licensed IP.
12.3.1 Portfolio of Licenses to Patents
Some industries have a practice of selling a portfolio of
licenses to patented IP (e.g., patented technology or know-how). Because the
patented IP represents functional IP (see Section 12.4.1), the related licenses
grant an entity’s customer a right to use the patented IP. In a typical
arrangement to sell such a portfolio of licenses, the rights conveyed to the
customer extend not only to all currently available patents (the “current
patents”) but also to any patents that the entity develops later in the license
term (the “future patents”). The effect of this type of arrangement is to expand
the rights that are initially granted to the customer (i.e., the current
patents) by providing the customer with the rights to future patents that are
developed over the term of the arrangement. The current patents and future
patents are capable of being distinct in accordance with ASC 606-10-25-19(a)
because the customer is able to benefit from the current patents or future
patents either on their own or together with readily available resources.
An entity that has entered into an arrangement with a customer to license a
portfolio of patents should consider the “separately identifiable” principle in
ASC 606-10-25-19(b) and related factors in ASC 606-10-25-21, including (1)
whether the current patents and future patents are inputs to a combined output,
(2) the level of integration, interrelation, or interdependence between the
current patents and future patents, and (3) the diminution of the utility of the
current patents without a right to the future patents. For example, the entity
should consider (1) how quickly the utility of the current patents diminishes
once new patents are issued and (2) how quickly the customer needs to
incorporate any updates and upgrades to the current patents to continue
benefiting and deriving utility from the current patents. If the entity is
required to immediately update the portfolio for any new patents once issued,
that may suggest that the utility of the current patents is significantly
diminished without the new patents.
The entity should consider its facts and circumstances when it assesses the
separately identifiable principle to determine whether the initially delivered
rights (i.e., the current patents) are distinct within the context of the
contract from the ongoing rights that it is contractually required to deliver
over the term of the agreement (i.e., the future patents).
12.3.2 Determining Whether Contractual Provisions Represent Attributes of a License or Additional Rights
A contract with a customer may contain provisions that limit the
customer’s use of a license of IP to a specific period, geographic region, or
use. For example, an entity may license media content to a customer that can be
(1) used for three years, (2) made available only to consumers in North America,
and (3) broadcasted only on a specific network. Often, such restrictions will be
attributes of the license. That is, the restrictions will define the rights the
customer has under the license, and all of those rights will be transferred to
the customer either at a point in time (if the license is a right to use IP) or
over time (if the license is a right to access IP). However, some restrictions,
or changes in restrictions over time, will require an entity to transfer
additional rights to a customer. Specifically, the amendments in ASU 2016-10
clarify that (1) certain contractual provisions indicate that an entity has
promised to transfer additional rights (i.e., an additional license) to a
customer and (2) promises to transfer additional rights should be accounted for
as separate performance obligations.
ASC 606-10
55-64
Contractual provisions that explicitly or implicitly
require an entity to transfer control of additional
goods or services to a customer (for example, by
requiring the entity to transfer control of additional
rights to use or rights to access intellectual property
that the customer does not already control) should be
distinguished from contractual provisions that
explicitly or implicitly define the attributes of a
single promised license (for example, restrictions of
time, geographical region, or use). Attributes of a
promised license define the scope of a customer’s right
to use or right to access the entity’s intellectual
property and, therefore, do not define whether the
entity satisfies its performance obligation at a point
in time or over time and do not create an obligation for
the entity to transfer any additional rights to use or
access its intellectual property.
- Subparagraph superseded by Accounting Standards Update No. 2016-10.
- Subparagraph superseded by Accounting Standards Update No. 2016-10.
55-64A
Guarantees provided by the entity that it has a valid
patent to intellectual property and that it will defend
that patent from unauthorized use do not affect whether
a license provides a right to access the entity’s
intellectual property or a right to use the entity’s
intellectual property. Similarly, a promise to defend a
patent right is not a promised good or service because
it provides assurance to the customer that the license
transferred meets the specifications of the license
promised in the contract.
The determination of whether contractual provisions related to a
license of IP represent an additional promise may require significant judgment.
Contractual provisions (restrictions) that define the scope of a license of IP
that has already been transferred to a customer would generally not be accounted
for as a separate performance obligation. For example, a restriction that limits
the use of a license to a five-year period would be an attribute of the single
license. However, contractual provisions that define additional rights that will
be transferred at a future date would generally be accounted for as a separate
performance obligation, as illustrated in the example below.
Example 12-3
An entity transfers to a customer a two-year license of
IP that can be used only in Jurisdiction A during year 1
but can be used in both Jurisdiction A and Jurisdiction
B during year 2 in exchange for a fixed fee of $100,000.
The entity concludes that the license is a right to
access IP that will be transferred to the customer over
time. In this example, the customer does not obtain
control of the license in Jurisdiction B until year 2.
That is, in year 2, the entity must transfer additional
rights that entitle the customer to use the license in
Jurisdiction B. Although the entity transfers the
license to use the IP in Jurisdiction A at the beginning
of year 1, the entity must still fulfill a second
promise to deliver the license to use the IP in
Jurisdiction B in year 2. Further, although the license
of IP obtained by the customer in year 1 may be the same
license of IP that will be used in year 2 (i.e., the
customer currently controls the right to use or access
the IP), the customer is precluded from using and
benefiting from that license in Jurisdiction B until
year 2. The obligation to transfer additional rights to
the customer at the beginning of year 2 should be
identified as an additional performance obligation under
the contract with the customer.
In allocating the transaction price of $100,000 to the
two performance obligations, the entity determines that
the stand-alone selling prices of delivering the license
to Jurisdiction A for two years and Jurisdiction B for
one year are $60,000 and $40,000, respectively. Under
these circumstances, the entity would then recognize
revenue of $30,000 over year 1 and $70,000 over year 2,
which is calculated as follows:
- Year 1 (Jurisdiction A) — ($60,000 ÷ 2) × 1 year of service = $30,000.
- Year 2 (Jurisdiction A) — ($60,000 ÷ 2) × 1 year of service = $30,000.
- Year 2 (Jurisdiction B) — $40,000 × 1 year of service = $40,000.
The example above assumes that the license constitutes a right
to access IP that will be transferred to the customer over time. The
determination of whether a license is a right to access IP for which revenue is
recognized over time or a right to use IP for which revenue is recognized at a
point in time is discussed in Section 12.4.
Paragraph BC45 of ASU 2016-10 indicates that a substantive break between the
periods for which an entity’s customer has the right to use IP might create
multiple licenses since the substantive break “might suggest that the customer’s
rights have been ‘revoked’ for that period of time and that the entity has made
an additional promise to transfer rights to use that same [IP] again at the
later date.” Accordingly, an entity should use judgment to determine whether a
break is “substantive” and therefore creates an additional license of IP (i.e.,
a separate performance obligation).
The Codification examples below illustrate how an entity would apply the guidance
on determining whether contractual provisions represent attributes of a license
or additional promises to a customer.
ASC 606-10
Example 59 — Right to Use Intellectual
Property
Case A — Initial License
55-389 An entity, a music
record label, licenses to a customer a recording of a
classical symphony by a noted orchestra. The customer, a
consumer products company, has the right to use the
recorded symphony in all commercials, including
television, radio, and online advertisements for two
years in Country A starting on January 1, 20X1. In
exchange for providing the license, the entity receives
fixed consideration of $10,000 per month. The contract
does not include any other goods or services to be
provided by the entity. The contract is
noncancellable.
55-390 The entity assesses
the goods and services promised to the customer to
determine which goods and services are distinct in
accordance with paragraph 606-10-25-19. The entity
concludes that its only performance obligation is to
grant the license. The term of the license (two years),
the geographical scope of the license (that is, the
customer’s right to use the symphony only in Country A),
and the defined permitted uses for the recording (that
is, use in commercials) are all attributes of the
promised license in this contract.
55-391 In determining that
the promised license provides the customer with a right
to use its intellectual property as it exists at the
point in time at which the license is granted, the
entity considers the following:
- The classical symphony recording has significant standalone functionality because the recording can be played in its present, completed form without the entity’s further involvement. The customer can derive substantial benefit from that functionality regardless of the entity’s further activities or actions. Therefore, the nature of the licensed intellectual property is functional.
- The contract does not require, and the customer does not reasonably expect, that the entity will undertake activities to change the licensed recording.
Therefore, the criteria in paragraph 606-10-55-62 are not
met.
55-392 In accordance with
paragraph 606-10-55-58B, the promised license, which
provides the customer with a right to use the entity’s
intellectual property, is a performance obligation
satisfied at a point in time. The entity recognizes
revenue from the satisfaction of that performance
obligation in accordance with paragraphs 606-10-55-58B
through 55-58C. Additionally, because of the length of
time between the entity’s performance (at the beginning
of the period) and the customer’s monthly payments over
two years (which are noncancellable), the entity
considers the guidance in paragraphs 606-10-32-15
through 32-20 to determine whether a significant
financing component exists.
Example 61A — Right to Use Intellectual
Property
55-399A An entity, a
television production company, licenses all of the
existing episodes of a television show (which consists
of the first four seasons) to a customer. The show is
presently in its fifth season, and the television
production company is producing episodes for that fifth
season at the time the contract is entered into, as well
as promoting the show to attract further viewership. The
Season 5 episodes in production are still subject to
change before airing.
Case A — License Is the Only Promise
in the Contract
55-399B The customer obtains
the right to broadcast the existing episodes, in
sequential order, for a period of two years. The show
has been successful through the first four seasons, and
the customer is both aware that Season 5 already is in
production and aware of the entity’s continued promotion
of the show. The customer will make fixed monthly
payments of an equal amount throughout the two-year
license period.
55-399C The entity assesses
the goods and services promised to the customer. The
entity’s activities to produce Season 5 and its
continued promotion of the show do not transfer a
promised good or service to the customer. Therefore, the
entity concludes that there are no other promised goods
or services in the contract other than the license to
broadcast the existing episodes in the television
series. The contractual requirement to broadcast the
episodes in sequential order is an attribute of the
license (that is, a restriction on how the customer may
use the license); therefore, the only performance
obligation in this contract is the single license to the
completed Seasons 1–4.
55-399D To determine whether
the promised license provides the customer with a right
to use its intellectual property or a right to access
its intellectual property, the entity evaluates the
intellectual property that is the subject of the
license. The existing episodes have substantial
standalone functionality at the point in time they are
transferred to the customer because the episodes can be
aired, in the form transferred, without any further
participation by the entity. Therefore, the customer can
derive substantial benefit from the completed episodes,
which have significant utility to the customer without
any further activities of the entity. The entity further
observes that the existing episodes are complete and not
subject to change. Thus, there is no expectation that
the functionality of the intellectual property to which
the customer has rights will change (that is, the
criteria in paragraph 606-10-55-62 are not met).
Therefore, the entity concludes that the license
provides the customer with a right to use its functional
intellectual property.
55-399E Consequently, in
accordance with paragraph 606-10-55-58B, the license is
a performance obligation satisfied at a point in time.
In accordance with paragraphs 606-10-55-58B through
55-58C, the entity recognizes revenue for the license on
the date that the customer is first permitted to air the
licensed content, assuming the content is made available
to the customer on or before that date. The date the
customer is first permitted to air the licensed content
is the beginning of the period during which the customer
is able to use and benefit from its right to use the
intellectual property. Because of the length of time
between the entity’s performance (at the beginning of
the period) and the customer’s annual payments over two
years (which are noncancellable), the entity considers
the guidance in paragraphs 606-10-32-15 through 32-20 to
determine whether a significant financing component
exists.
Example 61B — Distinguishing Multiple
Licenses From Attributes of a Single License
55-399K On December 15, 20X0,
an entity enters into a contract with a customer that
permits the customer to embed the entity’s functional
intellectual property in two classes of the customer’s
consumer products (Class 1 and Class 2) for five years
beginning on January 1, 20X1. During the first year of
the license period, the customer is permitted to embed
the entity’s intellectual property only in Class 1.
Beginning in Year 2 (that is, beginning on January 1,
20X2), the customer is permitted to embed the entity’s
intellectual property in Class 2. There is no
expectation that the entity will undertake activities to
change the functionality of the intellectual property
during the license period. There are no other promised
goods or services in the contract. The entity provides
(or otherwise makes available — for example, makes
available for download) a copy of the intellectual
property to the customer on December 20, 20X0.
55-399L In identifying the
goods and services promised to the customer in the
contract (in accordance with guidance in paragraphs
606-10-25-14 through 25-18), the entity considers
whether the contract grants the customer a single
promise, for which an attribute of the promised license
is that during Year 1 of the contract the customer is
restricted from embedding the intellectual property in
the Class 2 consumer products), or two promises (that
is, a license for a right to embed the entity’s
intellectual property in Class 1 for a five-year period
beginning on January 1, 20X1, and a right to embed the
entity’s intellectual property in Class 2 for a
four-year period beginning on January 1, 20X2).
55-399M In making this
assessment, the entity determines that the provision in
the contract stipulating that the right for the customer
to embed the entity’s intellectual property in Class 2
only commences one year after the right for the customer
to embed the entity’s intellectual property in Class 1
means that after the customer can begin to use and
benefit from its right to embed the entity’s
intellectual property in Class 1 on January 1, 20X1, the
entity must still fulfill a second promise to transfer
an additional right to use the licensed intellectual
property (that is, the entity must still fulfill its
promise to grant the customer the right to embed the
entity’s intellectual property in Class 2). The entity
does not transfer control of the right to embed the
entity’s intellectual property in Class 2 before the
customer can begin to use and benefit from that right on
January 1, 20X2.
55-399N The entity then
concludes that the first promise (the right to embed the
entity’s intellectual property in Class 1) and the
second promise (the right to embed the entity’s
intellectual property in Class 2) are distinct from each
other. The customer can benefit from each right on its
own and independently of the other. Therefore, each
right is capable of being distinct in accordance with
paragraph 606-10-25-19(a)). In addition, the entity
concludes that the promise to transfer each license is
separately identifiable (that is, each right meets the
criterion in paragraph 606-10-25-19(b)) on the basis of
an evaluation of the principle and the factors in
paragraph 606-10-25-21. The entity concludes that it is
not providing any integration service with respect to
the two rights (that is, the two rights are not inputs
to a combined output with functionality that is
different from the functionality provided by the
licenses independently), neither right significantly
modifies or customizes the other, and the entity can
fulfill its promise to transfer each right to the
customer independently of the other (that is, the entity
could transfer either right to the customer without
transferring the other). In addition, neither the Class
1 license nor the Class 2 license is integral to the
customer’s ability to use or benefit from the other.
55-399O Because each right is
distinct, they constitute separate performance
obligations. On the basis of the nature of the licensed
intellectual property and the fact that there is no
expectation that the entity will undertake activities to
change the functionality of the intellectual property
during the license period, each promise to transfer one
of the two licenses in this contract provides the
customer with a right to use the entity’s intellectual
property and the entity’s promise to transfer each
license is, therefore, satisfied at a point in time. The
entity determines at what point in time to recognize the
revenue allocable to each performance obligation in
accordance with paragraphs 606-10-55-58B through 55-58C.
Because a customer does not control a license until it
can begin to use and benefit from the rights conveyed,
the entity recognizes revenue allocated to the Class 1
license no earlier than January 1, 20X1, and the revenue
on the Class 2 license no earlier than January 1,
20X2.
12.3.3 Distinguishing an Option to Acquire Additional Rights From Provisions Giving Rise to Variable Consideration in the Form of a Sales- or Usage-Based Royalty
As discussed in ASC 606-10-55-64, contractual provisions in a
licensing transaction may allow an entity’s customer to obtain additional
benefits or rights after the initial transfer of the license. An entity may need
to use significant judgment to differentiate between contractual terms that
allow a customer to obtain additional rights that the customer does not already
control (thereby creating additional performance obligations) and contractual
terms that allow for additional usage of IP already controlled by the customer
(which would not create additional performance obligations but may entitle the
entity to additional variable consideration in the form of a sales- or
usage-based royalty). The entity will need to evaluate any option to acquire
additional rights to use or access the IP to determine whether the option gives
rise to a material right.
Paragraph BC46 of ASU 2016-10 states, in part, that
“judgment often is required in distinguishing a single promised license with
multiple attributes from a license that contains multiple promises to the
customer in the contract.” The determination of whether contractual provisions
that allow the customer to obtain additional benefits or rights constitute
optional purchases or variable consideration related to rights already
controlled by the customer could affect the timing of revenue recognition if the
optional additional rights give rise to a material right.
When options to acquire additional rights not already controlled
by the customer are priced at their stand-alone selling prices, the timing and
amount of revenue recognized will most likely be the same as if the contractual
rights gave rise to variable consideration in the form of a sales- or
usage-based royalty. However, the differentiation may still be important since
consideration in the form of a sales- or usage-based royalty is a form of
variable consideration to which the disclosure requirements in ASC 606-10-50-15
might apply (e.g., if the nature of the license is a right-to-access license of
IP that is transferred to the customer over time).
An entity will need to use judgment on the basis of the specific facts and
circumstances of the arrangement to determine whether (1) the contract includes
an option to acquire additional rights to use or access IP or (2) the
contractual provisions give rise to variable consideration in the form of a
sales- or usage-based royalty.
The following factors may indicate that the contractual provisions (1) give the
customer an option to acquire additional rights to use or access IP or (2)
represent an obligation to transfer additional rights to the customer that
constitutes a separate performance obligation:
- The customer’s right to use or access the initial IP changes when the additional rights are obtained (e.g., the customer can embed the IP within a new or different product or can use the IP in a different geographic area).
- The customer obtains new or expanded functionality as a result of the additional rights obtained.
- The additional rights obtained for a fee continue for the duration of the license agreement rather than expiring upon usage, and the additional usage during that period does not result in additional fees. That is, the additional rights are acquired for an additional initial fee, but the additional rights are not wholly consumed once the rights are acquired (e.g., the customer expands the use of functional IP from 100 users to 200 users for the duration of the license term) and no ongoing usage fee is payable.
- The license is transferred to a reseller (requiring the reseller to pay a fee per copy, license, or end user upon making a purchase or sale), and the reseller is not using the functionality provided by the license itself but is transferring the rights to use the IP to end users. Because the reseller is simply purchasing and reselling the software product, the software product is more akin to any other tangible product that is purchased for resale. In these situations, the transaction between the vendor and the reseller is one in which the vendor is selling and the reseller is purchasing incremental software rights that the reseller does not already control each time the reseller pays a fee to transfer the vendor’s software to an end user.
The following factors may indicate that the contractual provisions give the
customer a right to additional usage of a single license, which would give rise
to variable consideration:
- The customer controls the rights to use or access the IP but is required to pay additional consideration based on how often the IP is used (e.g., consideration is payable each time the IP performs a task, or each time the IP is integrated into a device and contributes to the device’s functionality).
- The additional usage of the IP does not provide sustained additional benefits without additional fees. For example, a customer may have to pay a fee each time it uses software to perform a task rather than a fixed fee that allows the customer to continually use the software to perform tasks.
Sometimes, specific performance by the licensor will be required before
additional rights are granted or additional usage of a single license is
allowed. For example, a software licensor may need to provide the licensee with
a software key each time software is embedded in a device. The fact that the
licensor is required to provide a software key for each license does not
necessarily mean that a new right is transferred to the licensee with each key
(i.e., specific actions required by the licensor are not in and of themselves
determinative of whether additional rights have been transferred to the
licensee). Rather, an entity should evaluate all facts and circumstances when
determining whether contractual provisions (1) give a customer the right to
acquire additional rights to use or access IP that it does not already control
in exchange for additional consideration or (2) give rise to variable
consideration in the form of a sales- or usage-based royalty.
12.3.3.1 Accounting for a Customer’s Option to Purchase or Use Additional Copies of Software
A software license arrangement accounted for as a
right-to-use license (i.e., a license for which revenue is recognized at a
point in time) may (1) transfer a license and require the customer to make a
fixed payment at inception and (2) include an option for the customer to
obtain additional rights that allow the software to be used by additional
users for incremental fees per user.7 Alternatively (or in addition), a right-to-use license arrangement may
provide for “additional usage” of a single license in exchange for
incremental fees per use.
As discussed in Section 12.3.3, an entity in a
right-to-use license arrangement will need to use judgment to determine
whether the nature of the arrangement is to provide the customer with an
option to obtain additional rights (e.g., for additional users) or to
require payment of incremental fees for additional usage of rights already
controlled by the customer.
An arrangement in which an entity provides an option to the
customer to obtain rights for additional users typically represents promises
to provide additional licenses (i.e., additional performance obligations)
for an incremental fee. Those optional additional purchases (i.e., options
that would require an entity to transfer additional rights to the customer)
would not initially be included in the contract; however, they should be
evaluated for favorable terms that may give rise to a material right. For
further discussion, see Section 12.3.3.2.
In some cases, additional copies of a software license could
represent additional usage of a single license as opposed to additional
users. As discussed in Section 12.3.3,
an entity will need to use judgment on the basis of the specific facts and
circumstances of the arrangement. For example, the ability to use additional
copies of a license for an incremental fee in certain reseller arrangements
could represent additional usage as opposed to optional purchases of
additional rights (see Example 12-5).
An arrangement in which an entity provides additional usage of a single
license (i.e., usage of rights already controlled by the customer) could
include additional consideration as part of the transaction price for a
single license. Because the additional potential consideration is based on
usage of a single license, it would be subject to the sales- or usage-based
royalty exception (under the assumption that the license is predominant if
there are multiple promises) and be recognized no earlier than when the
subsequent usage occurs.
Example 12-4
Licensor sells Customer Y 1,000 licenses of Product A
for $50,000. Each license allows Y one seat to use
Product A for the duration of the contract term.
Customer Y can purchase additional licenses of
Product A for $30 per license that will allow Y to
use Product A in an additional seat (i.e., add
users). Licensor provides separate activation keys
for each license. Customer Y can use additional
licenses purchased for the remaining contract
term.
The option to acquire additional licenses would be
viewed as an option that gives the customer
additional rights (and, therefore, as an additional
performance obligation if the option gives rise to a
material right). This is because if Y exercises the
option to acquire additional licenses to Product A,
Licensor would be required to transfer additional
rights for additional users that Y does not already
control. Therefore, Licensor should evaluate the
option to determine whether it gives rise to a
material right.
Example 12-5
Licensor provides OEM with a master copy of software
that OEM can use to reproduce copies of the license
for integration only into Product A, which
contributes to Product A’s functionality. OEM pays
Licensor a fee of $50 for each use (i.e.,
integration into Product A) up to 1,000 uses and $30
for each use above 1,000 licenses.
The customer controls the rights
provided by the software license and has committed
to pay a fee that varies depending on the use of the
license (rather than on the basis of additional
rights acquired, which would be a separate
performance obligation). The rights provided by the
software give rise to variable consideration to
which the sales- or usage-based royalty exception in
ASC 606-10-55-65 through 55-65B applies.
Example 12-6
Assume the same facts as in the
previous example, except that the contract gives OEM
the option to obtain the right to integrate the
software into Product B (and contribute to Product
B’s functionality) for an additional $10,000. If the
right is exercised, OEM will also pay a fee of $40
for each use of the software in Product B (the price
of the software included in Product A remains
unchanged). OEM will use the same master copy to
replicate the software as that provided in the
previous example, which requires no action by
Licensor.
The option to acquire the rights to include the
software in Product B allows OEM to acquire
additional rights to use the IP (and is therefore an
additional performance obligation if the option
gives rise to a material right). That is, the OEM
does not have the right to integrate the software
into Product B unless it exercises the option, at
which point Licensor will transfer additional rights
to OEM that OEM does not already control. Therefore,
Licensor should evaluate the option to determine
whether it gives rise to a material right. The
additional consideration that is paid to Licensor
for each use of the software in Product B is
variable consideration to which the sales- or
usage-based royalty exception in ASC 606-10-55-65
through 55-65B applies.
Example 12-7
Licensor enters into a five-year
contract to sell an unknown quantity of software
licenses to Reseller. Each license gives Reseller
the right to resell the individual software licenses
to end users. Reseller does not have any other
rights related to the software. Reseller pays
$50,000 for the first 2,500 software licenses that
can be downloaded on demand. Further, Reseller pays
$15 for each additional software license sold above
the initial 2,500 licenses during the five-year
contract term.
In this example, Reseller obtains
the right to resell Licensor’s software but does not
obtain end-user rights associated with the software.
Any additional consideration above the initial
$50,000 payment is in exchange for Licensor’s
granting additional software licenses that Reseller
will resell to end users. That is, Licensor
transfers additional rights to Reseller with each
additional license.
In addition, because the price per license sold after
the initial 2,500 licenses ($15 per license) is less
than the price per license for the first 2,500
licenses ($20 per license), Licensor should consider
whether there is a material right related to the
right to purchase additional software licenses.
The above issue is addressed in Q&A 58 (compiled from
previously issued TRG Agenda Papers 45 and 49) 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.
12.3.3.2 Material Right Assessment
If an entity in a right-to-use license arrangement determines that the
arrangement provides for an option to purchase additional rights such as
users (i.e., an option to acquire additional licenses, which would
constitute additional performance obligations), the entity should perform an
evaluation in accordance with ASC 606-10-55-42 to determine whether the
customer’s option to add licenses at a later date on the basis of a
per-license fee represents a material right. If the option represents a
material right, the entity should allocate a portion of the transaction
price for the initial license rights to the material right.
If the option does not represent a material right, the entity would not
account for the additional license rights until the subsequent purchases for
additional licenses occur. This accounting outcome (i.e., no identification
of a material right) results in a recognition pattern similar to that of an
arrangement that is determined to allow for additional usage. When the
arrangement is determined to provide for additional usage, consideration for
that incremental usage is deemed to be variable consideration for the
license already transferred. Therefore, since the arrangement includes a
license of IP, the sales- or usage-based royalty guidance in ASC
606-10-55-65 would apply (under the assumption that the license is
predominant if there are multiple promises). As a result, for a right-to-use
license, revenue would be recognized no earlier than when the subsequent
usage occurs.
The above issue is addressed in Implementation Q&A 58 (compiled from previously
issued TRG Agenda Papers 45 and 49). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
12.3.3.3 Customer’s Ability to Access or Download Additional Copies of Software
Whether an entity (i.e., a software vendor) is involved in
reproducing software copies does not in itself determine whether an
arrangement includes rights to additional users or usage of software. The
example below illustrates how an entity (the vendor) in a software
arrangement with a customer should account for the customer’s ability to
access or download additional copies of software when adding users may or
may not require additional direct involvement by the vendor.
Example 12-8
A customer in a software arrangement pays a fixed fee
of $300,000 for up to 500 copies of the software.
Each copy can only have a single user. The customer
pays an additional $400 per copy for copies in
excess of the initial 500. The number of copies is
measured, and the customer pays for any additional
users each quarter.
Consider the following scenarios:
- Scenario A — The customer has been given a master copy of the software and has the technical capability and legal right to create an unlimited number of copies without any further assistance from the vendor.
- Scenario B — The customer has been given access to download copies of the software and has the technical capability and legal right to download an unlimited number of copies without any further direct involvement by the vendor.
- Scenario C — The customer must request, and the vendor must provide, access codes for any additional downloads
The vendor must use judgment to determine whether the
additional copies in a particular fact pattern
should be regarded as additional usage (one license)
or additional users (multiple licenses). However,
this judgment is not solely affected by whether
adding users requires additional direct involvement
by the vendor.
In Scenario C, the fact that the
customer cannot obtain additional copies of the
software without the vendor’s direct involvement
does not in itself prevent the nature of the
arrangement from being additional usage (one
license). As discussed in Example 12-16, control of software may be
determined to have passed to a customer before the
software is downloaded if the seller has
nevertheless made the software available.
In Scenarios A and B, if the nature of the
arrangement is determined to be additional users
(multiple licenses), the fact that the customer can
obtain additional copies of the software without the
vendor’s direct involvement does not in itself mean
that the customer controls the additional licenses
and that the vendor has satisfied its performance
obligation. The vendor’s performance obligation
includes not only making the IP available to the
customer but also the act of granting those
rights.
Accordingly, the outcome of the
accounting analysis does not depend on whether
adding copies of a license requires additional
direct involvement by the vendor. In all three
scenarios above, the vendor should evaluate the
arrangement to determine whether the contract
provides for additional
users (i.e., separate performance obligations
that should be evaluated in accordance with the
guidance in ASC 606-10-55-42 on options to acquire
additional goods or
services) or additional usage of a single license
that was already delivered. The accounting for the
initial 500 copies (i.e., the committed volume by
the customer) is not the subject of this example.
Rather, this example addresses only the additional
copies in excess of the initial 500 copies to be
delivered to the customer.
The above issue is addressed in Implementation Q&A 58 (compiled from previously
issued TRG Agenda Papers 45 and 49). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
12.3.3.4 Recognition of Revenue From Software Arrangements When Additional Amounts Due Are Identified Through a Customer Audit
In certain software licensing arrangements, a customer may have the option to
purchase additional licenses without direct involvement from the software
vendor. For example, a customer may have the ability to use additional
licenses without first issuing a purchase order but instead is required to
self-report (and subsequently pay for) any additional licenses used. In
other software licensing arrangements, a customer may not have the ability
to use additional licenses without entering into another contract with the
software vendor for additional licenses.
It is common for a software vendor to have the right to audit the number of
licenses used by its customers. Such a license audit could result in (1) the
identification of additional licenses beyond what the customer self-reported
or is entitled to use and, therefore, (2) additional license fees. The
examples below illustrate the accounting for software arrangements when a
license audit results in the identification of additional licenses used by
the customer.
Example 12-9
Entity S, a software vendor, enters into a three-year
term-based license agreement with Customer C on
January 1, 20X1. Under the terms of the agreement, C
has the right to 100 licensed users of the software
at a price of $10 per user per year. The agreement
includes an option to purchase the right to
additional licensed users each year (determined to
be optional purchases rather than variable
consideration; see Section 12.3.3), also for $10 per user
per year. Customer C is not required to first issue
a purchase order to S to acquire and use additional
user licenses on its own, but it must provide a
report to S on the number of licenses used each
year. Entity S has the right to audit how many
licenses to the software C has used. The option to
purchase additional licenses does not represent a
material right because the price per additional user
per year is the stand-alone selling price.
On March 1, 20X1, C uses 10 additional software
licenses (for a total of 110 licensed users) but
does not report the increase to S. On February 15,
20X2, S performs an audit of C’s users and
identifies the 10 additional software licenses.
Entity S intends to enforce its right to collect the
additional fee of $10 per licensed user per year and
invoices C $100 (10 additional licensed users per
year × $10 per additional licensed user × 1 year) on
March 1, 20X2.
Entity S prepares financial statements for the year
ended December 31, 20X1, that are issued on February
28, 20X2. The information identified in the audit is
a recognized subsequent event because C exercised
its contractual option to acquire rights to
additional licensed users and such rights were
transferred to C on March 1, 20X1. Accordingly, even
though S was not aware of the additional licenses
being transferred, the information obtained as a
result of the audit confirmed that S had an
enforceable right to additional consideration for
promised goods or services (i.e., licenses)
transferred to C on March 1, 20X1, as a result of
the optional purchases made by C during the year
ended December 31, 20X1.
Example 12-10
Assume the same facts as in the
example above, except that Customer C is not
contractually authorized to use additional licenses
without entering into a separate contract with
Entity S. On February 15, 20X2, as a result of the
audit, S and C negotiate and execute a separate
contract for additional licenses. Because C
anticipates that it will need only five additional
licenses for the remainder of the term, S agrees to
only charge C for those additional licenses for an
additional license fee of $150 (5 additional
licenses per year × $10 per additional license × 3
years), which is invoiced at the time the separate
contract is executed.
Because C did not have a contractual right to the
additional users throughout 20X1, S (1) did not
transfer rights to additional users in 20X1 and (2)
does not have a contractual right to additional
consideration for the additional users as of
December 31, 20X1 (since the additional users were
not covered by a legally enforceable contract as of
December 31, 20X1). Accordingly, S concludes that
(1) a legally enforceable contract for the
additional licenses does not exist as of December
31, 20X1, and (2) the additional rights in the
separate contract are not transferred to C until
February 15, 20X2. Consequently, S should not record
revenue for the additional users in the year ended
December 31, 20X1.
12.3.4 Accounting for Bundled Licensing Arrangements — Right to Use New Content
In certain cases, a TV network may license its library of historical content as
well as provide a right to use all future content it develops to a broadcaster
that is seeking to be the distributor of the TV network’s content in the
broadcaster’s territory. As part of the transaction, the TV network might also
provide the broadcaster the right to sell a digital streaming subscription
service that includes access to the historical content as well as all future
content.
The example below illustrates how an entity should determine
whether a license to use a library of historical content and all future content
represents more than one performance obligation.
Example 12-11
Network XYZ, a U.S.-based cable TV network, enters into a
three-year arrangement with a foreign distributor. In
accordance with the arrangement:
- The foreign distributor is granted an exclusive license that includes digital streaming rights (in the foreign distributor’s territory) to XYZ’s library of historical content as well as XYZ’s new content that becomes available during the three-year term. Network XYZ has determined that its license to historical and new content is a license to functional IP.
- The foreign distributor plans to launch its XYZ Network subscription service in its territory at the inception of the arrangement.
- The library of historical content is transferred to the foreign distributor at inception.
- Network XYZ’s new content is made available after it is aired on Network XYZ and is immediately added to the library available to the foreign distributor for digital streaming.
The foreign distributor believes that
potential subscribers to its service attach a
significant degree of importance to XYZ’s new content.
Therefore, the foreign distributor believes that if it
did not have access to the new content, it would face a
challenge in attracting subscribers — even at a lower
price — to a subscription service containing only the
content available at contract inception.
The right to use the library of historical content and
all future content would generally represent two
performance obligations. In accordance with ASC
606-10-25-19 through 25-22, XYZ is required to assess
whether the promise to grant a license to the existing
content is distinct from the right to use new content
when and if new content is made available by XYZ. For
licenses of functional IP, it is important to determine
whether updates (e.g., rights to use new content)
significantly affect the functionality of the license
transferred at inception. In the determination of
whether the license is capable of being distinct, we
would expect that the foreign distributor can benefit
from the functionality provided by the existing content
on its own without the updates. Although the updates may
be important for the foreign distributor to attract
subscribers, the updates do not significantly modify the
functionality of the historical content, and the
historical content does not significantly modify the
functionality of the new content. In addition, the
historical content and the new content are not
significantly integrated, highly interdependent, or
highly interrelated, and XYZ can satisfy its promise to
transfer the rights to use the historical library of
content independently from satisfying its promise to
transfer the right to use new content.
However, entities should carefully analyze their facts
and circumstances.
12.3.5 Identifying Performance Obligations in a Hybrid Software Arrangement
Software providers may offer hybrid solutions in which a
customer may have the right to deploy the software (1) as either on-premise
software or a cloud-based service (with the ability to switch from one to the
other as needed) or (2) by using the on-premise software together with the
cloud-based service. On-premise software is installed and runs on the customer’s
devices (e.g., computers and servers) or is hosted by a third party under a
separate contract between the customer and that third party.8 A cloud-based service involves software that is physically hosted on the
software provider’s systems (or hosted by the software provider’s
cloud-computing vendor) and accessed by the customer over the Internet. In
arrangements involving these hybrid solutions, questions arise about how to
identify the promises (and, therefore, the performance obligations) in the
contract.
Example 12-12
An entity enters into a three-year contract with a
customer to provide 1,000 licenses of Product X for a
nonrefundable fee of $100,000. Under the terms of the
contract, the customer has an option to deploy the 1,000
licenses as either on-premise software or a cloud-based
service throughout the three-year license term. Assume
that the on-premise software and the cloud-based service
(1) each are fully functional on their own and (2)
provide effectively the same functionality to the
customer. At contract inception, the customer decides to
use 600 licenses of Product X as on-premise software and
400 licenses of Product X as a cloud-based service. Six
months later, the customer decides to use 500 licenses
of Product X as on-premise software and 500 licenses of
Product X as a cloud-based service.
We believe that it is reasonable to
conclude that the entity has promised (1) to provide the
right to use 1,000 software licenses of Product X and
(2) to stand ready to provide a cloud-based service
(i.e., to host the software licenses). If each of the
promises is distinct, there are two performance
obligations to which the nonrefundable $100,000 fee
should be allocated on a relative stand-alone selling
price basis (refer to Chapter 7 for a
discussion about allocating the transaction price).
Consideration allocated to Product X (i.e., the
on-premise software licenses) would be recognized once
control of Product X is transferred to the customer
(refer to the discussion in Section 12.5).
Since the performance obligation to provide the hosting
service is satisfied over time, consideration allocated
to this performance obligation should be recognized as
revenue over the three-year contract term (i.e., the
period over which the entity is required to stand ready
to provide the hosting service).
The functionality of on-premise software and a cloud-based
service in a hybrid cloud-based arrangement can vary between offerings to
customers and between entities. When identifying performance obligations in a
hybrid cloud-based arrangement, an entity should consider the guidance in ASC
606-10-25-19 through 25-21 to determine whether the on-premise software and the
cloud-based service are distinct (see Chapter 5 for further discussion of the
guidance on determining whether promises in a contract are distinct).
Example 9-2-3 of the AICPA Audit and Accounting Guide
Revenue Recognition
states, in part:
Many hybrid offerings will enable customers to perform
some functions with the on-premise software even when they are not
connected to the hosting service. An entity may determine that the
on-premise software meets the criteria of FASB ASC 985-20-15-5 and is
capable of being distinct. However, even when the software license is
within the scope of FASB ASC 606-10-55-54a and is capable of being
distinct, it may not be distinct in the context of the contract because
it is, for example, highly interdependent or interrelated with the
hosting service. In making this determination, the entity may consider
indicators such as the following:
-
Hosted functionality is limited to capabilities that are widely available from other vendors. For example, the entity offers online file storage and sharing with minimal integration to the on-premise software workflow. In such cases, a customer could gain substantially all of the benefits included in the offering by utilizing alternative vendor services. This would indicate that the software license likely is both capable of being distinct from the hosted service and distinct within the context of the contract because the entity is not providing unique and additional value from the integration of the software and the file storage.
-
A portion of the hosted functionality is available from other vendors, but the entity provides significant additional utility from the manner in which it integrates the software with its own hosted functionality. For example, the online storage and sharing is integrated with the on-premise software in such a manner that the customer gains significant capabilities or workflow efficiencies that would not be available when using another vendor’s hosted services. In such circumstances, the on-premise software is capable of being distinct, but the customer obtains a significant functional benefit by purchasing the complete hybrid offering from the entity. This may indicate that the software license and hosting service are highly interrelated to each other and are not distinct within the context of the contract.
-
Hosted functionality is limited to functions that the customer may also perform locally with the on-premise software. For example, the customer has the option to perform computationally intensive tasks on its own computer or upload them to the entity’s servers as part of the hosting service. In such circumstances, the customer can obtain the intended benefit of the offering with only the on-premise software. This may indicate that the software is not highly dependent on or interrelated with the hosting service and is therefore distinct within the context of the contract.
-
The hybrid offering workflow involves ongoing interactions between the on-premise software and hosted services. As a result, the utility of the offering would be significantly diminished if the customer is not connected to the hosting service. For example, the utility of the offering would be significantly diminished if the customer is unable to perform computationally intensive tasks when not connected to the hosting services. In such circumstances, the software and hosted services are highly interdependent or interrelated because (1) the customer gains significant functionality from the software and hosting services functioning together and (2) the entity fulfills its overall promise to the customer only by both transferring the on-premise license and providing the hosting services. This would indicate that the software is not distinct within the context of the contract.
In addition, in determining whether its on-premise software is distinct from its
cloud-based service, an entity may consider the following indicators, which are
not individually determinative or all-inclusive:
- Whether the entity’s on-premise software and cloud-based service are ever sold separately — The entity’s practice of selling the on-premise software or the cloud-based service separately typically indicates that there are two separate performance obligations (i.e., the promises should not be combined) since the customer may benefit from the on-premise software or the cloud-based service on its own. Separate sales also suggest that the on-premise software and the cloud-based service each have significant stand-alone functionality, which indicates that they are distinct within the context of the contract. For example, if the on-premise software separately provides substantially the same functionality as the cloud-based service, the two promises are likely to be distinct.
-
Whether the customer can benefit from each product or service (i.e., the on-premise software or the cloud-based service) either on its own or together with other resources that are readily available to the customer — For example, suppose that the customer has the ability to (1) obtain the same or similar cloud-based service from a different vendor, (2) use the alternative vendor’s cloud-based service with the entity’s on-premise software, and (3) receive substantially the same combined functionality as that of the entity’s hybrid offering. That ability may indicate that the entity’s on-premise software and cloud-based service each are capable of being distinct and are distinct within the context of the contract since (1) the entity is not providing a significant integration service for the on-premise software and the cloud-based service and (2) it is less likely that the on-premise software and the cloud-based service are highly interdependent or highly interrelated.Alternatively, suppose that the functionality of the on-premise software is significantly integrated with (rather than just improved by) the cloud-based service in such a way that the entity’s hybrid offering provides significant additional capabilities that cannot be obtained from an alternative vendor providing the cloud-based service. In that case, the presence of an alternative vendor providing a portion of the same utility with its cloud-based service could indicate that the promises are capable of being distinct, but the integrated nature of the promises could indicate that the promises are not distinct within the context of the contract.
- Whether the cloud-based service significantly modifies the on-premise software — The cloud-based service and the on-premise software may not be distinct within the context of the contract if rather than just enhancing the capabilities of the on-premise software, the cloud-based service modifies and significantly affects the functionality of the on-premise software. For example, suppose that the cloud-based service (1) employs artificial intelligence (AI) or machine learning that teaches and significantly affects the functionality of the on-premise software and (2) cannot employ the AI or machine learning without using the functionality of the on-premise software. This situation could indicate that the cloud-based service and the on-premise software are not distinct within the context of the contract because rather than just enhancing the capabilities of the on-premise software, the cloud-based service modifies and significantly affects the functionality of the on-premise software.
- Whether the absence of either the on-premise software or the cloud-based service significantly limits or diminishes the utility (i.e., the ability to provide benefit or value) of the other — If the on-premise software’s functionality is significantly limited or diminished without the use of the cloud-based service, and vice versa, that significantly limited or diminished functionality may indicate that the on-premise software and the cloud-based service (1) are highly interdependent or highly interrelated (i.e., they significantly affect each other) and (2) function together as inputs to a combined output. This, in turn, may indicate that the promises are not distinct within the context of the contract since the customer cannot obtain the intended benefit of the on-premise software or the cloud-based service without the other. That is, while the customer may be able to obtain some functionality from the on-premise software on a stand-alone basis, it would not obtain the intended outputs from the on-premise software if the on-premise software is not connected to the cloud-based service because the cloud-based service is critical to the customer’s intended use of the hybrid solution. In this situation, the entity cannot fulfill its promise to the customer by transferring the on-premise software or the cloud-based service independently (i.e., the customer could not choose to purchase one good or service without significantly affecting the other good or service in the contract).
-
Whether the functionality of the combined on-premise software and cloud-based service is transformative rather than additive — Transformative functionality should be assessed separately from additive functionality. Transformative functionality comprises features that significantly affect the overall operation and interaction of the on-premise software and the cloud-based service (e.g., collaboration, pushdown learning, customization). To be transformative, the on-premise software and the cloud-based service must significantly affect each other. That is, the on-premise software and the cloud-based service are inputs to a combined output such that the combined output has greater value than, or is substantively different from, the sum of the inputs. By contrast, additive functionality comprises features that provide an added benefit to the customer without substantively altering (1) the manner in which the functionality is used and (2) the benefits derived from the functionality of the on-premise software or the cloud-based service on a stand-alone basis. Even if added functionality is significant, it may not be transformative. It is more likely that the on-premise software and the cloud-based service are highly interdependent or highly interrelated when the functionality of the combined on-premise software and cloud-based service is transformative rather than additive.
-
Whether the entity’s marketing materials support a conclusion that the arrangement is for a combined solution rather than separate products or service offerings — The entity’s marketing materials may help clarify what the entity has promised to deliver to its customer and may provide evidence of the customer’s intended use of the on-premise software and the cloud-based service. Circumstances in which an entity markets its product as a “solution” (i.e., the marketing materials discuss the functions, features, and benefits of the combined offering with little or no discussion of the on-premise software and the cloud-based service separately) may help support a conclusion that the entity’s promise is a combined performance obligation. However, the entity should exercise caution when relying on its marketing materials since the manner in which the entity markets its hybrid offering would not, by itself, be sufficient to support a conclusion that the on-premise software and the cloud-based service represent a combined performance obligation.
Identifying performance obligations in hybrid cloud-based arrangements requires
judgment, and the determination of whether offerings in such arrangements
constitute a single performance obligation or multiple performance obligations
will depend on the facts and circumstances. A conclusion that the offerings in a
hybrid cloud-based arrangement represent a single performance obligation should
be carefully considered under ASC 606-10-25-19 through 25-21.
Example 12-13
Entity A is a developer of modeling
software that enables its customers to analyze, design,
and render virtual prototypes to assess the real-world
impact of products its customers are developing. Entity
A enters into a three-year noncancelable contract with a
customer to provide (1) an on-premise license to the
software and (2) a cloud-based service, which is an
online repository for in-process and final prototypes
that can be accessed by the customer’s employees from
any device that also has the on-premise software. While
the on-premise software and the cloud-based service are
never sold separately and are marketed as an integrated
offering, the on-premise software is fully functional
without the cloud-based service and has significant
utility on its own. The cloud-based service provides the
added benefit of allowing the customer’s employees to
share and collaborate on projects but is similar to
other cloud-based services provided by alternative
vendors. Those other cloud-based services would require
only minimal modifications to function with A’s
on-premise software.
We believe that it is reasonable to
conclude that the on-premise software license and the
cloud-based service are two separate performance
obligations for the following reasons:
-
While the on-premise software and the cloud-based service are not sold separately and are marketed as an integrated offering, there are other vendors that provide similar cloud-based services.
-
The cloud-based service does not significantly modify the on-premise software but merely serves as a repository for sharing prototypes.
-
The on-premise software is not significantly integrated with the cloud-based service since alternative cloud-based services would require only minimal modifications to function with the on-premise service.
-
The absence of the cloud-based service does not significantly limit or diminish the utility of the on-premise software (the intended use of the on-premise software is to analyze, design, and render virtual prototypes).
-
The functionality provided by the cloud-based service (added storage and collaboration functionality) is additive rather than transformative.
Example 12-14
Entity B is a developer of modeling software that enables
its customers to analyze, design, and render virtual
prototypes to assess the real-world impact of products
its customers are developing. Entity B enters into a
three-year noncancelable contract with a customer to
provide (1) an on-premise license to the software and
(2) a cloud-based service. The cloud-based service
serves as an online repository for in-process and final
prototypes that can be accessed by the customer’s
employees from any device that also has the on-premise
software. In addition, the cloud-based service interacts
with the on-premise software to provide continuous
real-time data updates, data mining and analysis,
predictive modeling, and machine-based learning (which
are computationally intensive tasks that can be
performed only through the cloud-based service) to
enable the customer to enhance and improve its products.
The nature of the customer’s products makes their
continual enhancement and improvement critical because
without such continual enhancement and improvement, the
products would quickly become obsolete. Similarly,
functions performed by B’s cloud-based service are
critical because without those functions, the on-premise
software would have little utility to the customer.
The on-premise software and the cloud-based service are
never sold separately and are marketed as an integrated
offering. There is significant integration of, and
interaction between, the on-premise software and the
cloud-based service such that together, they provide the
functionality required by the customer. The cloud-based
service is proprietary and can be used only with the
on-premise software; no other competitors can provide
(1) a similar service that can function with B’s
on-premise software or (2) a software product that can
function with B’s cloud-based service. Accordingly, B
determines that there is a transformative relationship
between the on-premise software and the cloud-based
service such that they are inputs to a combined output.
Further, because the on-premise software and the
cloud-based service each have little or no utility
without the other, they are highly interrelated and
highly interdependent.
We believe that it is reasonable to conclude that there
is one performance obligation (an integrated hybrid
cloud-based offering) for the following reasons:
-
Entity B’s on-premise software and cloud-based service are never sold separately.
-
The customer cannot benefit from the on-premise software or the cloud-based service either on its own or together with other resources that are readily available to the customer. There is no on-premise software or cloud-based service available from other vendors that can function with B’s offering.
-
The functionality of the on-premise software is significantly integrated with that of the cloud-based service in such a way that only together can the on-premise software and the cloud-based service provide the functionality (i.e., the intended benefit) required by the customer.
-
The absence of either the on-premise software or the cloud-based service significantly limits or diminishes the utility (i.e., the ability to provide benefit or value) of the other. The on-premise software’s functionality is significantly limited or diminished without the use of the cloud-based service, and vice versa. Therefore, the on-premise software and the cloud-based service (1) are highly interdependent and highly interrelated (i.e., they significantly affect each other) and (2) function together as inputs to a combined output. The customer cannot obtain the full intended benefit of the on-premise software or the cloud-based service on a stand-alone basis because each is critical to the customer’s intended use of the hybrid solution. Therefore, B cannot fulfill its promise to the customer by transferring the on-premise software or the cloud-based service independently (i.e., the customer could not choose to purchase one good or service without significantly affecting the other good or service in the contract).
-
The functionality of the combined on-premise software and cloud-based service is transformative rather than additive. That transformative functionality comprises features that significantly affect the overall operation and interaction of the on-premise software and the cloud-based service in such a way that the on-premise software and the cloud-based service significantly affect each other.
-
Entity B’s marketing materials support a conclusion that the arrangement is for a combined solution rather than separate product or service offerings.
Footnotes
6
Cases A and B of Example 10, on
which Case C is based, are reproduced in Section
5.3.2.3.
7
While this section addresses additional rights
associated with users, additional rights could also include other
incremental licenses, such as the right to use the software at
additional locations or for different business segments.
8
In accordance with ASC 606-10-55-54 and ASC 985-20-15-5,
software subject to a hosting arrangement is a license of IP (i.e.,
on-premise software) if (1) the “customer has the contractual right to
take possession of the software at any time during the hosting period
without significant penalty” and (2) “[i]t is feasible for the customer
to either run the software on its own hardware or contract with another
party unrelated to the vendor to host the software.”
12.4 Identifying the Nature of the License
In developing the revenue standard, the FASB and IASB committed to
developing a single, comprehensive framework to apply to all types of
revenue-generating transactions, including licenses of IP.9
As discussed in paragraph BC403 of ASU 2014-09, applying a single
framework to licenses of IP proved to be challenging because “licenses vary
significantly and include a wide array of different features and economic
characteristics, which lead to significant differences in the rights provided by a
license.” The boards acknowledged that in some situations, a customer may be unable
to control the license at the time of transfer because of the nature of the
underlying IP and the entity’s potential continuing involvement with the IP.
However, this is not always the case. Therefore, the boards recognized that in a
manner consistent with the standard’s general revenue recognition model, control of
some licenses may be transferred at a point in time while control of other licenses
may be transferred over time.
ASC
606-10
55-58 In
evaluating whether a license transfers to a customer at a
point in time or over time, an entity should consider
whether the nature of the entity’s promise in granting the
license to a customer is to provide the customer with
either:
- A right to access the entity’s intellectual property throughout the license period (or its remaining economic life, if shorter)
- A right to use the entity’s intellectual property as it exists at the point in time at which the license is granted.
55-58A An
entity should account for a promise to provide a customer
with a right to access the entity’s intellectual property as
a performance obligation satisfied over time because the
customer will simultaneously receive and consume the benefit
from the entity’s performance of providing access to its
intellectual property as the performance occurs (see
paragraph 606-10-25-27(a)). An entity should apply
paragraphs 606-10-25-31 through 25-37 to select an
appropriate method to measure its progress toward complete
satisfaction of that performance obligation to provide
access to its intellectual property.
55-58B An
entity’s promise to provide a customer with the right to use
its intellectual property is satisfied at a point in time.
The entity should apply paragraph 606-10-25-30 to determine
the point in time at which the license transfers to the
customer.
In determining whether to recognize revenue from a license of IP
over time or at a point in time, an entity needs to determine the nature of the
licensing arrangement. The nature of the arrangement is determined on the basis of
the entity’s promise to the customer and whether that promise (1) provides access to
the IP throughout the license term (i.e., “right to access”) or (2) provides a right
to use the IP as it exists at the point in time when control of the license is
transferred to the customer (i.e., “right to use”). Revenue from a license that
grants a right to access an entity’s IP is recognized over time since the customer
simultaneously receives and consumes the benefits of the entity’s IP throughout the
license periods (i.e., meets the requirement in ASC 606-10-25-27(a)). Revenue from a
license that grants a right to use an entity’s IP is recognized at the point in time
when control of the license is transferred to the customer. An entity’s
determination of when control of a license has been transferred to a customer should
be based, in part, on the indicators in ASC 606-10-25-30. However, control of a
license cannot be transferred to a customer before the customer is able to use and
benefit from the license (i.e., the license term has commenced). For further
discussion, see Section 12.5.
To help an entity determine whether a license is a right to access
or right to use the entity’s IP, the revenue standard provides guidance on assessing
the nature of a license of IP. An entity’s ongoing activities, or lack of
activities, may significantly affect the utility of the license (i.e., the
functionality or value of the IP to the customer). These activities may be
explicitly or implicitly promised by the entity and may include supporting or
maintaining its IP for the duration of the customer’s license period. Further, the
obligation to maintain or support the IP may need to be identified as a separate
promise under the contract (insofar as the activities transfer additional goods or
services to the customer). To assist in the evaluation of whether the license
provides the customer with a right to access or right to use the entity’s IP, the
revenue standard distinguishes between two types of IP: (1) functional and (2)
symbolic.
ASC
606-10
55-59 To determine whether the
entity’s promise [is] to provide a right to access its
intellectual property or a right to use its intellectual
property, the entity should consider the nature of the
intellectual property to which the customer will have
rights. Intellectual property is either:
-
Functional intellectual property. Intellectual property that has significant standalone functionality(for example, the ability to process a transaction, perform a function or task, or be played or aired). Functional intellectual property derives a substantial portion of its utility (that is, its ability to provide benefit or value) from its significant standalone functionality.
-
Symbolic intellectual property. Intellectual property that is not functional intellectual property (that is, intellectual property that does not have significant standalone functionality). Because symbolic intellectual property does not have significant standalone functionality, substantially all of the utility of symbolic intellectual property is derived from its association with the entity’s past or ongoing activities, including its ordinary business activities.
In the original guidance issued in ASU 2014-09, the FASB and IASB
decided that the determination of whether a license grants the customer a right to
access or right to use the entity’s IP should hinge on whether the licensor’s
ongoing activities are expected to significantly affect the underlying IP.
Stakeholders identified significant implementation questions, which focused mainly
on (1) the nature of the licensor’s activities that affect the IP and (2) how
entities should evaluate the impact of such activities on the IP (e.g., the effect
on the IP’s form and functionality, value, or both). Those questions were discussed
by the TRG, and the TRG acknowledged that different interpretations may arise
between what constitutes a right-to-access and a right-to-use license. As a result,
the FASB decided to clarify the guidance on identifying the nature of a license. As
indicated in ASC 606-10-55-59 (as amended by ASU 2016-10), the Board decided that the
assessment of whether a license provides the customer with a right to access or a
right to use the entity’s IP should be based on whether the underlying IP is
functional or symbolic. Refer to Sections 12.4.1 and 12.4.2 for additional information on
functional and symbolic IP.
Connecting the Dots
In some instances, identifying the nature of a license is
straightforward and the outcome of whether the license provides the customer
with a right to access or a right to use the entity’s IP is readily
apparent. However, in other situations, this assessment is more complicated
and requires significant consideration and judgment. Specifically, this may
be the case when the entity promises to provide multiple nonlicense goods
and services in addition to the license, or when the license is subject to
various restrictions. As discussed above, there are many factors that
influence the recognition of revenue from a license of IP. Therefore, it
would not be appropriate to assume that certain types of licenses should
always be accounted for in a similar manner.
12.4.1 Functional IP
IP may have significant stand-alone functionality. For example,
some IP can be aired or viewed (e.g., a song or a movie) or can perform a task.
The functionality (i.e., ongoing utility) of this IP is not affected by the
entity’s activities (or lack of activities) that do not transfer an additional
good or service to the customer. That is, the customer controls the
functionality provided by the license to IP when control of the IP is
transferred to the customer. Any activities the entity undertakes to maintain or
enhance the IP are likely to be identified as a separate promise under the
contract. A license in these circumstances can be referred to as a license to
functional IP. Examples of licenses to functional IP could include software,
drug compounds and formulas, and completed media content (such as films,
television shows, or music).
ASC
606-10
55-62 A license to functional
intellectual property grants a right to use the entity’s
intellectual property as it exists at the point in time
at which the license is granted unless both of the
following criteria are met:
- The functionality of the intellectual property to which the customer has rights is expected to substantively change during the license period as a result of activities of the entity that do not transfer a promised good or service to the customer (see paragraphs 606-10-25-16 through 25-18). Additional promised goods or services (for example, intellectual property upgrade rights or rights to use or access additional intellectual property) are not considered in assessing this criterion.
- The customer is contractually or practically required to use the updated intellectual property resulting from the activities in criterion (a).
If both of those criteria
are met, then the license grants a right to access the
entity’s intellectual property.
55-63 Because functional
intellectual property has significant standalone
functionality, an entity’s activities that do not
substantively change that functionality do not
significantly affect the utility of the intellectual
property to which the customer has rights. Therefore,
the entity’s promise to the customer in granting a
license to functional intellectual property does not
include supporting or maintaining the intellectual
property. Consequently, if a license to functional
intellectual property is a separate performance
obligation (see paragraph 606-10-55-55) and does not
meet the criteria in paragraph 606-10-55-62, it is
satisfied at a point in time (see paragraphs
606-10-55-58B through 55-58C).
Generally, the nature of a license to functional IP that is
distinct will provide a customer with the right to use an entity’s IP (i.e.,
point-in-time revenue recognition) unless (1) the entity’s ongoing activities
that will not transfer promised goods to the customer (i.e., those not deemed to
be additional promised goods to the customer) will significantly change the
utility of the license and (2) the customer is contractually or practically
required to use the updated IP once available. If these criteria are met, the
nature of the license is a right to access the entity’s IP (i.e., a license for
which revenue is recognized over time). As discussed in paragraph BC58 of ASU
2016-10, the FASB expected that at the time of issuance of ASU 2016-10, the
criteria in ASC 606-10-55-62 “will be met only infrequently, if at all.” That is
because additional goods or services provided to the customer (e.g., updates and
customization services) are typically promised goods or services that would not
meet the criterion in ASC 606-10-55-62(a).
The following examples in ASC 606 illustrate the identification of functional
IP:
ASC
606-10
Example 54 — Right to Use Intellectual Property
55-362 Using the same facts
as in Case A in Example 11 (see paragraphs 606-10-55-141
through 55-145), the entity identifies four performance
obligations in a contract:
- The software license
- Installation services
- Software updates
- Technical support.
55-363 The entity assesses
the nature of its promise to transfer the software
license. The entity first concludes that the software to
which the customer obtains rights as a result of the
license is functional intellectual property. This is
because the software has significant standalone
functionality from which the customer can derive
substantial benefit regardless of the entity’s ongoing
business activities.
55-363A The entity further
concludes that while the functionality of the underlying
software is expected to change during the license period
as a result of the entity’s continued development
efforts, the functionality of the software to which the
customer has rights (that is, the customer’s instance of
the software) will change only as a result of the
entity’s promise to provide when-and-if available
software updates. Because the entity’s promise to
provide software updates represents an additional
promised service in the contract, the entity’s
activities to fulfill that promised service are not
considered in evaluating the criteria in paragraph
606-10-55-62. The entity further notes that the customer
has the right to install, or not install, software
updates when they are provided such that the criterion
in 606-10-55-62(b) would not be met even if the entity’s
activities to develop and provide software updates had
met the criterion in paragraph
606-10-55-62(a).
55-363B Therefore, the entity
concludes that it has provided the customer with a right
to use its software as it exists at the point in time
the license is granted and the entity accounts for the
software license performance obligation as a performance
obligation satisfied at a point in time. The entity
recognizes revenue on the software license performance
obligation in accordance with paragraphs 606-10-55-58B
through 55-58C.
Example 56 — Identifying a Distinct
License
55-367 An entity, a
pharmaceutical company, licenses to a customer its
patent rights to an approved drug compound for 10 years
and also promises to manufacture the drug for the
customer for 5 years, while the customer develops its
own manufacturing capability. The drug is a mature
product; therefore, there is no expectation that the
entity will undertake activities to change the drug (for
example, to alter its chemical composition). There are
no other promised goods or services in the contract.
Case B — License Is Distinct
55-371 In this
case, the manufacturing process used to produce the drug
is not unique or specialized, and several other entities
also can manufacture the drug for the customer.
55-373 The entity
assesses the nature of its promise to grant the license.
The entity concludes that the patented drug formula is
functional intellectual property (that is, it has
significant standalone functionality in the form of its
ability to treat a disease or condition). There is no
expectation that the entity will undertake activities to
change the functionality of the drug formula during the
license period. Because the intellectual property has
significant standalone functionality, any other
activities the entity might undertake (for example,
promotional activities like advertising or activities to
develop other drug products) would not significantly
affect the utility of the licensed intellectual
property. Consequently, the nature of the entity’s
promise in transferring the license is to provide a
right to use the entity’s functional intellectual
property, and it accounts for the license as a
performance obligation satisfied at a point in time. The
entity recognizes revenue for the license performance
obligation in accordance with paragraphs 606-10-55-58B
through 55-58C.
Example 59 — Right to Use Intellectual
Property
Case A — Initial License
55-389 An entity, a music
record label, licenses to a customer a recording of a
classical symphony by a noted orchestra. The customer, a
consumer products company, has the right to use the
recorded symphony in all commercials, including
television, radio, and online advertisements for two
years in Country A starting on January 1, 20X1. In
exchange for providing the license, the entity receives
fixed consideration of $10,000 per month. The contract
does not include any other goods or services to be
provided by the entity. The contract is
noncancellable.
55-391 In determining that
the promised license provides the customer with a right
to use its intellectual property as it exists at the
point in time at which the license is granted, the
entity considers the following:
- The classical symphony recording has significant standalone functionality because the recording can be played in its present, completed form without the entity’s further involvement. The customer can derive substantial benefit from that functionality regardless of the entity’s further activities or actions. Therefore, the nature of the licensed intellectual property is functional.
- The contract does not require, and the customer does not reasonably expect, that the entity will undertake activities to change the licensed recording.
Therefore, the criteria in paragraph 606-10-55-62 are not
met.
Example 61A — Right to Use Intellectual
Property
55-399A An entity, a
television production company, licenses all of the
existing episodes of a television show (which consists
of the first four seasons) to a customer. The show is
presently in its fifth season, and the television
production company is producing episodes for that fifth
season at the time the contract is entered into, as well
as promoting the show to attract further viewership. The
Season 5 episodes in production are still subject to
change before airing.
Case A — License Is the Only Promise
in the Contract
55-399B The customer obtains
the right to broadcast the existing episodes, in
sequential order, for a period of two years. The show
has been successful through the first four seasons, and
the customer is both aware that Season 5 already is in
production and aware of the entity’s continued promotion
of the show. The customer will make fixed monthly
payments of an equal amount throughout the two-year
license period.
55-399C The entity assesses
the goods and services promised to the customer. The
entity’s activities to produce Season 5 and its
continued promotion of the show do not transfer a
promised good or service to the customer. Therefore, the
entity concludes that there are no other promised goods
or services in the contract other than the license to
broadcast the existing episodes in the television
series. The contractual requirement to broadcast the
episodes in sequential order is an attribute of the
license (that is, a restriction on how the customer may
use the license); therefore, the only performance
obligation in this contract is the single license to the
completed Seasons 1–4.
55-399D To determine whether
the promised license provides the customer with a right
to use its intellectual property or a right to access
its intellectual property, the entity evaluates the
intellectual property that is the subject of the
license. The existing episodes have substantial
standalone functionality at the point in time they are
transferred to the customer because the episodes can be
aired, in the form transferred, without any further
participation by the entity. Therefore, the customer can
derive substantial benefit from the completed episodes,
which have significant utility to the customer without
any further activities of the entity. The entity further
observes that the existing episodes are complete and not
subject to change. Thus, there is no expectation that
the functionality of the intellectual property to which
the customer has rights will change (that is, the
criteria in paragraph 606-10-55-62 are not met).
Therefore, the entity concludes that the license
provides the customer with a right to use its functional
intellectual property.
55-399E Consequently, in
accordance with paragraph 606-10-55-58B, the license is
a performance obligation satisfied at a point in time.
In accordance with paragraphs 606-10-55-58B through
55-58C, the entity recognizes revenue for the license on
the date that the customer is first permitted to air the
licensed content, assuming the content is made available
to the customer on or before that date. The date the
customer is first permitted to air the licensed content
is the beginning of the period during which the customer
is able to use and benefit from its right to use the
intellectual property. Because of the length of time
between the entity’s performance (at the beginning of
the period) and the customer’s annual payments over two
years (which are noncancellable), the entity considers
the guidance in paragraphs 606-10-32-15 through 32-20 to
determine whether a significant financing component
exists.
Case B — Contract Includes Two
Promises
55-399F Consistent with Case
A, the contract provides the customer with the right to
broadcast the existing episodes, in sequential order,
over a period of two years. The contract also grants the
customer the right to broadcast the episodes being
produced for Season 5 once all of those episodes are
completed.
55-399G The entity assesses
the goods and services promised to the customer. The
entity concludes that there are two promised goods or
services in the contract:
-
The license to the existing episodes (see paragraph 606-10-55-399C)
-
The license to the episodes comprising Season 5, when all of those episodes are completed.
55-399H The entity then
evaluates whether the license to the existing content is
distinct from the license to the Season 5 episodes when
they are completed. The entity concludes that the two
licenses are distinct from each other and, therefore,
separate performance obligations. This conclusion is
based on the following analysis:
-
Each license is capable of being distinct because the customer can benefit from its right to air the existing completed episodes on their own and can benefit from the right to air the episodes comprising Season 5, when they are all completed, on their own and together with the right to air the existing completed content.
-
Each of the two promises to transfer a license in the contract also is separately identifiable; they do not, together, constitute a single overall promise to the customer. The existing episodes do not modify or customize the Season 5 episodes in production, and the existing episodes do not, together with the pending Season 5 episodes, result in a combined functionality or changed content. The right to air the existing content and the right to air the Season 5 content, when available, are not highly interdependent or highly interrelated because the entity’s ability to fulfill its promise to transfer either license is unaffected by its promise to transfer the other. In addition, whether the customer or another licensee had rights to air the future episodes would not be expected to significantly affect the customer’s license to air the existing, completed episodes (for example, viewers’ desire to watch existing episodes from Seasons 1–4 on the customer’s network generally would not be significantly affected by whether the customer, or another network, had the right to broadcast the episodes that will comprise Season 5).
55-399I The entity assesses
the nature of the two separate performance obligations
(that is, the license to the existing, completed
episodes of the series and the license to episodes that
will comprise Season 5 when completed). To determine
whether the licenses provide the customer with rights to
use the entity’s intellectual property or rights to
access the entity’s intellectual property, the entity
considers the following:
-
The licensed intellectual property (that is, the completed episodes in Seasons 1–4 and the episodes in Season 5, when completed) has significant standalone functionality separate from the entity’s ongoing business activities, such as in producing additional intellectual property (for example, future seasons) or in promoting the show, and completed episodes can be aired without the entity’s further involvement.
-
There is no expectation that the entity will substantively change any of the content once it is made available to the customer for broadcast (that is, the criteria in paragraph 606-10-55-62 are not met).
-
The activities expected to be undertaken by the entity to produce Season 5 and transfer the right to air those episodes constitute an additional promised good (license) in the contract and, therefore, do not affect the nature of the entity’s promise in granting the license to Seasons 1–4.
55-399J Therefore, the entity
concludes that both the license to the existing episodes
in the series and the license to the episodes that will
comprise Season 5 provide the customer with the right to
use its functional intellectual property as it exists at
the point in time the license is granted. As a result,
the entity recognizes the portion of the transaction
price allocated to each license at a point in time in
accordance with paragraphs 606-10-55-58B through 55-58C.
That is, the entity recognizes the revenue attributable
to each license on the date that the customer is first
permitted to first air the content included in each
performance obligation. That date is the beginning of
the period during which the customer is able to use and
benefit from its right to use the licensed intellectual
property.
Generally, the nature of a license to functional IP that is
distinct will provide an entity’s customer with the right to use the entity’s
IP, which results in the entity’s recognition of revenue at the point in time at
which control of the license is transferred to the customer. However, there are
situations in which an entity grants a license to functional IP that is
transferred at contract inception but also promises to provide ongoing services
that are not distinct from the license (i.e., the license and ongoing services
are combined into a single performance obligation).
It is not acceptable for an entity to recognize revenue at the point in
time at which a license to functional IP is granted when the revenue is related
to a single performance obligation to (1) grant the license and (2) perform
ongoing substantive services that are not distinct from the license. ASC
606-10-55-57 states:
When a single performance obligation includes a license (or licenses) of
intellectual property and one or more other goods or services, the
entity considers the nature of the combined good or service for which
the customer has contracted (including whether the license that is part
of the single performance obligation provides the customer with a right
to use or a right to access intellectual property in accordance with
paragraphs 606-10-55-59 through 55-60 and 606-10-55-62 through 55-64A)
in determining whether that combined good or service is satisfied over
time or at a point in time in accordance with paragraphs 606-10-25-23
through 25-30 and, if over time, in selecting an appropriate method for
measuring progress in accordance with paragraphs 606-10-25-31 through
25-37.
Although a license to functional IP provides the customer with a
right to use the entity’s IP as it exists at a point in time, the presence of an
ongoing substantive service that is not distinct from the license indicates that
the customer cannot continue to benefit from the license without the ongoing
service. In addition, the entity’s performance obligation is not fully satisfied
upon transfer of the license because the entity has promised to provide an
ongoing substantive service that is not separable from the license. That is, the
license to the functional IP and the ongoing service are inputs into a combined
item. Therefore, the nature of the entity’s performance obligation involves
continuing to provide the customer with an ongoing service over time. Because
the entity does not fully satisfy its performance obligation upon transferring
the license to the customer, it is not appropriate to recognize revenue for the
single performance obligation at that point in time.
12.4.2 Symbolic IP
Some forms of IP may not have stand-alone functionality when
transferred to a customer. The utility of these forms of IP is significantly
derived from the entity’s past or ongoing activities undertaken to maintain or
support the IP, and such activities do not transfer additional goods or services
to the customer. That is, the value of the IP is largely dependent on the
entity’s ongoing support or maintenance of that IP. In addition, the customer is
contractually or practically required to use the updated IP. Licenses to IP
whose value is derived from an entity’s ongoing activities may include brands,
teams, trade names, logos, and franchise rights. For example, a license to a
sports team’s name is directly affected by the team’s performance and its
continued association with the league in which it plays. If the team ceases to
play games, the value of the IP would most likely decline significantly.
Further, a customer could not choose to use the form of the IP that existed when
the team was still playing games. Rather, the customer has to use the most
current form of the IP. These types of IP are referred to as symbolic IP.
ASC 606-10
55-60 A customer’s ability to
derive benefit from a license to symbolic intellectual
property depends on the entity continuing to support or
maintain the intellectual property. Therefore, a license
to symbolic intellectual property grants the customer a
right to access the entity’s intellectual property,
which is satisfied over time (see paragraphs
606-10-55-58A and 606-10-55-58C) as the entity fulfills
its promise to both:
-
Grant the customer rights to use and benefit from the entity’s intellectual property
-
Support or maintain the intellectual property. An entity generally supports or maintains symbolic intellectual property by continuing to undertake those activities from which the utility of the intellectual property is derived and/or refraining from activities or other actions that would significantly degrade the utility of the intellectual property.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
A symbolic license contains the characteristics of a
right-to-access license (i.e., a license for which revenue is recognized over
time) since the customer is simultaneously receiving the IP and benefiting from
it throughout the license period. An entity’s ongoing activities (including
actions that would significantly degrade the IP’s utility) will continue to
support or maintain (or significantly degrade) the IP’s utility to the
customer.
Connecting the Dots
As noted in paragraphs BC62 through BC65 of ASU 2016-10,
ASC 606 contains no guidance requiring the entity to promise or expect
to provide ongoing activities to maintain or support the IP. That is, if
the customer has acquired a license to symbolic IP, the license is a
right to access IP regardless of whether the entity expects to undertake
activities to maintain the IP. An example of this may be the right to a
license to a retired sports team’s name or logo. By contrast, under IFRS
15, an entity’s determination of whether a license is a right-to-use
rather than a right-to-access license is based on whether the underlying
IP is significantly affected by the entity’s ongoing activities. While
this is a difference between U.S. GAAP and IFRS Accounting Standards,
the FASB decided that the amendments in ASU 2016-10 would improve the
operability of the licensing guidance. For more discussion on
differences between U.S. GAAP and IFRS Accounting Standards, refer to
Appendix
A.
As noted in paragraph BC72 of ASU 2016-10, many right-to-access licenses “may
constitute a series of distinct goods or services that are substantially the
same and have the same pattern of transfer to the customer in accordance with
paragraph 606-10-25-14(b) (for example, a series of distinct periods [month,
quarter, year] of access).” See Section 5.3.3 for a discussion about the application of the
series guidance.
A right-to-access license is transferred to the customer (and thus, revenue is
recognized) over the shorter of the contractual term or the remaining economic
life of the IP. Therefore, if an entity provides a customer with a perpetual
license to symbolic IP, the entity will need to estimate the remaining economic
life of the IP to determine the appropriate period over which to recognize
revenue.
The following examples in ASC 606 illustrate the identification of symbolic IP:
ASC 606-10
Example 57 — Franchise Rights
55-375 An entity
enters into a contract with a customer and promises to
grant a franchise license that provides the customer
with the right to use the entity’s trade name and sell
the entity’s products for 10 years. In addition to the
license, the entity also promises to provide the
equipment necessary to operate a franchise store. In
exchange for granting the license, the entity receives a
fixed fee of $1 million, as well as a sales-based
royalty of 5 percent of the customer’s sales for the
term of the license. The fixed consideration for the
equipment is $150,000 payable when the equipment is
delivered.
Identifying Performance
Obligations
55-376 The entity
assesses the goods and services promised to the customer
to determine which goods and services are distinct in
accordance with paragraph 606-10-25-19. The entity
observes that the entity, as a franchisor, has developed
a customary business practice to undertake activities
such as analyzing the consumers’ changing preferences
and implementing product improvements, pricing
strategies, marketing campaigns, and operational
efficiencies to support the franchise name. However, the
entity concludes that these activities do not directly
transfer goods or services to the customer.
Licensing
55-380 The entity
assesses the nature of the entity’s promise to grant the
franchise license. The entity concludes that the nature
of its promise is to provide a right to access the
entity’s symbolic intellectual property. The trade name
and logo have limited standalone functionality; the
utility of the products developed by the entity is
derived largely from the products’ association with the
franchise brand. Substantially all of the utility
inherent in the trade name, logo, and product rights
granted under the license stems from the entity’s past
and ongoing activities of establishing, building, and
maintaining the franchise brand. The utility of the
license is its association with the franchise brand and
the related demand for its products.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
Example 58 — Access to Intellectual
Property
55-383 An entity, a creator
of comic strips, licenses the use of the images and
names of its comic strip characters in three of its
comic strips to a customer for a four-year term. There
are main characters involved in each of the comic
strips. However, newly created characters appear and
disappear regularly and the images of the characters
evolve over time. The customer, an operator of cruise
ships, can use the entity’s characters in various ways,
such as in shows or parades, within reasonable
guidelines.
55-384 In exchange for
granting the license, the entity receives a fixed
payment of $1 million in each year of the 4-year
term.
55-385 The entity concludes
that it has made no other promises to the customer other
than the promise to grant a license. That is, the
additional activities associated with the license do not
directly transfer a good or service to the customer.
Therefore, the entity concludes that its only
performance obligation is to transfer the license.
55-386 The entity assesses
the nature of its promise to transfer the license and
concludes that the nature of its promise is to grant the
customer the right to access the entity’s symbolic
intellectual property. The entity determines that the
licensed intellectual property (that is, the character
names and images) is symbolic because it has no
standalone functionality (the names and images cannot
process a transaction, perform a function or task, or be
played or aired separate from significant additional
production that would, for example, use the images to
create a movie or a show) and the utility of those names
and images is derived from the entity’s past and ongoing
activities such as producing the weekly comic strip that
includes the characters.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
55-387 Because the nature of
the entity’s promise in granting the license is to
provide the customer with a right to access the entity’s
intellectual property, in accordance with paragraph
606-10-55-58A, the entity accounts for the promised
license as a performance obligation satisfied over
time.
55-388 The entity recognizes
the fixed consideration allocable to the license
performance obligation in accordance with paragraphs
606-10-55-58A and 606-10-55-58C. The entity considers
paragraphs 606-10-25-31 through 25-37 in identifying the
method that best depicts its performance in the license.
Because the contract provides the customer with
unlimited use of the licensed characters for a fixed
term, the entity determines that a time-based method
would be the most appropriate measure of progress toward
complete satisfaction of the performance obligation.
Example 61 — Access to Intellectual
Property
55-395 An entity, a
well-known sports team, licenses the use of its name and
logo to a customer. The customer, an apparel designer,
has the right to use the sports team’s name and logo on
items including t-shirts, caps, mugs, and towels for one
year. In exchange for providing the license, the entity
will receive fixed consideration of $2 million and a
royalty of 5 percent of the sales price of any items
using the team name or logo. The customer expects that
the entity will continue to play games and provide a
competitive team.
55-396 The entity assesses
the goods and services promised to the customer to
determine which goods and services are distinct in
accordance with paragraph 606-10-25-19. The entity
concludes that the only good or service promised to the
customer in the contract is the license. The additional
activities associated with the license (that is,
continuing to play games and provide a competitive team)
do not directly transfer a good or service to the
customer. Therefore, there is one performance obligation
in the contract.
55-397 To determine whether
the entity’s promise in granting the license provides
the customer with a right to access the entity’s
intellectual property or a right to use the entity’s
intellectual property, the entity assesses the nature of
the intellectual property to which the customer obtains
rights. The entity concludes that the intellectual
property to which the customer obtains rights is
symbolic intellectual property. The utility of the team
name and logo to the customer is derived from the
entity’s past and ongoing activities of playing games
and providing a competitive team (that is, those
activities effectively give value to the intellectual
property). Absent those activities, the team name and
logo would have little or no utility to the customer
because they have no standalone functionality (that is,
no ability to perform or fulfill a task separate from
their role as symbols of the entity’s past and ongoing
activities).
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
55-398 Consequently, the
entity’s promise in granting the license provides the
customer with the right to access the entity’s
intellectual property throughout the license period and,
in accordance with paragraph 606-10-55-58A, the entity
accounts for the promised license as a performance
obligation satisfied over time.
55-399 The entity recognizes
the fixed consideration allocable to the license
performance obligation in accordance with paragraphs
606-10-55-58A and 606-10-55-58C. This includes applying
paragraphs 606-10- 25-31 through 25-37 to identify the
method that best depicts the entity’s performance in
satisfying the license. For the consideration that is in
the form of a sales-based royalty, paragraph
606-10-55-65 applies because the sales-based royalty
relates solely to the license that is the only
performance obligation in the contract. The entity
concludes that recognizing revenue from the sales-based
royalty when the customer’s subsequent sales of items
using the team name or logo occur is consistent with the
guidance in paragraph 606-10-55-65(b). That is, the
entity concludes that ratable recognition of the fixed
consideration of $2 million plus recognition of the
royalty fees as the customer’s subsequent sales occur
reasonably depict the entity’s progress toward complete
satisfaction of the license performance obligation.
Connecting the Dots
Airlines with large loyalty programs frequently enter
into agreements with a co-branded credit card partner in which mileage
credits and other consideration (e.g., award travel, upgrades, bag fee
waivers, lounge access) are sold to a financial institution. The mileage
credits are then issued to the financial institution’s credit card
customers, who are also airline loyalty members, as they make purchases
on their co-branded credit card. In these arrangements, the financial
institution will typically make an up-front payment to the airline for
advance purchases of mileage credit and future services to be provided
under the co-branded contract. The “advance services” include the
financial institution’s receiving direct access to the airline’s
customer list. When viewed from the airline’s perspective, these
co-branded agreements include two customers: the financial institution
and the credit card holder. The credit card holder is included as a
customer because of the mileage credits the holder will earn under its
loyalty agreement.
Considerations related to the application of ASC 606 to
these arrangements are discussed below.
Performance
Obligations
Airline entities with these arrangements will need to
carefully evaluate the terms of the agreements to properly identify and
evaluate the promised goods or services that will be transferred to the
customer(s). The significant performance obligations in a co-branded
agreement might include (1) the airline’s sale of the mileage credits to
the financial institution and (2) the right transferred by the airline
to the financial institution that allows the financial institution to
access the airline’s customer list and brand. Use of the airline’s brand
and access to the airline’s customer list would typically be combined as
a separate performance obligation since the financial institution would
use both in its marketing efforts directed at the airline’s customers to
increase its credit card business. For example, from the perspective of
the financial institution, access to only the airline’s brand would have
minimal value without access to the airline’s customer list since the
ability to target a common demographic of airline loyalty members is
valuable to a financial institution. Further, access to the customer
list without the brand would have limited value since the airline
customers are induced to enter into an agreement with the financial
institution by means of offers provided through the airline brand.
Therefore, the combined right to access an airline’s brand and customer
list would generally be considered “highly interdependent or highly
interrelated” under ASC 606-10-25-21(c). In addition, in the airline
industry, it would be uncommon for an airline to separately sell the
right to access its brand and customer list outside of a co-branded
agreement.
For a discussion about identifying performance
obligations in other co-branded credit card arrangements, see Section 5.3.2.3.2.
Allocation of Transaction Price
and Revenue Recognition
In accordance with ASC 606-10-55-54, the right to access
the airline’s customer list and brand is generally viewed as a right of
the financial institution to access the airline’s IP. ASC 606-10-55-58
distinguishes between (1) functional IP (the right to use an entity’s
IP, which promise is fulfilled at a point in time) and (2) symbolic IP
(the right to access an entity’s IP, which promise is fulfilled over
time). The right to access the airline’s customer list and brand over a
contractual period represents symbolic IP since the use of the brand and
customer list is beneficial to the financial institution as a result of
the financial institution’s continued association with the
airline.
As noted above, the other significant performance
obligation in a co-branded arrangement represents the sale of the
mileage credits to the financial institution. The financial institution
will typically transfer the mileage credits to its own customers as the
co-branded credits cards are used. The airline’s performance obligation
would then be satisfied at a point in time upon the redemption of miles
by credit card holders. Thus, the two performance obligations in a
co-branded arrangement have different revenue recognition patterns since
the performance obligation to provide mileage credits is satisfied at a
point in time (when the mileage credits are redeemed by credit card
holders) while the performance obligation to give the financial
institution the right to access the airline’s brand and customer list is
satisfied over the period of the co-branded agreement. Recognition of
the transaction price allocated to the mileage credits would be deferred
until the later of when (1) the miles are used or (2) the miles expire
(if applicable). In contrast, the transaction price allocated to the
right to access the airline brand and customer list would be recognized
over the period of the co-branded arrangement.
Further, the transaction price allocated to the symbolic
IP in a co-branded arrangement is variable since most of the payments
from the financial institution to the airline are dependent on the
successful acquisition of new credit card holders and subsequent use of
the card by the cardholders (which results in the payment of fees from
the financial institution to the airline). Therefore, the airline would
recognize revenue in accordance with the sales- or usage-based royalty
guidance in ASC 606-10-55-65.
12.4.3 Additional Flowchart for Determining the Nature of a License
The flowchart below, which is reproduced from ASC 606-10-55-63A,
provides an overview of the decision-making process for determining the nature
of an entity’s license of IP to a customer (i.e., for determining whether a
license of IP is a right to use or right to access an entity’s IP). Note,
however, that the flowchart does not include all of the guidance an entity is
required to consider and is not intended to be a substitute for the guidance
discussed above.
ASC 606-10
Footnotes
9
In January 2021, the FASB issued ASU 2021-02,
which allows a franchisor that is not a PBE (a “private-company franchisor”)
to use a practical expedient when identifying performance obligations in its
contracts with customers (i.e., franchisees) under ASC 606. See Section 5.3.5 for
additional details.
12.5 Transfer of Control and Recognition
ASC 606-10
55-58C Notwithstanding
paragraphs 606-10-55-58A through 55-58B, revenue cannot be
recognized from a license of intellectual property before
both:
-
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
Determining when control has been transferred to a customer may be difficult in
certain arrangements related to the licensing of IP, especially those related to
software that is delivered electronically.
12.5.1 Electronic Delivery of Software
The examples below discuss the transfer of control in
arrangements involving electronically delivered software.
Example 12-15
Assessing When Control Is Transferred
to the Customer for a Suite of Software
Licenses
Entity X enters into a five-year license agreement with
Customer B under which B purchases licenses to a suite
of software products consisting of five modules. At the
inception of the arrangement, B is required to make a
nonrefundable payment of $5 million to X for the
licenses to all five modules, and the license term for
the suite of licenses begins on January 1, 20X5.
Customer B has previewed all five modules and accepted
the software as of January 1, 20X5, but has only
obtained the access codes for, and downloaded, four of
the five modules. Customer B installs the modules itself
and expects that it will take three months to install
the four modules. Customer B does not download the fifth
module immediately because of system limitations but
plans to obtain the access code and install the fifth
module once installation of the first four modules is
complete. The access code for the fifth module is
available to B on demand.
In this scenario:
- Customer B is required to pay the nonrefundable license fee at the inception of the arrangement and has accepted the software.
- The license terms have begun.
- The access code for the fifth module is available to B at any time on demand.
Assuming that no other indicators of control are present,
X can reasonably conclude that control of the licenses
for all five modules is transferred to B on January 1,
20X5.
Example 12-16
Assessing When Control Is Transferred to the Customer
When the License Requires an Access Code or Product
Key
Entity X sells software licenses to customers that
represent right-to-use licenses (for which revenue is
recognized at a point in time) and give customers access
to the software via X’s Web site. Customers need either
an access code to download the software or a product key
to activate the software once downloaded. The software
cannot be used on the customer’s hardware without the
access code or the product key.
Entity X may not need to deliver the access code or
product key to the customer to conclude that control of
the software license has been transferred to the
customer. ASC 606-10-55-58B and 55-58C state, in part:
An entity’s promise to provide a customer with
the right to use its intellectual property is
satisfied at a point in time. The entity should
apply paragraph 606-10-25-30 to determine the
point in time at which the license transfers to
the customer.
Notwithstanding paragraphs 606-10-55-58A through
55-58B, revenue cannot be recognized from a
license of intellectual property before both:
-
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. [Emphasis added]
Entity X should consider the guidance on control in ASC
606-10-25-23 through 25-26 and the indicators in ASC
606-10-25-30 related to determining when a customer
obtains control of the software license.
In some circumstances, control of the software license
may be transferred to the customer before the access
code or product key is delivered. In particular, there
may be situations in which the access code or product
key has not been delivered but is nonetheless made
available to the customer at any time on demand. In such
circumstances, it will be necessary to consider whether
control has passed to the customer by focusing on the
indicators in ASC 606-10-25-30. For example, if the
customer has accepted the software, nonrefundable
payment has been received, the license term has begun,
and the customer has a current right to request and
receive the access code or product key, X may conclude
that control of the software license has been
transferred even though the access code or product key
has not been provided to the customer. These situations
may be viewed as analogous to bill-and-hold
arrangements, as discussed in ASC 606-10-55-81 through
55-84.
However, if payment terms or acceptance depends on
delivery of the software access code or product key, or
if X is not yet in a position to make the code or key
available, it would be unlikely that X could conclude
that control of a software license has been transferred
until the access code or product key has been provided
to the customer.
Example 12-17
Assessing When Control Is Transferred to the Customer
in a Hosting Arrangement
Entity Y enters into a license and hosting software
arrangement with Customer X that allows X to access via
the Internet and use software that Y physically hosts on
its servers. Customer X is required to pay a
nonrefundable license fee of $1,000 at the inception of
the arrangement. Customer X accepts the software, and
the license term begins once the hosting service
commences.
As part of the arrangement, X has the right to take
possession of the software at any time during the
contract period without incurring additional costs or
diminution of the software’s utility or value. That is,
there are no contractual or practical barriers to X’s
exercising its right to take possession of the software,
and X is able to benefit from the software on its own or
with readily available resources.
Entity Y concludes that the software license and hosting
service are each distinct and that the software license
gives X a right to use Y’s IP. If X exercises its right
to take possession of the software, Y will immediately
provide an access code that will enable X to download
the software.
In this scenario:
-
X is required to pay the nonrefundable license fee at the inception of the arrangement.
-
X has accepted the software, and the license term begins once the hosting service commences.
-
Y has made the access code available to X at any time on demand.
Therefore, assuming that no other indicators affecting
the transfer of control are present, Y can reasonably
conclude that control of the software license is
transferred to X when the license term and hosting
service begin. As a result, (1) the transaction price
allocated to the license is recognized at inception of
the arrangement (corresponding to its transfer of
control at that point in time) and (2) the transaction
price allocated to the hosting service is recognized
over time.
12.5.2 When Control Is Transferred in Reseller Arrangements
Reseller arrangements in which a reseller purchases software from a software
provider (the vendor) and then resells the software to end users are common in
the software industry. In these situations, the reseller is often the vendor’s
customer (rather than the end user). ASC 606-10-55-58C provides that revenue
cannot be recognized from a license of IP before both (1) an entity provides a
copy of the IP to a customer and (2) the period during which the customer can
use and benefit from the IP has begun. Questions arise about when revenue can be
recognized when sales of IP are made to resellers (e.g., distributors) rather
than end users.
Example 12-18
On March 15, 20X0, Vendor A enters into a reseller
arrangement with Reseller B that immediately permits B
to resell 1,000 licenses of A’s software (a form of
functional IP) for a nonrefundable up-front fee of
$200,000. Reseller B plans to resell the functional IP
to end users and will provide all set-up and maintenance
services directly to the end users. There is no
expectation that A will undertake activities to
substantively change the functionality of the IP, and
there are no promised goods or services in the contract
other than the license to the functional IP. Also on
March 15, 20X0, A ships to B a master copy of the
software; B receives the master copy on April 1, 20X0,
and can use it to replicate the software for resale.
Vendor A also makes the software available for download
on March 15, 20X0; however, B intends to use the master
copy rather than the downloaded version to replicate the
software for resale.
Vendor A should recognize revenue on
March 15, 20X0. As noted in ASC 606-10-55-58C, control
of IP cannot be transferred (and revenue cannot be
recognized) before (1) the “entity provides (or
otherwise makes available) a copy of the [IP] to the
customer” and (2) 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 IP. In a
reseller arrangement, the customer is not using the
functionality of the software; rather, the customer will
benefit from the software through the ability to resell
the software. Although B intends to use the master copy
to replicate the software, the software is made
available to B on March 15, 20X0, which is also when B
could begin reselling the software. Therefore, on March
15, 20X0, it would be appropriate for A to recognize the
nonrefundable fee of $200,000 as revenue. However, even
if A does not make the software available for download
and only ships B a master copy of the software, A could
recognize the nonrefundable fee of $200,000 as revenue
when it ships the master copy of the software to B on
March 15, 20X0, if control of the master copy is
transferred to B upon shipment (e.g., FOB shipping
point).
12.5.3 Recognition When a License Is Not Distinct From Other Goods or Services
If an entity determines that a license is not distinct and
should therefore be combined with other goods or services in a contract, the
entity will need to evaluate the nature of the combined goods and services to
determine (1) when the performance obligation is satisfied (i.e., at a point in
time or over time) and (2) the appropriate method of measuring progress for
revenue recognition over time, if applicable. This requirement is intended to
ensure that the arrangement is accounted for in a manner that is consistent with
the objective of the revenue standard. That is, revenue is recognized when (or
as) control of the good or service is transferred to the customer.
For example, assume the following:
-
A contract contains a five-year license for the right to access IP and a two-year service agreement, both of which meet the requirements for recognizing revenue over time.
-
The license is not distinct and is therefore combined with the service agreement as a single performance obligation.
-
The license is the predominant part of that combined single performance obligation.
In this example, it would not be appropriate to recognize revenue related to the
five-year license over a two-year period. Rather, the transaction price would be
recognized as revenue as the combined performance obligation (five-year
license plus two-year service agreement) is satisfied. In this case, the timing
of revenue recognition would be determined on the basis of the promised good or
service that is transferred over the longer period (i.e., the five-year
license).
12.6 License Renewals and Modifications
Renewals of and modifications to rights granted in a license arrangement occur
frequently. Entities should consider the nature and provisions of license renewals
and modifications when determining the appropriate accounting treatment. In
addition, the discussions in this section should be considered in conjunction with
those in Chapter 9 on contract
modifications.
Stakeholders questioned how entities should account for license renewals (or
extensions of the license period). Specifically, they asked whether renewals (or
extensions) result in the addition of a distinct license for which control is not
transferred until the new (extended) license period begins, or whether the extended
license period becomes part of the original license for which control may have
already been transferred to the customer (if it is an extension of a license that is
already controlled by the customer). For example, suppose that an entity provides a
right-to-use license to its customer for a three-year period. After two years, the
customer requests an extension of the license period for an additional two years,
which results in the customer’s right to use the license for a total of five years.
Stakeholders questioned whether the entity providing the right-to-use license (i.e.,
a license for which revenue is recognized at a point in time) would recognize
revenue at the point in time when the license term was extended (i.e., after two
years) or at the point in time when the extension period began (i.e., the beginning
of year 4).
As a result, the FASB included specific guidance in ASU 2016-10 to address
stakeholders’ concerns about right-to-use and right-to-access licenses. In
accordance with that guidance, renewals or extensions of licenses should be
evaluated as distinct licenses (i.e., a distinct good or service), and revenue
attributed to the distinct good or service cannot be recognized until (1) the entity
provides the distinct license (or makes the license available) to the customer and
(2) the customer is able to use and benefit from the distinct license. In reaching
this conclusion, the FASB observed in paragraph BC50(a) of ASU 2016-10 that “when
two parties enter into a contract to renew (or extend the license period of) a
license, the renewal contract is not combined with the original license contract
unless [one or more of] the criteria in paragraph 606-10-25-9 [on combining
contracts] have been met.” Therefore, the renewal right should be evaluated in the
same manner as any other additional rights granted after the initial contract (i.e.,
revenue should not be recognized until the customer can begin to use and benefit
from the license, which is generally at the beginning of the license renewal
period).
In addition to providing clarifying guidance in ASC 606-10-55-58C, the FASB provided
the following additional example to clarify the timing of revenue recognition for
renewals:
ASC 606-10
Example 59 — Right to Use Intellectual
Property
Case A — Initial License
55-389 An entity, a
music record label, licenses to a customer a recording of a
classical symphony by a noted orchestra. The customer, a
consumer products company, has the right to use the recorded
symphony in all commercials, including television, radio,
and online advertisements for two years in Country A
starting on January 1, 20X1. In exchange for providing the
license, the entity receives fixed consideration of $10,000
per month. The contract does not include any other goods or
services to be provided by the entity. The contract is
noncancellable.
[ASC 606-10-55-390 through 55-392
omitted.]
Case B — Renewal of the License
55-392A At the end of
the first year of the license period, on December 31, 20X1,
the entity and the customer agree to renew the license to
the recorded symphony for two additional years, subject to
the same terms and conditions as the original license. The
entity will continue to receive fixed consideration of
$10,000 per month during the 2-year renewal period.
55-392B The entity
considers the contract combination guidance in paragraph
606-10-25-9 and assesses that the renewal was not entered
into at or near the same time as the original license and,
therefore, is not combined with the initial contract. The
entity evaluates whether the renewal should be treated as a
new license or the modification of an existing license.
Assume that in this scenario, the renewal is distinct. If
the price for the renewal reflects its standalone selling
price, the entity will, in accordance with paragraph
606-10-25-12, account for the renewal as a separate contract
with the customer. Alternatively, if the price for the
renewal does not reflect the standalone selling price of the
renewal, the entity will account for the renewal as a
modification of the original license contract.
55-392C In determining
when to recognize revenue attributable to the license
renewal, the entity considers the guidance in paragraph
606-10-55-58C and determines that the customer cannot use
and benefit from the license before the beginning of the
two-year renewal period on January 1, 20X3. Therefore,
revenue for the renewal cannot be recognized before that
date.
55-392D Consistent with
Case A, because the customer’s additional monthly payments
for the modification to the license will be made over two
years from the date the customer obtains control of the
second license, the entity considers the guidance in
paragraphs 606-10-32-15 through 32-20 to determine whether a
significant financing component exists.
12.6.1 Early Renewal of a Term-Based License
In conjunction with a term-based license, entities often offer customers a
renewal option under which a customer can renew the contract and extend the
period over which the customer has the right to use the licensed IP. In many
cases, the customer may exercise its option to renew the license before the end
of the initial license term. Although the customer may already be using the
licensed IP, revenue attributable to the renewed license cannot be recognized
until the beginning of the renewal period.
Example 12-19
Entity P enters into a three-year license agreement with
Customer B under which B licenses software from P. The
license includes three years of PCS (e.g., upgrades, bug
fixes, and support). In exchange for the license and
PCS, B pays P total consideration of $2,700, which
consists of a $1,500 up-front payment for the license
and annual installment payments of $400 for PCS payable
at the end of each year. The contract states that B may
extend the license for one-year terms at any point
during the three-year license term for additional
consideration.
Other relevant information includes the following:
-
Entity P has concluded that the software license and PCS are distinct performance obligations.
-
The contract amounts reflect each performance obligation’s stand-alone selling price.
-
The software being licensed is functional IP, and the license gives B the right to use the software. As a result, P concludes that revenue allocated to the license should be recognized at the point in time that the customer obtains control of the license, which is assumed to be at contract inception.
-
The PCS is determined to be a stand-ready obligation that is satisfied by P ratably over the PCS term.
-
The initial contract does not include a material right.
At the end of year 2, B elects to extend the license for
an additional year (i.e., the total license term would
extend from three years to four years) in exchange for
an additional $900 of consideration. Entity P determines
that the additional license and PCS are priced at their
respective stand-alone selling prices ($500 for the
one-year term license and $400 for one year of PCS) and
that the additional one-year term license and associated
PCS are distinct performance obligations.
Entity P cannot recognize revenue allocated to the
one-year renewal of the license granted to B before the
expiration of the initial three-year license term.
In accordance with ASC 606-10-25-12, the contract
extension is accounted for as a separate contract since
the added goods and services (i.e., term license and
PCS) are distinct and priced at their respective
stand-alone selling prices. Although the customer
already has the software subject to the one-year
extension, the addition of one year to the right-to-use
license creates a new distinct license that is
transferred to the customer at the beginning of the
extension period. ASC 606-10-55-58C states that an
entity cannot recognize revenue from a license of IP
before both of the following:
-
The “entity provides (or otherwise makes available) a copy of the [IP] 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 [IP].”
ASC 606-10-55-58C further notes that an entity is not
permitted to recognize revenue before the beginning of
the license period even if the customer receives a copy
of the IP before the beginning of the license period.
Specifically, an entity is precluded from recognizing
revenue from a license renewal before the beginning of
the renewal period.
In accordance with the guidance in ASC 606-10-55-58C, P
is precluded from recognizing the consideration
allocated to the one-year term license (i.e., $500)
until the beginning of year 4 (i.e., upon the expiration
of the initial license term and beginning of the renewal
period). If B prepays the $900 before the beginning of
the renewal period, P would recognize that amount as a
contract liability. At the beginning of year 4, P would
recognize $500 immediately upon the transfer of the
one-year right-to-use license to B. Entity P would then
start recognizing the $400 of consideration allocated to
the additional year of PCS ratably over year 4.
Example 12-20
Assume the same facts as in the example
above, except that the additional consideration paid by
Customer B to extend the license for a year is $600
instead of $900 (i.e., the additional license and PCS
are not priced at their stand-alone selling prices,
which are $500 and $400, respectively). At the time of
the extension, Entity P is still entitled to $400 for
the remaining year of PCS it must provide B under the
original contract.
In accordance with ASC 606-10-25-13(a), P would account
for the early renewal (which is a form of a contract
modification) as if it were a termination of the
original contract and the creation of a new contract.
Entity P would combine the additional consideration of
$600 with the consideration promised by B under the
original contract and not yet recognized as revenue by P
(i.e., $400) and allocate the resulting sum to the
remaining performance obligations under the modified
contract. At the time of the modification, the
three-year term license under the original contract had
already been transferred to the customer along with two
years of PCS. Consequently, one year of PCS still must
be transferred under the original contract along with a
one-year term license and an additional year of PCS,
both of which were added as a result of the
modification. The combined consideration of $1,000 ($600
+ $400) would be allocated to the remaining performance
obligations as follows:
Even though the modification is
accounted for as if it were a termination of the
existing contract and the creation of a new
contract, the modification does not alter the
original license term. That is, the modification does
not change the original three-year term license to a
two-year term license. Rather, the modification adds a
one-year term license that begins after the expiration
of the original three-year term license and requires P
to allocate the consideration between the added one-year
term license and the remaining two years of PCS. At the
beginning of year 4, in a manner consistent with the
example above, P would recognize $385 immediately upon
the transfer of the one-year right-to-use license to B.
Further, P would start recognizing the $615 allocated to
the PCS ratably at the beginning of year 3 (the time of
the modification).
12.6.2 Extension of a Right-to-Access License Agreement
Regardless of whether a modification to renew or extend a
license is associated with a right to use IP or a right to access IP, the
modification framework in ASC 606-10-25-12 and 25-13 should be applied. The
example below illustrates the accounting for the extension of a right-to-access
license agreement.
Example 12-21
Entity X and Customer Y enter into a license agreement
under which Y is provided the right to access X’s IP for
three years for $3 million. After one year, X and Y
agree to extend the contract for an additional two years
for $1.8 million.
Assume that X has concluded that the additional two years
of access to its IP are distinct from access to its IP
over the initial three-year period.
Entity X should apply the modification guidance in ASC
606-10-25-12 and 25-13 (see Section 9.2). Entity X should first
determine whether the contract modification meets the
criteria in ASC 606-10-25-12 to be accounted for as a
separate contract.
In this example, the criterion in ASC
606-10-25-12(a) is met because the scope of the contract
is increased by two years and the right to access X’s IP
over that period is considered distinct in accordance
with ASC 606-10-25-19 through 25-22. The determination
that the right to access IP for an additional two years
provides additional goods or services that are distinct
is consistent with paragraph BC72 of ASU 2016-10, which
states that in many right-to-access license
arrangements, “the license may constitute a series of
distinct goods or services that are substantially the
same and have the same pattern of transfer to the
customer in accordance with paragraph 606-10-25-14(b)
(for example, a series of distinct periods [month,
quarter, year] of access).”
Entity X must also consider whether the contract
modification meets the criterion in ASC 606-10-25-12(b),
which requires the modification to increase the price of
the contract “by an amount of consideration that
reflects the entity’s standalone selling prices of the
additional promised goods or services.” If X determines
that the contract modification increases the price of
the contract by an amount of consideration that reflects
the entity’s stand-alone selling price for the added
rights to access the IP, the modification will be
accounted for as a separate contract. When considering
whether the price charged to the customer represents the
stand-alone selling price of additional distinct
promised goods or services, entities are allowed to
adjust the stand-alone selling price to reflect a
discount for costs they do not incur because they have
modified a contract with an existing customer. For
example, the renewal price that an entity charges a
customer is sometimes lower than the initial price
because the entity recognizes that the expenses
associated with obtaining a new customer can be excluded
from the renewal price.
If X determines that the contract modification does not
increase the price of the contract by an amount of
consideration that reflects the entity’s stand-alone
selling price of the added rights to access the IP, the
modification will be accounted for in accordance with
ASC 606-10-25-13. Since the added rights to access the
IP are considered distinct, X should account for the
modification as a termination of the existing contract
and the creation of a new contract in accordance with
ASC 606-10-25-13(a).
Regardless of whether the contract modification is
accounted for as a separate contract or as a termination
of the original contract and the creation of a new
contract, the modification should be accounted for
prospectively. That is, no cumulative-effect adjustment
should be recorded as a result of the modification.
If X determines that the $1.8 million represents the
stand-alone selling price of the right to access its IP
during the extension period, X would account for the
right to access its IP in years 4 and 5 as a separate
contract. Revenue for each year of the five-year
arrangement would be recorded as follows:
If X determines that the $1.8 million does not represent
the stand-alone selling price of the right to access its
IP during the extension period, X would account for the
modification as a termination of the original contract
and the creation of a new contract. Revenue for each
year of the five-year arrangement would then be recorded
as follows:
12.6.3 Renewals of PCS in a Software Arrangement
It is common for an entity’s software contract with a customer
to include both a software license and PCS for a defined term (e.g., 12 months).
In some cases, the software license is perpetual, or the term of the license is
greater than the initial PCS term. After the initial PCS term, the customer may
be entitled to renew the PCS at a renewal rate stated in the contract. Questions
have arisen about how to account for (1) a reinstatement of PCS after the
initial PCS term has lapsed (see Section
12.6.3.1) and (2) an option to renew PCS when it is not distinct
from a perpetual software license (see Section
12.6.3.2).
12.6.3.1 Reinstatement of PCS After Customer Lapse
As noted in Section
12.6.3, an entity could grant a license to software on a
perpetual basis or for a term greater than the initial PCS term, with an
option to renew the PCS at a stated renewal rate. If the customer does not
elect to renew the PCS, the entity may not have an obligation (explicit or
implied) to provide PCS to the customer after the initial PCS term. While
the customer does not have the right to receive software updates or support
if it does not renew the PCS, the customer retains the right to use the
software in its then current state.
Although the entity does not have a contractual, legal, or implied obligation
to provide PCS to the customer if the customer does not renew the PCS, the
entity may continue to provide PCS as a courtesy to the customer. However,
if there is no enforceable contract during the lapse period, the customer
might not have the legal right to retain and use the benefits, including any
software updates or enhancements, provided by the PCS during the lapse
period. If the customer renews the PCS after the initial PCS term has
lapsed, the entity may require the customer to pay a reinstatement fee equal
to the amount that the customer would have paid for the PCS during the lapse
period in addition to the fee for the remaining renewal period.
To account for a contract with a customer to reinstate PCS,
an entity can use either of the following two methods depending on the
nature of the PCS:10
-
Cumulative catch-up method (“Alternative A”) — Upon the customer’s reinstatement of the PCS, the entity should record a cumulative adjustment to revenue. Under this alternative, the fee paid by the customer to reinstate the PCS should be allocated to both the PCS provided during the lapse period (software updates and enhancements provided as a courtesy during the lapse period if control of these items is transferred to the customer upon reinstatement of the PCS) and the future services to be provided over the remaining PCS term after the reinstatement. The amount allocated to the software updates and enhancements provided during the lapse period is recognized immediately because control is transferred at the point in time at which the PCS is reinstated. The amount allocated to future services is recognized over time as these services are provided.
-
Prospective method (“Alternative B”) — Upon the customer’s reinstatement of the PCS, the entity should allocate the consideration in the contract (i.e., the reinstatement fee equal to what the customer would have paid during the lapse period and the fee for additional PCS) to the remaining months of PCS to be provided to the customer. This amount is recognized over time as the services are provided.
We believe that Alternative A is more appropriate if control over any updates
or software enhancements already received by the customer (i.e., the right
to legally retain bug fixes, updates, and enhancements that were provided
during the lapse period) is transferred to the customer only at the point in
time at which the PCS is reinstated. Under Alternative A, no revenue should
be recognized during the lapse period because there is no contract with the
customer. However, upon the customer’s reinstatement of the PCS, the entity
should recognize a cumulative adjustment to revenue in an amount that
corresponds to the rights transferred to the customer upon reinstatement
(which, under the facts of this scenario, is the reinstatement fee equal to
the amount that the customer would have paid for the PCS during the lapse
period). Although the customer may receive PCS during the lapse period, the
customer does not have the legal right to retain the benefits from the PCS
during this period; however, the rights to retain and use the benefits,
updates, and enhancements are transferred to the customer if the customer
renews the PCS. As noted above, the total fee charged to the customer
includes a reinstatement fee equal to the amount that the customer would
have paid for the PCS during the lapse period and an amount related to the
PCS to be provided under the remaining PCS term. Therefore, the fee paid by
the customer upon renewal is related to both the PCS still to be provided
under the contract and the PCS provided during the lapse period.
Because the nature of PCS can differ among entities, additional consideration
may be required if the entity does not provide upgrades, enhancements, or
bug fixes as part of the PCS (e.g., when the PCS includes only support). In
such cases, Alternative B may be more appropriate because the customer may
not receive incremental rights upon reinstatement.
Example 12-22
Entity V provides hospitals with communications
solutions, which consist of hardware, software, and
PCS for the software. On January 1, 20X1, V enters
into a contract with Customer C to grant C a
perpetual license to V’s software and 12 months of
PCS. The contract states that the PCS may be renewed
on an annual basis for $1,200. Entity V concludes
that the $1,200 represents the stand-alone selling
price of the PCS. In addition, V concludes that its
obligation to provide PCS is a stand ready
obligation that provides C with a benefit ratably
over the contract term.
At the end of the initial 12-month term, C does not
elect to renew the PCS and therefore does not make
any further payment. Although V does not have an
explicit or implicit obligation to provide any
services, V continues to provide the PCS, including
updates and enhancements to the software, as a
courtesy to C because V expects that C will
eventually reinstate the PCS. However, C does not
have the legal right to retain or use the benefits
of the updates or enhancements to the software until
it reinstates the PCS.
On April 1, 20X2 (i.e., three months
after the PCS has lapsed), C reinstates the PCS by
paying V $1,200, of which $300 represents a
reinstatement fee equal to the amount that C would
have paid for the PCS during the lapse period. The
new PCS term expires on December 31, 20X2. The
$1,200 fee paid by C is intended to compensate V for
the three months of PCS provided during the lapse
period and the remaining nine months of PCS to be
provided over the remaining period of the new PCS
term. Entity V concludes that control of the rights
to retain and use the benefits provided by the PCS
(i.e., the right to retain or use the enhanced and
updated software) during the three-month lapse
period is immediately transferred to the customer
once the PCS is reinstated.
Upon reinstatement of the PCS, it
would be acceptable for V to recognize $300 as
revenue immediately because this represents the
value of the rights that are transferred to C
immediately upon reinstatement of the PCS. In that
case, V would then recognize $900 as revenue over
the remaining contract period ending on December 31,
20X2.
12.6.3.2 Options to Renew PCS When PCS Is Not Distinct From a Perpetual Software License
The example below illustrates the identification of material
rights in a contract involving renewable PCS that is not distinct from a
perpetual software license.
Example 12-23
On January 1, 20X9, Company LN enters into a contract
with a customer to transfer a perpetual antivirus
software license and provide unspecified software
updates as PCS for one year in exchange for an
up-front, nonrefundable fee of $3,000, which is the
standard price paid by all new customers. Company LN
has concluded that the software license and PCS are
not distinct because the functionality and utility
of the software are highly dependent on the PCS and
vice versa. The updates significantly modify the
functionality of the software by permitting the
software to protect the customer from a significant
number of additional viruses that the software did
not protect against previously. The updates are also
integral to maintaining the utility of the software
license to the customer. Therefore, the transfer of
a perpetual antivirus software license and the
obligation to provide PCS constitute a single
performance obligation.
At the end of the year, the customer has an option to
renew the PCS on an annual basis for $300. The
customer may exercise this option each year on an
indefinite basis. The customer is expected to renew
the PCS for four additional years after the first
year of the contract.
The annual renewal options exercisable by the
customer each represent a material right in LN’s
contract. Since the license is not distinct
(separable) from the PCS, the customer is
effectively renewing the single performance
obligation (the combined license and PCS) each year
even though the software that is being provided is
in the form of a perpetual license.
Therefore, each annual renewal option represents a
material right because the renewal options enable
LN’s customer to renew the contract at a price that
is lower than the amount that new customers are
typically charged (i.e., only $300 is required to
renew as compared with the $3,000 that new customers
must pay). Because the material rights are accounted
for as separate performance obligations, LN
allocates the total transaction consideration of
$3,000 for the first year to the identified
performance obligations (services for the first-year
contract and the material rights) on a relative
stand-alone selling price basis. As described in ASC
606-10-55-45, as a practical alternative to
estimating the stand-alone selling price of the
renewal options, LN may be able to allocate the
transaction price to the renewal options (i.e., the
material rights) “by reference to the goods or
services expected to be provided and the
corresponding expected consideration.” In accordance
with ASC 606-10-55-42, the amount allocated to each
annual renewal option (i.e., the material rights)
would be recognized (1) as LN provides the service
to which the renewal option is related or (2) when
the renewal options expire.
12.6.4 Cloud Conversion or Switching Rights
Some entities in the software industry enter into contracts that
include (or are subsequently modified to include) an option that allows the
customer to convert from an on-premise license arrangement to a cloud-based
arrangement under which the software is hosted (e.g., SaaS). This issue has
become more prevalent because customers of software entities frequently migrate
from on-premise software solutions to cloud-based platforms. Often, when a
customer converts from an on-premise software arrangement to a SaaS arrangement,
the customer will lose or forfeit its rights to the on-premise version of the
software. Views differ on how to account for the revocation of the initial
licensing rights and the conversion to a hosted solution.
From inception or after modification, a software arrangement may
include a feature that allows a customer to convert a nonexclusive on-premise
term-based software license to a cloud-based or hosted software solution (e.g.,
a SaaS arrangement)11 for the same software (i.e., software with the same functionality and
features). An entity may also modify a nonexclusive on-premise term-based
software arrangement to immediately convert it to a SaaS arrangement. Further,
an entity’s software arrangement may allow a customer to (1) deploy a certain
number of licenses to software (e.g., 1,000 seats) and (2) use discretion to
determine how many licenses to deploy on an on-premise basis or as SaaS at any
point in time or at discrete points in time during the arrangement term. Cloud
conversion or switching rights vary widely in practice, and the determination of
the appropriate accounting for an arrangement that provides for such rights will
depend on the particular complexities involved.
In accordance with the guidance in ASC 606, revenue from
on-premise software licenses is typically recognized at the point in time when
both (1) the entity provides (or otherwise makes available) a copy of the
software to the customer and (2) the period in which the customer is able to use
and benefit from the license has begun. Revenue from a SaaS arrangement is
typically recognized over time because the performance obligation is likely to
meet the conditions for such recognition, particularly if the SaaS is a
stand-ready obligation. While ASC 606 includes guidance on contract
modifications, material rights, and sales with a right of return, it does not
directly address transactions in which a nonexclusive software license is
revoked or converted to a SaaS arrangement. As a result, there are diverse views
on the accounting for such arrangements, particularly those in which a
nonexclusive on-premise software license for which revenue is recognized at a
point in time is converted to a SaaS arrangement for the same underlying
software product for which revenue is recognized over time.
We believe that there could be more than one acceptable accounting model for
certain types of cloud conversion or switching arrangements. The next sections
provide illustrative examples of such arrangements and discuss views on how
entities may account for them. However, the examples are not all-inclusive, and
entities should carefully consider their specific facts and circumstances in
determining the appropriate accounting model. In addition, the accounting views
discussed for each example may not necessarily be the only methods that are
acceptable.
12.6.4.1 Initial Contract Includes a Cloud Conversion Right
The example below illustrates an initial nonexclusive on-premise term-based
software license contract that includes the right to convert the on-premise
software license to a SaaS arrangement.
Example 12-24
On January 1, 20X0, Entity A enters into a
noncancelable two-year contract with a customer for
an up-front fee of $1 million to provide a
nonexclusive on-premise software license with
maintenance or PCS for 100 seats and a right to
convert any of the on-premise license seats to a
SaaS arrangement at the beginning of the second year
(i.e., January 1, 20X1). The SaaS has the same
functionality and features as the on-premise
software but would be hosted by A instead of being
provided on an on-premise basis. Upon exercise of
the conversion right, the customer would be required
to forfeit the on-premise software license seats and
related PCS, and the conversion is irrevocable
(i.e., the customer cannot convert back to an
on-premise software license). Upon conversion, the
customer would be required to pay an incremental fee
of $500 per seat and would receive a credit for a
pro rata portion of the “unused” on-premise software
license and related PCS to apply to the price the
customer would pay for the SaaS.
Entity A has similar
arrangements with other customers and expects the
customer to convert 50 seats at the beginning of the
second year. The stand-alone selling prices are as
follows:
12.6.4.1.1 Alternative 1A — Material Right Model (Preferred View)
Under this alternative, an entity should
determine whether the conversion right represents a material right. ASC
606-10-55-42 through 55-44 state the following:
ASC 606-10
55-42 If, in a contract,
an entity grants a customer the option to acquire
additional goods or services, that option gives
rise to a performance obligation in the contract
only if the option provides a material right to
the customer that it would not receive without
entering into that contract (for example, a
discount that is incremental to the range of
discounts typically given for those goods or
services to that class of customer in that
geographical area or market). If the option
provides a material right to the customer, the
customer in effect pays the entity in advance for
future goods or services, and the entity
recognizes revenue when those future goods or
services are transferred or when the option
expires.
55-43 If a customer has
the option to acquire an additional good or
service at a price that would reflect the
standalone selling price for that good or service,
that option does not provide the customer with a
material right even if the option can be exercised
only by entering into a previous contract. In
those cases, the entity has made a marketing offer
that it should account for in accordance with the
guidance in this Topic only when the customer
exercises the option to purchase the additional
goods or services.
55-44 Paragraph
606-10-32-29 requires an entity to allocate the
transaction price to performance obligations on a
relative standalone selling price basis. If the
standalone selling price for a customer’s option
to acquire additional goods or services is not
directly observable, an entity should estimate it.
That estimate should reflect the discount that the
customer would obtain when exercising the option,
adjusted for both of the following:
-
Any discount that the customer could receive without exercising the option
-
The likelihood that the option will be exercised.
Under the material right guidance, an entity provides a material right if
the customer has the option to purchase the SaaS at a discount that is
incremental to the range of discounts typically provided for the SaaS to
that class of customer in similar circumstances. Any incremental fee the
customer is required to pay to exercise the conversion right is compared
with the stand-alone selling price of the SaaS. While the customer may
receive a credit for the “unused” portion of the on-premise term-based
software license and related PCS, only the incremental fee to exercise
the right is considered. This is because under Alternative 1A, a
nonexclusive on-premise term-based software license is not subject to
the right of return guidance since the entity does not receive an asset
back when the right is exercised (i.e., there is no return of an
asset).12 That is, the entity is not compensated with an asset of any value
as a result of the conversion since it can replicate a nonexclusive
software license for sale to any of its customers for a nominal cost. If
the incremental fee that the customer is required to pay to convert to
the SaaS reflects the stand-alone selling price of the SaaS, no material
right exists under ASC 606-10-55-43. Instead, the conversion right is
accounted for only if and when it is exercised. On the other hand, if
the conversion right represents a material right because the incremental
fee is less than the stand-alone selling price of the SaaS, that
material right would be accounted for as a separate performance
obligation. In accordance with ASC 606-10-55-44, the entity would
estimate the stand-alone selling price of the material right as the
discount the customer would obtain when exercising the material right,
adjusted for any discount the customer could receive without exercising
the option and the likelihood that the option will be exercised. If the
conversion option is exercised, the amount allocated to the material
right plus any incremental fee paid would generally be recognized over
the remaining term of the SaaS (and the PCS if not all licenses are
converted).
In Example 12-24,
A would need to assess whether the option to receive the SaaS at a
discount represents a material right. Because the incremental fee to be
paid by the customer of $500 per seat per year is significantly less
than the stand-alone selling price for the SaaS of $5,500 per seat per
year, A would conclude that a material right exists at contract
inception. Entity A could estimate the material right’s stand-alone
selling price as the $5,000 per seat per year discount ($5,500 SaaS
stand-alone selling price − $500 incremental fee to be paid), adjusted
for the likelihood that the option will be exercised.13 We believe that it would also be acceptable for A to estimate the
stand-alone selling prices of the on-premise software license and the
PCS by applying a similar adjustment for the likelihood that the option
will be exercised (which could truncate the term of the on-premise
software license and the PCS). For example, A might estimate the
stand-alone selling prices of the on-premise software license and the
PCS under the assumption that 50 seats of the license and related PCS
will have only a one-year term if customers are expected to convert half
the seats of the license to SaaS after one year.
Assume that A determines that the relative stand-alone selling price
allocation of the transaction price results in allocations to the
on-premise software license, PCS for 20X0, PCS for 20X1, and the
material right of $600,000, $100,000, $50,000, and $250,000,
respectively.14 Entity A will recognize $600,000 of revenue on January 1, 20X0,
for the on-premise software license and $100,000 for PCS ratably over
20X0. Revenue is deferred for the $50,000 allocated to PCS for 20X1 and
the $250,000 allocated to the material right, and those amounts are
recognized as contract liabilities. If the customer elects to exercise
the conversion right on 100 seats on January 1, 20X1, A would assess its
policy for accounting for the exercise of an option that includes a
material right and apply either of the following:
-
Separate contract model — The remaining unrecognized revenue of $50,000 related to PCS is recognized immediately since PCS for all 100 seats is forfeited and therefore will not be provided in 20X1. Revenue of $300,000, which is calculated by adding the material right allocation of $250,000 and the incremental fee of $50,000 ($500 incremental fee × 100 seats), is recognized over the remaining one-year SaaS term.
-
Contract modification model — Revenue of $350,000, which is calculated by adding the remaining unrecognized revenue of $50,000 related to PCS, the material right allocation of $250,000, and the incremental fee of $50,000, is recognized over the remaining one-year SaaS term.
Alternative 1A may be less costly to implement than Alternative 1B below
because the stand-alone selling price of the material right is estimated
only at contract inception and is not subsequently revised. In addition,
because the right of return model is not applied, the variable
consideration constraint would likewise not be applicable. Therefore,
revenue recognition could potentially be less volatile under the
material right model than under the right of return model discussed
below.
12.6.4.1.2 Alternative 1B — Right of Return Model (Acceptable View)
Under this alternative, an entity applies
the right of return guidance when accounting for the potential that a
nonexclusive on-premise term-based software license will be converted to
a SaaS arrangement. ASC 606-10-55-22 through 55-26 state the
following:
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.
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).
Under Alternative 1B, an on-premise software license is generally treated
like a tangible product, and the right of return guidance applies to the
exchange of a product for another product in accordance with ASC
606-10-55-22(c). However, while an entity would generally record an
asset for its right to recover a tangible product, an entity would not
record an asset for its right to recover a nonexclusive software license
in accordance with ASC 606-10-55-23(c) since the returned license has no
value to the entity. Therefore, in applying the right of return
guidance, the entity would estimate and recognize an adjustment to the
transaction price (and reduce revenue) at contract inception to account
for the potential conversion.15 The right of return would be accounted for as variable
consideration, subject to the constraint in ASC 606-10-32-11 and
32-12.16 The estimate of the variable consideration associated with the
right of return would be reassessed at the end of each reporting period
in accordance with ASC 606-10-55-25 and 55-26, with changes in the
estimate recognized as an adjustment to revenue. If the conversion right
is exercised, the amount previously deferred as a liability17 plus the incremental fee paid would generally be recognized as
revenue over the remaining term of the SaaS (and the PCS for any
licenses that are not converted).
In Example 12-24,
A would need to determine its estimate of variable consideration and how
much of that consideration, if any, should be constrained. Assume that A
determines that $500,000 of the $1 million transaction price is variable
consideration, which is calculated as ($4,000 on-premise software
license stand-alone selling price + $1,000 PCS stand-alone selling
price) × 100 seats × 1 year. In addition, assume that A estimates
variable consideration of $250,000 — calculated as ($4,000 on-premise
software license stand-alone selling price + $1,000 PCS stand-alone
selling price) × 50 seats × 1 year — and concludes that none of the
estimated variable consideration should be constrained.18 Therefore, A will recognize revenue of $600,000, or ($4,000
on-premise software license stand-alone selling price × 100 seats × 1
year) + ($4,000 on-premise software license stand-alone selling price ×
50 seats × 1 year), on January 1, 20X0, for the on-premise software
license and $100,000, or $1,000 PCS stand-alone selling price × 100
seats × 1 year, for PCS ratably over 20X0. In addition, A will recognize
a liability of $250,000, or $1 million − $500,000 fixed consideration −
$250,000 variable consideration, for the credit that the customer is
expected to receive for the on-premise software license and PCS that are
expected to be forfeited. Entity A will reassess its estimate of
variable consideration at the end of each reporting period.
Assume that on December 31, 20X0, A revises its estimate of the liability
associated with the right of return to $500,000 because it now expects
that the customer will convert all 100 seats to a SaaS arrangement.
Entity A will reverse $200,000 of revenue for the incremental 50 seats
of on-premise software expected to be forfeited ($4,000 on-premise
software license stand-alone selling price × 50 seats × 1 year) and
reclassify the $50,000 PCS contract liability for the incremental PCS
expected to be forfeited ($1,000 PCS stand-alone selling price × 50
seats × 1 year) for a total increase in liability of $250,000 related to
the credit expected to be granted to the customer. If the customer
elects to exercise the conversion right on 100 seats on January 1, 20X1,
revenue of $550,000, which is calculated by adding the liability of
$500,000 and the incremental fee of $50,000 ($500 incremental fee × 100
seats × 1 year), is recognized over the remaining one-year SaaS
term.
Because A’s initial estimate of the liability for the credit expected to
be granted to the customer was not sufficient, a significant amount of
revenue ultimately had to be reversed in a subsequent reporting period.
This example highlights the importance of critically evaluating how much
revenue should be constrained to ensure that it is probable that a
significant reversal in cumulative revenue recognized will not occur.
Given the risk of overestimating the amount of variable consideration to
which an entity can expect to be entitled for the on-premise software
license and PCS, we believe that many software entities, particularly
those that do not have sufficient historical data on conversion rates,
may find it challenging to determine an appropriate estimate of variable
consideration and constraint as required under Alternative 1B.
12.6.4.1.3 Tabular Summary of Alternatives 1A and 1B
The following table summarizes the timing
of revenue recognition under Alternatives 1A and 1B:
12.6.4.2 Initial Contract Is Modified to Convert a Term-Based License to SaaS
The example below illustrates a situation in which a
nonexclusive on-premise term-based software license contract (1) initially
does not include the right to convert the on-premise software
license to a SaaS arrangement but (2) is subsequently modified to
immediately convert the on-premise software license to a SaaS
arrangement.
Example 12-25
On January 1, 20X0, Entity B enters into a
noncancelable two-year contract with a customer for
an up-front fee of $1 million to provide a
nonexclusive on-premise software license with PCS
for 100 seats. At contract inception, there is no
explicit or implied right to convert any of the
on-premise license seats to a SaaS arrangement.19
On January 1, 20X1, B and the customer modify the
contract to convert 50 seats of the on-premise
software license to a SaaS arrangement for the
remaining term. The SaaS has the same functionality
and features as the licensed software but would be
hosted by B instead of being provided on an
on-premise basis. The customer is required to
forfeit the 50 on-premise software license seats and
related PCS (but will retain the other 50 seats on
an on-premise basis with the related PCS for the
remaining term), and the conversion is irrevocable
(i.e., the customer cannot convert back to an
on-premise software license). Upon contract
modification and conversion, the customer is
required to pay an incremental fee of $500 per seat
and receives a credit for the pro rata portion of
the “unused” term-based license and related PCS to
apply to the price the customer will pay for the
SaaS.
The stand-alone
selling prices are as follows:
12.6.4.2.1 Alternative 2A — Prospective Model (Preferred View)
Under this alternative, an entity should
evaluate the contract modification guidance since the contract has been
modified (i.e., there is a change in the scope and price). ASC
606-10-25-12 and 25-13 state the following:
ASC 606-10
25-12 An entity shall
account for a contract modification as a separate
contract if both of the following conditions are
present:
-
The scope of the contract increases because of the addition of promised goods or services that are distinct (in accordance with paragraphs 606-10-25-18 through 25-22).
-
The price of the contract increases by an amount of consideration that reflects the entity’s standalone selling prices of the additional promised goods or services and any appropriate adjustments to that price to reflect the circumstances of the particular contract. For example, an entity may adjust the standalone selling price of an additional good or service for a discount that the customer receives, because it is not necessary for the entity to incur the selling-related costs that it would incur when selling a similar good or service to a new customer.
25-13 If a contract
modification is not accounted for as a separate
contract in accordance with paragraph
606-10-25-12, an entity shall account for the
promised goods or services not yet transferred at
the date of the contract modification (that is,
the remaining promised goods or services) in
whichever of the following ways is applicable:
-
An entity shall account for the contract modification as if it were a termination of the existing contract, and the creation of a new contract, if the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification. The amount of consideration to be allocated to the remaining performance obligations (or to the remaining distinct goods or services in a single performance obligation identified in accordance with paragraph 606-10-25-14(b)) is the sum of:
-
The consideration promised by the customer (including amounts already received from the customer) that was included in the estimate of the transaction price and that had not been recognized as revenue and
-
The consideration promised as part of the contract modification.
-
-
An entity shall account for the contract modification as if it were a part of the existing contract if the remaining goods or services are not distinct and, therefore, form part of a single performance obligation that is partially satisfied at the date of the contract modification. The effect that the contract modification has on the transaction price, and on the entity’s measure of progress toward complete satisfaction of the performance obligation, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) at the date of the contract modification (that is, the adjustment to revenue is made on a cumulative catch-up basis).
-
If the remaining goods or services are a combination of items (a) and (b), then the entity shall account for the effects of the modification on the unsatisfied (including partially unsatisfied) performance obligations in the modified contract in a manner that is consistent with the objectives of this paragraph.
The contract modification is accounted for as a termination of the
existing contract and the creation of a new contract in accordance with
ASC 606-10-25-13(a) because the modification does not solely add goods
or services at their stand-alone selling prices (i.e., goods and
services are also forfeited, and any incremental fee paid for the SaaS
is not at its stand-alone selling price) and the remaining SaaS (and PCS
for any licenses that are not converted) is distinct. The contract
modification is accounted for prospectively, and any unrecognized
revenue that was included in the transaction price from the original
contract plus any additional consideration paid as part of the contract
modification is recognized over the remaining term of the SaaS (and the
PCS for any licenses that are not converted). There is no adjustment to
or reversal of revenue for the “unused” portion of the on-premise
software license since the modification is accounted for prospectively
(i.e., revenue is not “recycled”). Further, the entity does not receive
a “returned” asset since, as similarly noted in the discussion of
Alternative 1A, the entity does not receive an asset of any value back.
Therefore, none of the pro rata credit provided for the “unused” portion
of the on-premise software license that has been forfeited would be
included as part of the consideration allocated to the SaaS (and PCS for
any licenses that are not converted).
In Example 12-25,
B will recognize revenue of $800,000 ($4,000 on-premise software license
stand-alone selling price × 100 seats × 2 years) on January 1, 20X0, for
the on-premise software license and $100,000 ($1,000 PCS stand-alone
selling price × 100 seats × 1 year) for PCS ratably over 20X0. When the
contract is modified on January 1, 20X1, B has a contract liability
related to PCS of $100,000 and receives incremental consideration of
$25,000 ($500 incremental fee × 50 seats). Entity B will therefore
recognize $125,000 ($100,000 + $25,000) for both PCS and the SaaS over
the remaining one-year term.20
12.6.4.2.2 Alternative 2B — Return Model (Acceptable View)
Under this alternative, in a manner similar to that in Alternative 2A,
the contract modification is accounted for as a termination of the
existing contract and the creation of a new contract because the
modification does not solely add goods or services at their stand-alone
selling prices (i.e., goods and services are also forfeited, and any
incremental fee paid for the SaaS is not at its stand-alone selling
price) and the remaining SaaS (and PCS if not all licenses are
converted) is distinct. However, unlike Alternative 2A, Alternative 2B
treats the “unused” portion of the on-premise software license as being
effectively returned for a credit that can be applied toward the
purchase of the SaaS. Therefore, revenue associated with the unused
portion of the returned on-premise software license is reversed. The
amount of revenue reversed (i.e., the credit associated with the unused
portion of the returned on-premise software license), together with any
unrecognized revenue that was included in the transaction price from the
original contract and any additional consideration paid as part of the
contract modification, is recognized over the remaining term of the SaaS
(and the PCS for any licenses that are not converted).
In Example 12-25,
B will recognize revenue of $800,000 ($4,000 on-premise software license
stand-alone selling price × 100 seats × 2 years) on January 1, 20X0, for
the on-premise software license and $100,000 ($1,000 PCS stand-alone
selling price × 100 seats × 1 year) for PCS ratably over 20X0. When the
contract is modified on January 1, 20X1, B will reverse revenue of
$200,000 ($4,000 on-premise software license stand-alone selling price ×
50 seats × 1 year) for the returned portion of the on-premise software
license. Entity B also has a contract liability related to PCS of
$100,000 and receives incremental consideration of $25,000 ($500
incremental fee × 50 seats). Entity B will therefore recognize revenue
of $325,000 ($200,000 + $100,000 + $25,000) for both PCS and the SaaS
over the remaining one-year term.21
12.6.4.2.3 Tabular Summary of Alternatives 2A and 2B
The following table summarizes the timing
of revenue recognition under Alternatives 2A and 2B:
12.6.4.3 Initial Contract Is Modified to Add a Cloud Conversion Right
The example below illustrates a situation in which a
nonexclusive on-premise term-based software license contract (1) initially
does not include the right to convert the on-premise software
license to a SaaS arrangement but (2) is subsequently modified to add a
right to convert the on-premise software license to a SaaS arrangement.
Example 12-26
On January 1, 20X0, Entity C enters
into a noncancelable three-year contract with a
customer for an up-front fee of $3 million to
provide a nonexclusive on-premise software license
with PCS for 100 seats. At contract inception, there
is no explicit or implied right to convert any of
the on-premise license seats to a SaaS
arrangement.22
On January 1, 20X1, C and the
customer modify the contract to add a right to
convert any of the on-premise license seats to a
SaaS arrangement at the beginning of the third year
(i.e., January 1, 20X2). The SaaS has the same
functionality and features as the on-premise
software but would be hosted by C instead of being
provided on an on-premise basis. As in Example 12-24, the
customer would be required to forfeit the on-premise
software license seats and related PCS upon exercise
of the conversion right, and the conversion is
irrevocable (i.e., the customer cannot convert back
to an on-premise software license). Upon conversion,
the customer would be required to pay an incremental
fee of $1,000 per seat and would receive a credit
for a pro rata portion of the “unused” on-premise
software license and related PCS to apply to the
price the customer would pay for the SaaS.
The
stand-alone selling prices are as follows:
12.6.4.3.1 Alternative 3A — Prospective Material Right Model (Preferred View)
Under this alternative, in a manner similar to that under Alternative 2A,
the contract modification is accounted for as a termination of the
existing contract and the creation of a new contract because the
modification does not solely add goods or services at their stand-alone
selling prices (i.e., a conversion right is added for no additional
consideration, and any incremental fee to be paid for the SaaS is not at
its stand-alone selling price) and the remaining performance obligations
(PCS and a material right) are distinct. The contract modification is
accounted for prospectively, and any unrecognized revenue that was
included in the transaction price from the original contract is
allocated to the remaining performance obligations (PCS and a material
right). If the conversion option is exercised, the amount allocated to
the material right plus any incremental fee paid would generally be
recognized over the remaining term of the SaaS (and the PCS for any
licenses that are not converted).
In Example 12-25,
C will recognize revenue of $2.4 million ($8,000 on-premise software
license stand-alone selling price × 100 seats × 3 years) on January 1,
20X0, for the software license and $200,000 ($2,000 PCS stand-alone
selling price × 100 seats × 1 year) for PCS ratably over 20X0. When the
contract is modified on January 1, 20X1, C has a contract liability
related to PCS of $400,000. Entity C will allocate that amount to the
remaining PCS and the material right on the basis of their relative
stand-alone selling prices. The material right’s stand-alone selling
price would be estimated as the $10,000 per seat per year discount
($11,000 SaaS stand-alone selling price − $1,000 incremental fee to be
paid), adjusted for the likelihood that the option will be exercised. We
believe that it would also be acceptable for C to estimate the
stand-alone selling price of the PCS by applying a similar adjustment
for the likelihood that the option will be exercised (which could
truncate the term of the PCS).
Assume that C determines that the relative stand-alone selling price
allocation of the transaction price results in allocations to the PCS
for 20X1, the PCS for 20X2, and the material right of $100,000, $50,000,
and $250,000, respectively.23 Entity C will recognize $100,000 for PCS ratably over 20X1. If the
customer elects to exercise the conversion right on 100 seats on January
1, 20X2, C would assess its policy for accounting for the exercise of an
option that includes a material right and apply either of the following:
-
Separate contract model — The remaining unrecognized revenue of $50,000 related to PCS is recognized immediately since PCS for all 100 seats is forfeited and therefore will not be provided in 20X2. Revenue of $350,000, which is calculated by adding the material right allocation of $250,000 and the incremental fee of $100,000 ($1,000 incremental fee × 100 seats), is recognized over the remaining one-year SaaS term.
-
Contract modification model — Revenue of $400,000, which is calculated by adding the remaining unrecognized revenue of $50,000 related to PCS, the material right allocation of $250,000, and the incremental fee of $100,000, is recognized over the remaining one-year SaaS term.
Alternative 3A may be less costly to implement than Alternative 3B below
because the stand-alone selling price of the material right is estimated
only upon contract modification and is not subsequently revised. In
addition, because the right of return model is not applied, the variable
consideration constraint would likewise not be applicable. Therefore,
revenue recognition could potentially be less volatile under the
prospective material right model than under the right of return model
discussed below.
12.6.4.3.2 Alternative 3B — Right of Return Model (Acceptable View)
Under this alternative, in a manner similar to that under Alternative 3A,
the contract modification is accounted for as a termination of the
existing contract and the creation of a new contract because the
modification does not solely add goods or services at their stand-alone
selling prices (i.e., a conversion right is added for no additional
consideration, which could result in the forfeiture of goods and
services, and any incremental fee to be paid for the SaaS is not at its
stand-alone selling price) and the remaining PCS is distinct. However,
unlike Alternative 3A, Alternative 3B treats any “unused” portion of the
on-premise software license as being effectively returned for a credit
that can be applied toward the purchase of the SaaS. Therefore, revenue
associated with the expected unused portion of the returned on-premise
software license is reversed. The amount of revenue reversed (i.e., the
credit associated with the potential unused portion of the returned
on-premise software license), together with any unrecognized revenue
that was included in the transaction price from the original contract,
is accounted for prospectively over the remaining two-year term. In
applying the right of return guidance, the entity would estimate and
recognize an adjustment to the transaction price (and reduce revenue)
upon contract modification to account for the potential conversion.24 The right of return would be accounted for as variable
consideration, subject to the constraint in ASC 606-10-32-11 and
32-12.25 The estimate of variable consideration associated with the right
of return would be reassessed at the end of each reporting period in
accordance with ASC 606-10-55-25 and 55-26, with changes in the estimate
recognized as an adjustment to revenue. If the conversion right is
exercised, the amount previously deferred as a liability26 plus the incremental fee paid would generally be recognized as
revenue over the remaining term of the SaaS (and the PCS for any
licenses that are not converted).
In Example 12-26,
C will recognize revenue of $2.4 million ($8,000 on-premise software
license stand-alone selling price × 100 seats × 3 years) on January 1,
20X0, for the software license and $200,000 ($2,000 PCS stand-alone
selling price × 100 seats × 1 year) for PCS ratably over 20X0. When the
contract is modified on January 1, 20X1, C would need to determine its
estimate of variable consideration and how much of that consideration,
if any, should be constrained. Assume that C determines that $1 million
of the original transaction price of $3 million is variable
consideration, which is calculated as ($8,000 on-premise software
license stand-alone selling price + $2,000 PCS stand-alone selling
price) × 100 seats × 1 year. In addition, assume that C estimates
variable consideration of $500,000 — calculated as ($8,000 on-premise
software license stand-alone selling price + $2,000 PCS stand-alone
selling price) × 50 seats × 1 year — and concludes that none of the
estimated variable consideration should be constrained.27 Therefore, C will reverse revenue of $400,000 ($8,000 on-premise
software license × 50 seats × 1 year) and reclassify $100,000 of the PCS
contract liability for the PCS expected to be forfeited ($2,000 PCS
stand-alone selling price × 50 seats × 1 year) for a total liability of
$500,000 for the credit the customer is expected to receive. Entity C
also has a remaining contract liability related to PCS of $300,000 and
recognizes $200,000 ($2,000 PCS stand-alone selling price × 100 seats ×
1 year) for PCS ratably over 20X1.
Assume that on December 31, 20X1, C revises its estimate of the liability
associated with the right of return to $1 million because it now expects
that the customer will convert all 100 seats to a SaaS arrangement.
Entity C will reverse an additional $400,000 of revenue for the
incremental 50 seats of on-premise software expected to be forfeited
($8,000 software license stand-alone selling price × 50 seats × 1 year)
and reclassify $100,000 of the remaining PCS contract liability for the
incremental PCS expected to be forfeited ($2,000 PCS stand-alone selling
price × 50 seats × 1 year) for a total increase in liability of $500,000
related to the credit expected to be granted to the customer. If the
customer elects to exercise the conversion right on 100 seats on January
1, 20X2, revenue of $1.1 million, which is calculated by adding the
liability of $1 million and the incremental fee of $100,000 ($1,000
incremental fee × 100 seats × 1 year), is recognized over the remaining
one-year SaaS term.
Because C’s initial estimate of the liability for the credit expected to
be granted to the customer was not sufficient, a significant amount of
revenue ultimately had to be reversed in a subsequent reporting period.
This example highlights the importance of critically evaluating how much
revenue should be constrained to ensure that it is probable that a
significant reversal in cumulative revenue recognized will not occur.
Given the risk of overestimating the amount of variable consideration to
which an entity can expect to be entitled for the on-premise software
license and PCS, we believe that many software entities, particularly
those that do not have sufficient historical data on conversion rates,
may find it challenging to determine an appropriate estimate of variable
consideration and constraint as required under Alternative 3B.
12.6.4.3.3 Tabular Summary of Alternatives 3A and 3B
The following table summarizes the timing
of revenue recognition under Alternatives 3A and 3B:
12.6.4.4 Initial Contract Includes Cloud Mixing Rights With a Cap
The example below illustrates an initial contract that gives the customer the
right to use nonexclusive licensed software on both an on-premise basis and
a cloud basis, subject to a cap on the total number of seats.
Example 12-27
On January 1, 20X0, Entity D enters into a
noncancelable two-year contract with a customer for
an up-front fee of $1 million to provide 1,000
nonexclusive software licenses. Under the terms of
the contract, the customer has an option to deploy
each of the 1,000 licenses as either on-premise
software or SaaS throughout the two-year license
term. That is, the customer can use any mix of
on-premise software and SaaS at any point during the
license term as long as the number of licenses used
does not exceed 1,000 seats. The on-premise software
license and the SaaS (1) are each fully functional
on their own and (2) provide the same functionality
and features (other than D’s hosting of the SaaS).
At contract inception, the customer decides to use
600 licenses as on-premise software and 400 licenses
as SaaS. Six months later, the customer decides to
use 500 licenses as on-premise software and 500
licenses as SaaS.
We believe that D may reasonably conclude that it has
promised to (1) provide the right to use on-premise
software and (2) stand ready to provide SaaS (i.e.,
to host the software license). Since each of the
promises is likely to be distinct, there are two
performance obligations to which the $1 million fee
should be allocated on a relative stand-alone
selling price basis. We believe that it would be
acceptable for D to estimate the stand-alone selling
price of each performance obligation by considering
the expected mix of on-premise software and SaaS.
The stand-alone selling prices are determined at
contract inception and should not be subsequently
revised regardless of whether the mix of on-premise
software and SaaS changes after the initial
estimate. Consideration allocated to the on-premise
software would be recognized once control of the
license is transferred to the customer. In addition,
since the performance obligation to provide SaaS is
satisfied over time, consideration allocated to this
performance obligation would be recognized as
revenue over the two-year contract term (i.e., the
period over which D is required to stand ready to
provide SaaS).
Footnotes
10
The alternatives outlined in this section are
premised on the assumption that the entity does not have an implied
obligation to provide PCS during the lapse period.
11
In this instance, it is assumed that the SaaS
arrangement is accounted for as a service contract because the customer
does not have the ability to take possession of the underlying software
on an on-premise basis in accordance with the requirements of ASC
985-20-15-5.
12
This alternative view is consistent with the accounting for
on-premise term-based software licenses that enable the customer
to terminate the license agreement without penalty. For example,
if a customer paid for a one-year on-premise term-based software
license but had the ability to cancel the arrangement for a pro
rata refund with 30 days’ notice, the term of the initial
arrangement would be 30 days, with optional renewals thereafter.
In those circumstances, the right of return guidance would not
be applied.
13
While the material right’s stand-alone selling
price could be adjusted for any discount the customer could
receive without exercising the option, this example assumes that
the customer could not receive a discount without exercising the
option.
14
The allocation of the transaction price based on relative
stand-alone selling price is included for illustrative purposes
only and uses simplistic assumptions; judgment will be required
to determine stand-alone selling prices in this and similar fact
patterns.
15
The variable consideration resulting from the right of return
would generally be estimated on the basis of the transaction
price allocated to the on-premise software and related PCS and
the amount of that allocated transaction price that is expected
to be refunded as a credit to the SaaS arrangement (i.e., the
pro rata portion of the on-premise software and related PCS that
is “unused”). If the credit plus any incremental fee required to
convert to the SaaS arrangement is less than the stand-alone
selling price of the SaaS, the entity may need to consider
whether a material right has also been granted.
16
Under ASC 606-10-32-11, an entity includes variable consideration
in the transaction price “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.”
17
A liability for a return right is typically recognized as a
refund liability in accordance with ASC 606-10-55-23(b).
However, we believe that if an entity’s contract with a customer
is noncancelable and consideration therefore would not be
refunded to the customer, it would be acceptable to recognize
the liability as a contract liability (e.g., deferred revenue)
for the entity’s expected performance associated with a SaaS
arrangement.
18
The amount of variable consideration to include
in the transaction price is provided for illustrative purposes
only and uses simplistic assumptions; judgment will be required
to estimate variable consideration and the related constraint in
this and similar fact patterns.
19
Note that if an entity’s
contract does not contain a cloud conversion right
at contract inception, a practice of allowing
customers to convert their on-premise software
license to a SaaS arrangement may create an
implied right that is similar to the explicit
right provided to the customer in Example 12-24.
Significant judgment will be required to determine
when an implied right is created in these
circumstances.
20
Entity B would generally allocate the $125,000
between PCS and the SaaS on the basis of their relative
stand-alone selling prices if required to do so for presentation
or disclosure purposes. However, because both PCS and the SaaS
are stand-ready obligations that are recognized ratably over the
same period, the $125,000 was not allocated between the two
services for purposes of this illustration.
21
Entity B would generally allocate the $325,000
between PCS and the SaaS on the basis of their relative
stand-alone selling prices if required to do so for presentation
or disclosure purposes. However, because both PCS and the SaaS
are stand-ready obligations that are recognized ratably over the
same period, the $325,000 was not allocated between the two
services for purposes of this illustration.
22
See footnote 19.
23
See footnote 14.
24
See footnote 15.
25
See footnote 16.
26
See footnote 17.
27
See footnote 18.
12.7 Sales- or Usage-Based Royalties
An entity may license its IP to a customer and in exchange receive
consideration that may include fixed and variable amounts. Certain licensing
arrangements require the customer to pay the entity a variable amount based on the
underlying sales or usage of the IP (a “sales- or usage-based royalty”). As
discussed in Chapter 6, the
revenue standard requires an entity to estimate and constrain variable consideration
in a contract with a customer. The FASB and IASB decided to create an exception to
the general model for consideration in the form of a sales- or usage-based royalty
related to licenses of IP.
ASC
606-10
55-65 Notwithstanding the
guidance in paragraphs 606-10-32-11 through 32-14, an entity
should recognize revenue for a sales-based or usage-based
royalty promised in exchange for a license of intellectual
property only when (or as) the later of the following events
occurs:
-
The subsequent sale or usage occurs.
-
The performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has been satisfied (or partially satisfied).
Under the sales- or usage-based royalty exception to the revenue
standard’s general rule requiring an entity to include variable consideration in the
transaction price, if an entity is entitled to consideration in the form of a sales- or
usage-based royalty, revenue is not recognized until (1) the underlying sales or usage
has occurred and (2) the related performance obligation has been satisfied (or partially
satisfied). That is, an entity is generally not required to estimate the amount of a
sales- or usage-based royalty at contract inception; rather, revenue would be recognized
as the subsequent sales or usage occurs (under the assumption that the associated
performance obligation has been satisfied or partially satisfied).
ASC
606-10
55-65A The guidance
for a sales-based or usage-based royalty in paragraph
606-10-55-65 applies when the royalty relates only to a license
of intellectual property or when a license of intellectual
property is the predominant item to which the royalty relates
(for example, the license of intellectual property may be the
predominant item to which the royalty relates when the entity
has a reasonable expectation that the customer would ascribe
significantly more value to the license than to the other goods
or services to which the royalty relates).
55-65B When the
guidance in paragraph 606-10-55-65A is met, revenue from a
sales-based or usage-based royalty should be recognized wholly
in accordance with the guidance in paragraph 606-10-55-65. When
the guidance in paragraph 606-10-55-65A is not met, the guidance
on variable consideration in paragraphs 606-10- 32-5 through
32-14 applies to the sales-based or usage-based
royalty.
The sales- or usage-based royalty exception only applies if the royalty is associated with
a license of IP that is the predominant item. For example, if the royalty is associated
with a franchise license and other services provided to a franchisee, the exception
would apply if the customer can reasonably expect the franchise license to have
significantly more value than the services. Example 60 in ASC 606, which is reproduced
below, illustrates a situation in which a license of IP would be considered the
predominant item to which a contract’s sales-based royalty is related.
ASC 606-10
Example 60 — Sales-Based Royalty Promised in
Exchange for a License of Intellectual Property and Other Goods
and Services
55-393 An entity, a movie
distribution company, licenses Movie XYZ to a customer. The
customer, an operator of cinemas, has the right to show the
movie in its cinemas for six weeks. Additionally, the entity has
agreed to provide memorabilia from the filming to the customer
for display at the customer’s cinemas before the beginning of
the six-week airing period and to sponsor radio advertisements
for Movie XYZ on popular radio stations in the customer’s
geographical area throughout the six-week airing period. In
exchange for providing the license and the additional
promotional goods and services, the entity will receive a
portion of the operator’s ticket sales for Movie XYZ (that is,
variable consideration in the form of a sales-based
royalty).
55-394 The entity concludes
that the license to show Movie XYZ is the predominant item to
which the sales-based royalty relates because the entity has a
reasonable expectation that the customer would ascribe
significantly more value to the license than to the related
promotional goods or services. The entity will recognize revenue
from the sales-based royalty, the only fees to which the entity
is entitled under the contract, wholly in accordance with
paragraph 606-10-55-65. If the license, the memorabilia, and the
advertising activities were separate performance obligations,
the entity would allocate the sales-based royalties to each
performance obligation.
12.7.1 Whether to Apply the Sales- or Usage-Based Royalty Exception to Only Part of the Royalties
In some contracts, a single sales- or usage-based royalty may be
related to both a license of IP and another good or service (i.e., not a
license). After the revenue standard was issued, stakeholders communicated that
it is unclear whether a sales- or usage-based royalty should ever be split into
a portion to which the sales- or usage-based royalty exception would apply and a
portion to which the general constraint on variable consideration in step 3
would apply.
The FASB clarified in ASU 2016-10 that an entity should not
split a royalty into a portion that is subject to the sales- or usage-based
royalty exception and a portion that is subject to the general constraint on
variable consideration in step 3. However, as explained in paragraph BC75(a) of
the ASU, “this amendment does not affect the requirement to allocate fees due
from a sales-based or usage-based royalty to the performance obligations (or
distinct goods or services) in the contract to which the royalty relates,
regardless of the constraint model the entity is required to apply.” For an
illustration of how an entity would comply with the allocation requirement, see
Example 35, Case B, in ASC 606-10-55-275 through 55-279, which is reproduced in
Section
7.5.1.
In ASU 2016-10, the FASB also clarified that the sales- or usage-based royalty
exception applies when the license is the predominant item (regardless of
whether the license is distinct or combined with other goods or services as a
single performance obligation) in relation to other nonlicense goods or
services. That is, an entity either applies the sales- or usage-based royalty
exception in its entirety (if the license to IP is predominant) or applies the
general variable consideration guidance (if the license to IP is not
predominant). Further, the FASB clarified in paragraph BC75(b) of the ASU that
the sales- or usage-based royalty exception would also apply in “situations in
which no single license is the predominant item to which the royalty relates but
the royalty predominantly relates to two or more licenses promised in the
contract.” However, ASC 606 does not define the term “predominant.” As a result,
an entity will need to exercise judgment when determining whether the license to
IP is predominant.
12.7.2 Interaction of Sales- or Usage-Based Royalty Exception With Measuring Progress Toward Satisfaction of a Performance Obligation
When applying the sales- or usage-based royalty exception, an entity typically
would recognize revenue when (or as) the customer’s subsequent sales or usage
occurs. However, if the sales- or usage-based royalties accelerate revenue
recognition as compared with the entity’s satisfaction (or partial satisfaction)
of the associated performance obligation, the entity may be precluded from
recognizing some or all of the revenue as the subsequent sales or usage
occurs.
ASC 606-10-55-65 specifies that revenue from a sales- or usage-based royalty
promised in exchange for a license of IP is recognized only when (or as) the
later of the following events occurs:
- The subsequent sale or usage occurs.
- The performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has been satisfied (or partially satisfied).
Accordingly, revenue should be deferred if, and to the extent that, recognition
based on subsequent sales or usage (i.e., criterion (a)) is judged to be in
advance of satisfaction of a performance obligation (i.e., criterion (b)).
Royalty arrangements can differ greatly between entities and between contracts.
Further, the timing of the recognition of royalties can depend on the nature of
the underlying IP (i.e., right to access or right to use) as well as the
structure of the royalty payments. Therefore, the determination of whether
revenue from royalties should be deferred will depend on an analysis of the
specific facts and circumstances. For example, if the performance obligation to
which the royalties are related is a right-to-access license of IP, it will
often be helpful to consider whether the structure of the royalty payments
appropriately depicts progress toward satisfying the performance obligation of
providing access to the entity’s IP throughout the license period. If the
structure of the royalty payments does appropriately depict such progress, the
criteria in ASC 606-10-55-65(a) and (b) will coincide, and no deferral of
revenue will be necessary.
Whereas the amount determined under criterion (a) will be essentially a matter of
fact (actual sales or usage multiplied by the applicable royalty rate), an
entity will typically need to use judgment to determine the amount under
criterion (b). In particular, it will be important for an entity to identify an
appropriate measure of progress toward complete satisfaction of its obligation
(e.g., providing access to the entity’s IP) in accordance with ASC 606-10-25-31.
The entity should then apply the guidance in ASC 606-10-55-65 to determine
whether any revenue from royalties that have become payable on the basis of
sales or usage exceeds the amount of revenue that the entity determined by
applying the identified measure of progress. If so, the entity should defer that
excess and recognize it as a contract liability.
Note that ASC 606-10-55-65 requires an entity to recognize revenue upon the
occurrence of the later of the events described in ASC 606-10-55-65(a)
and (b). Consequently, it is never possible to recognize revenue in advance of
the amount payable under criterion (a) (actual sales or usage multiplied by the
applicable royalty rate), even if royalty rates have been back-end loaded in
such a way that royalties lag behind the measure of progress identified.
The example below illustrates the accounting for royalties
related to a right-to-access license under various scenarios.
Example 12-28
Entity S, a sports team, enters into a noncancelable
license agreement with Entity C, a clothing
manufacturer, under which C can use the sports team’s
logo on the shirts it manufactures and sells. The
license is a right to access S’s IP and is transferred
to C over time.
Consider the following scenarios:
-
Scenario 1 — The license is for a five-year period in exchange for a flat-rate royalty payable to S for every shirt sold. During the first year of the contract, a sporting competition is held. As a result of the sporting competition, the clothing manufacturer sells a much larger than normal number of shirts.
-
Scenario 2 — The license arrangement is such that the first shirt sold triggers a royalty payment of $1 million to S and the next 999,999 units sold do not trigger any further royalty payments. Each sale in excess of 1 million items triggers a $1 royalty.
Scenario 1
In Scenario 1, S concludes that it is reasonable for the
higher royalty payments in the first year of the license
to reflect a higher proportion of the total license
value being transferred to C in that year because C has
sold a disproportionately large number of shirts.
Accordingly, the structure of the royalty payments
appropriately depicts progress toward satisfying S’s
performance obligation of providing access to its IP
throughout the license period. It is unnecessary for S
to defer any of the royalty payments received in year 1
over the remainder of the license term.
In this example, although the royalties payable are
higher in the first year of the royalty arrangement, the
magnitude of the royalty payments corresponds to greater
value received by the customer in that year and,
consequently, is still consistent with progress toward
satisfaction of the performance obligation over time.
Scenario 2
In Scenario 2, S would be likely to conclude that the
first royalty payment of $1 million corresponds to the
benefit of the license being transferred for the first 1
million sales made by C. Accordingly, S could recognize
the first royalty payment of $1 million over the period
in which the first 1 million shirts are sold. For any
sales made in excess of the first 1 million items, S
would recognize the royalty payments of $1 per shirt
sold upon the sale of each item because the structure of
those subsequent royalty payments aligns with the
transfer of the benefit of the license to C.
In this scenario, it would not be appropriate for S to
recognize as revenue the entire $1 million royalty
payment received when the first shirt is sold because
that would not be a reasonable reflection of the
progress toward satisfaction of S’s performance
obligation. Because the royalties have been front-end
loaded in a way that does not reflect the value to the
customer, the royalties that have become payable on the
basis of sales or usage exceed the amount of revenue
that S determined by applying an appropriate measure of
progress. Therefore, revenue recognized is restricted to
the latter.
The example below illustrates the accounting for variable
royalty rates over the term of a right-to-access license.
Example 12-29
Entity S, a sports team, enters into a noncancelable
license agreement with Entity M, a manufacturer, under
which M can use the sports team’s logo on a product that
it manufactures and sells. The license is a right to
access S’s IP and is transferred to the customer over
time. The license is for a five-year period in exchange
for a royalty for every product sold.
The royalty rate decreases during the term of the
license: in years 1 through 3, M is required to pay 10
percent of the sales price of the product to S, whereas
in years 4 and 5, M is required to pay 8 percent of the
sales price of the product to S. The volume of product
sales on which the royalty is based is expected to be
approximately equal for each of the five years of the
license.
To apply the guidance in ASC 606-10-55-65, S will need to
determine an appropriate measure of progress toward
satisfying the performance obligation over time. Entity
S could consider whether the structure of the royalty
payments appropriately depicts progress toward
satisfying its performance obligation to provide access
to its IP throughout the license period.
Although the royalty rate decreases for the last two
years of the license period, S might conclude that the
structure of the royalty payments appropriately depicts
progress toward satisfying its performance obligation if
the change in rate reflects the decreased value of the
license to M in those years. For example, this might be
the case if M’s product was expected to have a higher
selling price in years 1 through 3 than in years 4 and
5; the reduction in royalty rate might have been
intended to reflect the lower gross margins that M could
expect in years 4 and 5 and, consequently, the lower
value of the license to M in those years.
However, if the structure of the royalty payments does
not appropriately depict progress toward satisfying S’s
performance obligation, S will need to determine an
appropriate measure of progress and use this to apply
the guidance in ASC 606-10-55-65. For example, because
the volume of product sales is expected to be broadly
flat, S may conclude that it is reasonable to regard the
benefit of the license as being transferred to M on a
straight-line basis over time. If so, S will need to
develop an appropriate method for determining what
amount of royalties received should be deferred to meet
the requirements of ASC 606-10-55-65. For example, if S
is able to reasonably estimate the royalties, it could
apply a blended rate to recognize revenue if doing so
would result in an appropriate measure of progress and
would not result in recognizing revenue before the
underlying sales or usage occurs.
The example below illustrates the accounting for variable
royalty rates paid in exchange for a right-to-use license.
Example 12-30
An entity enters into a contract to provide a customer
with a noncancelable license to the entity’s IP. There
are no other promised goods or services in the contract.
The entity determines that the license is a right-to-use
license (i.e., a license for which revenue is recognized
at a point in time) for a three-year period. The
customer’s estimated sales are expected to be
approximately equal for each of the three years under
license. For the use of the IP, the agreement requires
the customer to pay the entity a royalty of 10 percent
of the customer’s sales in year 1, 8 percent of the
customer’s sales in year 2, and 6 percent of the
customer’s sales in year 3.
The entity should account for the royalty payments in a
manner consistent with the legal form of the arrangement
and in accordance with the exception to the variable
consideration guidance for licenses of IP that include a
sales- or usage-based royalty. Consequently, the entity
would include the royalties in the transaction price on
the basis of the applicable contractual rate and the
customer’s sales in each year and then, in accordance
with ASC 606-10-55-65, recognize revenue at the later of
when (1) the “subsequent sale or usage occurs” or (2)
the “performance obligation to which some or all of the
sales-based or usage-based royalty has been allocated
has been satisfied (or partially satisfied).” Because
the license is a right-to-use license for which control
is transferred at the inception of the contract, the
“later” of the two conditions is met when the subsequent
sales occur.
12.7.3 Scope of the Sales- or Usage-Based Royalty Exception
12.7.3.1 Sale of IP Versus License of IP in Exchange for a Sales- or Usage-Based Royalty
The sales- or usage-based royalty exception is limited to narrow
circumstances in which the entity licenses its IP. Stakeholders have
questioned the scope of the sales- or usage-based royalty recognition
constraint in arrangements that are economically similar but legally
different.
The sales- or usage-based royalty exception in ASC 606-10-55-65 should be
applied by the licensor when accounting for the transfer of a license of
IP promised in exchange for a sales- or usage-based royalty; a sale
of IP does not qualify for the exception and, accordingly, would be
accounted for under the general revenue measurement and recognition guidance
in ASC 606.
The FASB and IASB decided against applying the exception for
sales- or usage-based royalties to IP more broadly. As indicated in
paragraph BC421 of ASU 2014-09, the boards believed that although the
exception “might not be consistent with the principle of recognizing some or
all of the estimate of variable consideration,” the disadvantage of such an
inconsistency in these limited circumstances is “outweighed by the
simplicity of [the exception’s requirements], as well as by the relevance of
the resulting information for this type of transaction.” Further, the boards
concluded that the exception should not be applied “by analogy to other
types of promised goods or services or other types of variable
consideration.” The boards’ full rationale for their decision is set out in
paragraphs BC415 through BC421 of ASU 2014-09. In addition, the sales- or
usage-based royalty exception should be applied to a contract that is a
licensing arrangement in form even if the arrangement is an in-substance
sale of IP. That is, the legal form of the transaction will determine which
revenue accounting guidance is applied (see Section 12.2.2).
Example 12-31
Entity X provides its customer with a license to
broadcast one of X’s movies on the customer’s
networks in exchange for a royalty of $10,000, which
is payable each time the movie is broadcasted over
the five-year license period. Entity X considers the
guidance in ASC 606-10-55-59 through 55-64A and
concludes that X has promised to its customer a
right to use X’s IP (i.e., X has satisfied its
performance obligation at the point in time at which
the customer is able to use and benefit from the
license).
Entity X applies the requirements of ASC 606-10-55-65
and does not recognize any revenue when the license
is transferred to the customer. Instead, X
recognizes revenue of $10,000 each time the customer
uses the licensed IP and broadcasts X’s movie.
Example 12-32
Entity X sells the copyright to one of its music
albums (i.e., all rights related to the IP) to a
customer in exchange for a promise of future
payments equal to $1 for each album sold by the
customer in the future and $0.01 for each time a
song on the album is played on the radio. Entity X
considers the guidance in ASC 606-10-25-23 through
25-30 and determines that its performance obligation
is satisfied at the point in time at which it
transfers the copyright to the customer.
Entity X should not apply the sales- or usage-based
royalty exception in ASC 606-10-55-65. Rather, in
accordance with ASC 606-10-32-2 and 32-3, upon
transferring control of the IP to the customer, X
recognizes revenue equal to its estimate of the
amount to which it will be entitled, subject to the
constraint on variable consideration specified by
ASC 606-10-32-11 and 32-12. Entity X then updates
its estimate and records a cumulative catch-up
adjustment at each subsequent reporting period as
required by ASC 606-10-32-14.
12.7.3.2 Whether Application of the Sales- or Usage-Based Royalty Exception Is Optional
The guidance in ASC 606-10-55-65 must be applied whenever a license to IP
that is the predominant item is subject to a sales- or usage-based royalty.
That is, applying the exception is not optional when the consideration due
in a licensing arrangement is in the form of a sales- or usage-based
royalty. Consider the examples below.
Example 12-33
Entity LN, a professional basketball
team, licenses its logo to a manufacturer of sports
apparel and receives a royalty payment for each item
of sports apparel sold. Entity LN has historical
experience that is highly predictive of the amount
of royalties that it expects to receive.
The sales- or usage-based royalty exception in ASC
606-10-55-65 states that revenue should be
recognized at the later of when (1) the
“subsequent sale or usage occurs” or (2) the
“performance obligation to which some or all of the
sales-based or usage-based royalty has been
allocated has been satisfied (or partially
satisfied).” The application of the sales- or
usage-based royalty exception is not optional, and
LN would be precluded from recognizing the royalty
revenue until the later of (1) the actual sale of
the sports apparel or (2) LN’s satisfaction of the
performance obligation to which the sales- or
usage-based royalty is related.
Example 12-34
Entity S licenses its software
(i.e., functional IP) to an OEM, which then
integrates S’s software with its own software for
inclusion in hardware devices (e.g., computers,
tablets, and smart devices) to be sold to end users.
Entity S sells 5,000 licenses to the OEM for $10 per
license (i.e., $50,000 in total consideration) that
is paid at contract inception. In addition, S
provides the OEM with 5,000 activation keys, each of
which allows the OEM to download S’s software for
integration with the OEM’s software to be included
in one hardware device. The license agreement allows
the OEM to acquire additional software licenses for
$10 per license by requesting additional activation
keys, which S readily provides to the OEM. Entity S
has concluded that providing additional license keys
to the OEM does not transfer any additional rights
not already controlled by the OEM (see Section
12.3.3).
The OEM can return any activation keys that are paid
for but not used to download and integrate the
software for inclusion in the OEM’s devices. The OEM
will receive a refund of $10 per license for any
activation keys returned.
Because S’s consideration for the transfer of the
licensed software (i.e., functional IP) is
contingent on the OEM’s subsequent usage, S must
apply the sales- or usage-based royalty exception
described in ASC 606-10-55-65. It would not be
appropriate for S to recognize revenue on the sale
of the license with the right of return before the
OEM’s subsequent usage.
Although the OEM has paid for the activation keys at
contract inception, because the amounts are
refundable to the extent that the OEM does not use
the IP by integrating it with the OEM’s software to
be included in hardware devices, the consideration
is in the form of a sales- or usage-based royalty.
Entity S would therefore be prohibited from
recognizing revenue until the subsequent sale or
usage of the IP occurs (in accordance with
606-10-55-65(a)). That is, it would not be
appropriate for S to estimate and constrain the
amount of consideration to which it expects to be
entitled and recognize such at the time the initial
5,000 licenses are transferred to the OEM.
12.7.3.3 Fixed Payments for a License of IP Receivable on Reaching a Sales- or Usage-Based Milestone
In many industries, it is common for contracts related to a license of IP to
include payment terms tied to milestones (“milestone payments”). These
milestone payments are frequently structured in such a way that entitlement
to or payment of an amount specified in the contract is triggered once a
sales target (i.e., a specified level of sales) has been reached (e.g., a
$10 million milestone payment is triggered once cumulative sales by the
licensee exceed $100 million).
Revenue with respect to such milestone payments should be recognized when the
sales- or usage-based milestone is reached (or later if the related
performance obligation has not been satisfied), as required by the exception
for sales- or usage-based royalties set out in ASC 606-10-55-65. This
requirement applies to milestone payments triggered by reference to any
sales- or usage-based thresholds even when the milestone amount to be paid
is fixed.
However, this exception should not be applied to
milestone payments related to the occurrence of any other event or indicator
(e.g., regulatory approval or proceeding into a beta phase of testing).
Paragraph BC415 of ASU 2014-09 states, “The [FASB and IASB] decided that for
a license of intellectual property for which the consideration is based on
the customer’s subsequent sales or usage, an entity should not recognize any
revenue for the variable amounts until the uncertainty is resolved (that is,
when a customer’s subsequent sales or usage occurs).” This paragraph
illustrates the boards’ intent that the exception should apply to
consideration only when the consideration is (1) related to licenses of IP
and (2) based on the customer’s subsequent sales or usage.
12.7.3.4 Application of the Sales- or Usage-Based Royalty Exception to a Refundable Up-Front Payment
There are certain situations in which (1) an up-front payment is made for the
sale of a license and (2) the up-front payment is refundable depending on
actual sales or usage of the license. In these cases, we believe that the
sales- or usage-based royalty exception would apply.
Example 12-35
Entity S licenses its software to an OEM, which then
integrates S’s software with its own software in
hardware devices (e.g., computers, tablets, and
smart devices) to be sold to end users. The license
constitutes a right-to-use license under ASC
606-10-55-58(b) and ASC 606-10-55-59(a) (i.e., a
license of functional IP). Entity S sells 5,000
licenses to the OEM for $10 per license (i.e.,
$50,000 in total consideration) that is paid at
contract inception. In addition, S provides the OEM
with 5,000 activation keys, each of which allows the
OEM to download S’s software for integration with
the OEM’s own software to be included in one
hardware device. The license agreement allows the
OEM to acquire additional software licenses for $10
per license by requesting additional activation
keys, which S readily provides to the OEM. Entity S
has concluded that providing additional license keys
to the OEM does not transfer any additional rights
not already controlled by the OEM.
The OEM can return any unused activation keys (i.e.,
with respect to licensed software not integrated
with the OEM’s devices). The OEM will receive a
refund of $10 per license for any activation keys
returned.
Entity S’s consideration for the transfer of the
licensed software is contingent on the OEM’s
subsequent usage. Accordingly, S must apply the
requirements of ASC 606-10-55-65 (with respect to
both the initial 5,000 licenses sold and any
additional licenses that may be purchased by the
OEM).
Although the OEM has paid for the initial 5,000
activation keys at contract inception, because the
amounts are refundable to the extent that the OEM
does not use the IP by integrating it with the OEM’s
software to be included in hardware devices, the
consideration is in the form of a sales- or
usage-based royalty. Entity S would therefore be
prohibited from recognizing revenue until the
subsequent usage of the IP occurs (i.e., when the
OEM integrates the software with the hardware and no
longer has the right to return the activation
keys).
Because the sales- or usage-based royalty exception
applies to this transaction, it would not be
appropriate for S to account for the transaction
under the general guidance on sales with a right of
return (see Section
6.3.5.3).
12.7.4 Recognition of Sales-Based Royalties When Information Is Received From the Licensee After the End of the Reporting Period
In certain licensing arrangements for which the consideration received from the
customer is based on the subsequent sales of IP, information associated with
those subsequent sales may not be available before the end of the reporting
period. Provided that the related performance obligation has been satisfied or
partially satisfied, ASC 606-10-55-65 requires that sales-based royalties
received for a license of IP be recognized when the subsequent sale or usage by
the licensee occurs. It would not be appropriate to delay recognition until the
sales information is received.
Example 12-36
Entity LN enters into a software license with Entity B
that allows inclusion of the software in computers that
B sells to third parties. Under the terms of the
license, LN receives royalties on the basis of the
number of computers sold that include the licensed
software. Upon delivery of the software to B, LN
satisfies the performance obligation to which the
sales-based royalty was allocated. Thereafter, LN
receives quarterly sales data in arrears, which allow it
to calculate the royalty payments due under the
license.
Entity LN should recognize revenue (royalty payments) for
computer sales made by B up to the end of its reporting
period even though sales data had not been received at
the end of that reporting period.
In this scenario, royalties should be recognized for
sales made by B up to the end of LN’s reporting period
on the basis of sales data received before LN’s
financial statements are issued or available to be
issued. If necessary, LN should estimate sales made in
any period not covered by such data. It would not be
appropriate for entities to omit sales-based royalties
from financial statements merely because the associated
sales data were received after the end of the reporting
period or were not received when the financial
statements were issued or available to be issued.
This conclusion is consistent with the
following view expressed in a speech delivered on
June 9, 2016, by Wesley Bricker, then deputy chief
accountant in the SEC's Office of the Chief Accountant,
at the 35th Annual SEC and Financial Reporting Institute
Conference:
The standard setters did not
provide a lagged reporting exception with the new
standard. Accordingly, I believe companies should
apply the sales- and usage-based royalty guidance
as specified in the new standard. The reporting,
which may require estimation of royalty usage,
should be supported by appropriate internal
accounting controls.
12.7.5 Sales- or Usage-Based Royalties With a Minimum Guarantee
Sometimes, the sales- or usage-based royalty may be subject to a minimum
guarantee, which establishes a floor for the amount of consideration to be paid
to the entity. The sales- or usage-based royalty exception applies only when the
consideration due under the licensing agreement is variable and the variability
is directly related to sales or usage of the underlying IP. That is, the
exception does not apply to any fixed consideration in a licensing
arrangement.
12.7.5.1 Application of the Sales- or Usage-Based Royalty Exception to Guaranteed Minimum Royalties Related to Functional IP
If there are no other performance obligations, a minimum guarantee related to
functional IP (i.e., a right-to-use license) should be recognized as revenue
at the point in time that the entity transfers control of the license to the
customer. Any royalties that exceed the minimum guarantee should be
recognized as the subsequent sales or usage related to the IP occurs, in
accordance with ASC 606-10-55-65.
Example 12-37
Entity LH enters into a five-year license agreement
with Customer MC under which MC can air all of the
existing seasons of a TV show in exchange for
royalties from MC’s sales and usage of the IP. In
addition, the contract contains a minimum guarantee
of $1 million per year. The existing seasons of the
TV show have stand-alone functionality and thus
represent functional IP.
Ignoring potential effects of financing, LH should
recognize the total minimum guarantee of $5 million
for the contract when control of the functional IP
is transferred to the customer and the license
period begins. This is because (1) the $5 million is
fixed as a result of the minimum guarantee and (2)
the underlying IP (i.e., the TV show) is functional
(revenue is recognized at a point in time).
Additional royalties that exceed the $1 million
minimum guarantee in any year should be recognized
as the subsequent sales and usage occur.
The above issue is addressed in Implementation Q&A 60 (compiled from previously
issued TRG Agenda Papers 58 and 60). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix
C.
12.7.5.2 Application of the Sales- or Usage-Based Royalty Exception to Guaranteed Minimum Royalties Related to Symbolic IP
For licenses of symbolic IP, the revenue standard does not prescribe a
one-size-fits-all model for recognizing revenue over time in situations in
which a sales- or usage-based royalty contract with a customer includes a
minimum guaranteed amount of consideration. As discussed at the November
2016 TRG meeting, the following are three acceptable approaches for
recognizing revenue in those situations:
-
Approach A — Recognize revenue as the subsequent sales or usage occurs in accordance with ASC 606-10-55-65 if an entity expects that the total royalties will exceed the minimum guarantee. This approach would be appropriate only if the estimated sales- or usage-based royalties are expected to exceed the minimum guarantee.
-
Approach B — Estimate the transaction price (as fixed consideration plus expected royalties to be earned over the license term) and recognize revenue over time by using an appropriate measure of progress, but limit cumulative revenue recognized to the cumulative royalties in excess of the minimum guarantee. Like Approach A, this approach would be appropriate only if the estimated sales- or usage-based royalties are expected to exceed the minimum guarantee. Under this approach, an entity will need to periodically revisit its estimate of the total consideration (fixed and variable) and update its measure of progress accordingly (which may result in a cumulative adjustment to revenue).
-
Approach C — Recognize the minimum guarantee over time by using an appropriate measure of progress over the license period, and recognize incremental royalties in excess of the minimum guarantee as the subsequent sales or usage related to those incremental royalties occurs.
An entity should evaluate its facts and circumstances to determine which
method under the standard appropriately depicts its progress toward
completion. In addition, entities should consider providing appropriate
disclosures to help users of their financial statements understand which
approach is being applied. Examples of such disclosures include the key
judgments the entity applied in selecting a measure of progress for
recognizing revenue from a license of symbolic IP.
The above issue is addressed in Implementation Q&A 59 (compiled from previously
issued TRG Agenda Papers 58 and 60). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
The example below further illustrates how to apply the three acceptable
approaches for recognizing revenue from symbolic IP arrangements with sales-
or usage-based royalties that include minimum guarantees.
Example 12-38
Entity G, a professional sports team, enters into a
three-year contract with Entity Y to license G’s
team logo trademark (which is symbolic IP). Entity Y
intends to include the trademark on various sports
merchandise (e.g., hats, shirts, and shorts) and
sell this merchandise to end consumers. In exchange
for the three-year trademark license, Y will pay G
sales-based royalties equal to 6 percent of Y’s
gross sales of merchandise that includes G’s
trademark. The contract also guarantees a minimum of
$1.5 million in royalties for the three-year
period.
Over the term of the contract, Y generates annual
gross sales, and is therefore required to pay
royalties to G, as follows:
- Year 1 — Annual gross sales of $15 million, royalties of $900,000.
- Year 2 — Annual gross sales of $8 million, royalties of $480,000.
- Year 3 — Annual gross sales of $13 million, royalties of $780,000.
Entity G would recognize revenue over the three-year
period under Approach A, B, or C in the manner
described below.
Approach A
Entity G could apply Approach A only if it expects
its estimated sales-based royalties to exceed the
minimum guarantee of $1.5 million. Under this
approach, G would use a measure of progress that
corresponds to the annual gross sales realized by Y
(for which there are corresponding royalty payments
due to G) and recognize annual revenue in the
amounts shown in the table below.
Under Approach A, G would recognize revenue as the
subsequent sales occur. Entity G should monitor its
estimates of royalties each reporting period and
update its measure of progress if it no longer
expects to earn total royalties that exceed the
minimum guarantee.
Approach B
Like Approach A, Approach B could be applied only if
G expects its estimated sales-based royalties to
exceed the minimum guarantee of $1.5 million. Under
this approach, G would estimate the total
transaction price (for the three-year period) and
select a measure of progress that results in G’s
recognition of the estimated (and constrained)
transaction price as G transfers the right to access
its symbolic IP to Y. If G uses a time-based measure
of progress, it would recognize annual revenue in
the amounts shown in the table below.
Under Approach B, G would estimate the total
consideration it expects to receive from Y during
the three-year period (as fixed consideration for
the minimum guarantee plus expected royalties to be
earned over the license term) and recognize revenue
over time by using an appropriate measure of
progress, but limit cumulative revenue recognized to
the cumulative royalties due. Therefore, in year 1,
G recognizes annual revenue of $720,000, one-third
of the total expected consideration to be received
of $2.16 million. However, in year 2, G is limited
to recognizing revenue of $660,000 because the
cumulative royalties received through year 2 is
$1.38 million. As a result, the cumulative revenue
recognized through year 2 is constrained to the
cumulative amount of royalties due.
Entity G should periodically revisit its estimate of
the total consideration (fixed and variable) and
update its measure of progress accordingly (which
may result in a cumulative adjustment to revenue).
Entity G should also monitor its estimates of
royalties each reporting period and update its
measure of progress if it no longer expects to earn
total royalties that exceed the minimum
guarantee.
Approach C
Entity G would be required to apply Approach C if it
does not expect its estimated sales-based royalties
to exceed the minimum guarantee of $1.5 million.
Under this approach, G would recognize the minimum
guarantee over time by using an appropriate measure
of progress and recognize incremental royalties in
excess of the minimum guarantee as the subsequent
sales related to those incremental royalties occur.
If G uses a time-based measure of progress, it would
recognize annual revenue in the amounts shown in the
table below.
Under Approach C, G would recognize $500,000 in each
of year 1 and year 2, which is equal to one-third of
the minimum guarantee amount of $1.5 million. Entity
G would not recognize any variable consideration
(i.e., royalties earned above the $1.5 million
minimum guarantee) until year 3, when the cumulative
consideration received exceeds the minimum guarantee
of $1.5 million. The revenue recognized in year 3 is
the sum of (1) the remaining $500,000 of the minimum
guarantee and (2) the incremental royalties of
$660,000 in excess of the minimum guarantee.
12.7.6 Allocating Fixed Consideration and Sales- or Usage-Based Royalties in a Licensing Arrangement With More Than One Performance Obligation
Complexities related to the allocation of the transaction price
to multiple performance obligations may arise when licensing contracts include a
combination of fixed consideration and royalties subject to the sales- or
usage-based royalty exception. As discussed in Section 12.7.5.2, there are several
acceptable approaches to accounting for a licensing arrangement that includes
both a minimum guaranteed amount and a sales- or usage-based royalty for any
sales or usage in excess of that minimum amount in a license of symbolic IP.
ASC 606-10
Example 35 — Allocation of Variable Consideration
55-270 An entity
enters into a contract with a customer for two
intellectual property licenses (Licenses X and Y), which
the entity determines to represent two performance
obligations each satisfied at a point in time. The
standalone selling prices of Licenses X and Y are $800
and $1,000, respectively.
Case A — Variable Consideration Allocated Entirely to
One Performance Obligation
55-271 The price
stated in the contract for License X is a fixed amount
of $800, and for License Y the consideration is 3
percent of the customer’s future sales of products that
use License Y. For purposes of allocation, the entity
estimates its sales-based royalties (that is, the
variable consideration) to be $1,000, in accordance with
paragraph 606-10-32-8.
55-272 To allocate
the transaction price, the entity considers the criteria
in paragraph 606-10-32-40 and concludes that the
variable consideration (that is, the sales-based
royalties) should be allocated entirely to License Y.
The entity concludes that the criteria in paragraph
606-10-32-40 are met for the following reasons:
-
The variable payment relates specifically to an outcome from the performance obligation to transfer License Y (that is, the customer’s subsequent sales of products that use License Y).
-
Allocating the expected royalty amounts of $1,000 entirely to License Y is consistent with the allocation objective in paragraph 606-10-32-28. This is because the entity’s estimate of the amount of sales-based royalties ($1,000) approximates the standalone selling price of License Y and the fixed amount of $800 approximates the standalone selling price of License X. The entity allocates $800 to License X in accordance with paragraph 606-10-32-41. This is because, based on an assessment of the facts and circumstances relating to both licenses, allocating to License Y some of the fixed consideration in addition to all of the variable consideration would not meet the allocation objective in paragraph 606-10-32-28.
55-273 The entity
transfers License Y at inception of the contract and
transfers License X one month later. Upon the transfer
of License Y, the entity does not recognize revenue
because the consideration allocated to License Y is in
the form of a sales-based royalty. Therefore, in
accordance with paragraph 606-10-55-65, the entity
recognizes revenue for the sales-based royalty when
those subsequent sales occur.
55-274 When License
X is transferred, the entity recognizes as revenue the
$800 allocated to License X.
Case B — Variable Consideration Allocated on the Basis
of Standalone Selling Prices
55-275 The price
stated in the contract for License X is a fixed amount
of $300, and for License Y the consideration is 5
percent of the customer’s future sales of products that
use License Y. The entity’s estimate of the sales-based
royalties (that is, the variable consideration) is
$1,500 in accordance with paragraph 606-10-32-8.
55-276 To allocate
the transaction price, the entity applies the criteria
in paragraph 606-10-32-40 to determine whether to
allocate the variable consideration (that is, the
sales-based royalties) entirely to License Y. In
applying the criteria, the entity concludes that even
though the variable payments relate specifically to an
outcome from the performance obligation to transfer
License Y (that is, the customer’s subsequent sales of
products that use License Y), allocating the variable
consideration entirely to License Y would be
inconsistent with the principle for allocating the
transaction price. Allocating $300 to License X and
$1,500 to License Y does not reflect a reasonable
allocation of the transaction price on the basis of the
standalone selling prices of Licenses X and Y of $800
and $1,000, respectively. Consequently, the entity
applies the general allocation requirements in
paragraphs 606-10-32-31 through 32-35.
55-277 The entity
allocates the transaction price of $300 to Licenses X
and Y on the basis of relative standalone selling prices
of $800 and $1,000, respectively. The entity also
allocates the consideration related to the sales-based
royalty on a relative standalone selling price basis.
However, in accordance with paragraph 606-10-55-65, when
an entity licenses intellectual property in which the
consideration is in the form of a sales-based royalty,
the entity cannot recognize revenue until the later of
the following events: the subsequent sales occur or the
performance obligation is satisfied (or partially
satisfied).
55-278 License Y is
transferred to the customer at the inception of the
contract, and License X is transferred three months
later. When License Y is transferred, the entity
recognizes as revenue the $167 ($1,000 ÷ $1,800 × $300)
allocated to License Y. When License X is transferred,
the entity recognizes as revenue the $133 ($800 ÷ $1,800
× $300) allocated to License X.
55-279 In the first
month, the royalty due from the customer’s first month
of sales is $200. Consequently, in accordance with
paragraph 606-10-55-65, the entity recognizes as revenue
the $111 ($1,000 ÷ $1,800 × $200) allocated to License Y
(which has been transferred to the customer and is
therefore a satisfied performance obligation). The
entity recognizes a contract liability for the $89 ($800
÷ $1,800 × $200) allocated to License X. This is because
although the subsequent sale by the entity’s customer
has occurred, the performance obligation to which the
royalty has been allocated has not been satisfied.
Example 57 — Franchise Rights
55-375 An entity
enters into a contract with a customer and promises to
grant a franchise license that provides the customer
with the right to use the entity’s trade name and sell
the entity’s products for 10 years. In addition to the
license, the entity also promises to provide the
equipment necessary to operate a franchise store. In
exchange for granting the license, the entity receives a
fixed fee of $1 million, as well as a sales-based
royalty of 5 percent of the customer’s sales for the
term of the license. The fixed consideration for the
equipment is $150,000 payable when the equipment is
delivered.
Identifying Performance Obligations
55-376 The entity
assesses the goods and services promised to the customer
to determine which goods and services are distinct in
accordance with paragraph 606-10-25-19. The entity
observes that the entity, as a franchisor, has developed
a customary business practice to undertake activities
such as analyzing the consumers’ changing preferences
and implementing product improvements, pricing
strategies, marketing campaigns, and operational
efficiencies to support the franchise name. However, the
entity concludes that these activities do not directly
transfer goods or services to the customer.
55-377 The entity determines
that it has two promises to transfer goods or services:
a promise to grant a license and a promise to transfer
equipment. In addition, the entity concludes that the
promise to grant the license and the promise to transfer
the equipment are each distinct. This is because the
customer can benefit from each good or service (that is,
the license and the equipment) on its own or together
with other resources that are readily available (see
paragraph 606-10-25-19(a)). The customer can benefit
from the license together with the equipment that is
delivered before the opening of the franchise, and the
equipment can be used in the franchise or sold for an
amount other than scrap value. The entity also
determines that the promises to grant the franchise
license and to transfer the equipment are separately
identifiable in accordance with the criterion in
paragraph 606-10-25-19(b). The entity concludes that the
license and the equipment are not inputs to a combined
item (that is, they are not fulfilling what is, in
effect, a single promise to the customer). In reaching
this conclusion, the entity considers that it is not
providing a significant service of integrating the
license and the equipment into a combined item (that is,
the licensed intellectual property is not a component
of, and does not significantly modify, the equipment).
Additionally, the license and the equipment are not
highly interdependent or highly interrelated because the
entity would be able to fulfill each promise (that is,
to license the franchise or to transfer the equipment)
independently of the other. Consequently, the entity has
two performance obligations:
- The franchise license
- The equipment.
Allocating the Transaction Price
55-378 The entity
determines that the transaction price includes fixed
consideration of $1,150,000 and variable consideration
(5 percent of the customer’s sales from the franchise
store). The standalone selling price of the equipment is
$150,000 and the entity regularly licenses franchises in
exchange for 5 percent of customer sales and a similar
upfront fee.
55-379 The entity
applies paragraph 606-10-32-40 to determine whether the
variable consideration should be allocated entirely to
the performance obligation to transfer the franchise
license. The entity concludes that the variable
consideration (that is, the sales-based royalty) should
be allocated entirely to the franchise license because
the variable consideration relates entirely to the
entity’s promise to grant the franchise license. In
addition, the entity observes that allocating $150,000
to the equipment and allocating the sales-based royalty
(as well as the additional $1 million in fixed
consideration) to the franchise license would be
consistent with an allocation based on the entity’s
relative standalone selling prices in similar contracts.
Consequently, the entity concludes that the variable
consideration (that is, the sales-based royalty) should
be allocated entirely to the performance obligation to
grant the franchise license.
Licensing
55-380 The
entity assesses the nature of the entity’s promise to
grant the franchise license. The entity concludes that
the nature of its promise is to provide a right to
access the entity’s symbolic intellectual property. The
trade name and logo have limited standalone
functionality; the utility of the products developed by
the entity is derived largely from the products’
association with the franchise brand. Substantially all
of the utility inherent in the trade name, logo, and
product rights granted under the license stems from the
entity’s past and ongoing activities of establishing,
building, and maintaining the franchise brand. The
utility of the license is its association with the
franchise brand and the related demand for its
products.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
-
Subparagraph superseded by Accounting Standards Update No. 2016-10.
55-381 The
entity is granting a license to symbolic intellectual
property. Consequently, the license provides the
customer with a right to access the entity’s
intellectual property and the entity’s performance
obligation to transfer the license is satisfied over
time in accordance with paragraph 606-10-55-58A. The
entity recognizes the fixed consideration allocable to
the license performance obligation in accordance with
paragraph 606-10-55-58A and paragraph 606-10-55-58C.
This includes applying paragraphs 606-10-25-31 through
25-37 to identify the method that best depicts the
entity’s performance in satisfying the license (see
paragraph 606-10-55-382).
55-382 Because the
consideration that is in the form of a sales-based
royalty relates specifically to the franchise license
(see paragraph 606-10-55-379), the entity applies
paragraph 606-10-55-65 in recognizing that consideration
as revenue. Consequently, the entity recognizes revenue
from the sales-based royalty as and when the sales
occur. The entity concludes that recognizing revenue
resulting from the sales-based royalty when the
customer’s subsequent sales occur is consistent with the
guidance in paragraph 606-10-55-65(b). That is, the
entity concludes that ratable recognition of the fixed
$1 million franchise fee plus recognition of the
periodic royalty fees as the customer’s subsequent sales
occur reasonably depict the entity’s performance toward
complete satisfaction of the franchise license
performance obligation to which the sales-based royalty
has been allocated.
The examples below illustrate possible approaches that may be
appropriate when a licensing arrangement includes (1) fixed consideration and
sales- or usage-based royalties and (2) more than one performance
obligation.
Example 12-39
Entity X, a cable TV network company, enters into a
four-year contract with Entity Y on January 1, 201X. The
contract gives Y an exclusive license, including digital
streaming rights (within specific territories), to a
preexisting library of X’s historical content in
addition to any new content that becomes available
during the four-year term. Entity X determines that
there are two distinct performance obligations in
accordance with ASC 606-10-25-19 through 25-22 as follows:
-
A license of the preexisting library of content (i.e., the historical content) transferred to Y at the outset of the contract. Entity X determines that this is a right-to-use license of IP for which revenue is recognized at a point in time in accordance with ASC 606-10-55-63.
-
A license for any new content that is transferred to Y as it becomes available throughout the duration of the contract. Entity X determines that the obligation to update the license arrangement to include new content is a stand-ready obligation to provide updates to Y over the license term. Entity X concludes that it will satisfy this obligation ratably over the four-year license term.
Entity Y is required to pay X a royalty fee of $2 per
subscriber per month over the contract term, subject to
a minimum guaranteed amount of $10 million. Entity X
estimates that over the contract term, it is probable
that X will be entitled to total royalties of $30
million. In addition, X determines that (1) the
stand-alone selling price of the license of historical
content is $12 million (40 percent of the total
estimated transaction price) and (2) the stand-alone
selling price of the license of new content is $18
million (60 percent of the total estimated transaction
price). The number of subscribers to Y’s service in year
1 is such that X is entitled to a royalty of $13
million.
Entity X determines that there are at least two
acceptable approaches (“Approach A” and “Approach B”) to
allocating the $10 million guaranteed minimum fee and
the $2 per subscriber royalty fee between the two
performance obligations in the contract.
Whichever approach is adopted, as discussed below, X will
need to consider whether it is required to constrain the
amount of revenue recognized in accordance with ASC
606-10-32-11 and apply the sales- or usage-based royalty
exception in ASC 606-10-55-65.
Revenue Recognition Based on Initial Allocation of
Fixed and Variable Consideration
Approach A
Under Approach A, X allocates both the fixed and variable
consideration to each performance obligation on the
basis of the relative stand-alone selling prices of the
historical and new content as follows:
In year 1, X recognizes revenue as follows:
- $4 million of the guaranteed minimum revenue allocated to the historical content is recognized upon the initial transfer of the historical content to Y.
- $1.5 million of the guaranteed minimum revenue is allocated to and recognized for the new content ($6 million ÷ 4 years of license term).
- The royalty payments received in excess of the $10 million guaranteed revenue are subject to the guidance in ASC 606-10-55-65 on recognizing revenue related to sales- or usage-based royalties. Therefore, $3 million ($13 million of royalties owed for year 1 less the $10 million of guaranteed minimum revenue) is allocated on a relative stand-alone selling price basis. Accordingly, $1.2 million is allocated to and recognized for the historical content, and $1.8 million is allocated to and recognized for the new content.
Thus, the total revenue recognized in year 1 under
Approach A is $8.5 million, as illustrated in the table
below.
Note that the royalties in excess of the guaranteed
minimum that are allocated to the new content in year 1
($1.8 million) do not need to be restricted in
accordance with ASC 606-10-55-65 because the total
revenue recognized for the new content ($3.3 million) is
less than the amount corresponding to the measure of
progress ($18 million ÷ 4 years of license term = $4.5
million).
Approach B
Under Approach B, X allocates the
consideration on a first in, first out basis.
Accordingly, the guaranteed minimum and estimated
royalties are first allocated to the historical content
and then to the new content, as illustrated in the table
below. Note that the estimated royalties are subject to
the constraint 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 (see
Section 6.3.3
for further discussion of this objective).
In year 1, X recognizes revenue as follows:
- $10 million of the guaranteed minimum allocated to the historical content is recognized upon the initial transfer of the historical content to Y.
- $2 million of the variable consideration allocated to the historical content is recognized when the first $2 million of royalties earned in excess of the guaranteed $10 million becomes payable by Y.
- While on a pro rata basis, X would recognize $4.5 million ($18 million ÷ 4 years of license term) with respect to the new content, X is able to recognize only $1 million with respect to the new content ($13 million of royalties owed for year 1 less the $12 million recognized with respect to the historical content) since the variable consideration is subject to the restriction in ASC 606-10-55-65 on recognizing revenue related to sales- or usage-based royalties.
Thus, the total revenue recognized in year 1 under
Approach B is $13 million, as illustrated in the table
below.
Revenue Recognition Based on Updated Allocation of
Fixed and Variable Consideration
Each of the approaches discussed above
is affected differently by a change in the estimate of
royalties to which the entity expects to be entitled.
The impact of any change in estimate under each approach
should be carefully considered in accordance with the
guidance on estimating and constraining variable
consideration, whose objective is to include some or all
of an amount of variable consideration estimated in the
transaction price 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 (see Section 6.3.3 for further discussion of
this objective).
Suppose that after one year, X updates the transaction
price in accordance with ASC 606-10-32-14 and concludes
that it is probable that X will be entitled to total
royalties of only $20 million over the four-year
contract term as a result of changing market conditions
(i.e., $10 million less than the original estimated
transaction price). Under ASC 606-10-32-43, X is
required to reallocate the transaction price to each
performance obligation on the same basis as at contract
inception. Also assume that in year 2, only $2 million
in additional royalties is earned and payable to X
(total consideration of $15 million has been earned to
date, and there is an expectation that an additional $5
million will be received for the remaining contract
term).
The effect of the updated expectations on revenue
recognized in year 2 under each approach is discussed
below.
Approach A
Under Approach A, X updates the allocation of the fixed
and variable consideration to each performance
obligation on the basis of the relative stand-alone
selling prices of the historical and new content as
follows:
Accordingly, revenue is recognized as follows:
Note that the royalties allocated to the
new content ($3 million) are not restricted in
accordance with ASC 606-10-55-65 because the total
revenue recognized for new content ($6 million) does not
exceed the amount corresponding to the measure of
progress, or ($12 million ÷ 4 years of license term) × 2
years = $6 million.
Approach B
Under Approach B, X updates the allocation of the fixed
and variable consideration to each performance
obligation on the basis of the relative stand-alone
selling prices of the historical and new content as
follows:
As a result of the updated estimate of the transaction
price, X is limited in recognizing additional revenue in
year 2 when it reallocates the total expected
consideration between the historical and new content.
Revenue is recognized as follows:
Note that the royalties allocated to the
new content ($5 million) are restricted under Approach B
in accordance with ASC 606-10-55-65 because the total
revenue otherwise recognized for the new content ($7
million) would exceed the amount corresponding to the
measure of progress, or ($12 million ÷ 4 years of
license term) × 2 years = $6 million. Consequently, $1
million of the royalties received in year 2 would need
to be deferred.
As noted in the tables above, Approach A and Approach B
have different accounting outcomes for both the
consideration recognized as revenue in year 1 of the
agreement and the changes in subsequent years to the
estimated consideration to which X expects to be
entitled. Care should be taken in the election of a
policy, and careful evaluation of the objective behind
constraining estimates of variable consideration should
guide this election.
Example 12-40
Entity K, a biotechnology company, enters into a contract
with Customer C to provide a license of functional IP as
well as R&D services. As a result of the late stage
of development of the IP and other factors, K has
concluded that the license and R&D services are
distinct performance obligations. The contract
consideration includes (1) an up-front payment ($30
million), (2) royalties of 8 percent of future sales
(estimated to be $50 million), and (3) a reimbursement
for the R&D services at cost plus a fixed margin
(estimated to be $20 million). Entity K has concluded
that the license to IP is predominant in the
arrangement.
Entity K has estimated the stand-alone selling prices of
the performance obligations as follows:
Performance Obligation
|
Stand-Alone Selling Price
|
---|---|
License
|
$ 80 million
|
R&D services
|
$ 20 million
|
Because the sales- or usage-based
royalty exception is a recognition constraint (applied
as part of step 5 of ASC 606’s revenue model), K could
still consider the sales-based royalties in the
estimated transaction price to be allocated even though
they are subject to the sales- or usage-based royalty
exception (and are constrained at contract inception).
That is, K might reasonably conclude that it can
allocate the royalties (estimated to be $50 million)
together with the up-front fee of $30 million (a total
expected amount of $80 million) entirely to the license
since such allocation would be consistent with the
stand-alone selling price of the license and, therefore,
with the allocation objective in ASC 606-10-32-28 and
ASC 606-10-32-40. Entity K could also allocate the $20
million to which it expects to be entitled for
performing the R&D services entirely to the R&D
services performance obligation. Such allocation would
also be consistent with the allocation objective because
the consideration to which K expects to be entitled as
it performs the R&D services represents the
stand-alone selling price for those services. The
approach described herein is consistent with the
approach illustrated in Example 35, Case A, of ASC
606.
As a result of the above allocations, K would recognize
(1) revenue of $30 million when the license is
transferred at contract inception ($80 million total
consideration allocated to the license, of which $50
million is constrained because of the sales- or
usage-based royalty exception) and (2) revenue for the
R&D services at the contractual reimbursement rate
as services are performed. Additional revenue related to
the transfer of the license would be recognized as
royalties become due (i.e., once sales associated with
the licensed IP occur).
Example 12-41
Assume the same facts as in the previous
example, except that the R&D services are reimbursed
by Customer C at cost with no margin (estimated to be
$15 million). Since Entity K would not typically provide
R&D services on a stand-alone basis for cost (i.e.,
with no margin), use of the allocation approach
described in the previous example would not result in an
allocation that is consistent with the allocation
objective in ASC 606-10-32-28 and ASC 606-10-32-40.
Consequently, K would not be able to use the same
approach in this situation.
If K continues to believe that the royalties are entirely
related to the license, K could allocate the total
expected transaction price ($95 million) to the
performance obligations on a relative stand-alone
selling price basis as follows:
Performance Obligation
|
Stand-Alone Selling Price
|
Relative Allocation
|
Allocation of Estimated Contract
Consideration
|
---|---|---|---|
License
|
$ 80 million
|
80%
|
$ 76 million
|
R&D services
|
$ 20 million
|
20%
|
$ 19 million
|
Total
|
$ 100 million
|
100%
|
$ 95 million
|
As the table illustrates, this approach would result in
the allocation of $76 million to the license and $19
million to the R&D services. If K concludes that the
royalties are entirely related to the license (i.e., the
criteria in ASC 606-10-32-40 are met), it would
recognize revenue of $26 million when the license is
transferred at contract inception (the $76 million
allocated transaction price less the $50 million that is
constrained because of the sales- or usage-based royalty
exception). Further, K would recognize (1) revenue of
$19 million allocated to the R&D services as the
R&D services are performed by using a single measure
of progress and (2) additional revenue related to the
transfer of the license as royalties become due (i.e.,
once sales associated with the licensed IP occur).
12.7.7 Applicability of the Sales- or Usage-Based Royalty Exception to Agents
The guidance in ASC 606-10-55-65 discusses situations in which
an entity transfers a license of IP to a customer in exchange for a sales- or
usage-based royalty. However, in some cases, an entity may be compensated in the
form of a sales- or usage-based royalty for services that are directly related
to a license of IP, but the entity itself is not licensing the IP because it is
not the owner of the IP. The examples below illustrate situations in which an
entity provides services in exchange for a sales- or usage-based royalty that is
directly related to a license of IP.
Example 12-42
Company X, acting as a film distributor (agent), enters
into arrangements to distribute filmed media content to
theaters or other outlets (e.g., video on demand service
providers) to make the content available for viewing by
various audiences. The filmed content was produced and
is owned by another entity (the “licensor”). In such
arrangements, X acts as an agent between the licensor
and the customer (e.g., a theater or another outlet). In
exchange for performing the agency services, X is
entitled to variable consideration based on the
licensor’s royalties underlying the sales related to the
licensed IP (e.g., ticket sales). The licensor’s
earnings and, in turn, the fees earned by X are directly
tied to the sales of the licensed IP.
Example 12-43
Company Y, acting as a talent agent, finds roles for its
clients in films or other theatrical productions. Each
of Y’s clients is paid a stated royalty percentage based
on the sales or usage of the film or production (i.e.,
the IP), and Y’s commission is equal to a stated
percentage of the royalty earned by the client. Company
Y does not own or control the film or production at any
point, and neither does Y’s client; rather, Y’s ability
to generate commissions depends on how the film or
production is monetized. Accordingly, the client’s
earnings and, in turn, the commissions earned by Y are
directly tied to the sales or usage of the licensed
IP.
Example 12-44
Company Z, acting as an agent, identifies licensees to
enter into contracts with Z’s clients (i.e., licensors).
Each of Z’s clients is paid a stated royalty percentage
based on the sales and usage of the IP licensed by the
licensee (e.g., a college logo on merchandise), and Z’s
commission is a stated percentage of the royalty earned
by its client. Company Z does not own or control the IP
at any point; rather, Z’s ability to generate
commissions is dependent on the existence of its
client’s IP. Accordingly, the client’s earnings and, in
turn, the commissions earned by Z are directly tied to
the sales or usage of the licensed IP.
In each of the examples above, the agent may account for the
fees or commissions it earned in accordance with either of the following views,
which are equally acceptable:
-
View 1 — The sales- or usage-based royalty exception in ASC 606-10-55-65 is applicable.
-
View 2 — The sales- or usage-based royalty exception in ASC 606-10-55-65 does not apply. Because the agent is not licensing IP on its own, it determines that the consideration it received was not in exchange for a license of IP; rather, the consideration was in exchange for the agency service it promised to perform under the contract. Therefore, the agent concludes that it should apply the variable consideration guidance in ASC 606-10-32-5 through 32-14, including the guidance on constraining estimates of variable consideration (see Section 6.3.3).
Generally, the sales- or usage-based royalty exception may be applied only in
limited situations by the licensor (i.e., when an entity licenses its IP and is
compensated in the form of a royalty that varies on the basis of the customer’s
sales or usage of the licensed IP). However, there are situations in which an
entity may apply the sales- or usage-based royalty exception even though it does
not own the IP or act as the principal in the arrangement (i.e., it does not
control or license the IP). When determining whether it is appropriate to apply
the sales- or usage-based royalty exception in these situations, entities should
consider the nature of the services being provided to the customer and use
judgment to determine whether such services are directly related to the IP that
is being licensed. That is, if the revenue to be received is based on a sales-
or usage-based royalty from a license of IP and the service provided by the
entity is directly related to that IP, it would be acceptable to apply the
royalty exception in ASC 606-10-55-65.
This conclusion is consistent with the discussion in paragraph BC415 of ASU
2014-09, which explains that if the exception did not apply, an entity would be
required to “report, throughout the life of the contract, significant
adjustments to the amount of revenue recognized at inception of the contract as
a result of changes in circumstances, even though those changes in circumstances
are not related to the entity’s performance.” On the basis of discussion with
the FASB staff, we understand that the Board did not intend to limit the
exception to owners of the IP (i.e., the logic for providing the exception would
apply equally to the owners of the IP and others receiving a portion of a
royalty for services directly related to the license of the IP).
If the services being provided are not directly linked to the underlying IP being
licensed or the entity’s compensation does not vary on the basis of the sales or
usage of the licensed IP, it would not be appropriate to apply the sales- or
usage-based royalty exception.
Chapter 13 — Contract Costs
Chapter 13 — Contract Costs
13.1 Introduction
ASC 340-40
05-1 This Subtopic provides
accounting guidance for the following costs related to a
contract with a customer within the scope of Topic 606 on
revenue from contracts with customers:
-
Incremental costs of obtaining a contract with a customer
-
Costs incurred in fulfilling a contract with a customer that are not in the scope of another Topic.
Under U.S. GAAP, the revenue standard’s cost guidance is codified in ASC 340-40
(i.e., separately from ASC 606). ASC 340-40 introduces comprehensive guidance on
accounting for costs of obtaining a contract within the scope of ASC 606 (see
Section 13.2) and
provides guidance on how to account for costs of fulfilling a contract with a
customer that are not within the scope of another standard (see Section 13.3).
In developing the revenue standard’s cost guidance, the FASB and IASB did not
intend to holistically reconsider cost accounting. Rather, they aimed to fill gaps
resulting from the superseding of guidance on revenue (and certain contract costs)
and promote convergence between U.S. GAAP and IFRS Accounting Standards. The boards
also wanted to improve consistency in the application of certain cost guidance.
Often, costs specific to a contract will be incurred by an entity before the entity has a contract with a customer (e.g., precontract costs). When considering how to account for precontract costs, entities should be mindful that such costs may include both costs of obtaining a contract and costs of fulfilling a contract, and that the requirements with respect to each are different.
13.2 Costs of Obtaining a Contract
ASC
340-40
15-2 The
guidance in this Subtopic applies to the incremental costs
of obtaining a contract with a customer within the scope of
Topic 606 on revenue from contracts with customers
(excluding any consideration payable to a customer, see
paragraphs 606-10-32-25 through 32-27).
ASC 340-40 provides an overall, comprehensive framework to account
for costs of obtaining a contract that are within the scope of ASC 606. That is, if
a contract falls within the scope of ASC 606, an entity should look to ASC 340-40
for all relevant guidance on costs of obtaining the contract.
Specifically, ASC 340-40 provides the following guidance on
recognizing the incremental costs of obtaining a contract with a customer:
ASC
340-40
25-1 An
entity shall recognize as an asset the incremental costs
of obtaining a contract with a customer if the entity
expects to recover those costs.
25-2 The
incremental costs of obtaining a contract are those costs
that an entity incurs to obtain a contract with a customer
that it would not have incurred if the contract had not been
obtained (for example, a sales commission).
25-3 Costs
to obtain a contract that would have been incurred
regardless of whether the contract was obtained shall be
recognized as an expense when incurred, unless those costs
are explicitly chargeable to the customer regardless of
whether the contract is obtained.
The flowchart below illustrates the process that entities should use
in applying the guidance in ASC 340-40-25-1 through 25-3 to determine the treatment
of costs of obtaining a contract with a customer.
13.2.1 General Considerations for Identifying Incremental Costs of Obtaining a Contract With a Customer
ASC 340-40-25-2 states that the “incremental costs of obtaining
a contract are those costs that an entity incurs to obtain a contract with a
customer that it would not have incurred if the contract had not been obtained
(for example, a sales commission).” Application of this guidance requires an
entity to identify those costs that are incurred (i.e., accrued) as a direct
result of obtaining a contract with a customer. An entity should apply existing
guidance outside of the revenue standard to determine whether a liability should
be recognized as a result of obtaining a contract with a customer. Upon
determining that a liability needs to be recorded, the entity should determine
whether the related costs were incurred because, and only because, a contract
with a customer was obtained.
In many circumstances, it may be clear whether particular costs
are costs that an entity incurs to obtain a contract. For example, if an
entity incurs a commission liability solely as a result of obtaining a contract
with customer, the commission would be an incremental cost incurred to obtain a
contract with a customer. However, in other circumstances, an entity may need to
exercise judgment and consider existing accounting policies for liability
accruals when determining whether a cost is incurred in connection with
obtaining a contract with a customer. If the determination of whether a cost has
been incurred is affected by other factors (i.e., factors in addition to
obtaining a contract with a customer), an entity will need to take additional
considerations into account when assessing whether a cost is an incremental cost
associated with obtaining a contract with a customer.
Examples 1 and 2 in ASC 340-40 illustrate how to identify
incremental costs of obtaining a contract.
ASC 340-40
Example 1 — Incremental Costs of
Obtaining a Contract
55-2 An entity, a provider of
consulting services, wins a competitive bid to provide
consulting services to a new customer. The entity
incurred the following costs to obtain the contract:
55-3 In accordance with
paragraph 340-40-25-1, the entity recognizes an asset
for the $10,000 incremental costs of obtaining the
contract arising from the commissions to sales employees
because the entity expects to recover those costs
through future fees for the consulting services. The
entity also pays discretionary annual bonuses to sales
supervisors based on annual sales targets, overall
profitability of the entity, and individual performance
evaluations. In accordance with paragraph 340-40-25-1,
the entity does not recognize an asset for the bonuses
paid to sales supervisors because the bonuses are not
incremental to obtaining a contract. The amounts are
discretionary and are based on other factors, including
the profitability of the entity and the individuals’
performance. The bonuses are not directly attributable
to identifiable contracts.
55-4 The entity observes that
the external legal fees and travel costs would have been
incurred regardless of whether the contract was
obtained. Therefore, in accordance with paragraph
340-40-25-3, those costs are recognized as expenses when
incurred, unless they are within the scope of another
Topic, in which case, the guidance in that Topic
applies.
Example 2 — Costs That Give Rise to an
Asset
55-5 An entity enters into a
service contract to manage a customer’s information
technology data center for five years. The contract is
renewable for subsequent one-year periods. The average
customer term is seven years. The entity pays an
employee a $10,000 sales commission upon the customer
signing the contract. Before providing the services, the
entity designs and builds a technology platform for the
entity’s internal use that interfaces with the
customer’s systems. That platform is not transferred to
the customer but will be used to deliver services to the
customer.
Incremental Costs of Obtaining a
Contract
55-6 In accordance with
paragraph 340-40-25-1, the entity recognizes an asset
for the $10,000 incremental costs of obtaining the
contract for the sales commission because the entity
expects to recover those costs through future fees for
the services to be provided. The entity amortizes the
asset over seven years in accordance with paragraph
340-40-35-1 because the asset relates to the services
transferred to the customer during the contract term of
five years and the entity anticipates that the contract
will be renewed for two subsequent one-year periods.
The FASB staff noted that the accounting for sales commissions
is generally straightforward in situations in which (1) the commission is a
fixed amount or a percentage of contract value and (2) the contract is not
expected to be (or cannot be) renewed. However, if compensation plans or other
costs incurred are complex, it may be difficult to determine which costs are
truly incremental and to estimate the period of amortization related to
them.
Examples of complex scenarios include:
- Plans with significant fringe benefits.
- Salaries based on the employee’s prior-year signed contracts.
- Commissions paid in different periods or to multiple employees for the sale of the same contract.
- Commissions based on the number of contracts the salesperson has obtained during a specific period.
- Legal and travel costs incurred in the process of obtaining a contract.
- Anticipated contract renewals.
Stakeholders expressed concerns that the term “incremental”
could lead to broad interpretations of the types of costs that would qualify as
costs to be capitalized under the revenue standard. In response to those
concerns, the FASB staff noted the following:
- An entity should consider whether costs would have been incurred if the customer (or the entity) decided that it would not enter into the contract just as the parties were about to sign the contract. If the costs (e.g., the legal costs of drafting the contract) would have been incurred even though the contract was not executed, the costs would not be incremental costs of obtaining a contract.
- When an entity is identifying incremental costs incurred to obtain a contract, it may be important for the entity to first consider guidance outside of the revenue standard on determining whether and, if so, when a liability has been incurred. That is, other guidance will generally determine when a cost has been incurred, while ASC 340-40 provides guidance on determining whether costs should be capitalized or expensed.
- When sales commissions are paid to different levels of employees, the revenue standard does not differentiate among the commissions on the basis of the employees’ respective functions or titles. For example, if an entity’s commission policy on new contracts was to pay 10 percent sales commission to the sales employee, 5 percent to the sales manager, and 3 percent to the regional sales manager, all of the commissions are viewed as incremental because the commissions would not have been incurred if the contract had not been obtained.
Entities should continue to refer to existing U.S. GAAP on
liability recognition to determine whether and, if so, when a liability needs to
be recorded in connection with a contract with a customer. Therefore, an entity
should initially apply the specific guidance on determining the recognition and
measurement of the liability (e.g., commissions, payroll taxes, 401(k) match).
If the entity recognizes a liability, only then should the entity determine
whether to record the related debit as an asset or as an expense.
However, entities need to use judgment to determine whether
certain costs, such as commissions paid to multiple employees for the signing of
a contract, are truly incremental. Entities should apply additional skepticism
to understand whether an employee’s compensation (i.e., commissions or bonus) —
particularly for individuals in different positions in the organization and
employees who are ranked higher in an organization — is related solely to
executed contracts or is also influenced by other factors or metrics (e.g.,
employee general performance or customer satisfaction ratings). Only those costs
that are incremental (e.g., costs that resulted from obtaining the contract) may
be capitalized (as long as other asset recognition criteria are met).
The table below outlines the views detailed in TRG Agenda Paper 57 and broadly summarized in Q&A 78 of
the FASB staff’s Revenue Recognition Implementation Q&As (the
“Implementation Q&As”). Quoted text is from TRG Agenda Paper 57.
Topic
|
Example/Question
|
Views Discussed
|
View Selected by FASB Staff
|
---|---|---|---|
Fixed employee salaries
|
“Example 1: An
entity pays an employee an annual salary of $100,000.
The employee’s salary is based upon the employee’s
prior-year signed contracts and the employee’s projected
signed contracts for the current year. The employee’s
salary will not change based on the current year’s
actual signed contracts; however, salary in future years
likely will be impacted by the current year’s actual
signed contracts. What amount, if any, should the entity
record as an asset for incremental costs to obtain a
contract during the year?”
|
View A:
“Determine what portion of the employee’s salary is
related to sales projections and allocate that portion
of the salary as an incremental cost to obtain a
contract.”
View B: “Do not
capitalize any portion of the employee’s salary as an
incremental cost to obtain a contract. The costs are not
incremental costs to any contract because the costs
would have been incurred regardless of the employee’s
signed contracts in the current year.”
|
View B. “[N]one
of the employee’s salary should be capitalized as an
incremental cost to obtain a contract. . . . Whether the
employee sells 100 contracts, 10 contracts, or no
contracts, the employee is still only entitled to a
fixed salary.”
“[T]he objective of the requirements in
[ASC] 340-40-25-1 is not to allocate costs that are
associated in some manner with an entity’s marketing and
sales activity. The objective is to identify the
incremental costs that an entity would not have incurred
if the contract had not been obtained.”
|
Some, but not all, costs are
incremental
|
“Example 2: An
entity pays a 5% sales commission to its employees when
they obtain a contract with a customer. An employee
begins negotiating a contract with a prospective
customer and the entity incurs $5,000 of legal and
travel costs in the process of trying to obtain the
contract. The customer ultimately enters into a $500,000
contract and, as a result, the employee receives a
$25,000 sales commission. What amount should the entity
capitalize as an incremental cost to obtain the
contract?”
|
View A: “The
entity should capitalize only $25,000 for the sales
commission. Those costs are the only costs that are
incremental costs to obtain the contract because the
entity would not have incurred the costs if the contract
had not been obtained.”
View B: “The
entity should capitalize $30,000, which includes the
sales commission, legal expenses, and travel expenses.
The entity would not have been able to obtain the
contract without incurring those expenses.”
|
View A. “[T]he
sales commission is the only cost that the entity would
not have incurred if the contract had not been obtained.
While the entity incurs other costs that are necessary
to facilitate a sale (such as legal, travel and many
others), those costs would have been incurred even if
the customer decided at the last moment not to execute
the contract.”
Consider a similar situation in which an
entity “incurs the same type of legal and travel
expenses to negotiate a contract, but the customer
decides not to enter into the contract right before the
contract was to be signed by both parties. [T]he travel
and legal expenses would still have been incurred even
though the contract was not obtained. However, the
commission would not have been incurred.”
|
Timing of commission payments
|
“Example 3: An
entity pays an employee a 4% sales commission on all of
the employee’s signed contracts with customers. For cash
flow management, the entity pays the employee half of
the commission (2% of the total contract value) upon
completion of the sale, and the remaining half of the
commission (2% of the total contract value) in six
months. The employee is entitled to the unpaid
commission, even if the employee is no longer employed
by the entity when payment is due. An employee makes a
sale of $50,000 at the beginning of year one. What
amount should the entity capitalize as an incremental
cost to obtain the contract?”
|
View A:
“Capitalize half of the commission ($1,000) and expense
the other half of the commission ($1,000).”
View B:
“Capitalize the entire commission ($2,000).”
|
View B. “The
commission is an incremental cost that relates
specifically to the signed contract and the employee is
entitled to the unpaid commission. [T]he timing of
payment does not impact whether the costs would have
been incurred if the contract had not been
obtained.”
“In this fact pattern, only the passage
of time needs to occur for the entity to pay the second
half of the commission. However, . . . there could be
other fact patterns in which additional factors might
impact the payment of a commission to an employee.” For
example, an entity could make the second half of the
commission contingent upon the employee’s selling
additional services to the customer or upon the
customer’s “completing a favorable satisfaction survey
about its first six months of working with the entity.”
Therefore, an “entity will need to assess its specific
compensation plans to determine the appropriate
accounting for incremental costs of obtaining a
contract.”
|
Commissions paid to different levels of
employees
|
“Example 4: An
entity’s salesperson receives a 10% sales commission on
each contract that he or she obtains. In addition, the
following employees of the entity receive sales
commissions on each signed contract negotiated by the
salesperson: 5% to the manager and 3% to the regional
manager. Which commissions are incremental costs of
obtaining a contract?”
|
View A: “Only
the commission paid to the salesperson is considered
incremental because the salesperson obtained the
contract.”
View B: “Only
the commissions paid to the salesperson and the manager
are considered incremental because the other employee
likely would have had no direct contact with the
customer.”
View C: “All of
the commissions are incremental because the commissions
would not have been incurred if the contract had not
been obtained.”
|
View C. “The new
revenue standard does not make a differentiation based
on the function or title of the employee that receives
the commission. It is the entity that decides which
employee(s) are entitled to a commission directly as a
result of entering into a contract.”
“[I]t is possible that several
commissions payments are incremental costs of obtaining
the same contract. However, [stakeholders are
encouraged] to ensure that each of the commissions are
incremental costs of obtaining a contract with a
customer, rather than variable compensation (for
example, a bonus)” that would not be incremental because
it also relies on factors other than sales.
|
Commission payments subject to a
threshold
|
“Example 5: An
entity has a commission program that increases the
amount of commission a salesperson receives based on how
many contracts the salesperson has obtained during an
annual period. The breakdown is as follows:
Which commissions are incremental costs
of obtaining a contract?”
|
View A: “No
amounts should be capitalized because the commission is
not directly attributable to a specific contract.”
View B: “The
costs are incremental costs of obtaining a contract with
a customer and, therefore, the costs should be
capitalized.”
|
View B. Both the
2 percent commission and the 5 percent commission are
incremental costs of obtaining a contract. “The entity
would apply other GAAP to determine whether a liability
for the commission payments should be recognized. When a
liability is recognized, the entity would recognize a
corresponding asset for the commissions. This is because
the commissions are incremental costs of obtaining a
contract with a customer. The entity has an obligation
to pay commissions as a direct result of entering into
contracts with customers. The fact that the entity’s
program is based on a pool of contracts (versus a
program in which the entity pays 3% for all contracts)
does not change the fact that the commissions would not
have been incurred if the entity did not obtain the
contracts with those customers.”
|
The above issue is addressed in Implementation Q&A 78 (compiled from
previously issued TRG Agenda Papers 57 and 60). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix C.
13.2.2 Sales Commissions and Compensation Structures
Commissions are often cited as an
example of an incremental cost incurred to obtain a
contract. Acknowledging that it may be difficult for an
entity to determine whether a commission paid was
incremental to obtaining the new contract, the boards
considered permitting a policy election that would allow
an entity to choose to recognize the acquisition costs
as either an asset or an expense. However, such an
election would be contrary to the goal of increasing
comparability, which is one of the key objectives of the
revenue standard; therefore, the boards ultimately
decided not to allow an accounting policy election for
costs of obtaining a contract. See Sections
14.6.3 and 14.7.4 for
discussion of the presentation of contract costs in an
entity’s classified balance sheet and income statement,
respectively.
|
Some commission plans include substantive service conditions that need to be met
before a commission associated with a contract (or group of contracts) is
actually earned by the salesperson. In such cases, some or all of the sales
commission may not be incremental costs incurred to obtain a contract with the
customer since the costs were not actually incurred solely as a result of
obtaining a contract with a customer. Rather, the costs were incurred as a
result of obtaining a contract with a customer and the salesperson’s
providing ongoing services to the entity for a substantive period.
A commission structure could have a service condition that is determined to be
nonsubstantive. In such a case, the commission is likely to be an incremental
cost incurred to obtain a contract with a customer if no other conditions need
to be met for the salesperson to earn the commission. In other cases, a
commission plan could include a service condition, but the reporting entity
determines on the basis of the amount and structure of the commission payments
that part of the entity’s commission obligation is an incremental cost incurred
to obtain a contract with a customer (because it is not tied to a
substantive service condition) while the rest of the commission is associated
with ongoing services provided by the salesperson (because it is tied to a
substantive service condition).
Sometimes, there may be other factors that affect the commission obligation, but
the ultimate costs are still incremental costs incurred to obtain the contract.
For example, a commission may be payable to a salesperson if a customer’s total
purchases exceed a certain threshold regardless of whether the salesperson is
employed when the threshold is met (i.e., there is no service condition). In
these cases, although no liability may be recorded when the contract with the
customer is obtained (because of the entity’s assessment of the customer’s
likely purchases), if the customer’s purchases ultimately exceed the threshold
and the commission is paid, the commission is an incremental cost of obtaining
the contract. That is, the commission is a cost that the entity would not have
incurred if the contract had not been obtained. This situation is economically
similar to one involving a paid commission that is subject to clawback if the
customer does not purchase a minimum quantity of goods or services.
Entities will need to carefully evaluate the facts and circumstances when factors
other than just obtaining a contract with a customer affect the amount of a
commission or other incurred costs. Entities should consider their existing
policies on accruing costs when determining which costs are incremental costs
incurred to obtain a contract with a customer.
Example 13-1
Entity A’s internal salespeople earn a commission based
on a fixed percentage (4 percent) of sales invoiced to a
customer. Half of the commission is paid when a contract
with a customer is signed; the other half is paid after
12 months, but only if the salesperson is still employed
by A. Entity A concludes that there is a substantive
service period associated with the second commission
payment, and A’s accounting policy is to accrue the
remaining commission obligation ratably as the
salesperson provides ongoing services to A.
Entity A enters into a three-year noncancelable service
contract with a customer on January 1, 20X7. The total
transaction price of $3 million is invoiced on January
1, 20X7. The salesperson receives a commission payment
of 2 percent of the invoice amount ($60,000) when the
contract is signed; the other half of the 4 percent
commission will be paid after 12 months if the
salesperson continues to be employed by A at that time.
That is, if the salesperson is not employed by A on
January 1, 20X8, the second commission payment will not
be made. Entity A records a commission liability of
$60,000 on January 1, 20X7, and accrues the second
$60,000 commission obligation ratably over the 12-month
period from January 1, 20X7, through December 31,
20X7.
Entity A concludes that only the first $60,000 is an
incremental cost incurred to obtain a contract with a
customer. Because there is a substantive service
condition associated with the second $60,000 commission,
A concludes that the additional cost is a compensation
cost incurred in connection with the salesperson’s
ongoing service to A. That is, the second $60,000
commission obligation was not incurred solely to obtain
a contract with a customer but was incurred in
connection with ongoing services provided by the
salesperson.
If the salesperson would be paid the commission even if
no longer employed, or if A otherwise concluded that the
service condition was not substantive, the entire
$120,000 would be an incremental cost incurred to obtain
a contract and would be capitalized in accordance with
ASC 340-40-25-1. Entities will need to exercise
professional judgment when determining whether a service
condition is substantive.
Because commission and compensation structures can vary
significantly between entities, an entity should evaluate its specific facts and
circumstances when determining which costs are incremental costs incurred to
obtain a contract with a customer. Since many entities pay sales commissions to
obtain contracts with customers, questions have arisen regarding how to apply
the revenue standard’s cost guidance to such commissions, including:
- Whether certain commissions (e.g., commissions on contract renewals or modifications, commission payments that are contingent on future events, and commission payments that are subject to clawback or thresholds) qualify as assets.
- The types of costs to capitalize (e.g., whether and, if so, how an entity should consider fringe benefits such as payroll taxes, pension, or 401(k) match) in determining the amount of commissions to record as incremental costs.
- The pattern of amortization for assets related to multiple performance obligations (e.g., for contract cost assets related to multiple performance obligations that are satisfied over disparate points or periods of time).
Entities should continue to first refer to existing U.S. GAAP on
liability recognition to determine whether and, if so, when a liability from a
contract with a customer needs to be recorded. For example, an entity would
apply the specific U.S. GAAP on liability (e.g., commissions, payroll taxes,
401(k) match) and then determine whether to record the related debit as an asset
or expense.
In addition, the revenue standard is clear that (1) an entity
should amortize the asset on a systematic basis and (2) the method should
reflect the pattern of transfer of goods or services to a customer to which the
asset is related. That is, the asset should be amortized in a manner that
reflects the benefit (i.e., revenue) generated from the asset. For further
discussion, see Section
13.4.1.
The above issue is addressed in Implementation Q&As 67 through 75 (compiled from
previously issued TRG Agenda Papers 23, 25, 57, and 60). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
13.2.2.1 Tiered Commissions
Commission plans for a specific employee that involve
initial contracts and contract renewals might be established in such a way
that (1) the commission is subject to a cumulative contract threshold and
(2) commission rates change depending on the number (or cumulative value) of
contracts signed. For instance, fixed or percentage commissions may commence
or change once a specified threshold is achieved for the cumulative number
or value of contracts. The examples below, which are adapted from examples
considered by the FASB staff in TRG Agenda Paper 23, illustrate various cumulative
threshold scenarios.
Example 13-2
Once a cumulative threshold number of contracts is
reached, the entity pays commission on individual
contracts as a percentage of the value of each contract in the manner
shown in the table below.
Number of Contracts Signed
|
Commission Rate
|
---|---|
1–5
|
0% commission
|
6–10
|
3% of individual contract
price
|
11 or more
|
5% of individual contract
price
|
Example 13-3
Once a cumulative threshold value of contracts is
reached, the entity pays commission on individual
contracts as a percentage of the value of each contract in the manner
shown in the table below.
Value of Contracts Signed
|
Commission Rate
|
---|---|
First $1 million
|
0% commission
|
Next $4 million
|
3% of individual contract
price
|
More than $5 million
|
5% of individual contract
price
|
Example 13-4
Once a cumulative threshold number
of contracts is reached, the entity pays commission
on the last contract as a percentage of the cumulative value of that contract
and the preceding contracts in the manner
shown in the table below, taking into account any
commission already paid.
Number of Contracts Signed
|
Commission Rate
|
---|---|
1–5
|
0% commission
|
6
|
3% of value of contracts
1–6
|
7–10
|
0% commission
|
11 or more
|
5% of value of all contracts
(including commission already paid on contracts
1–6)
|
Example 13-5
As shown in the table below, the
entity pays the first commission when the first
contract is signed. Subsequently, once a cumulative
threshold number of contracts is reached, the entity
pays a commission on the threshold contract that is
greater than the commission paid on the initial
contract and takes into account any commissions
previously paid. In this example, it is assumed that
the entity has no history of sales employees’
closing more than 15 new contracts in a period.
Number of Contracts Signed
|
Commission Amount
| |
---|---|---|
1
|
$ 3,000
| |
10
|
$ 5,000
|
cumulative commission (including $3,000 already
paid)
|
15
|
$ 10,000
|
cumulative commission (including $5,000 already
paid)
|
Assume that the commissions in all of the examples above are
incremental costs incurred to obtain a contract that should be capitalized
in accordance with ASC 340-40-25-1.
There are at least two acceptable approaches to determining
which commissions are incremental to obtaining a contract in the scenarios
described above. One approach (“Approach A”) would be to specifically
attribute the incremental costs of each contract to that contract. For
example, if no commission is paid until the fifth contract is signed, the
commission would be attributed to only the fifth contract. Another approach
(“Approach B”) would be to accrue commission for each contract on the basis
of the average commission rate expected to be paid under the commission
plan. For example, although a commission is paid only once the fifth
contract is signed, the commission is earned, and would be accrued, as
contracts 1 through 5 are signed. Entities should consider their historical
policies for recording commission liabilities when determining which
approach to apply.
Under the two alternative approaches, the entity in each of
the illustrative examples above should account for the tiered commissions as
follows:
-
Example 13-2:
-
Approach A — When the 6th contract is signed, the entity should capitalize 3 percent of the price of that contract and successive contracts as an incremental cost of obtaining a contract until the 11th contract is signed, at which point the entity should capitalize 5 percent of the price of that contract and successive contracts.
-
Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that seven contracts, each valued at $10,000, will be signed and therefore the total estimated price of the 6th and 7th contract is $20,000, it estimates the total commission to be capitalized as $600 ($20,000 × 3% commission). Upon the signing of each $10,000 contract, the entity may capitalize $86 of commission ($600 total estimated commission ÷ the 7 expected contracts signed = $86 estimated commission per contract).
-
-
Example 13-3:
-
Approach A — Upon the signing of the specific contract that results in the aggregate value of over $1 million in contract value, the entity should capitalize 3 percent of the price of that contract and successive contracts as an incremental cost of obtaining a contract until the $5 million aggregate value is reached, at which point the entity should capitalize 5 percent of the price of that contract and successive contracts.
-
Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that three contracts will be signed with an aggregate of $4 million in contract value (contract 1 is $1 million, contract 2 is $1 million, and contract 3 is $2 million), the entity will estimate $90,000 in commissions to be capitalized, or ($4 million − $1 million) × 3% commission. The entity may capitalize the relative value for each contract:
- Contract 1: ($1 million ÷ $4 million) × $90,000 = $22,500.
- Contract 2: ($1 million ÷ $4 million) × $90,000 = $22,500.
- Contract 3: ($2 million ÷ $4 million) × $90,000 = $45,000.
-
-
Example 13-4:
-
Approach A — When the 6th contract is signed, the entity should capitalize 3 percent of the cumulative prices of contracts 1 through 6 as an incremental cost of obtaining the 6th contract. Similarly, when the 11th contract is signed, the entity should capitalize 5 percent of the cumulative prices of contracts 1 through 11 (less the 3 percent previously paid on contracts 1 through 6) as an incremental cost of obtaining the 11th contract. Further, the entity should capitalize 5 percent of the price of each successive contract (beyond the 11th contract) as an incremental cost of obtaining a contract.
-
Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that eight contracts will be signed and the estimated cumulative prices of contracts 1 through 6 will be $32,000, it will estimate $960 in commissions to be capitalized ($32,000 × 3% commission). If the price of each contract is the same, the entity may capitalize $120 upon the signing of each contract ($960 total estimated commission ÷ the 8 expected contracts signed = $120 estimated commission per contract).
-
-
Example 13-5:
-
Approach A — Once the initial contract is signed, the entity should capitalize $3,000 as an incremental cost of obtaining that contract. The entity would not capitalize any additional amounts when contracts 2 through 9 are signed because the next commission “tier” has not been met. Once the 10th contract is signed, the entity should capitalize an additional $2,000. Similarly, the entity would not capitalize any additional amounts when contracts 11 through 14 are signed and should capitalize an additional $5,000 once the 15th contract is signed.
-
Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that 11 contracts will be signed and the price of each contract is the same, it may capitalize $455 when each contract is signed ($5,000 ÷ the 11 contracts signed = $455 to be capitalized as the commission amount per contract).
-
The above issue is addressed in Implementation Q&A 69 (compiled from previously
issued TRG Agenda Papers 23 and 25). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
13.2.2.2 Fringe Benefits
The example below illustrates the determination of whether
fringe benefits such as 401(k) match contributions associated with sales
commissions should be capitalized as incremental costs of obtaining
contracts with customers.
Example 13-6
Entity C has a policy to match 401(k) contributions
based on salaries paid to sales representatives,
including sales commissions. These sales commissions
are determined to meet the definition of incremental
costs of obtaining contracts with customers in ASC
340-40-25-2 and are therefore capitalized in
accordance with ASC 340-40-25-1.
When 401(k) match contributions (along with other
fringe benefits) are attributed directly to sales
commissions that are determined to be incremental
costs of obtaining contracts with customers, the
401(k) match contributions also qualify as
incremental costs of obtaining the contracts since
such costs would not have been incurred if the
contracts had not been obtained. However,
incremental costs of obtaining contracts with
customers would not include fringe benefits
constituting an allocation of costs that would have
been incurred regardless of whether a contract with
a customer had been obtained.
The above issue is addressed in Implementation Q&A 74 (compiled from previously
issued TRG Agenda Papers 23, 25, 57, and 60). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
13.2.2.3 Asset Manager Costs
The FASB noted that the treatment of sales commissions paid
to third-party brokers in arrangements between asset managers and other
parties may vary depending on the facts and circumstances of the arrangement
(i.e., the commission would be recognized in some cases as an expense and in
other cases as an asset). This outcome was not the FASB’s intent; therefore,
the Board decided to retain specific cost guidance for investment companies
in ASC 946-605-25-8, which has been moved to ASC 946-720. Further, in
December 2016, the FASB issued ASU 2016-20, which aligns the
cost capitalization guidance in ASC 946 for advisers to both public funds
and private funds (see Chapter 18).
13.2.3 Practical Expedient in ASC 340-40-25-4 for Expensing Contract Acquisition Costs
ASC
340-40
25-4 As a practical expedient,
an entity may recognize the incremental costs of
obtaining a contract as an expense when incurred if the
amortization period of the asset that the entity
otherwise would have recognized is one year or
less.
If an entity elects the practical expedient to expense
incremental costs of obtaining a contract when incurred because the amortization
period of the asset would have been one year or less, the entity is also
required, under ASC 606-10-50-22, to disclose such election (see Chapter 15 on disclosure requirements). In
addition, the practical expedient should be applied consistently to contracts
with similar characteristics and in similar circumstances.
13.2.3.1 Whether the Practical Expedient Must Be Applied to All Contracts
The practical expedient in ASC 340-40-25-4 to expense
contract acquisition costs that would be amortized over a period of less
than one year needs to be applied consistently to contracts with similar
characteristics and in similar circumstances in accordance with ASC
606-10-10-3. Therefore, if an entity has contracts with dissimilar
characteristics or dissimilar circumstances, it can choose for each class of contract whether to apply the
expedient.
The identification of contracts with similar characteristics
and the evaluation of similar circumstances should be performed as an
entity-wide assessment. An entity with multiple subsidiaries or business
units that operate in multiple jurisdictions might determine that different
subsidiaries or business units have contracts with dissimilar
characteristics or dissimilar circumstances.
13.2.3.2 Whether the Practical Expedient May Be Applied Selectively on a Contract-by-Contract or Cost-by-Cost Basis
An entity is required to apply the practical expedient in
ASC 340-40-25-4 consistently to contracts with similar characteristics and
in similar circumstances in accordance with ASC 606-10-10-3. Therefore, if
an entity has contracts with dissimilar characteristics or dissimilar
circumstances, it can choose for each class of contract whether to apply the
expedient, but it is not permitted to apply the practical expedient
selectively on a contract-by-contract basis.
Further, an entity is not permitted to apply the practical
expedient in ASC 340-40-25-4 to some costs attributable to performance
obligations in a contract but not others. The incremental costs of obtaining
a contract that are required to be capitalized in accordance with ASC
340-40-25-1 are related to the contract as a whole; the capitalized costs of
obtaining a contract form a single asset even if the contract contains more
than one performance obligation. Therefore, if the practical expedient in
ASC 340-40-25-4 is applied, it should be applied to the contract as a whole.
The practical expedient is available only if the amortization period of the
entire asset that the entity otherwise would have recognized is one year or
less.
13.2.3.3 Practical Expedient Unavailable When the Amortization Period Is Greater Than One Year
The example below illustrates a situation in which the
practical expedient in ASC 340-40-25-4 would not be available.
Example 13-7
Entity B enters into a contract with
a customer to provide the following:
-
Product X delivered at a point in time.
-
Maintenance of Product X for one year.
-
An extended warranty on Product X that covers years 2 and 3 (Product X comes with a one-year statutory warranty).
Each of the elements is determined
to be a separate performance obligation.
A sales commission of $200 is earned
by the salesperson. This represents $120 for the
sale of Product X (payable irrespective of whether
the customer purchases the maintenance or extended
warranty) and an additional $40 each for the sale of
the maintenance contract and the sale of the
extended warranty ($80 commission for the sale of
both).
The commission is determined to meet
the definition of an incremental cost of obtaining
the contract in ASC 340-40-25-2 and is therefore
capitalized in accordance with ASC 340-40-25-1.
In this fact pattern, the entity
cannot elect the practical expedient in ASC
340-40-25-4 to expense costs as incurred because the
amortization period of the asset that the entity
would recognize is more than one year (i.e., the
extended warranty performance obligation included in
the contract is for years 2 and 3). The entity may,
however, determine that it is appropriate to
attribute the asset created by the commission to the
individual performance obligations and record
amortization of the asset in an amount that
corresponds to the revenue recognized as each good
or service is transferred to the customer (see
Section 13.4.1.1).
13.2.3.4 Amortization Periods Slightly Greater Than One Year
As previously noted, an entity is precluded from using the
practical expedient in ASC 340-40-25-4 if the amortization period of the
asset that the entity otherwise would have recognized is greater than one
year. This restriction applies even if the amortization period is only
slightly greater than one year.
Example 13-8
Entity A enters into a
noncancelable contract with a customer to provide
marketing services for 13 months. A commission of
$100 is earned by the salesperson in connection with
A’s entering into the contract with the customer.
The commission is determined to meet the definition
of an incremental cost of obtaining the contract in
ASC 340-30-25-2 and is therefore capitalized in
accordance with ASC 340-40-25-1. Entity A concludes
that the asset is related to the entire contract to
provide 13 months of marketing services.
In this fact pattern, the entity
cannot elect the practical expedient in ASC
340-40-25-4 to expense costs as incurred since the
amortization period of the asset that the entity
would otherwise recognize is more than one year
(i.e., the 13 months in which marketing services are
being performed).
13.2.4 Using the Portfolio Approach When Accounting for Contract Costs
The guidance in ASC 340-40 was developed contemporaneously with
that in ASC 606. ASC 340-40-05-1 expressly indicates that ASC 340-40 is aligned
with ASC 606, stating that “[t]his Subtopic provides accounting guidance for the
following costs related to a contract with a customer within the scope of Topic
606 on revenue from contracts with customers.”
ASC 606 is applied at the individual contract level (or to a
combination of contracts accounted for under ASC 606-10-25-9). In addition, ASC
606-10-10-4 allows an entity to apply, as a practical expedient, the revenue
recognition guidance to a portfolio of contracts rather than an individual
contract. The practical expedient can only be used “if the entity reasonably
expects that the effects on the financial statements of applying [the revenue
recognition guidance] to the portfolio would not differ materially from applying
[the revenue recognition guidance] to the individual contracts (or performance
obligations) within that portfolio.” In addition, ASC 606-10-10-3 states that an
“entity shall apply this guidance, including the use of any practical
expedients, consistently to contracts with similar characteristics and in
similar circumstances.”
If an entity reasonably expects that contract costs recorded
under a portfolio approach would not differ materially from contract costs that
would be recorded individually, it may apply a portfolio approach to account for
the costs. The entity would use judgment in determining the characteristics of
the portfolio in a manner similar to its assessment of whether a portfolio
satisfies the requirements in ASC 606-10-10-4.
In applying the portfolio approach, an entity should consider
paragraph BC69 of ASU
2014-09, which states, in part, that the FASB and IASB “did
not intend for an entity to quantitatively evaluate each outcome and, instead,
the entity should be able to take a reasonable approach to determine the
portfolios that would be appropriate for its types of contracts.” In determining
the characteristics and composition of the portfolio, an entity should consider
the nature and timing of costs incurred and the pattern of transferring control
of the related good or service to the customer (e.g., amortization of the
capitalized costs).
13.2.5 Determining When to Recognize and How to Measure Incremental Costs
Arrangements for the payment of some incremental costs of obtaining a contract
may be complex. For example, payment of a sales commission may be (1) contingent
on a future event, (2) subject to clawback, or (3) based on achieving cumulative
targets.
The revenue standard does not address the issue of when to
initially recognize the incremental costs of obtaining a contract. Rather, ASC
340-40 only addresses which costs to capitalize and subsequent recognition of
amortization or impairment expense. Therefore, other Codification topics (e.g.,
ASC 275, ASC 710, ASC 712, ASC 715, and ASC 718) specify when a liability for
costs should be recognized and how that liability should be measured.
If an entity concludes that a liability for incremental costs of obtaining a
contract should be recognized under the relevant Codification topic, the
guidance in ASC 340-40-25-1 should be applied to determine whether those
recognized costs should be capitalized as an asset or recognized immediately as
an expense.
The above issue is addressed in Implementation Q&A 78 (compiled from previously issued
TRG Agenda Papers 57 and 60). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
13.3 Costs of Fulfilling a Contract
ASC
340-40
15-3 The
guidance in this Subtopic applies to the costs incurred in
fulfilling a contract with a customer within the scope of
Topic 606 on revenue from contracts with customers, unless
the costs are within the scope of another Topic or Subtopic,
including, but not limited to, any of the following:
- Topic 330 on inventory
- Paragraphs 340-10-25-1 through 25-4 on preproduction costs related to long-term supply arrangements
- Subtopic 350-40 on internal-use software
- Topic 360 on property, plant, and equipment
- Subtopic 985-20 on costs of software to be sold, leased, or otherwise marketed.
25-5 An entity shall recognize an
asset from the costs incurred to fulfill a contract only if
those costs meet all of the following criteria:
-
The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify (for example, costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved).
-
The costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.
-
The costs are expected to be recovered.
25-6 For costs incurred in
fulfilling a contract with a customer that are within the
scope of another Topic (for example, Topic 330 on inventory;
paragraphs 340-10-25-1 through 25-4 on preproduction costs
related to long-term supply arrangements; Subtopic 350-40 on
internal-use software; Topic 360 on property, plant, and
equipment; or Subtopic 985-20 on costs of software to be
sold, leased, or otherwise marketed), an entity shall
account for those costs in accordance with those other
Topics or Subtopics.
25-7 Costs that relate directly to
a contract (or a specific anticipated contract) include any
of the following:
-
Direct labor (for example, salaries and wages of employees who provide the promised services directly to the customer)
-
Direct materials (for example, supplies used in providing the promised services to a customer)
-
Allocations of costs that relate directly to the contract or to contract activities (for example, costs of contract management and supervision, insurance, and depreciation of tools and equipment used in fulfilling the contract)
-
Costs that are explicitly chargeable to the customer under the contract
-
Other costs that are incurred only because an entity entered into the contract (for example, payments to subcontractors).
25-8 An entity shall recognize the
following costs as expenses when incurred:
-
General and administrative costs (unless those costs are explicitly chargeable to the customer under the contract, in which case an entity shall evaluate those costs in accordance with paragraph 340-40-25-7)
-
Costs of wasted materials, labor, or other resources to fulfill the contract that were not reflected in the price of the contract
-
Costs that relate to satisfied performance obligations (or partially satisfied performance obligations) in the contract (that is, costs that relate to past performance)
-
Costs for which an entity cannot distinguish whether the costs relate to unsatisfied performance obligations or to satisfied performance obligations (or partially satisfied performance obligations).
The flowchart below illustrates the process that entities should use
in applying the guidance in ASC 340-40-25-5 through 25-8 to determine how to account
for costs of fulfilling a contract with a customer.
The revenue standard does not modify accounting for fulfillment
costs that are addressed by other applicable U.S. GAAP, but it does create guidance
on fulfillment costs that are outside the scope of other Codification topics,
including costs related to certain preproduction activities (i.e., those not covered
by other applicable standards).
Because the FASB and IASB did not intend to reconsider cost guidance
altogether, the revenue standard focuses on costs of fulfilling a contract that are
not within the scope of another standard. Accordingly, if costs are within the scope
of another standard and that standard requires them to be expensed, it is not
possible to argue that they should be capitalized in accordance with ASC 340-40. In
addition, only costs directly related to a contract or anticipated contract with a
customer are within the scope of ASC 340-40. Costs not directly related to a
contract or anticipated (specified) contract should not be evaluated for
capitalization under ASC 340-40. Further, when determining whether fulfillment costs
are within the scope of ASC 340-40, the reporting entity should also consider its
relationship with the other entity in the arrangement. That is, if the reporting
entity incurs costs and transfers consideration to another entity, and that other
entity also transfers consideration to the reporting entity in exchange for goods or
services, the reporting entity should consider whether the consideration exchanged
between the two parties should be accounted for as (1) consideration payable to a
customer under ASC 606 or (2) consideration received from a vendor under ASC 705-20.
For additional discussion, see Sections 3.2.8 and 6.6.5.
The boards’ intent in developing this guidance was to develop a
clear objective for recognizing and measuring an asset arising from the costs
incurred to fulfill a contract; therefore, the boards decided that the costs must be
directly related to a contract or anticipated contract to be included in the cost of
the asset.
Connecting the Dots
Stakeholders have questioned whether costs incurred for an
anticipated contract (e.g., costs for design and development or nonrecurring
engineering) (1) would be within the scope of ASC 340 and therefore could be
capitalized or (2) should be expensed in accordance with ASC 730. This issue
is similar to the TRG’s discussion of preproduction activities (see
Section 13.3.4); however, the costs incurred for an
anticipated contract would pertain to a contract that is not yet obtained
and whose terms might not yet be known. Factors for an entity to consider in
determining whether the costs should be capitalized include, but are not
limited to, (1) the likelihood or certainty that the entity will obtain the
contract, (2) the likelihood that the costs will be recovered under the
specific anticipated contract, (3) whether the costs create or enhance an
asset that will be transferred to the customer once the entity obtains the
contract (such costs could be capitalizable under other guidance), and (4)
whether the costs are considered to be costs associated with R&D and
would therefore be within the scope of ASC 730 and expensed as incurred. An
entity will need to carefully consider the facts and circumstances of the
arrangement in determining the appropriate treatment of costs incurred
before a contract was obtained.
Example 2 in ASC 340-40 illustrates how to account for costs of
fulfilling a contract.
ASC 340-40
Example 2 — Costs That
Give Rise to an Asset
55-5 An entity enters into a
service contract to manage a customer’s information
technology data center for five years. The contract is
renewable for subsequent one-year periods. The average
customer term is seven years. The entity pays an employee a
$10,000 sales commission upon the customer signing the
contract. Before providing the services, the entity designs
and builds a technology platform for the entity’s internal
use that interfaces with the customer’s systems. That
platform is not transferred to the customer but will be used
to deliver services to the customer.
Costs to Fulfill a
Contract
55-7 The initial costs incurred to
set up the technology platform are as follows:
55-8 The initial setup costs relate
primarily to activities to fulfill the contract but do not
transfer goods or services to the customer. The entity
accounts for the initial setup costs as follows:
-
Hardware costs — accounted for in accordance with Topic 360 on property, plant, and equipment
-
Software costs — accounted for in accordance with Subtopic 350-40 on internal-use software
-
Costs of the design, migration, and testing of the data center — assessed in accordance with paragraph 340-40-25-5 to determine whether an asset can be recognized for the costs to fulfill the contract. Any resulting asset would be amortized on a systematic basis over the seven-year period (that is, the five-year contract term and two anticipated one-year renewal periods) that the entity expects to provide services related to the data center.
55-9 In addition to the initial
costs to set up the technology platform, the entity also
assigns two employees who are primarily responsible for
providing the service to the customer. Although the costs
for these two employees are incurred as part of providing
the service to the customer, the entity concludes that the
costs do not generate or enhance resources of the entity
(see paragraph 340-40-25-5(b)). Therefore, the costs do not
meet the criteria in paragraph 340-40-25-5 and cannot be
recognized as an asset using this Topic. In accordance with
paragraph 340-40-25-8, the entity recognizes the payroll
expense for these two employees when incurred.
13.3.1 Variable Consideration and Uncertain Transaction Price
As noted above, an entity would need to be able to demonstrate
whether any capitalized costs are recoverable. That is, the entity’s contract
with a customer needs to generate sufficient profit to recover any capitalized
costs. Otherwise, no asset should be recorded or a recorded asset would be
impaired (see Section 13.4.2). Determining whether
capitalized costs are recoverable may be challenging when the contract contains
variable consideration rather than fixed consideration.
When an entity enters into a contract with a customer to provide
goods or services for variable consideration and the transaction price is fully
or partially constrained at the time the customer obtains control of the goods
or services, the entity may incur an up-front loss until the uncertainty
associated with the variable consideration is resolved. That is, the amount of
the asset(s) derecognized or fulfillment costs recognized exceeds the amount of
revenue to be recognized on the date the entity satisfies its performance
obligation(s) because of the application of the constraint on variable
consideration.
An entity should not defer costs associated with transferred
goods or services in a contract when variable consideration is fully or
partially constrained. Rather, an entity should expense costs that are not
eligible for capitalization under other authoritative literature (e.g., ASC 330
on inventory; ASC 360 on property, plant, and equipment; or ASC 985-20 on costs
of software to be sold, leased, or otherwise marketed) unless (1) such costs
meet the criteria to be capitalized in accordance with ASC 340-401 or (2) the resolution of an uncertainty giving rise to the constraint on
variable consideration will result in the entity’s recovery of an asset (e.g., a
sales return).
In assessing whether costs meet the criteria to be capitalized
as fulfillment costs, an entity should consider the guidance in ASC 340-40-25-5,
which states that an entity should recognize an asset from the costs incurred to
fulfill a contract only if all of the following criteria are met:
-
The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify (for example, costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved).
-
The costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.
-
The costs are expected to be recovered.
Since costs attributed to a satisfied performance obligation do not generate or
enhance resources that the entity will use in satisfying, or continuing to
satisfy, future performance obligations, such costs do not meet criterion (b)
and would not be eligible for capitalization under ASC 340-40.
Example 13-9
Entity A, a manufacturer, sells goods to
Customer B, a distributor, for resale to B’s customers.
The manufacturer is required to recognize revenue when,
after consideration of the indicators of control in ASC
606-10-25-30, it determines that control of goods has
been transferred to the distributor.
Entity A enters into a contract with B
to sell goods with a cost basis of $180,000 for
consideration of $200,000. However, the goods have a
high risk of obsolescence, which may cause A to provide
rebates or price concessions to B in the future (i.e.,
the transaction price is variable). The contract does
not include a provision for product returns, and A does
not expect to accept any return of obsolete goods.
Entity A adjusts (i.e., constrains) the
transaction price and concludes that $170,000 is the
amount of consideration that is probable of not
resulting in a significant revenue reversal. When
control of the goods is transferred to B, A recognizes
revenue of $170,000 (the constrained transaction price)
and costs of $180,000.2 As a result, A incurs a loss of $10,000.
13.3.2 Initial Losses and Expected Future Profits
Questions arise about whether losses incurred on an initially
satisfied performance obligation can be capitalized when an entity is expected
to generate profits on the sale of optional goods or services to a customer.
This scenario is illustrated in the example below.
Example 13-10
Entity E’s business model includes the
sale of (1) equipment and (2) parts needed to maintain
that equipment. It is possible for customers to source
parts from other suppliers, but the regulatory
environment in which E’s customers operate is such that
customers will almost always choose to purchase parts
from E (the original equipment manufacturer). The spare
parts are needed for the equipment to properly function
for its expected economic life.
Entity E’s business model is to sell the
equipment at a significantly discounted price (less than
the cost to manufacture the equipment) when E believes
that doing so is likely to secure a profitable stream of
parts sales. This initial contract is only for the
equipment; it does not give E any contractual right to
require that customers subsequently purchase any parts.
However, E’s historical experience indicates that (1)
customers will virtually always subsequently purchase
parts and (2) the profits on the parts sales will more
than compensate for the discount given on the
equipment.
The equipment has a cost of $200 and
would usually be sold for a profit. However, the
equipment is sold at a discounted price of $150 if
subsequent parts sales are expected.
When the equipment is sold for $150, E
is not permitted to defer an element of the cost
of $200 to reflect its expectation that this sale will
generate further, profitable sales in the future.
In accordance with ASC 340-40-25-6, when
the costs of fulfilling a contract are within the scope
of another standard, they should be accounted for in
accordance with that standard. In the circumstances
described, the cost of $200 is within the scope of ASC
330 and must be expensed when the equipment is sold.
Further, ASC 340-40-25-8(c) requires “[c]osts that
relate to satisfied performance obligations (or
partially satisfied performance obligations) in the
contract (that is, costs that relate to past
performance)” to be expensed when incurred.
Although E expects customers to purchase
additional parts that will give rise to future profits,
those additional purchases are at the customer’s option
and are not part of the contract to sell the equipment.
Since E has satisfied its obligation to deliver the
equipment, it is required to recognize revenue of $150
and the $200 cost in full.
Consequently, a loss of $50 arises on
the initial sale of the equipment.
Connecting the Dots
In November 2015, TRG members discussed scenarios in
which an entity sells goods or services to a customer at a loss with a
strong expectation of profit on future orders from that customer (e.g.,
exclusivity or sole provider contractual terms). TRG members agreed that
if those further purchases are optional, the underlying goods or
services would not be considered promised goods or services in the
initial contract with the customer; rather, any such options would be
evaluated for the existence of a material right. For further discussion,
see Chapter 11.
The above issue is addressed in TRG Agenda Paper 49. For additional information and
Deloitte’s summary of issues discussed in the TRG Agenda Papers and
Implementation Q&As, see Appendix C.
13.3.3 Contracts Satisfied Over Time
ASC 340-40-25-8(c) requires fulfillment costs attributed to
satisfied (or partially satisfied) performance obligations to be expensed as
incurred. In addition, the revenue standard requires fulfillment costs to be
evaluated for expense or deferral independently of the recording of the
associated revenue.
13.3.3.1 Recognition of Fulfillment Costs Incurred Before the Transfer of Goods or Services When Revenue Is Recognized Over Time
ASC 340-40-25-5 requires an entity to capitalize the costs
incurred to fulfill a contract with a customer if the costs meet all of the
following criteria:
-
The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify . . . .
-
The costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.
-
The costs are expected to be recovered. [Emphasis added]
ASC 340-40-25-7 provides various examples of contract
fulfillment costs, including direct labor, direct materials, and allocations
of costs that are directly related to the contract (e.g., insurance,
depreciation of tools and equipment used). In some contracts, fulfillment
costs (e.g., implementation or other set-up costs) may be incurred before an
entity begins satisfying its performance obligation. Further, in some cases,
the costs incurred will enhance a resource of the entity that the entity
will use in satisfying its performance obligation(s) to the customer.
An entity may need to exercise significant professional judgment when
determining whether fulfillment costs incurred enhance a resource of the
entity that the entity will use in satisfying its performance obligation(s)
to the customer. To evaluate whether fulfillment costs meet the criterion in
ASC 340-40-25-5(b) for capitalization, an entity should consider whether the
costs (1) generate or enhance a resource (i.e., an asset, including a
service) that will be transferred to the customer or (2) will be used by the
entity in connection with transferring goods or services to the customer.
The following considerations may be helpful in the evaluation:
-
Is the customer’s ability to benefit from the fulfillment activities limited to the use of the entity’s service? If the customer cannot benefit from the entity’s fulfillment activities other than from the use of the entity’s service, the fulfillment costs may be enhancing the entity’s resources.
-
Do the fulfillment activities expand the entity’s service capabilities? If the fulfillment activities are required before the entity can begin transferring services to the customer and they expand the entity’s service capacity, the related fulfillment costs would most likely enhance a resource of the entity that the entity will use in satisfying its performance obligation(s) to the customer.
We do not believe that an entity needs to have physical
custody of an enhanced resource for fulfillment costs to qualify for
capitalization under ASC 340-40-25-5(b). For example, the criterion in ASC
340-40-25-5(b) could be met if the enhancements are made at the customer’s
location but will be used by the entity in connection with satisfying the
performance obligation(s).
If the costs generate or enhance a resource that will be
transferred to the customer, they may not enhance a resource of the
entity that the entity will use in satisfying its performance
obligation(s) to the customer. Such costs may still initially meet the
criteria for capitalization (under either ASC 340-40 or other U.S. GAAP),
but such costs would typically be recognized as an expense once the related
asset is transferred to the customer.
Example 13-11
Entity P enters into a four-year
contract with a customer to provide hosted software
services. Before the hosted software services can
begin, P is required to perform implementation
services, which create interfaces between the
customer’s infrastructure and P’s hosted software.
The implementation services will not transfer to the
customer a good or service that is distinct because
the customer can only benefit from the interface
connection through use of the hosted software
services. For the implementation services, P charges
the customer $600, which is included in the overall
transaction price that is allocated to the
performance obligation to provide hosted software
services. Entity P incurs fulfillment costs of $500
to perform the implementation services.
Because the implementation services
do not transfer a distinct good or service to the
customer, the fulfillment costs of $500 do not
enhance a resource that will be controlled by the
customer. Rather, the fulfillment costs enhance a
resource that P will use to satisfy its performance
obligation. Therefore, the fulfillment costs of $500
meet the criterion in ASC 340-40-25-5(b) for
capitalization.
13.3.3.2 Fulfillment Costs Related to Past Performance When Revenue Is Recognized Over Time
The example below illustrates the accounting for costs
related to performance completed to date that an entity incurred to fulfill
a contract satisfied over time.
Example 13-12
Entity X has entered into a contract
that consists of a single performance obligation
satisfied over time. The transaction price is
$1,250, and the expected costs of fulfilling the
contract are $1,000, resulting in an expected
overall margin of 20 percent. Entity X has decided
that it is appropriate to use an output method to
measure its progress toward completion of the
performance obligation.
As of the reporting date, X has
incurred cumulative fulfillment costs of $360, all
of which are related to performance completed to
date. Using the output measure of progress, X
determines that revenue with respect to performance
completed to date should be measured at $405,
resulting in a margin of approximately 11.1 percent
for the work performed to date. The total expected
costs of fulfilling the contract remain at
$1,000.
ASC 340-40-25-8 lists certain costs
incurred in fulfillment of the contract that must be
expensed when incurred. As indicated in ASC
340-40-25-8(c), such costs include “[c]osts that
relate to satisfied performance obligations (or
partially satisfied performance obligations) in the
contract (that is, costs that relate to past
performance).” Accordingly, the $360 in cumulative
fulfillment costs incurred should be expensed since
all of these costs are related to performance
completed to date.
As noted in ASC 606-10-25-31, the measure of progress
used to recognize revenue for performance
obligations satisfied over time is intended to
depict the goods or services for which control has
already been transferred to the customer. Recording
an asset (e.g., work in progress) for costs of past
performance would be inconsistent with the notion
that control of the goods or services is transferred
to the customer over time (i.e., as performance
occurs).
However, any contract fulfillment costs incurred by
an entity that are related to future
performance (e.g., inventories and other assets that
have not yet been used in the contract and are still
controlled by the seller) would be recognized as
assets if (1) they meet the conditions of a
Codification topic or subtopic other than ASC 340-40
(e.g., ASC 330, ASC 350, ASC 360) or (2) they are
outside the scope of a Codification topic or
subtopic other than ASC 340-40 and meet all of the
criteria in ASC 340-40-25-5.
In addition, note that if X had
decided that it was appropriate to use cost as a
measure of progress, X would have determined that
the performance obligation is 36 percent complete,
or ($360 ÷ $1,000) × 100%. Accordingly, X would have
recognized revenue of $450 (36% × $1,250), which
would have resulted in a margin of 20 percent.
13.3.3.3 Accounting for Costs Incurred in the Production of a Customized Good
Sometimes, an entity may incur costs at or near contract
inception but before it begins to satisfy its performance obligations under
the contract. This situation can arise when an entity purchases raw
materials that will be used in the production of a customized good, as
illustrated in the example below.
Example 13-13
Company KB produces aluminum-related
products (“widgets”), which are created through a
process of melting, molding, and curing the aluminum
into a unique customized widget. The cost of the raw
materials (i.e., aluminum) is significant to the
overall cost of a widget (approximately 40–60
percent of the overall cost of the finished good).
To produce a widget, KB must perform the following
activities:
-
Procure the aluminum (i.e., the raw materials).
-
Melt the aluminum.
-
Mold the aluminum.
-
Polish the molded aluminum (i.e., polish the widget).
The raw materials (i.e., aluminum)
purchased by KB are standard and not unique to a
specific customer (i.e., KB can use the raw
materials to fulfill any customer order). The
molding’s design is based on a customer’s
specifications (i.e., the mold used to create the
widget is unique to a specific customer). Because
the raw materials are not unique to a specific
customer, KB could redirect the raw materials (and
the melted aluminum) to a different customer before
pouring the melted aluminum into the molding.
However, once KB pours the melted aluminum into the
mold, KB would incur significant costs to rework the
molded aluminum for another customer. Therefore, the
aluminum has no alternative use to KB other than to
fulfill the initial order placed by a specific
customer.
In addition, the termination clauses
in KB’s contracts provide KB with an enforceable
right to payment for performance completed to date
if the contract is canceled. Accordingly, KB
concludes that its performance obligation to produce
a customized widget meets the criterion in ASC
606-10-25-27(c) to be satisfied over time because
the completed widget has no alternative use and KB
has an enforceable right to payment for performance
completed to date. Company KB determines that the
most appropriate measure of progress for recognizing
revenue over time is labor hours incurred (that
conclusion is not the subject of this example).
On March 26, 20X8, KB enters into a
contract with a customer to produce a customized
widget for a fixed price of $120. In a manner
consistent with its general revenue recognition
policy, KB recognizes revenue related to its
contract over time by using labor hours incurred as
the measure of progress.
Company KB expects that it will
incur the following labor hours to produce the
customized widget:
As noted above, before KB pours the
melted aluminum into the molding, the aluminum has
an alternative use to KB (i.e., KB can redirect the
aluminum to another customer regardless of whether
the aluminum is solid or liquid). Accordingly, until
the aluminum is poured into the customer-specific
molding, KB recognizes the aluminum in its raw
material inventory. It is only when the melted
aluminum is poured into the molding that KB will
begin to perform under its contract with the
customer because this is the point in time at which
the aluminum has no alternative use to KB (i.e.,
because KB would incur significant costs to rework
the molded aluminum for another customer).
Therefore, KB should begin to recognize revenue once
it pours the melted aluminum into the molding. On
the basis of labor hours incurred, KB concludes that
satisfaction of its performance obligation will be 2
percent complete once it begins to perform under the
contract (i.e., when it begins pouring the melted
aluminum into the molding). Consequently, KB will
recognize revenue of $2.40 (2 percent of the fixed
price per widget of $120) once the aluminum is
melted and KB begins to pour the aluminum into the
molding.
As also noted above, the cost of the
raw materials (i.e., aluminum) is significant to the
overall cost of the widget. In this arrangement, KB
pays $50 for the aluminum materials. Company KB
expects that its total cost of fulfilling the
contract (inclusive of the $50 raw material cost)
will be $100. That is, the raw material cost
represents 50 percent of the estimated total costs
that KB will incur under the contract.
Company KB should expense the cost
of the aluminum once the melted aluminum is poured
into the molding because this is the point in time
at which the aluminum no longer has an alternative
use to KB, which indicates that KB has commenced its
performance under the contract (i.e., satisfaction
of its performance obligation is 2 percent
complete). Accordingly, the cost of the aluminum,
which represents a fulfillment cost under the
contract, should be expensed. This conclusion is
consistent with the guidance in ASC 340-40-25-8(c),
which requires costs related to satisfied or
partially satisfied performance obligations to be
expensed as incurred. In accordance with ASC
340-40-25-8(c), because KB will begin to satisfy its
performance obligation under the contract when the
melted aluminum is poured into the molding, the cost
of the aluminum should be expensed once the aluminum
is no longer deemed to be raw material
inventory.
In addition to being consistent with the guidance in ASC
340-40-25-8(c), the conclusion in the example above that the cost of the
aluminum should be expensed once the aluminum no longer has an alternative
use to the entity is consistent with the following view expressed by the
FASB staff in Implementation Q&A 76 (compiled from previously
issued TRG Agenda Papers 33 and 34) regarding an analogous fact pattern:
The staff’s view is that costs incurred before the
[contract establishment date (CED)] are costs to fulfill an anticipated
contract and would be recognized as an asset under the guidance in
Subtopic 340-40. Costs would be expensed immediately at the CED if they
relate to progress made to date because the goods or services
constituting a performance obligation have already been transferred to
the customer. The remaining asset would be amortized over the period
over which the goods or services to which the asset relates will be
transferred to the customer.
13.3.3.4 Costs Incurred to Fulfill a Combined Performance Obligation Satisfied Over Time
ASC 340-40-25-5 through 25-8 provide guidance on accounting
for costs incurred to fulfill a contract with a customer within the scope of
ASC 606. Specifically, ASC 340-40-25-5 requires the following three criteria
to be met for an entity to capitalize costs incurred to fulfill such a
contract:
-
The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify . . . .
-
The costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.
-
The costs are expected to be recovered.
In addition, ASC 340-40-25-8 requires an entity to recognize
the following costs as expenses when incurred:
-
General and administrative costs (unless those costs are explicitly chargeable to the customer under the contract, in which case an entity shall evaluate those costs in accordance with paragraph 340-40-25-7)
-
Costs of wasted materials, labor, or other resources to fulfill the contract that were not reflected in the price of the contract
-
Costs that relate to satisfied performance obligations (or partially satisfied performance obligations) in the contract (that is, costs that relate to past performance)
-
Costs for which an entity cannot distinguish whether the costs relate to unsatisfied performance obligations or to satisfied performance obligations (or partially satisfied performance obligations).
As quoted above, ASC 340-40-25-8(c) indicates that an entity
should not capitalize costs related to completely or partially satisfied
performance obligations. Further, ASC 340-40-25-8(d) requires an entity to
expense costs when incurred if the entity cannot determine whether the costs
are related to past performance or to future performance. Accordingly, if an
entity incurs costs related to past performance or cannot determine whether
the costs are related to past performance or to future performance, the
entity should expense the costs when incurred rather than capitalize
them.
In some arrangements, costs (other than set-up costs) are
incurred at or around the time an entity begins to satisfy a performance
obligation. For example, an entity may physically deliver hardware used as
part of a combined performance obligation to provide services (e.g., an
integrated monitoring solution) to a customer over time. That is, the
hardware is not distinct; rather, it forms part of a combined performance
obligation that is satisfied over time. The hardware may be recorded by the
entity as inventory before it is physically transferred to the customer and
would typically be derecognized by the entity once it is physically
delivered to the customer since it would most likely be a fulfillment
cost.
Depending on the facts and circumstances, it may or may not be acceptable
under ASC 340-40 for an entity to capitalize initial fulfillment costs
incurred when the costs are related to part of a combined performance
obligation that will be satisfied over time. Generally, before delivery, the
asset to which the fulfillment costs are related (e.g., hardware) is held in
the entity’s inventory and is therefore within the scope of the inventory
accounting guidance of ASC 330. However, once the asset is physically
transferred to the customer, the asset may no longer be within the scope of
ASC 330.
We observe that when the guidance in ASC 330 is applicable, ASC 330-10-10-1
and ASC 330-10-35-2 are particularly relevant to the determination of when
to recognize the cost (i.e., expense) of the asset. ASC 330-10-10-1 states:
A major objective of accounting for inventories is the proper
determination of income through the process of matching appropriate
costs against revenues.
ASC 330-10-35-2 states, in part:
The cost basis of recording inventory ordinarily achieves the
objective of a proper matching of costs and revenues.
Because the cost should be recognized with the related revenue, we believe
that it may sometimes be acceptable to defer the cost.
In addition, we believe that in some cases, the asset may no longer be within
the scope of ASC 330 once it is deployed in a specific customer contract
(i.e., once it is shipped to a customer). At this point, the costs related
to the asset could be evaluated as contract fulfillment costs in accordance
with ASC 340-40.
If ASC 340-40 is applicable, an entity should consider the three criteria in
ASC 340-40-25-5 to determine whether capitalization of the costs is
appropriate. Generally, the asset to which the costs are related is
physically delivered to the customer as part of a specific contract with
that customer; therefore, criterion (a) is met. Further, if the entity
expects to recover the costs of the delivered asset through the transaction
price, the entity would conclude that criterion (c) is met.
Unlike the evaluations of criteria (a) and (c),
respectively, which are relatively straightforward, the evaluation of
whether criterion (b) is met (i.e., whether the costs generate or enhance a
resource of the entity that the entity will use to satisfy its performance
obligation in the future) generally requires more judgment. As discussed in
Section
13.3.3.1, an entity should consider the following factors to
determine whether the asset delivered to the customer generates or enhances
a resource of the entity that the entity will use to satisfy its performance
obligation in the future (e.g., to provide the ongoing service):
- Is the customer’s ability to benefit from the fulfillment activities limited to the use of the entity’s service? If the customer cannot benefit from the entity’s fulfillment activities other than from the use of the entity’s service, the fulfillment costs may be enhancing the entity’s resources.
- Do the fulfillment activities expand the entity’s service capabilities? If the fulfillment activities are required before the entity can begin transferring services to the customer and they expand the entity’s service capacity, the related fulfillment costs would most likely enhance a resource of the entity that the entity will use in satisfying its performance obligation(s) to the customer.
We also believe that the following additional factors are relevant to the
determination of whether capitalization of the fulfillment costs is appropriate:
- Does the activity that results in delivery of the asset to the customer factor into the entity’s measure of progress toward complete satisfaction of the performance obligation? For example, the entity may demonstrate that the fulfillment costs enhance a resource that will be used to satisfy the entity’s performance obligation in the future if the entity does not begin satisfying its performance obligation until the asset is delivered to the customer.
- Does the entity still have some level of control or influence over the asset once the asset is physically delivered to the customer? Although the asset is physically delivered to the customer, the entity may be providing a service that requires the entity to integrate the asset and the service to deliver a combined output (e.g., because the asset and service are highly interdependent or highly interrelated). The entity may conclude that by transferring a combined service to the customer (e.g., a service that the entity delivers by using both hardware and the service), it continues to maintain some level of control or influence over the asset that is being used as an input to deliver a combined output. That is, the entity’s service continues to dictate how the customer uses the asset even if the customer has physical possession. This analysis is consistent with the evaluation of whether an entity controls a good or service before the good or service is transferred to an end customer and therefore is a principal, as discussed in ASC 606-10-55-37A(c).
On the basis of the above factors, an entity should evaluate whether the
fulfillment costs enhance the entity’s resources that the entity will use to
satisfy (or continue to satisfy) its performance obligation in the future.
If the entity determines that capitalization of the related costs is
appropriate in accordance with ASC 340-40-25-5, it should subsequently
amortize the costs related to the asset as it transfers the related
services.
Because of the level of judgment necessary to evaluate
whether capitalization is appropriate — specifically, whether the asset
generates or enhances a resource of the entity that the entity will use to
satisfy its remaining performance obligation — we would encourage entities
with similar types of arrangements to consult with their accounting
advisers. Further, it may be appropriate in some cases to evaluate whether
the arrangement contains a lease when the performance of the contract relies
on a specified asset; see Deloitte’s Roadmap Leases for more information on
determining whether a contract is or contains a lease.
13.3.3.5 Learning Curve Costs
Certain contracts may include significant costs associated with a “learning
curve.” In these instances, because the entity has not yet gained process
and knowledge efficiencies, significant costs attributed to a learning curve
may be incurred during the early phases of the contract.
We believe that learning curve costs are generally not eligible for
capitalization under ASC 340-40. This view is consistent with paragraphs
BC312 through BC314 of ASU 2014-09, in which the FASB states, in part, that
ASC 606 addresses the accounting for the effects of learning costs when both
of the following conditions are met:
- “An entity has a single performance obligation to deliver a specified number of units.”
- “The performance obligation is satisfied over time.”
The FASB states that in this situation, an entity would most likely select
the cost-to-cost method to measure the progress of transferring the goods or
services to the customer since under this method, the entity would record
more revenue and expense for the units produced early in the production
cycle (as a result of the learning curve costs) than it would for the later
units. The Board explains that this method of measurement is appropriate
because if an entity were to sell a customer only one unit rather than
multiple units, the entity would charge the customer a higher per-unit price
to recover its learning curve costs. Since the performance obligation is
satisfied over time (because control is transferred to the customer as the
costs are incurred), capitalization of learning curve costs would not be
appropriate in this situation because the costs are related to the
fulfillment of a partially satisfied performance obligation.
13.3.3.6 Labor Costs Incurred to Fulfill a Contract for Goods or Services When Revenue Is Recognized Over Time
ASC 340-40-25-7 provides guidance on the types of costs that
constitute fulfillment costs within the scope of ASC 340-40 if they are
outside the scope of other Codification topics. Costs incurred to produce
goods for which revenue is recognized at a point in time would typically be
treated as inventory costs within the scope of ASC 330. However, costs
incurred to provide goods or services for which revenue is recognized over
time would typically not be within the scope of ASC 330 since control over
those goods or services is transferred to the customer as the entity
performs.
Questions have arisen regarding the amounts to be included in fulfillment
costs related to labor.
While “salaries and wages of employees who provide the promised services
directly to the customer” are the only example of direct labor costs that is
cited in ASC 340-40-25-7(a), direct labor costs also include fringe benefits
and other labor-related costs incurred in compensating an employee whose
primary employment efforts are directly related to a contract with a
customer. In addition, ASC 340-40-25-7(c) indicates that fulfillment costs
include certain allocated labor costs (i.e., indirect labor costs) related
to overhead, such as those incurred for contract management and
supervision.
We believe that costs that would have been capitalizable as inventory had
they been within the scope of ASC 330 would typically also represent
fulfillment costs directly related to a contract in accordance with ASC
340-40. ASC 330-10-30-1 provides the following guidance on determining the
amounts to be included in inventory:
As applied to inventories, cost
means in principle the sum of the applicable expenditures and charges
directly or indirectly incurred in bringing an article to its existing
condition and location. It is understood to mean acquisition and
production cost, and its determination involves many
considerations.
In authoritative literature, specific references to the composition of labor
costs are limited. However, the ASC master glossary’s definition of direct
loan origination costs includes a reference to ASC 310-20-55, which includes
examples of forms of employee compensation that would be considered direct
labor costs associated with originating a loan. Although the concepts
discussed in the examples are specifically related to direct costs incurred
in connection with loan origination activities, we believe that it is
appropriate for an entity to consider the implementation guidance in ASC
310-20 by analogy to identify forms of employee compensation that should be
included in the composition of labor costs.
The example in ASC 310-20-55-12 states:
Payroll-related fringe benefits include any costs incurred for
employees as part of the total compensation and benefits program.
Examples of such benefits include all of the following:
- Payroll taxes
- Dental and medical insurance
- Group life insurance
- Retirement plans
- 401(k) plans
- Stock compensation plans, such as stock options and stock appreciation rights
- Overtime meal allowances.
Further, ASC 310-20-25-6 states, in part:
Bonuses are part of an
employee’s total compensation. The portion of the employee’s total
compensation that may be deferred as direct loan origination costs is
the portion that is directly related to time spent on the activities
contemplated in the definition of that term and results in the
origination of a loan.
We believe that in a manner consistent with the above guidance, labor costs
include base pay, overtime pay, vacation and holiday pay, illness pay, shift
differential, payroll taxes, and contributions to a supplemental
unemployment benefit plan. Further, other employee benefit costs such as
cash bonuses, profit sharing, stock bonus plans, insurance benefits,
retirement benefits, and other miscellaneous benefits (both discretionary
and nondiscretionary) are among the labor costs that are eligible for
inclusion in fulfillment costs directly related to a contract.
13.3.4 Costs Related to Preproduction Activities
Preproduction costs of a long-term supply arrangement represent
incurred costs related to the design and development of products to be sold
under an entity’s contract with a customer, which could be an anticipated
contract that the entity can specifically identify. For example, preproduction
costs could include dies and other tools (tooling) that the entity will use in
making products under the arrangement. The dies and other tools may or may not
be transferred to the customer under such an arrangement.
The TRG addressed certain issues related to the costs that an
entity incurs in performing these preproduction activities. Stakeholders raised
questions about how an entity should apply the revenue standard’s cost guidance
when assessing preproduction activities, including questions related to the
scope of the guidance (i.e., the costs to which such guidance would apply).
Specifically, TRG members in the United States discussed whether entities should
continue to account for certain preproduction costs under ASC 340-10 or whether
such costs will be within the scope of ASC 340-40 after the revenue standard
becomes effective.
The FASB considered removing the guidance in ASC 340-10 to
confirm that these costs would be within the scope of ASC 340-40. However, in
February 2017, the FASB ultimately elected to retain the guidance in ASC 340-10
on accounting for preproduction costs related to long-term supply arrangements.
Accordingly, the costs previously within the scope of ASC 340-10 will continue
to be within the scope of ASC 340-10.
The above issue is addressed in Implementation Q&A 66 (compiled from
previously issued TRG Agenda Papers 46 and 49). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix C.
While retaining the guidance in ASC 340-10 will clarify how to
account for costs that are squarely within the scope of that guidance, there
remain questions related to the accounting for fulfillment costs that are not
clearly within the scope of ASC 340-10 (or other applicable U.S. GAAP) and to
which the guidance in ASC 340-40 may be applicable. For example, when an entity
begins incurring costs that enhance a resource that may be used to satisfy an
obligation with a potential customer (i.e., there is not yet a contract with a
customer), or when an entity receives consideration from a potential customer to
fully or partially cover the costs incurred, the entity may need to use
significant judgment in determining whether the fulfillment costs incurred are
within the scope of ASC 340-40. We believe that entities may find the following
considerations helpful when evaluating the accounting for preproduction
costs:
-
Are the fulfillment costs related to a contract with a customer that can be specifically identified? If so, the costs are likely to be within the scope of ASC 340-40 (if they are not within the scope of other guidance).
-
Do the fulfillment costs create a good or service that will be transferred to a customer? If so, the costs are likely to be deferred until the good or service is transferred to the customer.
-
Do the fulfillment costs create an output that is part of the entity’s ordinary activities? If the costs incurred create an asset that will be transferred to a third party, but the asset to be transferred is not an output of the entity’s ordinary activities, the counterparty is not a customer as defined in ASC 606, and therefore, the arrangement is not within the scope of ASC 606 or ASC 340-40.
Entities may receive payments from customers, potential
customers, or third parties that are intended to cover some or all of the costs
of certain preproduction activities. An entity’s conclusion regarding the scope
of the associated costs may inform the entity’s accounting for the corresponding
payment. For example, if an entity concludes that it is incurring preproduction
costs that are within the scope of ASC 340-40 but are not related to a good or
service that will be transferred to the customer (i.e., the costs are not
performance obligations), any consideration that the entity received from the
customer would be within the scope of ASC 606 and would form part of the
transaction price in the contract with the customer. However, if an entity
concludes that the fulfillment costs incurred are not within the scope of ASC
340-40 (e.g., because they are not related to a contract or anticipated contract
that the entity can specifically identify), third-party reimbursements of such
costs may not be within the scope of ASC 606.
13.3.5 Set-Up and Mobilization Costs
Set-up and mobilization costs represent certain direct costs
incurred at contract inception to allow an entity to satisfy its performance
obligations. For example, when construction companies prepare to begin
performance under a contract with a customer, they often incur direct costs
related to the transportation (i.e., “mobilization”) of equipment (e.g., cranes,
cement trucks) that they would not have incurred if the contract had not been
obtained. In other industries, mobilization may include activities such as
system preparation, staff training, or the hiring of additional staff.
When an entity’s contract involves mobilization activities, it is important for
the entity to consider whether those activities (1) transfer control of one or
more promised goods or services to a customer as they are performed or (2) are
set-up activities for the entity’s benefit that facilitate the transfer of one
or more promised goods or services to a customer in the future.
When mobilization activities transfer benefit to an entity’s
customer as they are performed, the entity will need to consider whether those
activities (1) represent one or more distinct goods or services or (2) form part
of a larger performance obligation.
Frequently, costs related to the mobilization of equipment do not result in the
transfer of a good or service to the customer; rather, they represent set-up
activities. The costs incurred in the mobilization of machinery (e.g., labor,
overhead, other direct costs) may meet the definition of assets under other U.S.
GAAP, such as the guidance on property, plant, and equipment. To the extent that
costs are not within the scope of other accounting standards and do not result
in the transfer of a good or service to the customer, entities should assess
these costs in accordance with the revenue standard’s cost guidance in ASC
340-40.
If an entity has acquired new equipment to be used in the
fulfillment of a contract, certain costs that the entity incurred in
transporting the new equipment to a designated location must be capitalized as
an asset under ASC 360. In contrast, once equipment has been used and is then
transported for use under a separate contract, such costs would no longer be
within the scope of ASC 360. However, the costs may be viewed as fulfillment
costs. If the entity concludes that the costs are fulfillment costs outside the
scope of ASC 360, it should apply the guidance in ASC 340-40 to determine
whether capitalization is appropriate.
The example below illustrates the accounting for set-up and
mobilization costs.
Example 13-14
Company A enters into a contract with a
customer to construct an urban skyscraper over a
two-year period. To fulfill the contract, A determines
that it will need to purchase two new cranes. Company A
incurs $150,000 to have these cranes transported to a
facility where A stores cranes that are not currently
deployed. The company also incurs $500,000 in direct
costs to transport the two new cranes and five
additional cranes from the storage area to the
designated customer location. Company A determines that
the transportation costs are expected to be recovered
through the contract with the customer. In addition, A
concludes that the use of the cranes to construct the
skyscraper does not constitute a lease under ASC
842.
Because the $150,000 represents costs
incurred to get new equipment ready for its intended use
(i.e., transportation of newly acquired equipment), A
should apply the guidance in ASC 360 to account for such
costs.
Regarding the $500,000 in direct costs
to transport the cranes to the customer’s location: ASC
340-40-25-5 requires an entity to recognize an asset for
costs incurred in the fulfillment of a contract if the
costs (1) are directly related to the contract, (2)
enhance the resources that the entity will use to
perform under the contract, and (3) are expected to be
recovered. Company A should recognize the transportation
costs of $500,000 as an asset when incurred because (1)
the cranes (and therefore the related transportation
costs) are directly related to the contract, (2)
relocating the cranes enhances the entity’s resources
(i.e., the cranes) since it puts the cranes in a
location that allows the entity to satisfy its
performance obligation(s) under the contract, and (3) A
has determined that the transportation costs are
expected to be recovered.
13.3.6 Relationship Between ASC 985-20 and ASC 340-40
ASC 985-20-15-3 states, in part, that the guidance in ASC 985-20 does not apply to
“[a]rrangements to deliver software or a software system, either alone or together
with other products or services, requiring significant production, modification, or
customization of software.” ASC 985-20 generally applies to the costs of computer
software that is being developed for general release to the market as opposed to
being developed solely to meet a specific customer’s needs. Nevertheless, some costs
may be incurred for software that (1) will be delivered to a specific customer under
a contract and (2) also will be marketed to others. As illustrated in the example
below, the vendor should determine which costs are incurred for software that is
being developed for general release and which costs are incurred for software that
is being developed for specific contracts.
A vendor may be required to apply the guidance in ASC 985-20 when accounting for
software costs it incurred before entering into a contract if the costs were
incurred for a product that will be marketed to multiple customers. However, a
vendor must use judgment to determine whether costs incurred to develop software
before a contract is signed are costs associated with fulfilling the contract and
therefore subject to the guidance in ASC 340-40 or costs subject to the requirements
of ASC 985-20, particularly when there is a very limited market for the product and
the product will require additional customization under contracts with future
customers.
Example 13-15
Entity L has existing software that it has used on a previous
contract for which it maintains the proprietary rights. It
had begun to reconfigure the software into an open
architecture format when it signed a contract for delivery
of a strategic air defense system that will use at least
some of the modules of the open architecture software.
Entity L anticipates that it will be able to use the open
architecture software on several future contracts.
Under ASC 985-20, L may be required to capitalize some of the
software development costs associated with the reconfigured
open architecture software if those costs meet the criteria
for capitalization. However, the costs associated with
developing the modules in accordance with the terms of the
defense contract should not be accounted for under ASC
985-20 if significant production, modification, or
customization of the software would be required; instead,
such costs should be accounted for under ASC 340-40.
As noted above, ASC 985-20 does not apply to costs incurred
for computer software that requires significant production,
modification, or customization under a contractual
agreement. Although L retains the rights to the software, at
least some portion of the development effort must be used to
satisfy the requirements of the defense contract. The costs
associated with developing modules that are promised goods
or services under that contract are costs incurred to
fulfill the contract and thus within the scope of ASC
340-40; accordingly, they should not be accounted for under
ASC 985-20.
If the ultimate product will include functionalities that are
distinct and separable and are not promised goods or
services under the current defense contract (i.e., they will
be used only for future contracts), the development costs of
such functionalities might be subject to the guidance in ASC
985-20 depending on the market for the software. That is, if
the additional modules have a broad customer base and are
not limited to one or a few contracts, ASC 985-20 would
apply since the costs for these additional modules would be
incurred in the absence of a specific contract.
Footnotes
1
ASC 340-40-25-6 indicates that when costs incurred to
fulfill a contract with a customer are within the scope of any other
Codification topics or subtopics, such costs should be accounted for in
accordance with those other topics or subtopics.
2
The entity may need to consider
applying the impairment guidance in ASC 330 to
similar goods held in inventory.
13.4 Amortization and Impairment of Contract Costs
13.4.1 Amortization
ASC 340-40
35-1 An asset recognized in accordance with paragraph 340-40-25-1 or 340-40-25-5 shall be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. The asset may relate to goods or services to be transferred under a specific anticipated contract (as described in paragraph 340-40-25-5(a)).
35-2 An entity shall update
the amortization to reflect a significant change in the
entity’s expected timing of transfer to the customer of
the goods or services to which the asset relates. Such a
change shall be accounted for as a change in accounting
estimate in accordance with Subtopic 250-10 on
accounting changes and error corrections.
ASC 340-40 does not provide specific guidance on the method an entity should use
to amortize contract costs recognized as assets. Rather, ASC 340-40-35-1
requires an entity to amortize such costs “on a systematic basis that is
consistent with the transfer to the customer of the goods or services to which
the asset relates.” Entities will therefore have to determine an appropriate
method for amortizing costs capitalized in accordance with ASC 340-40-25-1 or
ASC 340-40-25-5.
Amortization of capitalized costs on a “systematic basis” should
take into account the expected timing of transfer of the goods and services
related to the asset, which typically corresponds to the period and pattern in
which revenue will be recognized in the financial statements. The pattern in
which the related revenue is recognized could be significantly front-loaded,
back-loaded, or seasonal, and costs should be amortized accordingly.
To determine the pattern of transfer, entities may need to
analyze the specific terms of each arrangement. In determining the appropriate
amortization method, they should consider all relevant factors, including (1)
their experience with, and ability to reasonably estimate, the pattern of
transfer and (2) the timing of the transfer of control of the goods or services
to the customer. In some situations, more than one amortization method may be
acceptable if it reasonably approximates the expected period and pattern of
transfer of goods and services. However, certain amortization methods may be
unacceptable if they are not expected to reflect the period and pattern of such
transfer. When entities select a method, they should apply it consistently to
similar contracts. If there is no evidence to suggest that a specific pattern of
transfer can be expected, a straight-line amortization method may be
appropriate.
If the pattern in which the contractual goods or services are transferred over
the contract term varies significantly each period, it may be appropriate to use
an amortization model that more closely aligns with the transfer pattern’s
variations. For example, amortization could be allocated to the periods on the
basis of the proportion of the total goods or services that are transferred each
period. If the cost is related to goods or services that are transferred at a
point in time, the amortized cost would be recognized at the same point in
time.
When the contractual goods or services are transferred over a
period of uncertain duration, entities should consider whether the relationship
with the customer is expected to extend beyond the initial term of a “specific
anticipated contract” (as referred to in ASC 340-40-35-1 and described in ASC
340-40-25-5(a)). For example, if an entity enters into a four-year contract with
a customer but the customer is expected to renew that contract for two years,
the appropriate amortization period may be six years (i.e., the expected
duration of the period in which the customer will purchase the related goods or
services, which could be the expected life of the customer relationship).
When an entity’s customer has been granted a material right to
acquire future goods or services and revenue related to the material right is
being deferred, it would typically be reasonable for the entity to consider the
amount allocated to that right when determining the amortization method for the
costs that are capitalized in accordance with ASC 340-40-25-1 or ASC
340-40-25-5.
13.4.1.1 Allocation Among Performance Obligations
When an asset is recognized for the incremental costs of
obtaining a contract, ASC 340-40-35-1 requires that asset to be amortized in
a manner that is “consistent with the transfer to the customer of the
goods or services to which the asset relates” (emphasis added).
When the pattern of transfer differs for separate performance obligations in
a contract, it may be appropriate to allocate the costs among the
performance obligations and to amortize the capitalized costs accordingly.
For example, the costs could be allocated on the basis of the stand-alone
selling prices of the performance obligations.
The FASB staff has noted that an entity could satisfy the
requirement in ASC 340-40-35-1 in accordance with either of the following
two views:3
(a) View A — Allocate the asset to the individual
performance obligations on a relative basis (in proportion to the
transaction price allocated to each performance obligation) and
amortize the respective portion of the asset based on the pattern of
performance for the underlying performance obligation . . . .
(b) View B — Amortize the single asset using one
measure of performance considering all of the performance
obligations in the contract. Use a measure that best reflects the
“use” of the asset as the goods and services are transferred. Note
that this approach may result in a similar pattern of amortization
as View A, but without any specific allocation of the contract cost
asset to individual performance obligations.
Note that as discussed in Section 13.2.3.3, an entity is not
permitted to apply the practical expedient in ASC 340-40-25-4 (recognizing
the “costs of obtaining a contract as an expense when incurred if the
amortization period of the asset that the entity otherwise would have
recognized is one year or less”) to some performance obligations in a
contract but not others. Therefore, when the costs of obtaining a contract
are allocated to different performance obligations so that they are
amortized over different periods, the practical expedient in ASC 340-40-25-4
can only be applied if all of the amortization
periods are one year or less.
The above issue is addressed in Implementation Q&A 75 (compiled from previously
issued TRG Agenda Papers 23 and 25). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
The example below illustrates an allocation of the costs of
obtaining a contract among different performance obligations.
Example 13-16
Entity B enters into a contract with
a customer to provide the following:
-
Product X delivered at a point in time.
-
Maintenance of Product X for one year.
-
An extended warranty on Product X that covers years 2 and 3 (Product X comes with a one-year statutory warranty).
Each of the elements is determined
to be a separate performance obligation.
A sales commission of $200 is earned
by the salesperson. This represents $120 for the
sale of Product X (payable irrespective of whether
the customer purchases the maintenance or extended
warranty) and an additional $40 each for the sale of
the maintenance contract and the sale of the
extended warranty ($80 commission for the sale of
both).
The commission is determined to meet
the definition of an incremental cost of obtaining
the contract in ASC 340-40-25-2 and is therefore
capitalized in accordance with ASC 340-40-25-1.
As discussed above, incremental
costs of obtaining a contract that are capitalized
in accordance with ASC 340-40-25-1 can be allocated
to specific performance obligations for amortization
purposes. Therefore, it would be acceptable in the
circumstances under consideration to attribute the
$200 commission asset in the following manner:
-
$120 to Product X — To be expensed upon delivery of Product X to the customer.
-
$40 to the maintenance contract — To be expensed over the one-year period of maintenance.
-
$40 to the extended warranty — To be expensed over the two-year period of the warranty (i.e., years 2 and 3).
The asset will therefore be
amortized as follows:
Note that in this fact pattern, the
entity cannot apply the practical expedient in ASC
340-40-25-4 to expense the sales commission when
incurred because the total amortization period for
the asset exceeds one year (see Section
13.2.3.3). Neither can the expedient be
applied specifically to the commission allocated to
the maintenance contract (notwithstanding that it is
amortized over a period of one year) because if the
practical expedient is applied, it must be applied
to the contract as a whole (see Section
13.2.3.2).
13.4.1.2 Determining the Amortization Period of an Asset Recognized for the Incremental Costs of Obtaining a Contract With a Customer
Stakeholders have raised questions about determining the
amortization period of an asset recognized for the incurred incremental costs of
obtaining a contract with a customer, including how to determine whether a
commission paid on renewal is commensurate with an initial commission and under
what circumstances it would be appropriate to amortize the asset over the
expected customer life. The FASB staff has noted that the amortization guidance
in ASC 340-40 is conceptually consistent with that on estimating the useful
lives of long-lived assets. Since entities already use judgment to estimate
useful lives of long-lived assets, the staff believes that entities would also
do so in determining amortization periods for assets related to incremental
costs of obtaining a contract.
An entity should use judgment in determining the contract(s) to
which a commission is related. The staff has noted that if an entity pays a
commission on the basis of only the initial contract without an expectation that
the contract will be renewed (given the entity’s past experience or other
relevant information), amortizing the asset over the initial contract term would
be an appropriate application of the revenue standard. However, if the entity’s
past experience indicates that a contract renewal is likely, the amortization
period could be longer than the initial contract term if the asset is related to
goods or services to be provided during the contract renewal term.
When estimating the amortization period of an asset arising from
incremental costs of obtaining a contract, entities should (1) identify the
contract(s) to which the cost (i.e., commission) is related, (2) determine
whether the commission on a renewal contract is commensurate with the commission
on the initial contract, and (3) evaluate the facts and circumstances to
determine an appropriate amortization period that would extend beyond the
contract period if there are anticipated renewals associated with the costs of
obtaining the contract.
The FASB staff has confirmed that the amortization period of an
asset recognized for the incremental incurred costs of obtaining a contract
might be, but should not be presumed to be, the entire customer life. The staff
has suggested that facts and circumstances may clearly indicate that amortizing
the asset over the average customer term is inconsistent with the amortization
guidance in ASC 340-40-35-1. An entity should use judgment in assessing the
goods or services to which the asset is related.
In estimating the amortization period for an asset recognized in
accordance with ASC 340-40-25-1 (“customer acquisition asset”), an entity will
need to use judgment to identify “the goods or services to which the asset
relates.” The estimated amortization period could range from the initial
contract term on the low end to the average customer life on the high end
depending on the specific facts and circumstances. When determining the life of
the customer acquisition asset, the entity will need to make judgments similar
to those it makes when determining the amortization or depreciation period for
other long-lived assets.
An entity should first identify the contract(s) related to the
customer acquisition asset (e.g., commission payment). That is, an entity will
need to consider whether the asset is related only to the initial contract with
the customer or also to specific anticipated contracts (e.g., renewals) with the
customer. For example, if a commission is paid on contract renewals and the
commission is commensurate with the initial commission paid, the customer
acquisition asset originally recorded may be related only to the initial
contract.
However, if an entity’s past experience indicates that a contract renewal is
likely, the amortization period could be longer than the initial contract term
if the asset is related to goods or services to be provided under a contract
renewal. An entity will need to use judgment to determine whether the asset is
related to goods or services to be provided under the contract renewal term.
Amortizing an asset over a period longer than the initial contract period would
not be appropriate when the entity pays a commission on a contract renewal that
is commensurate with the commission paid on the initial contract.
If no commissions are incurred in connection with a contract
renewal, or if the commission paid is not commensurate with the initial
commission, an entity will need to use judgment when determining whether the
customer acquisition asset is related to (1) all future contracts with the
customer (i.e., the customer life) or (2) one or more, but not all, future
contracts with the customer. The revenue standard does not require an entity to
amortize a customer acquisition asset over the expected customer life. Rather,
the asset should “be amortized on a systematic basis that is consistent with the
transfer to the customer of the goods or service to which the asset relates.” An
entity will need to determine the appropriate amortization period on the basis
of all relevant facts and circumstances.
Since the capitalized asset is similar to an intangible asset,
an entity might consider the guidance in ASC 350-30 on determining the useful
life of intangible assets. Specifically, ASC 350-30-35-3 states, in part:
The estimate of the useful life of an intangible asset to
an entity shall be based on an analysis of all pertinent factors, in
particular, all of the following factors with no one factor being more
presumptive than the other: . . .
f. The level of maintenance expenditures required to obtain the
expected future cash flows from the asset (for example, a material
level of required maintenance in relation to the carrying amount of
the asset may suggest a very limited useful life). As in determining
the useful life of depreciable tangible assets, regular maintenance
may be assumed but enhancements may not.
Entities may perform various activities geared toward
maintaining customer relationships. In some instances, there may be significant
barriers to a customer’s changing service providers or suppliers so that once a
contractual relationship is formed between an entity and a customer, little
effort may be needed for the entity to retain the customer. However, in other
circumstances, entities may operate in a highly competitive environment in which
there are only limited barriers, if any, to a customer’s switching service
providers or suppliers. In these circumstances, entities may need to make
additional investments or incur other costs to maintain customer relationships
(e.g., invest in innovative products or services, or provide customer
incentives). The additional investments may be akin to “maintenance
expenditures” that may affect the useful life of a customer acquisition
asset.
While an entity will need to use judgment to determine the
amortization period of the customer acquisition asset, the entity might consider
the following factors:
-
Incremental costs of obtaining a sale (e.g., commissions) relative to ongoing contract value — A small commission relative to the value of the contract could suggest that the customer acquisition asset has limited value and that the asset life is relatively short. In contrast, a higher commission payment relative to the contract value (1) could suggest that the entity believes the asset to be of greater value or (2) may be related to anticipated contracts with the customer.
-
Degree of difficulty in switching service providers or suppliers — If it is difficult for a customer to switch service providers or suppliers, the customer acquisition asset may have a longer life. Accordingly, the entity may expect that the efforts it performed to acquire the customer will provide it with value over a longer period (i.e., over some or all contract renewals). In contrast, if there are only limited barriers to a customer’s switching service providers or suppliers (and there are other service providers or suppliers available to the customer), the customer acquisition asset may have a shorter life.
-
Extent to which the product or service changes over the customer life — Significant changes in the underlying product or service over the customer life may suggest that the life of the customer acquisition asset is shorter than the customer life. That is, the asset may be related to some, but not all, anticipated contracts with the customer. For example, if a customer’s decision about whether to renew a contract is influenced by enhancements made to products or services, the activities required to initially obtain the customer may not be related to all anticipated contract renewals with the customer. In contrast, if the same service or product is provided in each renewal period, the customer acquisition asset may be attributed to all anticipated contract renewals.
-
Other customer maintenance activities — If the entity incurs significant costs (relative to the initial incremental cost incurred) to maintain a customer relationship, the useful life of the customer acquisition asset could be short. However, if only limited costs are required to maintain a customer relationship, the useful life of the customer acquisition asset could extend to all anticipated contracts with the customer (i.e., the customer life). Fulfillment costs would not be considered customer maintenance costs. Only costs that are incremental to transferring the specified goods or services to the customer should be evaluated as maintenance costs.
The above factors are not all-inclusive, and none of them are
determinative. Accordingly, an entity should consider all relevant facts and
circumstances when determining the amortization period for customer acquisition
assets. In addition, an entity should adequately disclose the method it uses to
determine the amortization for each reporting period in accordance with ASC
340-40-50-2(b).
The above issue is addressed in Implementation Q&As 71 and 79 (compiled from previously
issued TRG Agenda Papers 23, 25, 57, and 60). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
13.4.1.2.1 Specific Anticipated Contract Not Limited to Contract Renewals
The reference to a “specific anticipated contract” in
ASC 340-40-35-1 is not limited to contract renewals. Although the
guidance in ASC 340-40-35-1 will often be relevant in the context of
contract renewals (see Section
13.4.1.2), it is not limited to contract renewals for
purposes of determining the amortization period for capitalized
incremental costs incurred to obtain a contract.
For example, an entity may incur incremental costs of obtaining a
contract to deliver one part of an overall project for a customer. The
entity may have been informed that if it successfully fulfills its
performance obligations under the initial contract, the customer will
award the entity an additional contract to deliver other parts of the
project. If the entity will not incur any further incremental costs to
obtain the additional contract, it may be appropriate to regard the
additional contract as a “specific anticipated contract” under ASC
340-40-35-1.
13.4.1.2.2 Evaluating Whether Commissions Paid on a Contract Renewal Are Commensurate With Commissions Paid on the Initial Contract
Paragraph BC309 of ASU 2014-09 states that amortization
of an asset over a period longer than the initial contract period would
not be appropriate when a commission paid on a contract renewal is
commensurate with the commission paid on the initial contract.
The FASB staff has confirmed that when commissions are
paid on contract renewals, an entity should evaluate whether the
commission on renewal is commensurate with the initial commission by
considering the amount of the commissions relative to the contracts’
value. It has specifically noted that “assessing whether a renewal
commission is commensurate with an initial commission solely on the
basis of the level of effort to obtain the contract would not be
consistent with the guidance in Subtopic 340-40.”4
In addition, the FASB staff has clarified that it holds
the following views5 irrespective of the relative level of effort involved with
obtaining the original contract and the renewal contract:
-
“[I]n general, it would be reasonable for an entity to conclude that a renewal commission is ‘commensurate with’ an initial commission if the two commissions are reasonably proportional to the respective contract value (for example, 5% of the contract value is paid for both the initial and the renewal contract).”
-
“Similarly, [it] would be reasonable for an entity to conclude that a renewal commission is not ‘commensurate with’ an initial commission if it is disproportionate to the initial commission (for example, 2% renewal commission as compared to a 6% initial contract commission).”
The above issue is addressed in Implementation Q&A 72 (compiled from previously
issued TRG Agenda Papers 23, 25, 57, and 60). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
13.4.1.2.3 Determining the Appropriate Amortization Period of Commissions When a Commission Paid Upon Renewal Is Not Commensurate With the Initial Commission
Stakeholders have also raised questions about the appropriate
amortization period for a commission paid to an employee for obtaining
an initial contract that has a high likelihood of renewal. That is,
should the commission be amortized over the initial contract term, or
should the amortization period include the expected renewal period? The
amortization period will depend on many factors, including whether a
commission is paid on contract renewals and, if so, whether the
commission paid is commensurate with the initial commission.
Example 13-17
Entity X enters into a two-year contract with a
customer. On signing the initial contract, X pays
its salesperson $200 for obtaining the contract.
An additional commission of $120 is paid each time
the customer renews the contract for another two
years. Assume that the $120 renewal commission is
not commensurate with the $200 initial commission,
which means that some of the commission paid for
the initial contract should be attributed to the
contract renewal as well. On the basis of
historical experience, 98 percent of X’s customers
are expected to renew their contract for at least
two more years (i.e., the contract renewal is a
specific anticipated contract), and the average
customer life is four years.
In this example, we believe that there are at
least two acceptable approaches to amortizing the
initial $200 commission and the $120 renewal commission:
-
Approach 1 — Amortize the initial commission amount of $200 over the contract period that includes the anticipated renewal (i.e., four years). When the contract is renewed, the additional $120 commission would be combined with the remaining asset and amortized over the remaining two-year period, as shown in the following table:
-
Approach 2 — Bifurcate the initial commission into two parts: (1) $120, the amount that is commensurate with the renewal commission and that pertains to obtaining a two-year contract, and (2) $80, the amount that is considered to be paid for obtaining the initial contract plus the anticipated renewal (i.e., the customer relationship). The $120 would then be amortized over the initial two-year contract term, and the $80 would be amortized over the entire four-year period, as shown in the following table:
As noted in the example above, we believe that there are
multiple acceptable approaches to amortizing costs of obtaining contract
assets when commissions paid upon renewal are not commensurate with the
initial commission paid. The example below illustrates how the
alternatives may be applied when a good or service is transferred at the
inception of an arrangement and another good or service is transferred
over time.
Example 13-18
Software Company
Company A enters into a software
arrangement with a customer in exchange for
consideration of $1,300. Under the arrangement, A
provides a software license ($1,000) and three
years of postcontract customer support (PCS) ($100
per year). In addition, the arrangement includes
two years of optional PCS renewals for which the
customer is able to renew at $100 per year. At
contract inception, A expects that the customer
will renew the PCS for both years. The
corresponding commission rates for the software
license and PCS (including renewals) are as
follows:
For purposes of this example, assume that revenue
is recognized as follows:
As illustrated above, the commission paid upon
PCS renewal in years 4 and 5 is not commensurate
with the commission paid on PCS in the initial
contract; therefore, the initial commission is
related to both the original contract and the
renewal periods. We believe that in this example,
there are at least two acceptable approaches to
amortizing the initial $120 commission and the $2
renewal commission:
-
Approach 1 — Amortize the initial commission amount of $120 proportionately over the contract period that includes the anticipated renewals (e.g., five years) by multiplying the annual revenue amount in each year by Percentage 1. The incremental commission from years 4 and 5 would be amortized over the remaining two-year period, as shown in the following table:
-
Approach 2 — Amortize the total expected commission amount of $122 over the contract period that includes the anticipated renewals (e.g., five years) by multiplying the annual revenue amount by Percentage 2, as shown in the following table:
The above issue is addressed in Implementation Q&A 71 (compiled from previously
issued TRG Agenda Papers 23, 25, 57, and 60). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
13.4.1.3 Accounting for Unamortized Contract Costs Upon Modification
ASC 606-10-25-13(a) provides that when specified criteria
are met, an entity should account for a contract modification “as if it were
a termination of the existing contract, and the creation of a new contract.”
Although the contract modification is accounted for as if it were a
termination of the existing contract and the creation of a new contract, the
original contract was not in fact terminated. Therefore, any unamortized
contract costs that existed immediately before the contract modification
should not be written off unless those costs are no longer related to the remaining goods or services. Rather,
those unamortized contract costs should be carried forward into the new
contract and amortized on a systematic and rational basis that is consistent
with the transfer of goods or services related to the asset.
An entity will need to use judgment when determining which
remaining goods or services to be transferred under the modified contract
are related to the asset (see Section 13.4.1.2). Further, the entity
should consider whether the asset is impaired by applying the guidance in
ASC 340-40-35-3 through 35-5 (see Section
13.4.2).
13.4.2 Impairment
ASC 340-40
35-3 An entity shall recognize an impairment loss in profit or loss to the extent that the carrying amount of an asset recognized in accordance with paragraph 340-40-25-1 or 340-40-25-5 exceeds:
- The amount of consideration that the entity expects to receive in the future and that the entity has received but has not recognized as revenue, in exchange for the goods or services to which the asset relates (“the consideration”), less
- The costs that relate directly to providing those goods or services and that have not been recognized as expenses (see paragraphs 340-40-25-2 and 340-40-25-7).
35-4 For the purposes of
applying paragraph 340-40-35-3 to determine the
consideration, an entity shall use the principles for
determining the transaction price (except for the
guidance in paragraphs 606-10-32-11 through 32-13 on
constraining estimates of variable consideration) and
adjust that amount to reflect the effects of the
customer’s credit risk. When determining the
consideration for the purposes of paragraph 340-40-35-3,
an entity also shall consider expected contract renewals
and extensions (with the same customer).
35-5 Before an entity
recognizes an impairment loss for an asset recognized in
accordance with paragraph 340-40-25-1 or 340-40-25-5,
the entity shall recognize any impairment loss for
assets related to the contract that are recognized in
accordance with another Topic other than Topic 340 on
other assets and deferred costs, Topic 350 on goodwill
and other intangible assets, or Topic 360 on property,
plant, and equipment (for example, Topic 330 on
inventory and Subtopic 985-20 on costs of software to be
sold, leased, or otherwise marketed). After applying the
impairment test in paragraph 340-40-35-3, an entity
shall include the resulting carrying amount of the asset
recognized in accordance with paragraph 340-40-25-1 or
340-40-25-5 in the carrying amount of the asset group or
reporting unit to which it belongs for the purpose of
applying the guidance in Topics 360 and 350.
35-6 An entity shall not recognize a reversal of an impairment loss previously recognized.
The objective of impairment is to determine whether the carrying amount of the
contract acquisition and fulfillment costs asset is recoverable. This is
consistent with other impairment methods under U.S. GAAP and IFRS Accounting
Standards that include an assessment of customer credit risk and expectations of
whether variable consideration will be received.
Further, the FASB decided that it would not be appropriate to reverse an
impairment charge when the reasons for impairment are no longer present. In
contrast, the IASB decided to allow a reversal of the impairment charge in these
circumstances. The boards decided to diverge on this matter to maintain
consistency with their respective existing impairment models for other types of
assets.
To test a contract cost asset for impairment, an entity must
consider the total period over which it expects to receive an economic benefit
from the asset. Accordingly, to estimate the amount of remaining consideration
that it expects to receive, the entity would also need to consider goods or
services under a specific anticipated contract (e.g., a contract renewal).
However, the impairment guidance as originally issued in ASU 2014-09 appeared to
contradict itself because it also indicated that an entity should apply the
principles used to determine the transaction price when calculating the “amount
of consideration that [the] entity expects to receive.”6 The determination of the transaction price would exclude renewals.7
At the July 2014 TRG meeting, TRG members generally agreed that
when testing a cost asset for impairment, an entity would consider the economic
benefits from anticipated contract extensions or renewals if the asset is
related to the goods and services that would be transferred during those
extension or renewal periods.
As a result of the TRG discussions noted above, the FASB issued
ASU
2016-20, which includes certain technical corrections that
amend ASC 340-40 to clarify that for impairment testing, an entity should:
-
Consider contract renewals and extensions when measuring the remaining amount of consideration the entity expects to receive.
-
Include in the amount of consideration the entity expects to receive both (1) the amount of cash expected to be received and (2) the amount of cash already received but not yet recognized as revenue.
-
Test for and recognize impairment in the following order: (1) assets outside the scope of ASC 340-40 (such as inventory under ASC 330), (2) assets accounted for under ASC 340-40, and (3) reporting units and asset groups under ASC 350 and ASC 360.
Footnotes
3
Quoted text from Implementation Q&A 75.
4
Quoted from Implementation Q&A 72.
5
See footnote 4.
6
ASC 340-40-35-4 (paragraph 102 of IFRS 15).
7
ASC 606-10-32-4 (paragraph 49 of IFRS 15) states, “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.”
13.5 Onerous Performance Obligations
Both U.S. GAAP and IFRS Accounting Standards include guidance on accounting for
certain types of onerous contracts. A contract is considered onerous if the
aggregate cost required to fulfill the contract is greater than the expected
economic benefit to be obtained from the contract. When this condition is met, the
guidance may require an entity to recognize the expected future loss before actually
incurring the loss. Onerous contracts have historically been accounted for as
follows:
-
U.S. GAAP — As indicated in ASC 605-10-05-4, existing guidance under U.S. GAAP addresses the recognition of losses on the following specific transactions:
-
Separately priced extended warranty and product maintenance contracts (ASC 605-20).
-
Construction- and production-type contracts (ASC 605-35).
-
Certain software arrangements (ASC 985-605).
-
Certain insurance contracts (ASC 944-605).
-
Certain federal government contracts (ASC 912-20).
-
Continuing care retirement community contracts (ASC 954-440).
-
Prepaid health care services (ASC 954-450).
-
Certain long-term power sales contracts (ASC 980-350).In addition, ASC 450-20 provides overall guidance on accounting for loss contingencies. Such guidance requires an entity to recognize an expected loss if the contingency is probable and the amount is reliably estimable. Further, ASC 330-10-35-17 and 35-18 provide guidance on the recognition of losses on firm purchase commitments related to inventory.
-
-
IFRS Accounting Standards — IAS 37 provides general guidance on the recognition and measurement of losses on onerous contracts.
In developing the revenue standard, the FASB and IASB considered including
guidance on identifying and measuring onerous performance obligations (i.e., an
“onerous test”). As stated in paragraph BC294 of ASU 2014-09, the boards initially (1)
believed that “an onerous test was needed because the initial measurements of
performance obligations are not routinely updated” and (2) “noted that including an
onerous test would achieve greater convergence of U.S. GAAP and IFRS [Accounting
Standards].”
Many stakeholders disagreed with including an onerous test in the revenue
standard. Those stakeholders provided feedback indicating that application of an
onerous test at the performance obligation level may result in the recognition of a
liability for an onerous performance obligation even if the overall contract is
expected to be profitable. In addition, stakeholders believed that the existing
guidance on accounting for onerous contracts was sufficient and that additional
guidance was unnecessary.
The boards considered this feedback and ultimately agreed that the existing
guidance under both U.S. GAAP and IFRS Accounting Standards sufficiently addresses
onerous contracts. Consequently, the boards decided not to include specific guidance
on accounting for onerous contracts in the revenue standard, but rather to retain
existing onerous contract guidance. Accordingly, contracts within the scope of the
guidance referred to above may need to be evaluated as onerous contracts.
Connecting the Dots
As noted above, one of the reasons that the boards initially wanted to include
an onerous test in the revenue standard was to promote convergence between
U.S. GAAP and IFRS Accounting Standards. Although achieving convergence was
one of the goals of the revenue standard, paragraph BC296 of ASU 2014-09
states the boards “noted that although their existing guidance on onerous
contracts is not identical, they are not aware of any pressing practice
issues resulting from the application of that existing guidance.”
Accordingly, the absence of an onerous test in the revenue standard is not
expected to hinder overall convergence of revenue recognition under U.S.
GAAP and IFRS Accounting Standards; however, differences in the accounting
for onerous contracts will remain. While the existing guidance on accounting
for onerous contracts has not changed, there have been changes to other
guidance on recognizing revenue and costs as a result of the revenue
standard. Therefore, entities should carefully consider the interaction
between the revenue standard and existing guidance on onerous contracts to
ensure that no changes result.
13.5.1 Technical Corrections to ASC 605-35-25
The revenue standard supersedes most of the guidance in ASC 605-35-25. However,
the existing guidance in ASC 605-35-25 on provision for loss contracts was
retained because the FASB decided not to include specific guidance on onerous
contracts in the revenue standard but to retain the practice under U.S. GAAP of
recording losses on onerous contracts within the scope of ASC 605-35. The
technical corrections of ASU 2016-20 include an update to ASC 605-35-25 that
allows an entity to determine the provision for losses on contracts within the
scope of ASC 605-35 at the performance obligation level or the contract level as
an accounting policy election.
13.5.1.1 Providing for Anticipated Losses
As noted above, the guidance on onerous contracts within the scope of ASC 605-35
was not superseded by ASU 2014-09 or any of the amendments to the ASU’s
guidance. Consequently, the following guidance is still applicable to
construction type contracts:
ASC 605-35
Provisions for Losses on Contracts
25-45 For a
contract on which a loss is anticipated, an entity shall
recognize the entire anticipated loss as soon as the
loss becomes evident.
25-46 When
the current estimates of the amount of consideration
that an entity expects to receive in exchange for
transferring promised goods or services to the customer,
determined in accordance with Topic 606, and contract
cost indicate a loss, a provision for the entire loss on
the contract shall be made. Provisions for losses shall
be made in the period in which they become evident.
25-46A For
the purpose of determining the amount that an entity
expects to receive in accordance with paragraph
605-35-25-46, the entity shall use the principles for
determining the transaction price in paragraphs
606-10-32-2 through 32-27 (except for the guidance in
paragraphs 606-10-32-11 through 32-13 on constraining
estimates of variable consideration) and allocating the
transaction price in paragraphs 606-10-32-28 through
32-41. In addition, the entity shall adjust that amount
to reflect the effects of the customer’s credit
risk.
25-47 If a
group of contracts are combined based on the guidance in
paragraph 606-10-25-9, they shall be treated as a unit
in determining the necessity for a provision for a loss.
If contracts are not combined, the loss is determined at
the contract level (see paragraph 605-35-25-45). As an
accounting policy election, performance obligations
identified in accordance with paragraphs 606-10-25-14
through 25-22 may be considered separately in
determining the need for a provision for a loss. That
is, an entity can elect to determine provisions for
losses at either the contract level (including contracts
that are combined in accordance with the guidance in
paragraph 606-10-25-9) or the performance obligation
level. An entity shall apply this accounting policy
election in the same manner for similar types of
contracts.
Losses on contracts should not be allocated to future periods by spreading them
over the remaining contract years or deferring them in expectation of receiving
future or follow-on contract awards. In addition, contract losses should be
accrued when known regardless of whether they are currently deductible for tax
purposes.
When an entity concludes that a loss on a contract within the scope of ASC 605-35
has been incurred (i.e., total estimated contract costs exceed the consideration
expected to be received), the entity should apply the guidance in ASC
605-35-25-49 to determine which costs to factor into the calculation of the
loss. Such costs include all costs allocable to the contract under ASC
340-40-25-5 through 25-8.
Example 13-19
Entity Y constructs and repairs ships
for the federal government. To record revenue on
long-term construction contracts over time, Y uses a
cost-to-cost method. Entity Y charges general and
administrative costs to related contracts (i.e., those
costs are explicitly chargeable to the customer under
the contracts). According to Y’s current projections, Y
will incur a loss on several ship-building contracts,
primarily because of delays and disruptions caused by
the government to Y’s established construction schedule.
As a result of such delays and disruptions, Y will use
additional labor hours to complete the contracts, incur
incremental general and administration costs, and limit
the efficiencies anticipated in the original bid.
ASC 605-35-25-49 states that the
estimated loss should include costs allocable to
contracts under ASC 340-40-25-5 through 25-8. In
accordance with ASC 340-40-25-7(d) and 25-8(a), when Y
determines the loss to record on its contracts, it would
include general and administrative expenses in the
provision for anticipated losses if they are costs that
are explicitly chargeable to the customer under the
contracts.
13.5.2 Application of the Loss Guidance in ASC 605-35 That Affects Impairment of Capitalized Contract Cost Assets
The example below illustrates how to record an impairment of an
asset related to the capitalized costs of fulfilling a contract in a manner
consistent with the guidance in ASC 605-35-45-2.
Example 13-20
Company M provides a cleaning and
restoration service for certain outdoor spaces after
natural disasters have occurred. On June 30, 20X0, M
enters into a contract with a customer to clean up and
restore a beach after a disastrous hurricane. Since the
service that M provides under the contract requires the
use of construction vehicles and the assembly of
temporary infrastructure (e.g., a piping system for
moving sand or water to and from various locations), M
incurs significant up-front costs to fulfill the
contract. Company M expects that the costs of mobilizing
the necessary construction vehicles and assembling the
temporary infrastructure will be recovered through the
contract with the customer. In addition, M determines
that it should recognize revenue from the contract over
time by using an input method based on costs incurred.
At contract inception, M estimates or
determines the following:
One year later, on June 30, 20X1, M updates its EAC
calculation and now expects to incur a loss on the
contract. The updated calculations are as follows:
As a result, M will recognize the expected contract loss
immediately (as of June 30, 20X1) in accordance with the
guidance in ASC 605-35 in the amount of $300,000. Note
that M will also have to record a cumulative catch-up
adjustment to revenue in the same period (as of June 30,
20X1).8
Company M should first record an impairment of the asset
related to the capitalized costs of fulfilling the
contract. If the expected loss on the contract caused an
impairment of the entire asset related to the
capitalized costs of fulfilling the contract, M should
then account for the remainder of the expected loss as a
loss reserve, which would be classified as a liability
on M’s balance sheet. Recording impairment in this order
is consistent with the guidance in ASC 605-35-45-2,
which states the following:
Provisions for losses on
contracts shall be shown separately as liabilities
on the balance sheet, if significant, except in
circumstances in which related costs are
accumulated on the balance sheet, in which case
the provisions may be deducted from the related
accumulated costs. In a classified balance
sheet, a provision shown as a liability shall be
shown as a current liability. [Emphasis
added]
On the basis of the guidance above, which was issued
before the guidance in ASC 606 but has not been amended
or superseded, the expected loss first impairs the
capitalized contract costs of fulfilling the contract.
Subsequently, a provision for a loss is established on
the balance sheet.
Company M should record the following journal entry:
Since the expected loss on the contract ($300,000) is
larger than the remaining asset related to the
capitalized costs of fulfilling the contract ($120,000),
M needs to establish a loss reserve (liability) to
account for the remainder of the expected loss
($180,000).
13.5.3 Separately Priced Extended Warranty Contracts and Product Maintenance Contracts
The recognition of losses resulting from separately priced extended
warranty or product maintenance contracts is addressed in ASC 605-20-25-1 and ASC
605-20-25-6. These contracts provide warranty protection or product services not
included in the original price of the product covered by the contracts. Under ASC
605-20-25-6, a loss on such contracts is recognized if the expected costs plus the
amount of any asset recorded for the incremental cost of obtaining a contract exceed
the contract liability plus any amount not yet due from the customer related to the
performance obligation. To record a loss, an entity should first expense any asset
recorded for the incremental cost of obtaining a contract and then recognize a
liability for the remainder of the loss. In determining whether a loss should be
recognized, an entity should group contracts in a consistent manner.
Footnotes
8
For simplicity, any adjusting revenue entry (and
any corresponding adjustment to the loss
provision) is not illustrated in this example.
Chapter 14 — Presentation
Chapter 14 — Presentation
14.1 Overview
ASC 606-10
45-1 When either party to a
contract has performed, an entity shall present
the contract in the statement of financial
position as a contract asset or a contract
liability, depending on the relationship between
the entity’s performance and the customer’s
payment. An entity shall present any unconditional
rights to consideration separately as a
receivable.
As discussed in Chapter 4,
a contract with a customer creates legal rights and obligations. The rights under
the contract will generally give rise to contract assets as the entity performs (or
accounts receivable, if an unconditional right to consideration exists); and
contract liabilities are created when consideration is received (or receivable) in
advance of performance. Each reporting period, an entity is required to assess its
financial position related to its contracts with customers. Depending on the extent
to which an entity has performed and the amount of consideration received (or
receivable) by the entity under a contract, the entity could record a contract asset
or a contract liability.
Paragraph BC317 of ASU 2014-09 indicates that an entity should present its remaining rights and obligations under a contract on a net basis. The reasoning behind this is that neither party to the contract would continue to fulfill its obligations if it knew that the other party would not perform. Because the rights and obligations in a contract are interdependent, contract assets and contract liabilities that arise in the same contract should be presented net.
Receivables should be recorded separately from contract assets since only the
passage of time is required before consideration is due. That is, receivables are
only subject to credit risk. In contrast, contract assets are subject to more than
just credit risk (e.g., they are also subject to performance risk). As discussed in
paragraph BC323 of ASU 2014-09, the FASB and IASB believed that making a distinction
between contract assets and receivables was important to financial statement users.
Consequently, only contract assets and contract liabilities are reported net.
Accounts receivable should be reported separately.
ASC 606-10-45-5 addresses the use of alternative descriptions for contract assets and contract liabilities as follows:
ASC 606-10
45-5 This guidance uses the terms contract asset and contract liability but does not prohibit an entity from using alternative descriptions in the statement of financial position for those items. If an entity uses an alternative description for a contract asset, the entity shall provide sufficient information for a user of the financial statements to distinguish between receivables and contract assets.
Paragraph BC321 of ASU 2014-09 notes the FASB’s and IASB’s observation that
“some industries have historically used different labels to describe contract assets
and contract liabilities or may recognize them in more than one line item either in
the financial statements or in the notes.” The ASU does not prohibit an entity from
using alternative terms or from using additional line items to present the assets
and liabilities, but it requires an entity to provide appropriate disclosures that
adequately describe the assets and liabilities.
Terms that are commonly used in practice to describe contract assets and contract liabilities include, but are not limited to, the following:
- Contract assets — Unbilled receivables, progress payments to be billed.
- Contract liabilities — Deferred revenue, unearned revenue.
For discussion of income statement presentation matters, including the requirements
in SEC Regulation S-X, see Sections 14.7.3 through
14.7.6.
14.2 Contract Liabilities
ASC 606-10
45-2 If a customer pays consideration, or an entity has a right to an amount of consideration that is unconditional (that is, a receivable), before the entity transfers a good or service to the customer, the entity shall present the contract as a contract liability when the payment is made or the payment is due (whichever is earlier). A contract liability is an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or an amount of consideration is due) from the customer.
A contract liability would exist when an entity has received consideration but has not transferred the related goods or services to the customer. This is commonly referred to as deferred revenue. An entity may also have an unconditional right to consideration (i.e., a receivable) before it transfers goods or services to a customer.
The example below, which is reproduced from ASC 606, illustrates how an entity
would account for a contract liability and receivable. (For further discussion about
receivables, see Section
14.5.)
ASC 606-10
Example 38 — Contract Liability and Receivable
Case A — Cancellable Contract
55-284 On January 1, 20X9, an entity enters into a cancellable contract to transfer a product to a customer on March 31, 20X9. The contract requires the customer to pay consideration of $1,000 in advance on January 31, 20X9. The customer pays the consideration on March 1, 20X9. The entity transfers the product on March 31, 20X9. The following journal entries illustrate how the entity accounts for the contract:
- The entity receives cash of $1,000 on March 1, 20X9 (cash is received in advance of performance).
- The entity satisfies the performance obligation on March 31, 20X9.
Case B — Noncancellable Contract
55-285 The same facts as in Case A apply to Case B except that the contract becomes noncancellable on January 31, 20X9. The following journal entries illustrate how the entity accounts for the contract:
- January 31, 20X9 is the date at which the entity recognizes a receivable because it has an unconditional right to consideration.
- The entity receives the cash on March 1, 20X9.
- The entity satisfies the performance obligation on March 31, 20X9.
55-286 If the entity issued the invoice before January 31, 20X9, the entity would not recognize the receivable and the contract liability in the statement of financial position because the entity does not yet have a right to consideration that is unconditional (the contract is cancellable before January 31, 20X9).
14.3 Refund Liabilities
Some contracts with customers may result in refund liabilities owed
to customers. The most common of such refund liabilities are return provisions in
sales contracts that permit the customer to return the product if certain
circumstances arise. These liabilities may also arise when an entity receives cash
in advance, but the agreement is cancelable because of certain termination
provisions in the agreement (see Section 4.4.1). When these provisions are present in a contract, the
seller would recognize a liability to reflect its obligation to return amounts paid
or payable by the customer (i.e., a refund liability).
An agreement that includes a provision for termination without penalty may not be a
contract under step 1 of ASC 606 (i.e., a contract may not exist for the cancelable
term). Such a provision may therefore affect the presentation of these arrangements
on the balance sheet. For a cancelable contract (with a termination right without
penalty), funds received in advance should not be classified as a contract
liability. Funds received in advance that are associated with a cancelable term
(with a termination right without penalty) should be presented separately from any
contract liability as a refund liability, or similar liability.
A refund liability should not be presented together with contract
liabilities that arise under the same contract. A contract liability is defined in
ASC 606-10-45-2 as “an entity’s obligation to transfer goods or services to a
customer for which the entity has received consideration (or an amount of
consideration is due) from the customer.” A refund liability, however, represents
the customer’s conditional right to consideration from the seller (as opposed to
consideration receivable from the customer) and does not represent a performance
obligation. Consequently, we believe that the refund liability should be presented
separately from the contract liability. Note that as a result, the refund liability
would not be netted with any contract assets the entity may recognize.
Example 14-1
Entity A sells Product X to 10 separate
customers for $100 each and does not charge a restocking
fee. On the basis of its historic experience, A expects that
one of these products will be returned. As a result, A
should recognize a refund liability of $100 for the one
product out of 10 that it expects will be returned. In
addition to Product X, A also sells Product Z (considered a
separate performance obligation from Product X). One
customer has prepaid for Product Z in the amount of $1,000.
As a result, A has recorded a contract liability of
$1,000.
In accordance with the guidance above, A
should record a refund liability of $100 and a separate
contract liability of $1,000 (i.e., A should not present the
refund liability together with the contract liability).
For a discussion about offsetting refund liabilities against
accounts receivable, see Example
14-6.
14.4 Contract Assets
ASC 606-10
45-3 If an entity performs by
transferring goods or services to a customer
before the customer pays consideration or before
payment is due, the entity shall present the
contract as a contract asset, excluding any
amounts presented as a receivable. A contract
asset is an entity’s right to consideration in
exchange for goods or services that the entity has
transferred to a customer. An entity shall assess
a contract asset for impairment in accordance with
Topic 310 on receivables. An impairment of a
contract asset shall be measured, presented, and
disclosed in accordance with Topic 310 (see also
paragraph 606-10-50-4(b)).
Pending Content (Transition
Guidance: ASC 326-10-65-1)
45-3 If an entity performs by
transferring goods or services to a customer
before the customer pays consideration or before
payment is due, the entity shall present the
contract as a contract asset, excluding any
amounts presented as a receivable. A contract
asset is an entity’s right to consideration in
exchange for goods or services that the entity has
transferred to a customer. An entity shall assess
a contract asset for credit losses in accordance
with Subtopic 326-20 on financial instruments
measured at amortized cost. A credit loss of a
contract asset shall be measured, presented, and
disclosed in accordance with Subtopic 326-20 (see
also paragraph 606-10-50-4(b)).
A contract asset would exist when an entity has a contract with a customer for
which revenue has been recognized (i.e., goods or services have been transferred to
the customer) but customer payment is contingent on a future event (e.g.,
satisfaction of additional performance obligations). Such an amount is commonly
referred to as an unbilled receivable.
The following example from the revenue standard illustrates the recording of a
contract asset for performance completed under a
contract before an unconditional right to
consideration exists:
ASC 606-10
Example 39 — Contract Asset Recognized for the Entity’s Performance
55-287 On January 1, 20X8, an entity enters into a contract to transfer Products A and B to a customer in exchange for $1,000. The contract requires Product A to be delivered first and states that payment for the delivery of Product A is conditional on the delivery of Product B. In other words, the consideration of $1,000 is due only after the entity has transferred both Products A and B to the customer. Consequently, the entity does not have a right to consideration that is unconditional (a receivable) until both Products A and B are transferred to the customer.
55-288 The entity identifies
the promises to transfer Products A and B as performance
obligations and allocates $400 to the performance obligation
to transfer Product A and $600 to the performance obligation
to transfer Product B on the basis of their relative
standalone selling prices. The entity recognizes revenue for
each respective performance obligation when control of the
product transfers to the customer.
55-289 The entity satisfies the performance obligation to transfer Product A.
55-290 The entity satisfies the performance obligation to transfer Product B and to recognize the unconditional right to consideration.
14.5 Receivables
ASC 606-10
45-4 A receivable is an
entity’s right to consideration that is
unconditional. A right to consideration is
unconditional if only the passage of time is
required before payment of that consideration is
due. For example, an entity would recognize a
receivable if it has a present right to payment
even though that amount may be subject to refund
in the future. An entity shall account for a
receivable in accordance with Topic 310. Upon
initial recognition of a receivable from a
contract with a customer, any difference between
the measurement of the receivable in accordance
with Topic 310 and the corresponding amount of
revenue recognized shall be presented as an
expense (for example, as an impairment loss).
Pending Content (Transition Guidance: ASC
326-10-65-1)
45-4 A receivable is an entity’s right
to consideration that is unconditional. A right to
consideration is unconditional if only the passage
of time is required before payment of that
consideration is due. For example, an entity would
recognize a receivable if it has a present right
to payment even though that amount may be subject
to refund in the future. An entity shall account
for a receivable in accordance with Topic 310 and
Subtopic 326-20. Upon initial recognition of a
receivable from a contract with a customer, any
difference between the measurement of the
receivable in accordance with Subtopic 326-20 and
the corresponding amount of revenue recognized
shall be presented as a credit loss expense.
The revenue standard was not intended to change either the timing of receivable
recognition or the subsequent accounting for receivables. While both
contract assets and receivables are similar in that they represent
an entity’s right to consideration, the risks associated with each
differ. As noted in Section 14.1, receivables are only exposed to credit
risk since only the passage of time is required before receivables
are due. However, contract assets are exposed to both credit risk
and other risks (e.g., performance risk).
An entity could have a present and unconditional right to payment, and therefore
a receivable, even if there is a refund obligation that may require
the entity to pay consideration to a customer in the future (e.g.,
when a product is returned, or when rebates are earned on a
specified volume of purchases). Since refund obligations give rise
to variable consideration, they could affect the transaction price
(see Section
6.3.5.2) and the amount of revenue recognized.
However, an entity’s present right to consideration may not be
affected by the potential need to refund consideration in the
future. Consequently, in certain circumstances, a gross receivable
could be recorded along with a liability. This is discussed further
in paragraph BC326 of ASU 2014-09 and is illustrated in the
following example from ASC 606:
ASC 606-10
Example 40 — Receivable Recognized for the Entity’s Performance
55-291 An entity enters into a contract with a customer on January 1, 20X9, to transfer products to the customer for $150 per product. If the customer purchases more than 1 million products in a calendar year, the contract indicates that the price per unit is retrospectively reduced to $125 per product.
55-292 Consideration is due when control of the products transfer to the customer. Therefore, the entity has an unconditional right to consideration (that is, a receivable) for $150 per product until the retrospective price reduction applies (that is, after 1 million products are shipped).
55-293 In determining the
transaction price, the entity concludes at
contract inception that the customer will meet the
1 million products threshold and therefore
estimates that the transaction price is $125 per
product. Consequently, upon the first shipment to
the customer of 100 products the entity recognizes
the following.
55-294 The refund liability (see paragraph 606-10-32-10) represents a refund of $25 per product, which is expected to be provided to the customer for the volume-based rebate (that is, the difference between the $150 price stated in the contract that the entity has an unconditional right to receive and the $125 estimated transaction price).
Connecting the Dots
At the April 2016 FASB-only TRG meeting,
the FASB staff noted that it has received questions
about the point in time at which a receivable should
be recorded under a contract with a customer
(including when contract assets would be
reclassified as accounts receivable). The FASB staff
agreed that some confusion could have resulted from
the wording in Example 38, Case B, of the revenue
standard (reproduced in Section 14.2), which
some believed was not aligned with the guidance that
identifies a receivable as a right to consideration
that is unconditional other than for the passage of
time. Partly in response to stakeholders’ concerns
acknowledged at the meeting, the FASB later issued
ASU
2016-20, which contains guidance
aimed at clarifying the timing of revenue
recognition related to receivables (referred to in
ASU 2016-20 as “Issue 9”). See Section
18.3.3.6 for further information about
the ASU’s clarifications related to Issue 9.
At the TRG meeting, the staff also noted
that it has received other questions, including
inquiries about situations in which performance
occurs over time and whether receivables should be
recorded as performance occurs or when amounts are
invoiced and due. The staff observed that there is
diversity in practice today regarding how and when
receivables are recorded and that such diversity is
not likely to be eliminated under the revenue
standard. However, the staff reiterated that these
questions do not affect revenue recognition; rather,
they affect the presentation of assets on an
entity’s balance sheet.
The example below illustrates how an entity that
satisfies its sole performance obligation in a contract with a
customer and plans to invoice the customer in multiple annual
installments should reflect the transaction on its balance
sheet.
Example 14-2
On March 1, 20X1, Entity A
enters into a contract with one performance
obligation (software license that is determined to
be satisfied at a point in time on March 1, 20X1)
for $3,600. Entity A delivers the software license
on March 1, 20X1, and will invoice the customer in
three equal and annual installments of $1,200 on
March 1 of 20X1, 20X2, and 20X3. Payment is due by
April 1 of each year.
Entity A should record a
receivable for the full contract amount ($3,600)
when it satisfies the performance obligation on
March 1, 20X1. That is, the $3,600 should be
recorded as a receivable in accordance with ASC
606-10-45-4, which states that a “receivable is an
entity’s right to consideration that is
unconditional” and a “right to consideration is
unconditional if only the passage of time is
required before payment of that consideration is
due.” As noted in paragraph BC323 of ASU 2014-09,
“making the distinction between a contract asset
and a receivable is important because doing so
provides users of financial statements with
relevant information about the risks associated
with the entity’s rights in a contract. That is
because although both would be subject to credit
risk, a contract asset also is subject to other
risks, for example, performance risk.” In this
scenario, A’s rights are only subject to credit
risk because the sole performance obligation has
been satisfied as of March 1, 20X1 (i.e., A has an
unconditional right to cash for the full contract
amount).
The example below illustrates how an entity that
satisfies its performance obligation over time in its contracts with
customers and plans to invoice each customer with different payment
terms should reflect the transactions on its balance sheet.
Example 14-3
On March 1, 20X1, Entity A
enters into two identical (other than payment
terms) noncancelable contracts with two different
customers, Customer Y and Customer Z. The
contracts each contain the same single performance
obligation (i.e., cleaning services) that is
satisfied over time. The transaction price is
$2,400. Each customer is issued an invoice on
March 1, 20X1, and A provides continuous service
from March 1, 20X1, through February 28, 20X2.
Customer Y’s payment is due on March 31, 20X1, but
is received by A on April 15, 20X1. Customer Z’s
payment is due on April 15, 20X1. There are
multiple views on how A should reflect these
transactions on its balance sheet as of March 31,
20X1:
-
Alternative A — Entity A should record a receivable when it issues an invoice to its customer and begins satisfying the performance obligation. The right to consideration is unconditional because only the passage of time up to the due date is required (since A has already begun performing the services). Accordingly, A’s transactions with Y and Z would be reflected in the financial statements as follows:
-
Alternative B — Until the invoice is due, A should build up its receivable balance incrementally as it satisfies its performance obligation. For Y, since payment is due on March 31, 20X1, the full receivable balance is recorded. For Z, the full receivable balance would be recorded once payment is due on April 15, 20X1. Accordingly, A’s transactions with Y and Z would be reflected in the financial statements as follows:
Discussions with the FASB staff confirmed that the Board
did not intend to change practice related to when receivable
balances are recorded. Depending on an entity’s existing accounting
policies, either Alternative A or Alternative B could be
acceptable.
Connecting the Dots
As further discussed in Section
14.7.1, contract assets and contract
liabilities should be determined at the contract
level (i.e., not at the performance obligation
level), and only a net contract asset or net
contract liability should be presented for a
particular contract. Receivables, however, would be
presented separately from contract assets and
contract liabilities, as also discussed in that
section. This issue is addressed in Q&As 61
through 63 (compiled from previously issued
TRG Agenda Papers 7 and
11) of the FASB staff’s
Revenue Recognition Implementation
Q&As (the “Implementation
Q&As”). For additional information and
Deloitte’s summary of issues discussed in the
Implementation Q&As, see Appendix
C.
Implementation Q&A 34 (compiled from
previously issued TRG Agenda Papers 30 and
34) discusses the difficulty of
determining when a customer paid for a particular
good or service under a contract involving multiple
promised goods or services because of the fungible
nature of cash (see Section 7.7 for
additional discussion about allocating cash payments
to specific performance obligations). Since
receivables are presented separately from contract
assets and contract liabilities, the allocation of
cash to performance obligations in a contract
involving multiple performance obligations could
also affect the recognition of receivables, contract
assets, and contract liabilities. Consider the
example below.
Example 14-4
On January 1, 20X1, Entity A
enters into a noncancelable contract with a
customer that contains two performance
obligations: a software license (satisfied at a
point in time) and a service (satisfied over time
from January 1, 20X1, through December 31, 20X3).
Entity A issues an invoice on January 1, 20X1, for
the first year (due on February 1, 20X1) and
subsequently issues an invoice on each anniversary
for the next two years. The transaction price of
the contract is $6,000 (invoiced at $2,000 per
year). As a result of allocating the transaction
price to each performance obligation on a relative
stand-alone selling price basis, 60 percent of
revenue ($3,600) is allocated to the license and
40 percent of revenue ($2,400) is allocated to the
service. Contractually, each $2,000 invoice
provides the right to receive service for one year
($800) and applies to one-third of the total
license fee of $3,600 ($1,200). Entity A has the
contractual right to bill and collect payment for
the remaining license fee independent of providing
any future service.
On January 1, 20X1, the
software license is transferred to the customer
and the service commences. The customer pays the
$2,000 invoice in full on February 1, 20X1. Entity
A has an accounting policy of recording the
receivable when amounts are invoiced and the
associated performance obligation has been
satisfied or has commenced.
There are multiple views on how this
transaction should be presented as of and for the
period ended March 31, 20X1:
-
Alternative A — To identify the receivable amount in this contract, A must first allocate the payment made on February 1, 20X1, to the performance obligations contractually tied to the payment. Entity A would then determine the remaining receivable for performance obligations satisfied when payment is unconditional. Accordingly, the transaction would be reflected in the financial statements as follows:
-
Alternative B — Entity A would allocate cash entirely to the satisfied performance obligations (i.e., the software license and the satisfied portion of the service) and record the remaining consideration due that is associated with the satisfied performance obligations as a receivable. Consequently, as illustrated below, A would not present any contract liability for services paid for by the customer before performance.
Because cash is fungible and
can be allocated at either the contract level or
the performance obligation level, either
Alternative A or Alternative B could be
acceptable. Entities should apply a consistent
approach for similar contracts and in similar
circumstances.
14.6 Classification as Current or Noncurrent
If an entity presents a classified balance sheet, it should determine whether certain
revenue-related balances should be presented as current or noncurrent (or bifurcated
between the two).
14.6.1 Contract Assets and Contract Liabilities
In a manner similar to the treatment of assets and liabilities
related to the receipt or use of cash (e.g., receivables, prepaid assets, or
debt), contract assets and contract liabilities should be bifurcated between
current and noncurrent when presented in a classified balance sheet. Note that
the contract asset or contract liability determined at the contract level (i.e.,
after the contract assets and contract liabilities for each performance
obligation within a single contract have been netted, as discussed in Section 14.7.1) is the contract asset or
contract liability that should be bifurcated between current and noncurrent when
presented in a classified balance sheet
14.6.2 Refund Liabilities
The example below considers whether it is appropriate for an
entity to classify refund liabilities (or similar liabilities) as a noncurrent
liability in a classified balance sheet.
Example 14-5
Entity P, an entity with an operating cycle of less than
12 months, expects to return proceeds related to refund
liabilities (or similar liabilities) more than 12 months
after the reporting date. However, the counterparty can
demand a refund of amounts previously paid at any
time.
Entity P should not classify the portion that it expects
to repay more than 12 months after the reporting date as
a noncurrent liability in a classified balance sheet.
All amounts related to such liabilities should be
recorded as a current liability because the counterparty
can demand a refund at any time.
On a classified balance sheet, the refund liability should not be presented as
noncurrent if the customer can cancel the contract at any point or within 12
months or less. Rather, all amounts should be recorded as a current liability.
The refund liability is excluded from contract liabilities because the customer
must, in effect, make a separate purchase decision when the noncancelable term
ends, at which point it could demand a refund of funds previously paid.
ASC 470-10-45-10, which
specifies that loans due on demand should be presented as a current liability,
supports this view.
ASC 470-10
45-10 The current liability
classification shall include obligations that, by their
terms, are due on demand or will be due on demand within
one year (or operating cycle, if longer) from the
balance sheet date, even though liquidation may not be
expected within that period. The demand provision is not
a subjective acceleration clause as discussed in
paragraph 470-10-45-2.
14.6.3 Capitalized Contract Costs
It is acceptable for costs of obtaining or fulfilling a contract to be bifurcated
between current and noncurrent in a classified balance sheet. Alternatively, in
a manner similar to the treatment of (1) intangible assets, (2) inventory, or
(3) property, plant, and equipment, capitalized costs of obtaining or fulfilling
a contract may be presented as a single asset and neither bifurcated nor
reclassified between current and noncurrent assets. That is, the assets would be
classified as long-term unless they had an original amortization period of one
year or less.
14.7 Other Presentation Matters
14.7.1 Unit of Account for Presentation
Under ASC 606, a contract asset can arise when the amount of
revenue recognized by an entity exceeds the amount that
has already been paid by the customer together with any unpaid amounts
recognized as receivables. Conversely, a contract liability can arise when the
amount of revenue recognized by an entity is less than
the amount that has already been paid by the customer together with any unpaid
amounts recognized as receivables.
When there are multiple performance obligations in a contract
(or in multiple contracts accounted for as a single combined contract in
accordance with ASC 606-10-25-9), it is possible that revenue recognized is in
excess of amounts paid or receivable for some performance obligations but less
than amounts paid or receivable for other performance obligations. In such
circumstances, the appropriate unit of account for presenting contract assets
and contract liabilities is the contract. Accordingly, it is not appropriate to
present both contract assets and contract liabilities for a single contract;
instead, a single net figure should be presented.
ASC 606-10-45-1 states that “[w]hen either party to a contract
has performed, an entity shall present the contract in the statement of
financial position as a contract asset or a contract liability, depending on the
relationship between the entity’s performance and the customer’s payment. An
entity shall present any unconditional rights to consideration separately as a
receivable.”
This also applies to circumstances in which multiple contracts
are combined and are accounted for as a single contract in accordance with the
requirements for combination in ASC 606-10-25-9.
Paragraph BC317 of ASU 2014-09 explains that the “Boards decided
that the remaining rights and performance obligations in a
contract should be accounted for and presented on a
net basis, as either a contract asset or a contract liability. . . . The
Boards decided that those interdependencies are best reflected by accounting and presenting on a net basis the remaining
rights and obligations in the statement of financial position” (emphasis
added).
See also Section 14.7.2.1 for discussion of offsetting contract assets
and contract liabilities against other assets and liabilities.
Unit of account considerations for presentation purposes are
addressed in Implementation Q&As 61 through 63 (compiled from
previously issued TRG Agenda Papers 7 and 11). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
Connecting the Dots
As a corollary to the discussion in Section 6.3.5.5.1 that variability due
to changes in the foreign currency exchange is not variable
consideration, questions have been raised about the accounting for
receivables, contract assets, and contract liabilities in contracts that
include consideration denominated in a foreign currency. Specifically,
stakeholders have asked how an entity should apply the guidance in ASC
830 on foreign currency matters to the recognized assets and liabilities
in a customer contract with the expectation that more contract assets
may arise in contracts under ASC 606.
ASC 606 requires an entity to recognize (1) a contract
asset if the entity performs by transferring goods or services to a
customer before the customer pays consideration or before payment is due
or (2) a contract liability if the entity receives (or has an
unconditional right to receive) consideration before it transfers goods
or services to the customer.
Contract liabilities are nonmonetary liabilities because they require an
entity to perform a service in the future. Contract assets are monetary
assets because they will ultimately be settled for a fixed amount of
cash.
A separate issue arises if a single contract with a
customer contains a performance obligation that is in a contract asset
position and another performance obligation that is in a contract
liability position. ASC 606 requires an entity to present contract
assets and contract liabilities on a net basis in the balance sheet.
Therefore, questions have arisen about whether the guidance in ASC 830
should be applied to the gross contract asset and liability balances
separately or only to the net contract asset or liability for a single
contract. We believe that the guidance in ASC 830 should be applied on a
gross basis. For a complete discussion of this issue, see Section 4.8 of
Deloitte’s Roadmap Foreign Currency Matters.
14.7.2 Balance Sheet Offsetting
14.7.2.1 Offsetting Contract Assets and Contract Liabilities Against Other Assets and Liabilities
ASC 606 uses the terms “contract asset” and “contract
liability” (defined in ASC 606-10-20) in the context of revenue arising from
contracts with customers and provides guidance on the presentation of
contract assets and contract liabilities in the statement of financial
position (see ASC 606-10-45-1 through 45-5). Entities may also recognize
other types of assets or liabilities as a result of revenue or other
transactions related to customers. Examples might include costs of obtaining
a contract capitalized in accordance with ASC 340-40-25-1, financial assets
or liabilities as defined in ASC 825-10-20 (e.g., receivables), and
provisions as defined in ASC 460.
In practice, it will not be possible for entities to offset
contract assets and contract liabilities against other assets and
liabilities given that the contract assets and contract liabilities do not
represent determinable amounts owed by each party. ASC 210-20 prohibits
offsetting of assets and liabilities unless required or permitted by another
Codification subtopic, and neither ASC 606-10 nor any other Codification
subtopic includes such a requirement or permission with respect to contract
assets and contract liabilities.
The above issue is addressed in Implementation Q&A 63 (compiled from previously
issued TRG Agenda Papers 7 and 11). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
14.7.2.2 Offsetting Refund Liabilities Against Accounts Receivable
For an entity to offset refund liabilities against accounts
receivable, all of the following criteria in ASC 210-20-45-1 must be met:
-
Each of two parties owes the other determinable amounts.
-
The reporting party has the right to set off the amount owed with the amount owed by the other party.
-
The reporting party intends to set off.
-
The right of setoff is enforceable at law.
If an entity has a legally enforceable contract and amounts have been billed
(i.e., there is an unconditional right to payment for amounts billed), but
because of a termination right a contract has not been identified under step
1 of ASC 606, the entity will generally recognize a refund liability (or
similar liability) and accounts receivable.
If the contract is legally enforceable and the recognition of accounts
receivable is appropriate, presenting the amounts net would generally be
inappropriate. ASC 210-20 provides guidance on evaluating whether an asset
and a liability may be netted. For example, ASC 210-20-45-1 outlines the
criteria used to determine whether a right of setoff exists, including the
requirement that the reporting party have both the legal right and the
intent to set off. If the reporting entity does not expect the customer to
terminate, it effectively believes that the customer will pay in the normal
course and that the entity will provide goods or services. In such a case,
the criteria related to the right of setoff would not be met and the entity
should not net the amounts.
However, when the criteria related to the right of offset are met, a
reporting entity is not required to net the amounts. An entity’s decision to
offset when the criteria in ASC 210-20-45-1 are met is an accounting policy
election that should be applied consistently to all similar types of
transactions.
The example below illustrates how to determine whether it is
permissible to offset a refund liability against accounts receivable.
Example 14-6
Company P manufactures widgets and
sells them to various retailers, which ultimately
sell the widgets to end customers. Company P has
concluded that the retailers are its customers and
that control of the widgets is transferred to the
retailers upon delivery to them. Upon receipt of the
widgets, retailers have 90 days to return any unsold
widgets to P. If a retailer exercises its right to
return a widget, P provides a credit against the
retailer’s accounts receivable balance. That is, P
does not pay cash to settle the refund liability;
rather, it offsets the refund liability against any
currently outstanding accounts receivable.1 In accordance with ASC 606-10-32-10, P
estimates a refund liability for widgets that it
expects retailers to return.
Company P must evaluate the criteria
in ASC 210-20 to determine whether it is permitted
to offset the refund liability against accounts
receivable in P’s balance sheet.
In practice, P may not have the
legal right to offset the refund liability against
amounts receivable from a retailer. Further, the
estimated refund liability may not represent a
determinable amount because P estimated the refund
liability by using a portfolio of information.
The notion that an entity should apply ASC 210-20 to
determine whether offsetting is appropriate is consistent with the
considerations related to offsetting contract assets and contract
liabilities against other assets and liabilities (see Section 14.7.2.1 for
a discussion of that issue).
The above issue is addressed in Implementation Q&A 63 (compiled
from previously issued TRG Agenda Papers 7 and 11). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix
C.
14.7.3 Income Statement Classification of Interest
Many companies offer financing arrangements to customers who
purchase their products. Some of these companies may also offer financing of
products sold by other vendors. Often, the financing is offered through a wholly
owned subsidiary of the parent company. In other situations, the parent itself
may also offer this financing.
For purposes of the consolidated financial statements, the interest income generated from certain financing arrangements may be classified as revenue in the income statement. Paragraph BC29 of ASU 2014-09 states that the FASB and IASB “decided not to amend the existing definitions of revenue in each of their conceptual frameworks.” The legacy guidance in paragraph 79 of FASB Concepts Statement 6 indicates that cash inflows, such as interest, that
are the result of an entity’s ongoing major or central
operations represent revenue. When the major activity of a subsidiary is
the financing of products, the interest income generated from this financing
would represent its major revenue-generating activity. Therefore, this interest
income would continue to be classified as revenue for consolidated financial
statement purposes. However, the interest income (i.e., the financing component)
should be presented separately from the revenue from the sale (i.e., revenue
from contracts with customers) in accordance with the requirements of ASC
606-10-32-20.
Connecting the Dots
In December 2021, the FASB updated the definition of revenue in FASB Concepts Statement 8, Chapter 4 (the “FASB Concepts
Statement”). Under the revised definition, revenues are “inflows or
other enhancements of assets of an entity or settlements of its
liabilities (or a combination of both) from delivering or producing
goods, rendering services, or carrying out other activities.” Notably,
the FASB eliminated the phrase “ongoing major or central operations.”
However, the updated definition of revenue in the FASB Concepts
Statement did not amend the ASC master glossary’s definition of revenue
or the definition of a customer within the scope of ASC 606. In
addition, the FASB Concepts Statement does not represent authoritative
guidance. Further, paragraph E84 of the FASB Concepts Statement states,
in part, that “[o]ther activities . . . are those activities that permit
others to use the entity’s resources, which, for example, result in
interest.” Therefore, we do not expect that the updated definition of
revenue in the FASB Concepts Statement would result in a change in
practice regarding the determination of (1) which transactions should be
accounted for and presented as revenue under ASC 606 and (2) whether
interest income can be classified as revenue (presented separately from
revenue from contracts with customers). See Section 3.2.8 for more
information.
Conversely, if interest income is generated as a result of an activity that does not derive from an entity’s ongoing major or central operations (i.e., an activity that is peripheral or incidental to an entity’s central activities, as described by paragraph 75 of FASB Concepts Statement 6),
such income is unlikely to be classified as revenue.
SEC registrants’ analysis of whether the activity generating the
interest income is a result of the ongoing major or central operations should
include questions such as the following:
-
Does management discuss the financing operation in the MD&A or Business sections of the Form 10-K?
-
Does management provide focus on the financing operation in other external communications (e.g., analyst calls, press releases)?
-
Is the financing operation a separate reportable segment?
SEC registrants should also consider the guidance in SEC
Regulation S-X, Rule 5-03, regarding separate disclosure of revenue from
services and revenue from products when presenting this interest income in the
statement of comprehensive income.
The examples below demonstrate the concepts explained above.
Example 14-7
Company A sells machinery. The company
has a subsidiary, B, whose sole operations are to
provide financing to customers who purchase the
machinery from A. In this situation, the interest income
generated by B from its product financing is part of the
consolidated entity’s major ongoing operations and
should therefore be classified as revenue in A’s
consolidated statement of comprehensive income,
separately from revenue from contracts with
customers.
Example 14-8
Company X sells vehicles. The company
does not have a financing subsidiary, has not previously
provided financing to its customers, and does not have
any intent to provide financing in the future. However,
as a result of a large order placed by Customer Y, X has
agreed to provide financing to Y. In this situation,
because X has no history of providing financing to
customers, and because financing arrangements are not
part of X’s ongoing operations, the interest income
generated from Y should not be classified as revenue in
X’s consolidated financial statements.
14.7.4 Income Statement Classification of Amortized Contract Costs
Generally, the amortization of any incremental costs of
obtaining a contract that are capitalized under ASC 340-40 should be classified
in the income statement as selling, general, and administrative (SG&A)
expense.
Under ASC 340-40, an entity is required to recognize the
incremental costs of obtaining a contract (i.e., those costs that would not have
been incurred if the contract had not been obtained) as an asset if the entity
expects to recover them.2 When capitalized, the costs are “amortized on a systematic basis that is
consistent with the transfer to the customer of the goods or services to which
the asset relates.” However, ASC 340-40 does not include guidance on the
presentation of amortized contract costs in the income statement.
In addition, the Codification does not contain guidance on the
types of expenses that represent SG&A expense or cost of sales. SEC
Regulation S-X, Rule 5-03(b), provides limited guidance by indicating the
various line items that should appear on the face of the income statement (if
applicable). Rule 5-03(b) indicates that the cost of any tangible goods sold and
the cost of any services sold are “[c]osts and expenses applicable to sales and
revenues.” Further, Rule 5-03(b) requires a separate line item for SG&A
expenses.
Despite the limited authoritative guidance, we believe that
SG&A expense in the income statement would be the preferred classification
of the amortization of incremental costs of obtaining a contract that are
capitalized under ASC 340-40. This is because such costs represent costs of
acquiring a contract (e.g., selling costs), as opposed to costs of fulfilling a
contract that generally would be included in cost of goods sold (or a similar
line item).
14.7.5 Income Statement Presentation of Reimbursements for Out-of-Pocket Expenses
ASC 606 does not explicitly address out-of-pocket
reimbursements. However, ASC 606-10-32-2 defines the transaction price as “the
amount of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer, excluding amounts
collected on behalf of third parties (for example, some sales taxes).”
Therefore, generally all consideration provided to the entity from the customer
should be included in the transaction price and allocated to the promised goods
or services identified in the contract. This includes reimbursements for
out-of-pocket expenses incurred in connection with fulfilling the entity’s
performance obligation(s) to the customer. However, the transaction price should
not include reimbursements related to goods or services transferred to the
customer if the entity is merely acting as an agent in purchasing such goods or
services on behalf of the customer.
The example below illustrates how to present reimbursements
received from a customer for out-of-pocket expenses.
Example 14-9
Company X enters into an agreement to identify and
acquire specified goods on behalf of Customer P from a
third party for which X will earn a commission
calculated as a percentage of the agreed purchase price.
Company X has determined that it is acting as an agent
in this arrangement, in accordance with ASC 606-10-55-36
through 55-40. In addition, as part of the agreement, P
will reimburse X for reasonable out-of-pocket expenses
(e.g., hotels, meals, transportation). Consequently, X
must determine how to present the out-of-pocket expenses
and reimbursements.
Company X should first determine the nature of the
out-of-pocket expenses reimbursed by P. If such costs
are incurred for X to fulfill its agency service and are
not incurred on behalf of P, X’s out-of-pocket costs and
related reimbursements should generally be presented
gross. Alternatively, if in the course of providing its
agency services to P, X were to incur and be reimbursed
for costs on behalf of P that provide a good or service
to P, such costs should generally be presented net.
Assume that X determines that its
reimbursable out-of-pocket expenses (e.g., hotels,
meals, transportation) are expenses that (1) X incurs in
fulfilling its agency service, (2) are not incurred on
behalf of P, and (3) do not provide a good or service to
P. On the basis of this determination, X will include
any amounts collected (or expected to be collected) as
reimbursements in the transaction price for the agency
service delivered to P. As a result, such reimbursements
will be presented gross in X’s income statement.
14.7.6 Interaction Between ASC 606 and SEC Regulation S-X, Rule 5-03(b)
SEC Regulation S-X, Rule 5-03(b)
§210.5-03 Statements of comprehensive income. . .
.
(b) If income is derived from more than
one of the subcaptions described under § 210.5-03.1,
each class which is not more than 10 percent of the sum
of the items may be combined with another class. If
these items are combined, related costs and expenses as
described under § 210.5-03.2 shall be combined in the
same manner.
1. Net sales and gross revenues. State
separately:
(a) Net sales of tangible products (gross sales
less discounts, returns and allowances), (b)
operating revenues of public utilities or others;
(c) income from rentals; (d) revenues from
services; and (e) other revenues. Amounts earned
from transactions with related parties shall be
disclosed as required under § 210.4-08(k). A
public utility company using a uniform system of
accounts or a form for annual report prescribed by
federal or state authorities, or a similar system
or report, shall follow the general segregation of
operating revenues and operating expenses reported
under § 210.5-03.2 prescribed by such system or
report. If the total of sales and revenues
reported under this caption includes excise taxes
in an amount equal to 1 percent or more of such
total, the amount of such excise taxes shall be
shown on the face of the statement parenthetically
or otherwise.
SEC Regulation S-X, Rule 5-03(b), indicates the various line items that should
appear on the face of the income statement. Specifically, a registrant should
separately present any amounts that represent 10 percent of the sum of income
derived from net sales of tangible products, operating revenues of public
utilities or others, income from rentals, revenues from services, and other
revenues. Aside from minor revisions, no updates have been made to Rule 5-03(b)
since the issuance of ASU
2014-09. Further, there is limited guidance on interpreting
the requirements of Rule 5-03(b) — for example, the terms “income from rentals,”
“revenues from services,” “products,” and “services” are not specifically
defined. Despite the long-standing need for registrants to use judgment when
applying Rule 5-03(b), stakeholders have raised concerns about the interplay
between Rule 5-03(b) and new accounting standards, including the revenue
standard.
The interaction between ASC 606 and Rule 5-03(b) was discussed at the March 2018
CAQ SEC Regulations Committee joint meeting with the SEC staff. As indicated in
the highlights of that meeting, the SEC
staff noted that it is encouraging registrants to submit real-life examples of
potential inconsistencies in income statement classification that may arise
between ASC 606 and Rule 5-03(b). For additional information, see Deloitte’s May
22, 2018, journal entry.
For considerations related to the disaggregation of revenue in accordance with
the disclosure requirements of ASC 606, see Section
15.2.2.
Footnotes
1
Company P would pay cash to
settle the refund liability only if the customer
did not have an outstanding accounts receivable
balance.
2
ASC 340-40-25-4 provides a practical expedient under
which “an entity may recognize the incremental costs of obtaining a
contract as an expense when incurred if the amortization period of the
asset that the entity otherwise would have recognized is one year or
less.”
Chapter 15 — Disclosure
Chapter 15 — Disclosure
15.1 Background and Objective
One of the goals of the FASB and IASB in the revenue project was to provide
financial statement users with more useful information through improved disclosures.
ASC 606-10-50-1 outlines the objective of the revenue standard’s disclosure
requirements as follows:
ASC 606-10
50-1 The objective of the
disclosure requirements in this Topic is for an entity to
disclose sufficient information to enable users of financial
statements to understand the nature, amount, timing, and
uncertainty of revenue and cash flows arising from contracts
with customers. To achieve that objective, an entity shall
disclose qualitative and quantitative information about all
of the following:
-
Its contracts with customers (see paragraphs 606-10-50-4 through 50-16)
-
The significant judgments, and changes in the judgments, made in applying the guidance in this Topic to those contracts (see paragraphs 606-10-50-17 through 50-21)
-
Any assets recognized from the costs to obtain or fulfill a contract with a customer in accordance with paragraph 340-40-25-1 or 340-40-25-5 (see paragraphs 340-40-50-1 through 50-6).
Connecting the Dots
As discussed in Section
1.9.2, the revenue standard requires entities to disclose both
quantitative and qualitative information that enables “users of financial
statements to understand the nature, amount, timing, and uncertainty of
revenue and cash flows arising from contracts with customers.” Entities
should be proactive in developing the disclosures required by the revenue
standard because of the substantive system and implementation challenges
that may arise when entities (1) gather the information necessary for
drafting the required disclosures and (2) implement controls to review
related disclosures and underlying data. Among the disclosures that may pose
system and implementation challenges are those related to (1) remaining
performance obligations (commonly referred to as the “backlog” disclosure),
(2) contract assets and contract liabilities, and (3) disaggregation of
revenue (including the relationship between disaggregated revenue and
segment information). Even if the timing or amount of revenue recognized is
not affected by the revenue standard, the disclosure obligations will be
affected.
The revenue standard includes significant disclosure requirements, which are
both quantitative and qualitative. Meeting these disclosure requirements will
require significant judgment. Some disclosures may be applicable for some entities
while immaterial or extraneous for others.
See Deloitte’s July 11, 2018, Heads Up for additional information
about the disclosures required under the revenue standard and examples of such
disclosures.
15.1.1 Level of Aggregation or Disaggregation
ASC 606-10
50-2 An entity shall consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the various requirements. An entity shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have substantially different characteristics.
Entities should (1) “consider the level of detail necessary to satisfy the
disclosure objective and how much emphasis to place on each of the various
requirements,”1 (2) “aggregate or disaggregate disclosures so that useful information is
not obscured by either the inclusion of a large amount of insignificant detail
or the aggregation of items that have substantially different
characteristics,”2 and (3) not repeat disclosures if the information is already presented in
the manner required by other accounting standards.
15.1.2 Disclosures in Comparative and Interim Periods
ASC 606-10
50-3 Amounts disclosed are for each reporting period for which a statement of comprehensive income (statement of activities) is presented and as of each reporting period for which a statement of financial position is presented. An entity need not disclose information in accordance with the guidance in this Topic if it has provided the information in accordance with another Topic.
In a manner consistent with presentation requirements, entities are required to
provide the prescribed disclosures for both current and comparative periods.
Throughout this chapter of the Roadmap, we provide illustrative examples that
highlight certain aspects of the revenue standard’s disclosure guidance and
reflect our views on how that guidance might be applied. However, these examples
are not intended to be templates or comprehensive resources. Rather, they should
be regarded as tools to help entities consider key judgments and issues arising
in the application of the requirements.
The illustration below gives an overview of the annual disclosure requirements
in ASC 606 (there are certain exceptions for nonpublic entities; see Chapter 16).
Annual Disclosures
The illustration below gives an overview of the interim disclosure requirements in ASC 270. The items shown in gray illustrate the annual required disclosures that are not required during interim periods.
Interim Disclosures3
Refer to Section 15.1.4 for
a more comprehensive summary of the disclosure requirements, including information
on the disclosures that a nonpublic entity may elect not to apply as well as interim
disclosures. As shown in Section 15.1.4,
certain information about performance obligations (including remaining performance
obligations) must still be provided in interim disclosures.
15.1.3 Omission of Disclosures
ASC 606-10-50-1 notes that the “objective of the disclosure
requirements in [ASC 606] is for an entity to disclose sufficient information to
enable users of financial statements to understand the nature, amount, timing,
and uncertainty of revenue and cash flows arising from contracts with
customers.” The revenue standard delineates three broad disclosure categories
and detailed disclosure requirements for meeting this objective.
Throughout ASC 606-10-50, the FASB consistently uses the term
“shall” in conjunction with the information specified (e.g., “shall disclose,”
“shall provide,” “shall explain”). Therefore, the specific disclosures would
generally be required. However, like other mandatory disclosure provisions in
the Codification, those in ASC 606 do not require financial statement
disclosures that are irrelevant or immaterial. In paragraph BC331 of
ASU 2014-09, the FASB and
IASB acknowledge that an entity needs to consider both relevance and materiality
when determining the disclosures to be provided:
The [FASB
and IASB] also decided to include disclosure guidance to help an entity meet
the disclosure objective. However, those disclosures should not be viewed as
a checklist of minimum disclosures, because some disclosures may be relevant
for some entities or industries but may be irrelevant for others. The Boards
also observed that it is important for an entity to consider the disclosures
together with the disclosure objective and materiality. Consequently,
paragraph 606-10-50-2 clarifies that an entity need not disclose information
that is immaterial.
For example, an entity would most likely not discuss the methods
it uses to measure progress on performance obligations satisfied over time if
(1) revenue was not recognized in such a manner or (2) management concludes that
the quantitative and qualitative impact of the disclosure requirement is
immaterial (e.g., an immaterial portion of total revenue is recognized in such
manner). However, as with other materiality assessments, entities should
carefully consider whether the omission of a required disclosure represents an
error. Entities are encouraged to consult with their legal and financial
advisers when making such determinations.
Further, while the disclosures specified in ASC 606 are
generally viewed as mandatory, the manner in which an entity satisfies each of
the revenue standard’s disclosure requirements may vary significantly. ASC
606-10-50-2 specifies that an entity should evaluate the level of detail to
provide in its required disclosures and the amount of emphasis to place on each
disclosure requirement.
Accordingly, the level of detail or prominence that an entity
includes to achieve each of the specific disclosure requirements could differ
depending on the entity’s specific facts and circumstances.
The assessment of which disclosures need to be provided should
be made for each reporting period since a disclosure deemed to be irrelevant or
immaterial in previous periods may subsequently become relevant and material
(e.g., as a result of increases in the monetary values to be disclosed or
changes in qualitative factors).
15.1.4 Summary of Disclosure Requirements, Including Election for Nonpublic Entities and Interim Requirements
Category
|
Disclosure Requirements
|
Election Available to Nonpublic
Entities
|
Interim Requirement (ASC 270)4
|
---|---|---|---|
Disaggregation of revenue
|
Disaggregate revenue into categories
that depict how revenue and cash flows are affected by
economic factors.
|
Yes5
|
Yes
|
Sufficient information to understand the
relationship between disaggregated revenue and each
disclosed segment’s revenue information.
|
Yes
|
Yes
| |
Contract balances
|
Opening and closing balances
(receivable, contract assets, and contract
liabilities).
|
No
|
Yes
|
Amount of revenue recognized from
beginning contract liability balance.
|
Yes
|
Yes
| |
Explanation of significant changes in
contract balances (using qualitative and quantitative
information).
| Yes |
No
| |
Performance obligations (including
remaining performance obligations)
|
Qualitative information about (1) when
performance obligations are typically satisfied, (2)
significant payment terms, (3) the nature of goods or
services promised, (4) obligations for returns of
refunds, and (5) warranties.
|
No
|
No
|
Amount of revenue recognized from
performance obligations satisfied in prior periods
(e.g., changes in transaction price estimates).
| Yes | Yes | |
Transaction price allocated to the
remaining performance obligations:
| |||
|
Yes
|
Yes
| |
|
Yes
|
Yes
| |
Significant judgments and estimates
|
Qualitative information about
determining the timing of:
|
| |
|
Yes6
|
No
| |
|
Yes
|
No
| |
Qualitative and quantitative
information7 about:
|
|
| |
|
Yes
|
No
| |
|
No
|
No
| |
|
Yes
|
No
| |
|
Yes
|
No
| |
Contract costs |
Qualitative information about:
|
|
|
|
Yes
|
No
| |
|
Yes
|
No
| |
Quantitative information about:
|
|
| |
|
Yes
|
No
| |
|
Yes
|
No
| |
Practical expedients | Disclosure of practical expedients used. | Yes8 | No |
Footnotes
1
Quoted from ASC 606-10-50-2.
2
See footnote 1.
3
IAS 34 provides the interim disclosure requirements under
IFRS Accounting Standards. In addition, IFRS 15 amended IAS 34 to require
entities to disclose information about disaggregated revenue from contracts
with customers during interim periods. IFRS 15 does not require entities to
disclose information about contract balances and remaining performance
obligations on an interim basis as required under U.S. GAAP. For more
information about differences between U.S. GAAP and IFRS Accounting
Standards on revenue-related topics, see Appendix A.
4
This column represents the
interim disclosure requirements in years after the
year of adoption of the revenue standard.
5
At a minimum, a nonpublic entity
must disclose revenue that is disaggregated in
accordance with the timing of transfer of goods or
services (e.g., goods transferred at a point in
time and services transferred over time) and
qualitative information about how economic factors
affect revenue and cash flows.
6
The election available to
nonpublic entities applies only to the requirement
to disclose information about why the methods used
to recognize revenue over time provide a faithful
depiction of the transfer of goods or services to
a customer. Nonpublic entities are still required
to disclose the information about the methods used
to recognize revenue over time in accordance with
ASC 606-10-50-18(a).
7
This includes the methods,
inputs, and assumptions used in an entity’s
assessment.
8
However, nonpublic entities that
have elected the practical expedient or policy
election in ASU 2021-02
are required to disclose the practical expedient or
policy election used.
15.2 Contracts With Customers
ASC 606-10
50-4 An entity shall disclose
all of the following amounts for the reporting period unless
those amounts are presented separately in the statement of
comprehensive income (statement of activities) in accordance
with other Topics:
- Revenue recognized from contracts with customers, which the entity shall disclose separately from its other sources of revenue
- Any impairment losses recognized (in accordance with Topic 310 on receivables) on any receivables or contract assets arising from an entity’s contracts with customers, which the entity shall disclose separately from impairment losses from other contracts.
Pending Content (Transition
Guidance: ASC 326-10-65-1)
50-4 An entity shall disclose all of the
following amounts for the reporting period unless
those amounts are presented separately in the
statement of comprehensive income (statement of
activities) in accordance with other Topics:
- Revenue recognized from contracts with customers, which the entity shall disclose separately from its other sources of revenue
- Credit losses recorded (in accordance with Subtopic 326-20 on financial instruments measured at amortized cost) on any receivables or contract assets arising from an entity’s contracts with customers, which the entity shall disclose separately from credit losses from other contracts.
The first disclosure requirement seems obvious, but it may not always be
straightforward. That is, an entity must disclose its revenue from contracts with
customers unless the revenue is presented separately in the statement of
comprehensive income (or statement of activities, in the case of a nonprofit
entity). As a result, the entity must determine which of its contracts or revenue
streams are being accounted for in accordance with ASC 606 rather than in accordance
with guidance on other revenue transactions, such as those related to financial
instruments (interest income), leases (lease income), or insurance contracts. For
example, an entity may be a lessor and derive revenue from its leasing operations in
addition to various services it provides in contracts with customers. As further
discussed in Chapter 3, some
contracts with customers (or portions of contracts with customers) are outside the
scope of ASC 606. In those circumstances, unless the lessor’s two sources of revenue
are separately presented in the income statement, the lessor must disclose the
breakdown of those two revenue sources: (1) revenue from contracts with customers
(i.e., those contracts or portions of a contract that are being accounted for in
accordance with ASC 606) and (2) lease income accounted for in accordance with ASC
842.
To take another example, an entity that derived
revenue from financial instruments, leases, and contracts with customers (ASC 606
contracts) may present or disclose its revenues as follows:
Similarly, an entity is required to disclose any impairment losses related to
its contracts with customers (e.g., bad debt expense on customer receivables and
impairment of contract assets) separately from other impairments, such as losses
recorded on other financial instruments (e.g., investments) or lease
receivables.
15.2.1 Interaction Between ASC 606 and SEC Regulation S-X, Rule 5-03(b)
As explained in Section 14.7.6, SEC Regulation S-X, Rule
5-03(b), requires various line items to be presented on the face of the income
statement. In addition, ASC 606 includes requirements related to the
disaggregation of revenue, which are discussed in Section 15.2.2. While ASC 606 permits the disaggregated
information to be presented or disclosed, the requirements of Rule 5-03(b)
cannot be satisfied solely by meeting the ASC 606 requirements. Therefore,
public entities need to consider both sets of requirements when preparing their
financial statements (i.e., they must comply with the SEC’s presentation
requirements regardless of how disaggregated revenue amounts are disclosed in
the footnotes).
15.2.2 Disaggregation of Revenue
The table below summarizes the disclosure
requirements discussed in this section, including the disclosures that a
nonpublic entity may elect not to apply as well as required interim
disclosures.
Category | Disclosure Requirements | Election Available to Nonpublic Entities | Interim Requirement (ASC 270) |
---|---|---|---|
Disaggregation of revenue | Disaggregate revenue into categories that depict how revenue and cash flows are affected by economic factors. | Yes9 | Yes |
Sufficient information to understand the relationship between disaggregated revenue and each disclosed segment’s revenue information. | Yes | Yes |
To meet the revenue standard’s disclosure objective, an entity is required to
disaggregate revenue into categories. Revenue from contracts with customers
presented in the statement of comprehensive income typically comprises sales of
various types of goods and services and involves customers from different
markets or geographic regions. As discussed in paragraph BC336 of ASU 2014-09,
“because the most useful disaggregation of revenue depends on various
entity-specific or industry-specific factors, the Boards decided that Topic 606
should not prescribe any specific factor to be used as the basis for
disaggregating revenue from contracts with customers.” Instead, the boards
included implementation guidance that provides examples of categories that may
be appropriate to disclose in an entity’s financial statements. One or more than
one category may be presented depending on what is most meaningful to the
business.
The revenue standard’s implementation
guidance also suggests that an entity should consider
various sources of information (e.g., investor
information, internal reports) in determining the
categories to use for disaggregation of revenue. To
enable users of the financial statements to understand
the relationship between an entity’s revenue and how the
entity manages its business, entities are required to
describe the relationship between disaggregated revenue
and segment disclosures in accordance with ASC 280.
These disclosures do not need to be in a particular
format; as a result, some entities may describe the
interaction between the two required disclosures in the
revenue footnote, while others may include the
disclosures in the segment footnote. In addition, since
the guidance is not prescriptive, the disclosures may
also be presented in a tabular format or narrative
format.
|
Entities should examine whether (1) the information necessary to produce these disclosures is readily available and (2) there are proper controls in place for reviewing this information.
ASC 606-10
50-5 An entity shall disaggregate revenue recognized from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. An entity shall apply the guidance in paragraphs 606-10-55-89 through 55-91 when selecting the categories to use to disaggregate revenue.
55-89 Paragraph 606-10-50-5
requires an entity to disaggregate revenue from
contracts with customers into categories that depict how
the nature, amount, timing, and uncertainty of revenue
and cash flows are affected by economic factors.
Consequently, the extent to which an entity’s revenue is
disaggregated for the purposes of this disclosure
depends on the facts and circumstances that pertain to
the entity’s contracts with customers. Some entities may
need to use more than one type of category to meet the
objective in paragraph 606-10- 50-5 for disaggregating
revenue. Other entities may meet the objective by using
only one type of category to disaggregate revenue.
55-90 When
selecting the type of category (or categories) to use to
disaggregate revenue, an entity should consider how
information about the entity’s revenue has been
presented for other purposes, including all of the
following:
-
Disclosures presented outside the financial statements (for example, in earnings releases, annual reports, or investor presentations)
-
Information regularly reviewed by the chief operating decision maker for evaluating the financial performance of operating segments
-
Other information that is similar to the types of information identified in (a) and (b) and that is used by the entity or users of the entity’s financial statements to evaluate the entity’s financial performance or make resource allocation decisions.
55-91 Examples of categories
that might be appropriate include, but are not limited
to, all of the following:
-
Type of good or service (for example, major product lines)
-
Geographical region (for example, country or region)
-
Market or type of customer (for example, government and nongovernment customers)
-
Type of contract (for example, fixed-price and time-and-materials contracts)
-
Contract duration (for example, short-term and long-term contracts)
-
Timing of transfer of goods or services (for example, revenue from goods or services transferred to customers at a point in time and revenue from goods or services transferred over time)
-
Sales channels (for example, goods sold directly to consumers and goods sold through intermediaries).
50-6 In addition, an entity
shall disclose sufficient information to enable users of
financial statements to understand the relationship
between the disclosure of disaggregated revenue (in
accordance with paragraph 606-10-50-5) and revenue
information that is disclosed for each reportable
segment, if the entity applies Topic 280 on segment
reporting.
50-7 An entity, except for a
public business entity, a not-for-profit entity that has
issued, or is a conduit bond obligor for, securities
that are traded, listed, or quoted on an exchange or an
over-the-counter market, or an employee benefit plan
that files or furnishes financial statements with or to
the Securities and Exchange Commission (SEC), may elect
not to apply the quantitative disaggregation disclosure
guidance in paragraphs 606-10-50-5 through 50-6 and
606-10-55-89 through 55-91. If an entity elects not to
provide those disclosures, the entity shall disclose, at
a minimum, revenue disaggregated according to the timing
of transfer of goods or services (for example, revenue
from goods or services transferred to customers at a
point in time and revenue from goods or services
transferred to customers over time) and qualitative
information about how economic factors (such as type of
customer, geographical location of customers, and type
of contract) affect the nature, amount, timing, and
uncertainty of revenue and cash flows.
The following example in ASC 606 illustrates how an entity could present the disaggregation of its revenue in a tabular format to meet the quantitative disclosure requirements in ASC 606-10-50-6:
ASC 606-10
Example 41 — Disaggregation of Revenue — Quantitative Disclosure
55-296 An entity reports the following segments: consumer products, transportation, and energy, in accordance with Topic 280 on segment reporting. When the entity prepares its investor presentations, it disaggregates revenue into primary geographical markets, major product lines, and timing of revenue recognition (that is, goods transferred at a point in time or services transferred over time).
55-297 The entity determines that the categories used in the investor presentations can be used to meet the objective of the disaggregation disclosure requirement in paragraph 606-10-50-5, which is to disaggregate revenue from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. The following table illustrates the disaggregation disclosure by primary geographical market, major product line, and timing of revenue recognition, including a reconciliation of how the disaggregated revenue ties in with the consumer products, transportation, and energy segments in accordance with paragraphs 606-10-50-6.
Connecting the Dots
For many years, segment reporting has been a perennial topic of focus for the
SEC (and SEC comment letters) and, as such, a topic of focus for many
companies. Focus areas related to segments include (1) the
identification and aggregation of operating segments, (2) changes in
reportable segments, (3) product and service revenue by segment, (4)
operating segments and goodwill impairment, and (5) information about
geographic areas. Because of the historical challenges related to
segment disclosures and the revenue standard’s requirements related to
disaggregation, it is critical for each organization to evaluate the
appropriate level at which to present its disaggregated revenue
balances. As stated in ASC 606-10-55-90, an entity can make this
determination by using (1) “[d]isclosures presented outside the
financial statements (for example, in earnings releases, annual reports,
or investor presentations),” (2) “[i]nformation regularly reviewed by
the chief operating decision maker for evaluating the financial
performance of operating segments,” and (3) other similar information
“that is used by the entity or users of the entity’s financial
statements to evaluate the entity’s financial performance or make
resource allocation decisions.”
At the 2016 AICPA Conference on Current SEC and PCAOB
Developments, the SEC staff highlighted that the disclosure guidance in ASC 606
on disaggregation of revenue is similar to the segment reporting guidance, but
it noted that ASC 606 does not provide an impracticability exception. Further,
the SEC staff stated that its reviews of filings will include reviews of other
materials, such as investor presentations and earnings releases, to determine
whether the appropriate amount of disaggregation is disclosed.
In recent years, the SEC staff has issued comments to registrants on various
themes related to the disaggregation of revenue under ASC 606. In those
comments, the staff has:
- Questioned differences between the categories of revenue disclosed in the financial statements and the manner in which sales are categorized in other places such as MD&A, earnings releases, earnings calls, investor presentations, income statements, materials reviewed by the CODM, and other materials used by the registrant to evaluate the registrant’s financial performance or make resource allocation decisions.
- Requested clear disclosures about how the revenue categories identified fairly depict the effect of economic factors on the nature, amount, timing, and uncertainty of revenue and cash flows. Economic factors could be macroeconomic, industry-specific, or entity-specific. The SEC staff has asked registrants to specifically address how they considered the guidance in ASC 606-10-55-89 through 55-91.
- Noted that fewer revenue categories were disclosed than would be
expected given the variety of products and services described in other
places within or outside of the financial statements. The SEC staff has
challenged a registrant’s aggregation of revenue sources that, on the
basis of other information provided by the registrant, appear to have
different characteristics and risk profiles that would result in
differences in the nature, amount, timing, and uncertainty of revenue
and cash flows. For example, the following characteristics have been
observed by the staff:
- A revenue source that may or may not be subject to returns.
- The dollar magnitude of contribution to margins.
- Sales by brand.
- Underlying market trends.
- Volatility in demand.
- Uncertainty regarding availability of resources.
- The regulatory environment.
- The business model or strategy.
For additional information and excerpts from a sample of SEC comment letters on
this topic, see Section 2.18.4 of
Deloitte’s Roadmap SEC Comment Letter
Considerations, Including Industry Insights.
The following illustrative disclosure of a company’s disaggregation of revenue highlights some of the questions an entity may think about when implementing the guidance on disaggregating revenue balances:
Connecting the Dots
The disclosure of disaggregated revenue does not need to be in any
particular format and may be presented in a tabular format or a
narrative format.
At the November 2016 TRG meeting, in response to a
question about the form of this disclosure, the FASB staff indicated
that a tabular reconciliation (such as that of Example 41 in ASC
606-10-55-296 and 55-297) is not required. However, the staff also noted
that an entity must still provide the information required under ASC
606-10-50-6 (i.e., information that enables users to understand the
relationship between the disclosure of disaggregated revenue and revenue
disclosed for each reportable segment). A summary of the TRG’s
discussion is available in TRG Agenda Paper 60.
15.2.3 Contract Balances
The table below summarizes the disclosure requirements discussed in this section
through Section
15.2.3.5.2, including the disclosures that a nonpublic entity may
elect not to apply as well as required interim disclosures.
Category | Disclosure Requirements | Election Available to Nonpublic Entities | Interim Requirement (ASC 270) |
---|---|---|---|
Contract balances | Opening and closing balances (receivables, contract assets, and contract liabilities). | No | Yes |
Amount of revenue recognized from beginning contract liability balance. | Yes | Yes | |
Explanation of significant changes in contract balances (using qualitative and quantitative information). | Yes | No |
According to paragraph BC343 of ASU 2014-09:
Users of
financial statements emphasized that it was critical to them to have
information on the movements in the contract balances presented separately
because it would help them understand information about the following:
-
The amount of the opening balance of the contract liability balance that will be recognized as revenue during the period
-
The amount of the opening balance of the contract asset that will be transferred to accounts receivable or collected in cash during the period.
Because of this feedback, items (a) and (b) above were incorporated into the
requirements in ASC 606-10-50-8(a) and (b) shown below. In a manner similar to
how the FASB designed the disclosure requirements related to the disaggregation
of revenue, the Board provided some optionality in terms of how contract
balances and changes in contract balances should be presented (i.e., a tabular
format is not required).
Questions that entities could consider in preparing these disclosures (and
others) include, but are not limited to, the following:
-
On reassessment of disclosures already presented in the financial statements, are those disclosures sufficient?
-
What controls are in place to test the completeness and accuracy of the information disclosed?
-
Is the legacy accounting information system capable of providing this information? Is that system within the scope of internal control over financial reporting?
-
If the entity had any acquisitions or divestitures during the fiscal year, do those acquisitions or divestitures affect the revenue disclosures?
-
What qualitative information would the financial statement user find relevant to supplement quantitative information?
-
Have there been material changes in the timing of when performance obligations will result in revenue recognition?
-
What payment terms (e.g., payments in arrears, milestones, contingent payments, post-paid customers) give rise to contract assets?
-
What transactions (e.g., business combinations) would change future balances?
-
Why did the balance(s) change?
-
In a typical contract, how does the satisfaction of performance obligations correlate with customer payment?
ASC 606-10
50-8 An entity shall disclose all of the following:
- The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed
- Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period
-
Subparagraph superseded by Accounting Standards Update No. 2016-20.
50-9 An entity shall explain
how the timing of satisfaction of its performance
obligations (see paragraph 606-10-50-12(a)) relates to
the typical timing of payment (see paragraph
606-10-50-12(b)) and the effect that those factors have
on the contract asset and the contract liability
balances. The explanation provided may use qualitative
information.
50-10 An entity shall provide an explanation of the significant changes in the contract asset and the contract liability balances during the reporting period. The explanation shall include qualitative and quantitative information. Examples of changes in the entity’s balances of contract assets and contract liabilities include any of the following:
- Changes due to business combinations
- Cumulative catch-up adjustments to revenue that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price (including any changes in the assessment of whether an estimate of variable consideration is constrained), or a contract modification
- Impairment of a contract asset
- A change in the time frame for a right to consideration to become unconditional (that is, for a contract asset to be reclassified to a receivable)
- A change in the time frame for a performance obligation to be satisfied (that is, for the recognition of revenue arising from a contract liability).
15.2.3.1 Disclosure of Opening and Closing Balances — Receivables, Contract Assets, and Contract Liabilities
In a manner consistent with the disclosure requirement to present or disclose revenue from contracts with customers, an entity must present separately on the face of the financial statements or disclose the opening and closing balances of receivables, contract assets, and contract liabilities. In addition, an entity may consider disclosing where such balances are included in the statement of financial position.
15.2.3.2 Disclosure of Revenue Recognized From Contract Liability Balance
Drawing on the components of a rollforward of contract balances, the revenue
standard requires quantitative disclosure of amounts recognized in the
current reporting period (and comparative periods presented) that were in
the prior period-end’s contract liability balance.
For example, suppose that an entity had a deferred revenue (contract liability) balance of $2,000 as of December 31, 20X7. In accordance with ASC 606-10-50-8(b), the entity is required to disclose what amount of that $2,000 was recorded in 20X8 (or the first quarter of 20X8, depending on the reporting period presented). If $1,500 of the $2,000 was recognized in the first quarter of 20X8, the entity should disclose $1,500 as the amount of revenue recognized during that period that was previously included in the deferred revenue (contract liability) balance as of December 31, 20X7.
15.2.3.3 Election Available to Nonpublic Entities
ASC 606-10
50-11 An entity, except for a public business entity, a not-for-profit entity that has issued, or is a conduit bond
obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or an
employee benefit plan that files or furnishes financial statements with or to the SEC, may elect not to provide
any or all of the disclosures in paragraphs 606-10-50-8 through 50-10 and 606-10-50-12A. However, if an entity
elects not to provide the disclosures in paragraphs 606-10-50-8 through 50-10 and 606-10-50-12A, the entity
shall provide the disclosure in paragraph 606-10-50-8(a), which requires the disclosure of the opening and
closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not
otherwise separately presented or disclosed.
15.2.3.4 Disclosure Examples
The example below, which is reproduced from the FASB’s and IASB’s 2011 exposure
draft on revenue (issued by the FASB as a proposed ASU), illustrates a reconciliation of contract
assets and contract liabilities. Although such a reconciliation is not
required, the example shows how some entities may present some of the
required information on contract balances.
Example in the FASB’s and IASB’s
2011 Exposure Draft
Example 19 —
Reconciliation of Contract Assets and Contract
Liabilities
An entity has two main business
units: a services business and a retail business.
Customers of the services business typically pay a
portion of the promised consideration in advance of
receiving the services and the remaining amount upon
completion of the services. The service contracts do
not include a significant financing component.
Customers of the retail business typically pay in
cash at the time of transfer of the promised
goods.
During 20X1, the entity recognized
revenue of $18,500 from contracts with customers
($1,000 of which was cash sales from the entity’s
retail business). The entity received $3,500
payments in advance.
Included in the transaction price of
one of the entity’s services contracts is a
performance bonus that the entity will receive only
if it meets a specified milestone by a specified
date. The entity includes that performance bonus in
the transaction price and recognizes revenue over
time using an appropriate method of measuring
progress. As of December 31, 20X0, the entity was
not reasonably assured to be entitled to the
cumulative amount of consideration that was
allocated to the entity’s past performance at that
date. However, during 20X1 the entity became
reasonably assured to be entitled to the performance
bonus. Consequently, the entity recognized a
contract asset and revenue of $500 for the portion
of the bonus relating to the entity’s performance in
the previous reporting period.
As a result of a business
combination on December 31, 20X1, the entity’s
contract assets increased by $4,000 and its contract
liabilities increased by $1,900.
The illustrative disclosure below shows how an entity might provide the
information required under ASC 606-10-50-8 through 50-10.
15.2.3.5 Additional Considerations
15.2.3.5.1 Rollforward of Contract Balances
Under ASC 606, an entity is required to present or
disclose opening and closing contract balances in its annual and interim
financial statements. In addition, an entity is required under ASC
606-10-50-8(b) to disclose revenue recognized from the prior year-end
contract liability balance.10 However, an entity does not need to provide a full rollforward of
the information required under ASC 606-10- 50-8(b) about revenue
recognized from the prior year-end contract liability balance.
Paragraph BC346 of ASU 2014-09 states, in part:
[The FASB and IASB] decided that, instead of
requiring a tabular reconciliation of the aggregate contract
balances [as they had proposed in their 2010 and 2011 exposure
drafts on revenue], they would require an entity to disclose
qualitative and quantitative information about the entity’s contract
balances (see paragraphs 606-10-50-8 through 50-10). This approach
balances the needs of users of financial statements with preparers’
concerns because the qualitative and quantitative disclosures
provide users of financial statements with the information they
requested (that is, information on when contract assets are
typically transferred to accounts receivable or collected as cash
and when contract liabilities are recognized as revenue). In
addition, the Boards decided that those disclosures would be more
cost-effective than a reconciliation. The Boards also observed that
this approach would not result in a significant change for many
entities that are already disclosing similar information.
Accordingly, a rollforward of contract balances is not
required because the FASB decided that in a manner consistent with
paragraph BC346 of ASU 2014-09, entities should be given some
flexibility to determine how to present contract balances and changes in
those balances.
However, at the November 2016 TRG meeting,11 the FASB staff noted that although a full rollforward is not
required, an entity may elect to present the disclosures related to
contract balances in the form of a full rollforward. Further, when doing
so, an entity may:
-
Present such information on a quarterly basis to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, which is the disclosure objective stated in the revenue standard.
-
Provide a gross figure that includes revenue recognized (1) from the prior recorded contract liability balance and (2) that flowed in and out of the balance in the same period (i.e., the typical line item [deduction] that would be present in a full rollforward of the contract liability balance).
-
Include a quarterly rollforward of each quarter separately, but omit a year-to-date rollforward. For example, a calendar-year-end public company reporting its second-quarter financial information may provide a rollforward of the three months ended March 31 and a separate rollforward of the three months ended June 30, but may forgo providing a rollforward of the six months ended June 30.
15.2.3.5.2 Contract Liability Balance Disclosures
An entity should present certain liabilities, such as
refund liabilities, separately from contract liabilities (see Section 14.3 for
a discussion about the need to present refund liabilities separately
from contract liabilities). These liabilities may commonly arise when an
entity sells products with a right of return and the entity expects that
a certain quantity of those products will be returned (see Sections 6.3.5.2
and 6.3.5.3). These liabilities may also arise when an entity
receives cash in advance, but the agreement is cancelable because of
certain termination provisions in the agreement (see Section
4.4.1).
Assume that an entity chooses to present a full
rollforward of its contract liability. Further assume that (1) some of
the entity’s arrangements contain termination provisions and (2) amounts
received by the entity that are related to such contracts have been
recorded as a liability separate from the contract liability. The entity
would not be permitted to include the separate liability in its contract
liability balance disclosures required by ASC 606-10-50-8. However, one
approach may be to reclassify the separate liability as a contract
liability when, for example, the contract is no longer cancelable
without penalty and the amounts are recharacterized as deferred revenue.
The illustrative disclosure below demonstrates the contract liability
rollforward approach for entities that elect such presentation related
to their separate liabilities.
Illustrative Disclosure —
Contract Liability Balance Rollforward
Changes in the contract
liability balance were as follows for the years
ended December 31, 20X8, and December 31,
20X7:
15.2.4 Performance Obligations
The table below summarizes the disclosure requirements discussed in this section
through Section 15.2.4.3.2,
including the disclosures that a nonpublic entity may elect not to apply as well
as required interim disclosures.
Category | Disclosure Requirements | Election Available to Nonpublic Entities | Interim
Requirement
(ASC 270) |
---|---|---|---|
Performance
obligations
(including
remaining
performance
obligations) | Qualitative information about (1) when performance obligations are typically satisfied, (2) significant payment terms, (3) the nature of goods or services promised, (4) obligations for returns or refunds, and (5) warranties. | No | No |
Amount of revenue recognized from
performance obligations satisfied in prior
periods (e.g., changes in transaction price
estimates). | Yes | Yes | |
Transaction price allocated to the remaining performance obligations:
| Yes | Yes | |
Yes | Yes |
Quantitative and qualitative information about an entity’s performance
obligations should also be disclosed. These required disclosures should
complement an entity’s accounting policy disclosure and, like the other
disclosures required under the revenue standard, should be tailored and written
in a manner that avoids boilerplate language. Questions that entities may
consider helpful in developing the required disclosures related to performance
obligations include the following:
-
What are the typical promises made to the customer?
-
Does the entity satisfy the performance obligation(s) upon shipment, upon delivery, as services are rendered, or upon completion of service?
-
If bill-and-hold arrangements are in place, have performance obligations associated with these contracts been disclosed?
-
How is the entity’s performance tied to its payment terms?
-
When is payment typically due?
-
Does the contract contain a significant financing component?
-
Is the consideration amount variable (e.g., because of return or refund rights)? If so, what drives the variability (e.g., assumptions and judgments)?
-
Is the estimate of variable consideration typically constrained? Is it consistent with estimates in prior periods?
-
Is there a performance obligation to arrange for another party to transfer goods or services (i.e., is the entity acting as an agent)?
-
Are there any material rights created by (1) favorable renewal terms or (2) customer loyalty or incentive programs?
-
Does the entity offer warranties? If so, are they assurance-type warranties or promised services?
15.2.4.1 Nature of Performance Obligations
ASC 606-10
50-12 An entity shall
disclose information about its performance
obligations in contracts with customers, including a
description of all of the following:
-
When the entity typically satisfies its performance obligations (for example, upon shipment, upon delivery, as services are rendered, or upon completion of service) including when performance obligations are satisfied in a bill-and-hold arrangement
-
The significant payment terms (for example, when payment typically is due, whether the contract has a significant financing component, whether the consideration amount is variable, and whether the estimate of variable consideration is typically constrained in accordance with paragraphs 606-10-32-11 through 32-13)
-
The nature of the goods or services that the entity has promised to transfer, highlighting any performance obligations to arrange for another party to transfer goods or services (that is, if the entity is acting as an agent)
-
Obligations for returns, refunds, and other similar obligations
-
Types of warranties and related obligations.
The illustrative disclosure below shows how an entity might provide the information required under ASC 606-10-50-12.
15.2.4.2 Disclosure of Revenue Recognized From Past Performance
In accordance with ASC 606-10-50-12A, an entity is required to disclose “out of
period” adjustments attributable to changes in estimates. That is, if an
estimate of variable consideration is adjusted (or a royalty is received
after a right-to-use license has been transferred to the customer) and an
adjustment to revenue is accordingly recognized in the period, the
adjustment to revenue should be disclosed.
ASC 606-10
50-12A An entity shall
disclose revenue recognized in the reporting period
from performance obligations satisfied (or partially
satisfied) in previous periods (for example, changes
in transaction price).
The example below illustrates the application of ASC 606-10-50-12A.
Example 15-1
An entity has entered into a long-term construction contract that includes two forms of consideration: a fixed component of $3,000 and a potential performance bonus of $1,000. Therefore, the total potential consideration in this contract is $4,000. However, as of contract inception, no variable consideration is included in the transaction price — that is, the transaction price is constrained (see Chapter 6 for further discussion on estimating and constraining the transaction price).
As of September 30, 20X8, the entity’s performance under the contract is 50 percent complete. Therefore, using the original estimate of the transaction price, the entity recognizes revenue of $1,500 (50 percent of $3,000).
Subsequently, on the basis of further information and estimation during the
entity’s year-end close process, it is believed to
be probable that the entity will receive the
performance bonus. Therefore, the entity includes a
cumulative catch-up adjustment in accordance with
ASC 606-10-32-42 through 32-45 (see Chapter 6) and updates
its transaction price to $4,000. As a result, on
December 31, 20X8, the entity records $500 in
revenue to catch up during the fourth quarter of
20X8 for the prior performance under the
contract.
In accordance with ASC 606-10-50-12A, this $500 cumulative catch-up adjustment should be disclosed. The entity may make this disclosure as follows:
The disclosure may be presented in a narrative format in the entity’s financial statements. For example, the entity could provide a narrative disclosure that states, “For the three-month period ending December 31, 20X8, the Company recognized $500 in revenue from performance obligations satisfied in the prior period; the cumulative catch-up adjustment resulted from a change in transaction price related to variable consideration that was constrained in prior periods.”
15.2.4.3 Transaction Price Allocated to the Remaining Performance Obligations
The requirement in ASC 606-10-50-13 to provide information
on the transaction price allocated to the remaining performance obligations
is a new and challenging disclosure requirement; however, it is viewed as a
critical disclosure by users of financial statements. Many refer to this
disclosure as the “backlog” disclosure because it requires disclosure of
expected future revenue to be recorded on partially completed contracts.
Specifically, ASC 606-10-50-13 requires disclosure as
follows:
ASC 606-10
50-13 An entity shall
disclose the following information about its
remaining performance obligations:
-
The aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the reporting period
-
An explanation of when the entity expects to recognize as revenue the amount disclosed in accordance with paragraph 606-10-50-13(a), which the entity shall disclose in either of the following ways:
-
On a quantitative basis using the time bands that would be most appropriate for the duration of the remaining performance obligations
-
By using qualitative information.
-
For example, suppose that a calendar-year-end entity sells a
two-year noncancelable magazine subscription to a customer on April 1, 20X8,
for an up-front payment of $24. Therefore, as of December 31, 20X8, the
entity has fulfilled nine months of the contract by delivering nine
magazines to the customer and has recognized $9 of revenue. In accordance
with ASC 606-10-50-13, the entity is required to include in its disclosures
for December 31, 20X8, a quantitative disclosure of the remainder ($15) as
the transaction price allocated to the remaining performance obligations
since it expects to fulfill the remaining 15 months of the subscription and
recognize the remaining $15 in revenue in future periods (i.e., in the years
ending (1) December 31, 20X9, and (2) December 31, 20Y0).
Since determining when performance obligations are satisfied
is a matter of judgment, as discussed above and in Section 15.3, the required disclosures
related to remaining performance obligations may be subjective and difficult
to determine. In light of this, entities could consider the following
questions when developing their disclosures in accordance with ASC
606-10-50-13 through 50-15:
-
For existing contracts, do the entity’s disclosures accurately portray:
-
The amount and expected timing of revenue to be recognized from the remaining performance obligations?
-
Trends related to the amounts and expected timing of revenue to be recognized from the remaining performance obligations?
-
Risks associated with expected future revenue? (Risks may increase if remaining performance obligations are not satisfied until much later.)
-
The effect of changes in judgments or circumstances?
-
-
Is the timing of revenue recognition uncertain? (If so, qualitative disclosures may be appropriate.)
-
Are there contracts and associated performance obligations that have an original expected duration of one year or less? (See Section 15.2.4.3.1.)
-
Has the entity recognized revenue as invoiced in accordance with ASC 606-10-55-18? (See Section 15.2.4.3.1.)
-
Has the entity recognized sales- or usage-based royalties in exchange for a license of intellectual property (IP) in accordance with ASC 606-10-55-65 through 55-65B? (See Section 15.2.4.3.1.)
-
Has the entity allocated variable consideration entirely to a wholly unsatisfied performance obligation or distinct good or service that forms part of a series in accordance with ASC 606-10-32-40? (See Section 15.2.4.3.1.)
-
What is the relationship between the required disclosures about remaining performance obligations and other disclosures, such as MD&A disclosures and backlog disclosures in filings outside the financial statements, if applicable? (For example, entities that voluntarily disclose information about future revenues in backlog disclosures within filings outside the financial statements should consider where this information is coming from, whether it would satisfy the revenue standard’s disclosure requirements, and whether the appropriate controls for reviewing this information are already implemented and operating effectively.)
15.2.4.3.1 Election Not to Provide Certain Disclosures
Under ASC 606-10-50-16, certain nonpublic entities can
elect not to provide the disclosures described in ASC 606-10-50-13
through 50-15. In addition, an election under ASC 606-10-50-14 or 50-14A
is available to all entities for contracts in any of the following
circumstances:
-
The original expected duration of the contract is one year or less.
-
Revenue from the satisfaction of the performance obligations is recognized in the amount invoiced in accordance with ASC 606-10-55-18 (see Section 8.5.8.1).
-
The contract provides for variable consideration constituting a sales- or usage-based royalty promised in exchange for a license of IP that is accounted for in accordance with ASC 606-10-55-65 through 55-65B (see Section 12.7).
-
Certain instances in which the guidance in ASC 606-10-32-40 is applied (see Section 7.5.4).
ASC 606-10
50-14 An entity need not
disclose the information in paragraph 606-10-50-13
for a performance obligation if either of the
following conditions is met:
-
The performance obligation is part of a contract that has an original expected duration of one year or less.
-
The entity recognizes revenue from the satisfaction of the performance obligation in accordance with paragraph 606-10-55-18.
50-14A An entity need not
disclose the information in paragraph 606-10-50-13
for variable consideration for which either of the
following conditions is met:
-
The variable consideration is a sales-based or usage-based royalty promised in exchange for a license of intellectual property accounted for in accordance with paragraphs 606-10-55-65 through 55-65B.
-
The variable consideration is allocated entirely to a wholly unsatisfied performance obligation or to a wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation in accordance with paragraph 606-10-25-14(b), for which the criteria in paragraph 606-10-32-40 have been met.
50-14B The optional
exemptions in paragraphs 606-10-50-14(b) and
606-10-50-14A shall not be applied to fixed
consideration.
50-15 An entity shall
disclose which optional exemptions in paragraphs
606-10-50-14 through 50-14A it is applying. In
addition, an entity applying the optional
exemptions in paragraphs 606-10-50-14 through
50-14A shall disclose the nature of the
performance obligations, the remaining duration
(see paragraph 606-10-25-3), and a description of
the variable consideration (for example, the
nature of the variability and how that variability
will be resolved) that has been excluded from the
information disclosed in accordance with paragraph
606-10- 50-13. This information shall include
sufficient detail to enable users of financial
statements to understand the remaining performance
obligations that the entity excluded from the
information disclosed in accordance with paragraph
606-10-50-13. In addition, an entity shall explain
whether any consideration from contracts with
customers is not included in the transaction price
and, therefore, not included in the information
disclosed in accordance with paragraph
606-10-50-13. For example, an estimate of the
transaction price would not include any estimated
amounts of variable consideration that are
constrained (see paragraphs 606-10-32-11 through
32-13).
50-16 An entity, except for a
public business entity, a not-for-profit entity
that has issued, or is a conduit bond obligor for,
securities that are traded, listed, or quoted on
an exchange or an over-the-counter market, or an
employee benefit plan that files or furnishes
financial statements with or to the SEC, may elect
not to provide the disclosures in paragraphs
606-10-50-13 through 50-15.
As noted in ASC 606-10-50-14B above, if an entity elects
to use the optional exemptions from the requirement to disclose the
information described in ASC 606-10-50-13, the entity would still need
to disclose the amount of fixed consideration allocated to outstanding
performance obligations. That is, the entity would still need to
disclose the amount of consideration allocated to outstanding
performance obligations that is not contingent on the resolution of an
uncertainty (i.e., not variable consideration).
The example below illustrates a situation in which an
entity would not be required to disclose information about its remaining
performance obligations because the contract is cancelable within one
year or less without substantive penalty.
Example 15-2
On November 1, 20X0, Company A
enters into a two-year term software license
agreement to provide a right-to-use license of IP
and postcontract customer support (PCS) during the
contract term to Customer B in exchange for a
fixed fee of $2,400, which is prepaid by B at
contract inception. Customer B can terminate the
contract for convenience at any time by providing
90 days’ notice to A in exchange for a pro rata
refund of its prepaid consideration. For example,
if B notifies A that it intends to terminate the
agreement at the beginning of month 2, B would no
longer be able to use the IP after the end of
month 4 (i.e., 90 days later) but would receive a
refund of $2,000 (i.e., consideration for months 5
through 24). As a result of the cancellation
provision, the contract would be accounted for as
a three-month term license (and PCS) with optional
renewals. See Section
4.4.1.1.2.
Company A’s year-end is December
31. As of December 31, 20X0, A is not required to
disclose information about its remaining
performance obligations in its contract with B in
accordance with the disclosure requirement in ASC
606-10-50-13. This is because ASC 606-10-50-14
states that an entity does not need to disclose
information about its remaining performance
obligations (as required under ASC 606-10-50-13)
if the performance obligation is part of a
contract that has an original expected duration of
one year or less.
Although A’s contract with B has
a stated contract term of two years, the contract
is legally enforceable for only three months
because of B’s ability to terminate the contract
for convenience with no penalty by providing 90
days’ notice. Therefore, for purposes of applying
the guidance and disclosure requirements in ASC
606, the contract term is only three months. If
the election is not made and B has not given
notice to cancel the contract, the remaining
performance obligation that could be included in
the disclosure would be limited to the three-month
obligation to provide PCS.
In addition, because $2,100 of
the up-front consideration received from B is
related to potential contract renewals that are,
in effect, optional purchases (i.e., consideration
for months 4 through 24), that amount should
initially be presented as a deposit liability (or
similar liability) rather than a contract
liability. That is, on November 1, 20X0, the
$2,100 does not represent A’s obligation to
transfer goods or services to a customer for which
the entity has received consideration (or for
which the amount is due) from the customer. This
is because A is not obligated to transfer
additional term licenses and PCS to the customer
until the customer exercises its option to renew
the contract (by electing not to terminate the
contract).
This presentation and the
disclosure requirements could be the same for
other contracts that include cancellation
provisions with no substantive termination
penalties or pro rata refund provisions (e.g., a
contract to provide two years of consulting
services or SaaS for $2,400 that is cancelable
without a substantive penalty by giving 90 days’
notice).
15.2.4.3.2 Illustrative Examples
The Codification examples below illustrate how an entity
could disclose its allocation of the transaction price to the remaining
performance obligations to meet the requirements of ASC
606-10-50-13.
ASC 606-10
Example 42 —
Disclosure of the Transaction Price Allocated to
the Remaining Performance Obligations
55-298 On June 30, 20X7, an
entity enters into three contracts (Contracts A,
B, and C) with separate customers to provide
services. Each contract has a two-year
noncancellable term. The entity considers the
guidance in paragraphs 606-10-50-13 through 50-15
in determining the information in each contract to
be included in the disclosure of the transaction
price allocated to the remaining performance
obligations at December 31, 20X7.
Contract
A
55-299 Cleaning services are
to be provided over the next two years typically
at least once per month. For services provided,
the customer pays an hourly rate of $25.
55-300 Because the entity
bills a fixed amount for each hour of service
provided, the entity has a right to invoice the
customer in the amount that corresponds directly
with the value of the entity’s performance
completed to date in accordance with paragraph
606-10-55-18. Consequently, the entity could elect
to apply the optional exemption in paragraph
606-10-50-14(b). If the entity elects not to
disclose the transaction price allocated to
remaining performance obligations for Contract A,
the entity would disclose that it has applied the
optional exemption in paragraph 606-10-50-14(b).
The entity also would disclose the nature of the
performance obligation, the remaining duration,
and a description of the variable consideration
that has been excluded from the disclosure of
remaining performance obligations in accordance
with paragraph 606-10-50-15.
Contract
B
55-301 Cleaning services and
lawn maintenance services are to be provided as
and when needed with a maximum of four visits per
month over the next two years. The customer pays a
fixed price of $400 per month for both services.
The entity measures its progress toward complete
satisfaction of the performance obligation using a
time-based measure.
55-302 The entity discloses
the amount of the transaction price that has not
yet been recognized as revenue in a table with
quantitative time bands that illustrates when the
entity expects to recognize the amount as revenue.
The information for Contract B included in the
overall disclosure is as follows.
Contract
C
55-303 Cleaning services are
to be provided as and when needed over the next
two years. The customer pays fixed consideration
of $100 per month plus a one-time variable
consideration payment ranging from $0–$1,000
corresponding to a one-time regulatory review and
certification of the customer’s facility (that is,
a performance bonus). The entity estimates that it
will be entitled to $750 of the variable
consideration. On the basis of the entity’s
assessment of the factors in paragraph
606-10-32-12, the entity includes its estimate of
$750 of variable consideration in the transaction
price because it is probable that a significant
reversal in the amount of cumulative revenue
recognized will not occur. The entity measures its
progress toward complete satisfaction of the
performance obligation using a time-based
measure.
55-304 The entity discloses
the amount of the transaction price that has not
yet been recognized as revenue in a table with
quantitative time bands that illustrates when the
entity expects to recognize the amount as revenue.
The entity also includes a qualitative discussion
about any significant variable consideration that
is not included in the disclosure. The information
for Contract C included in the overall disclosure
is as follows.
55-305 In addition, in
accordance with paragraph 606-10-50-15, the entity
discloses qualitatively that part of the
performance bonus has been excluded from the
disclosure because it was not included in the
transaction price. That part of the performance
bonus was excluded from the transaction price in
accordance with the guidance on constraining
estimates of variable consideration.
55-305A The entity does not
meet the criteria to apply the optional exemption
in paragraph 606-10-50-14A because the monthly
consideration is fixed and the variable
consideration does not meet the condition in
paragraph 606-10-50-14A(b).
Example 43 —
Disclosure of the Transaction Price Allocated to
the Remaining Performance Obligations —
Qualitative Disclosure
55-306 On January 1, 20X2, an
entity enters into a contract with a customer to
construct a commercial building for fixed
consideration of $10 million. The construction of
the building is a single performance obligation
that the entity satisfies over time. As of
December 31, 20X2, the entity has recognized $3.2
million of revenue. The entity estimates that
construction will be completed in 20X3 but it is
possible that the project will be completed in the
first half of 20X4.
55-307 At December 31, 20X2,
the entity discloses the amount of the transaction
price that has not yet been recognized as revenue
in its disclosure of the transaction price
allocated to the remaining performance
obligations. The entity also discloses an
explanation of when the entity expects to
recognize that amount as revenue. The explanation
can be disclosed either on a quantitative basis
using time bands that are most appropriate for the
duration of the remaining performance obligation
or by providing a qualitative explanation. Because
the entity is uncertain about the timing of
revenue recognition, the entity discloses this
information qualitatively as follows:
As of December 31, 20X2, the aggregate amount
of the transaction price allocated to the
remaining performance obligation is $6.8 million,
and the entity will recognize this revenue as the
building is completed, which is expected to occur
over the next 12–18 months.
The illustrative disclosure below further demonstrates
how an entity may provide a quantitative disclosure of the transaction
price to be allocated to the remaining performance obligations.12
15.2.5 Impact of Termination Provisions on Disclosure
Termination provisions may significantly affect revenue recognition for entities.
In addition, contracts with termination provisions may affect an entity’s
financial statement disclosures.
15.2.5.1 Effect of Termination Provisions on Disclosures Related to Remaining Performance Obligations
In an arrangement with a termination provision, an entity should not include
amounts that are subject to termination without penalty in its required
disclosures related to remaining performance obligations. Under the
requirements outlined in ASC 606-10-50-13, an entity must disclose the
“aggregate amount of the transaction price allocated to the performance
obligations that are unsatisfied . . . as of the end of the reporting
period.”
When arrangements include provisions for termination without penalty, the
amounts excluded from the assessment under step 1 of ASC 606 are, in effect,
optional purchases. Any amounts that are paid or due are thus accounted for
as a refund liability (or similar liability) and not a contract liability.
Because these amounts are related to a cancelable arrangement for which a
contract does not exist (as determined under step 1), they do not represent
any part of the transaction price (as determined under step 3) related to
unsatisfied performance obligations (which would be identified as part of
step 2).
15.2.5.2 Supplemental Disclosures Related to Termination Provisions
An entity is not necessarily precluded from separately disclosing the amounts
of refund liability within the financial statement notes that discuss
remaining performance obligations. An entity must not indicate that the
refund liabilities are part of the transaction price related to its
remaining performance obligations. However, the entity generally would not
be precluded from specifying the refund liability in its financial statement
notes if it properly describes this GAAP amount.
For example, an entity might provide the disclosure
below.
Illustrative Disclosure — Transaction Price Allocated
to Remaining Performance Obligations
As of December 31, 20X7, approximately $4.5 million
of revenue is expected to be recognized from
remaining performance obligations. The Company
expects to recognize revenue on approximately 65
percent of these amounts over the next 12 months,
with the remaining balance recognized
thereafter.
In addition, approximately $0.8 million is recorded
as a refund liability in the Company’s consolidated
balance sheet that is not included in the above
remaining performance obligations. This liability is
generally related to amounts received from customers
but is associated with termination provisions for
arrangements that are cancelable at the customer’s
discretion (and the Company would be required to
refund such amounts).
15.2.5.3 Effect of Termination Provisions on Contract Balance Disclosures
When some of an entity’s arrangements contain termination
provisions, any amounts received that are not associated with contracts
identified under step 1 of ASC 606 should be recorded as a separate
liability apart from the contract liability. Therefore, the entity would not
be permitted to include the refund liability in its contract liability
balance disclosures required by ASC 606-10-50-8. However, if the entity
chooses to present a full rollforward of its contract liability, one
approach may be to reclassify the refund liability as a contract liability
when the termination right lapses (i.e., when the contract is no longer
cancelable without penalty and the amounts are recharacterized as deferred
revenue). Under this approach, the reclassification of the refund liability
as a contract liability would be presented in a manner consistent with the
illustrative disclosure in
Section 15.2.3.5.2.
Footnotes
9
See footnote 5.
10
In December 2016, the FASB issued ASU
2016-20, which clarified (by moving the
content previously in ASC 606-10-50-8(c) to ASC 606-10-50-12A)
that “the disclosure of revenue recognized from performance
obligations satisfied (or partially satisfied) in previous
periods applies to all performance obligations and is not
limited to performance obligations with corresponding contract
balances.”
11
For more information about the November 7, 2016,
TRG meeting, see TRG Agenda Paper 60 and
Deloitte’s November 2016 TRG Snapshot.
12
This illustrative disclosure includes the
optional exemptions applied in ASC 606-10-50-14 and 50-14A. In
addition to disclosing the optional exemptions applied, an
entity should disclose the qualitative information required in
ASC 606-10-50-15.
15.3 Significant Judgments
The table below summarizes the disclosure requirements discussed in this section
through Section 15.3.2,
including the disclosures that a nonpublic entity may elect not to apply as well as
required interim disclosures.
Category | Disclosure Requirements | Election Available to Nonpublic Entities | Interim
Requirement
(ASC 270) |
---|---|---|---|
Significant judgments and estimates | Qualitative information about determining the timing of:
| Yes13 | No |
| Yes | No | |
Qualitative and quantitative information14 about: | |||
| Yes | No | |
| No | No | |
| Yes | No | |
| Yes | No |
An entity is required to disclose information about the judgments, and changes
in judgments, it made in applying ASC 606 to help financial statement users better
understand the application of its accounting policies as well as the assumptions and
methods used. Questions that entities could consider in implementing the revenue
standard’s disclosure requirements related to significant judgments and estimates
include the following:
-
Are all significant judgments and estimates related to variable consideration, significant financing components, or noncash consideration included in the disclosures?
-
Are all significant judgments and estimates related to the determination of stand-alone selling prices included in the disclosures?
-
Has the entity adequately disclosed information about the methods, inputs, and assumptions used in the annual financial statements?
-
What judgments does the entity make in selecting an appropriate measure of progress?
-
What estimates does the entity make in determining the level of completion?
-
What information does management consider to determine when performance obligations are satisfied?
-
-
Has the entity adequately described significant judgments and estimates related to (1) performance obligations satisfied at a point in time, (2) performance obligations satisfied over time, and (3) the transaction price and amounts allocated to performance obligations?
ASC 606-10
50-17 An entity shall disclose the judgments, and changes in the judgments, made in applying the guidance in this Topic that significantly affect the determination of the amount and timing of revenue from contracts with customers. In particular, an entity shall explain the judgments, and changes in the judgments, used in determining both of the following:
- The timing of satisfaction of performance obligations (see paragraphs 606-10-50-18 through 50-19)
- The transaction price and the amounts allocated to performance obligations (see paragraph 606-10-50-20).
The illustration below summarizes the requirements in ASC 606 related to the disclosure of significant judgments about revenue.
15.3.1 Determining the Timing of Satisfaction of Performance Obligations (i.e., the Timing of Revenue Recognition)
ASC 606-10
50-18 For performance obligations that an entity satisfies over time, an entity shall disclose both of the following:
- The methods used to recognize revenue (for example, a description of the output methods or input methods used and how those methods are applied)
- An explanation of why the methods used provide a faithful depiction of the transfer of goods or services.
50-19 For performance obligations satisfied at a point in time, an entity shall disclose the significant judgments made in evaluating when a customer obtains control of promised goods or services.
50-21 An entity except for a
public business entity, a not-for-profit entity that has
issued, or is a conduit bond obligor for, securities
that are traded, listed, or quoted on an exchange or an
over-the-counter market, or an employee benefit plan
that files or furnishes financial statements with or to
the SEC, may elect not to provide any or all of the
following disclosures:
- Paragraph 606-10-50-18(b), which states that an entity shall disclose, for performance obligations satisfied over time, an explanation of why the methods used to recognize revenue provide a faithful depiction of the transfer of goods or services to a customer
- Paragraph 606-10-50-19, which states that an entity shall disclose, for performance obligations satisfied at a point in time, the significant judgments made in evaluating when a customer obtains control of promised goods or services . . . .
15.3.2 Determining the Transaction Price and the Amounts Allocated to Performance Obligations
ASC 606-10
50-20 An entity shall disclose information about the methods, inputs, and assumptions used for all of the following:
- Determining the transaction price, which includes, but is not limited to, estimating variable consideration, adjusting the consideration for the effects of the time value of money, and measuring noncash consideration
- Assessing whether an estimate of variable consideration is constrained
- Allocating the transaction price, including estimating standalone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract (if applicable)
- Measuring obligations for returns, refunds, and other similar obligations.
50-21 An entity except for a
public business entity, a not-for-profit entity that has
issued, or is a conduit bond obligor for, securities
that are traded, listed, or quoted on an exchange or an
over-the-counter market, or an employee benefit plan
that files or furnishes financial statements with or to
the SEC, may elect not to provide any or all of the
following disclosures: . . .
c. Paragraph 606-10-50-20, which states that an
entity shall disclose the methods, inputs, and
assumptions used to determine the transaction
price and to allocate the transaction price.
However, if an entity elects not to provide the
disclosures in paragraph 606-10-50-20, the entity
shall provide the disclosure in paragraph
606-10-50-20(b), which states that an entity shall
disclose the methods, inputs, and assumptions used
to assess whether an estimate of variable
consideration is constrained.
Footnotes
13
See footnote 6.
14
See footnote 7.
15.4 Contract Costs
The table below summarizes the disclosure requirements discussed in this section, including the disclosures that a nonpublic entity may elect not to apply as well as required interim disclosures.
Category | Disclosure Requirements | Election Available to Nonpublic Entities | Interim
Requirement
(ASC 270) |
---|---|---|---|
Contract costs | Qualitative information about:
| Yes | No |
Yes | No | ||
Quantitative information about:
| Yes | No | |
Yes | No |
Entities are required to disclose significant judgments related to contract
costs to help users of financial statements understand the types of costs that the
entity has recognized as assets and how those assets are subsequently amortized or
impaired.
ASC 340-40
50-1 Consistent with the overall disclosure objective in paragraph 606-10-50-1 and the guidance in paragraphs 606-10-50-2 through 50-3, an entity shall provide the following disclosures of assets recognized from the costs to obtain or fulfill a contract with a customer in accordance with paragraphs 340-40-25-1 or 340-40-25-5.
50-2 An entity shall describe
both of the following:
-
The judgments made in determining the amount of the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph 340-40-25-1 or 340-40-25-5)
-
The method it uses to determine the amortization for each reporting period.
50-3 An entity shall disclose all of the following:
- The closing balances of assets recognized from the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph 340-40-25-1 or 340-40-25-5), by main category of asset (for example, costs to obtain contracts with customers, precontract costs, and setup costs)
- The amount of amortization and any impairment losses recognized in the reporting period.
50-4 An entity, except for a public business entity, a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or an employee benefit plan that files or furnishes financial statements with or to the Securities and Exchange Commission, may elect not to provide the disclosures in paragraphs 340-40-50-2 through 50-3.
The illustrative disclosure below shows how an entity may disclose the
qualitative information required under ASC 340-40-50-1.
15.5 Disclosure of Practical Expedients Used
The table below summarizes the disclosure requirements discussed in this section, including the disclosures that a nonpublic entity may elect not to apply as well as required interim disclosures.
Category | Disclosure Requirements | Election Available to Nonpublic Entities | Interim
Requirement
(ASC 270) |
---|---|---|---|
Practical
expedients | Disclosure of practical expedients used. | Yes15 | No |
A number of practical expedients are available to both public business entities
(PBEs) and nonpublic entities in the application of the recognition and measurement
principles within the standard. Specific disclosures similar to accounting policy
disclosures are required if an entity elects certain of these practical expedients.
For example, an entity is required to disclose that it is electing the practical
expedients related to (1) significant financing components (as discussed further in
Chapter 6), (2) contract
costs (as discussed further in Chapter
13), and (3) disclosures for remaining performance obligations (as
discussed further in Section
15.2.4.3.1).
ASC 606-10
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.
50-23 An entity, except for a public business entity, a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or an employee benefit plan that files or furnishes financial statements with or to the SEC, may elect not to provide the disclosures in paragraph 606-10-50-22.
ASC 340-40
50-5 If an entity elects to use the practical expedient in paragraph 340-40-25-4 on the incremental costs of obtaining a contract, the entity shall disclose that fact.
50-6 An entity, except for a public business entity, a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, or an employee benefit plan that files or furnishes financial statements with or to the Securities and Exchange Commission, may elect not to provide the disclosure in paragraph 340-40-50-5.
ASC 952-606
50-1
If an entity elects to use the practical expedient in
paragraph 952-606-25-2, the entity shall disclose that
fact.
50-2
An entity that makes the accounting policy election to
recognize pre-opening services as a single performance
obligation as described in paragraph 952-606-25-3 shall
disclose that fact.
Further, the amendments in ASU 2016-10, ASU 2016-12, and
ASU
2021-02 include additional practical expedients related to the
following:
-
Shipping and handling activities — ASU 2016-10 permits an entity to account for shipping and handling activities that occur after the customer has obtained control of a good as fulfillment activities (i.e., an expense) rather than as a promised service (i.e., a revenue element). An entity may also elect to account for shipping and handling as a promised service. The ASU also explains that shipping and handling activities performed before the control of a product is transferred do not constitute a promised service to the customer in the contract (i.e., they represent fulfillment costs). The election to account for shipping and handling services as a promised good or service or a fulfillment cost typically should not apply to companies whose principal service offering is shipping or transportation. Further, we believe that such election (1) should be applied consistently and (2) is available to entities that recognize revenue for the sale of goods either at a point in time or over time. Refer to Section 5.2.4.3 for further information.An entity that elects to apply this accounting policy is required to provide the accounting policy disclosures in ASC 235-10-50-1 through 50-6.
-
Sales tax presentation — ASU 2016-12 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.” Refer to Section 6.7 for further information.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.
-
Private-company franchisor — ASU 2021-02 allows a franchisor that is not a PBE (a “private-company franchisor”) to use a practical expedient when identifying performance obligations in its contracts with customers (i.e., franchisees) under ASC 606. When using the practical expedient, a private-company franchisor that has entered into a franchise agreement would treat certain preopening services provided to its franchisee as distinct from the franchise license. In addition, a private-company franchisor that applies the practical expedient must make a policy election to either (1) apply the guidance in ASC 606 to determine whether the preopening services that are subject to the practical expedient are distinct from one another or (2) account for those preopening services as a single performance obligation. The practical expedient and policy election are intended to reduce the cost and complexity of applying ASC 606 to preopening services associated with initial franchise fees. Refer to Section 5.3.5 for further information.A private-company franchisor that elects to use the practical expedient is required to provide the disclosure in ASC 952-606-50-1. In addition, a private-company franchisor that elects to use the practical expedient and to account for preopening services as a single performance obligation is required to provide the disclosure in ASC 952-606-50-2.
If entities elect one or more practical expedients, they should disclose that fact in their financial statements. Entities should consider the appropriate placement for the disclosure of their use of practical expedients. For example, some or all of the elections might appropriately be included in “Significant Accounting Policies” (i.e., footnote 1), whereas it may be appropriate to include other elections in the revenue recognition footnote. The guidance does not dictate where such disclosures should be included; it only indicates that they must be included.
The illustrative disclosure below shows how an entity may disclose that
management has elected certain practical expedients available under the revenue
standard.
The illustrative disclosure below shows how an entity may describe its use of the practical expedient related to contract costs in accordance with ASC 606-10-50-22.
Footnotes
15
See footnote
8.
Chapter 16 — Nonpublic-Entity Elections
Chapter 16 — Nonpublic-Entity Elections
16.1 Background
During the final years of development of the revenue standard, the
FASB was under pressure from the AICPA and others regarding the establishment of
U.S. GAAP for nonpublic entities. Specifically, some criticized the FASB for setting
standards for large public companies that increase the complexity (and, therefore,
the cost) associated with producing financial statements. As a result, the Financial
Accounting Foundation, the FASB’s parent organization, created the Private Company
Council to help the FASB determine when there should be differences in U.S. GAAP for
nonpublic entities (see Deloitte’s May 25, 2012, journal entry and June 5, 2012,
Heads
Up for more information). Accordingly, throughout the
redeliberations and final development of the revenue standard, the FASB considered
the disparate needs of users of nonpublic entities’ financial statements.
Ultimately, the FASB concluded that no specific recognition or measurement
differences for nonpublic entities were necessary. However, the Board also
concluded, largely on the basis of feedback from the nonpublic-entity community,
that differences in the required disclosure package and mandatory effective date of
the revenue standard would be appropriate for nonpublic entities. In addition, after
the revenue standard was finalized, the FASB decided to provide recognition
exceptions for franchisors that are not public business entities (“private-company
franchisors”) by issuing ASU
2021-02, which allows private-company franchisors to use a practical
expedient and a policy election when identifying performance obligations in their
contracts with customers (i.e., franchisees) under ASC 606. See Section 5.3.5 for additional
details.
At the same time the FASB was developing the revenue standard, it was working on a
separate project to clarify which entities would be within the scope of the relief
available to nonpublic entities under financial reporting standards. In that
project, the Board decided to answer the question of which entities qualified for
nonpublic-entity relief indirectly by determining, in stages, which entities would
not qualify for such relief. The Board began its analysis by determining what
constitutes a “public business entity” (PBE). In ASU
2013-12, and as noted in Chapter
2, the Board defined the term as follows:
A public business entity is a business entity meeting any one of the criteria
below. Neither a not-for-profit entity nor an employee benefit plan is a
business entity.
-
It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
-
b. It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
-
c. It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
-
It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
-
It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business entity solely because
its financial statements or financial information is included in another
entity’s filing with the SEC. In that case, the entity is only a public
business entity for purposes of financial statements that are filed or
furnished with the SEC.
In defining PBEs to exclude not-for-profit entities and employee benefit plans, the
Board deferred to future deliberations, on a standard-by-standard basis, its
determination of which, if any, not-for-profit entities and employee benefit plans
would be eligible for relief available to nonpublic entities. Accordingly, the Board
subsequently determined that an entity would be eligible for such relief under the
revenue standard if it does not meet the definition of any of the following:
-
A PBE.
-
A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
-
An employee benefit plan that files or furnishes financial statements with or to the SEC.
After determining which entities could be afforded relief in application, the FASB
considered the costs and benefits of making the requirements in the revenue standard
applicable to nonpublic entities and decided to provide those entities with relief
related to:
-
Disclosures.
-
Mandatory effective date.
-
Identification of performance obligations related to preopening services provided by a franchisor (refer to Section 5.3.5 for additional information).
16.2 Disclosure Elections
The Background Information and Basis for Conclusions of ASU 2014-09 explains that one of the goals of
ASC 606 is to improve the revenue disclosure guidance under U.S. GAAP. As a result
of the disclosure requirements in ASC 606 (which are discussed in detail in
Chapter 15), financial statement users
will have better information to help them make financial decisions. However, when
the FASB was developing the revenue standard, it received feedback from nonpublic
entities related to (1) the increased costs that nonpublic entities would incur to
meet the expanded disclosure requirements and (2) questions about why nonpublic
entities should be required to provide the same level of disclosure as public
entities given that users of nonpublic-entity financial statements, typically debt
holders, have greater access to management. The FASB considered the costs and
benefits of its disclosure package and decided to provide various relief to
nonpublic entities.
The table below summarizes the disclosures that a nonpublic entity may elect not to
apply (the ASU’s disclosure requirements are covered in Chapter 15 as well as in the left column below).
Disclosure Requirement
|
Election for Nonpublic Entities
|
---|---|
Present or disclose revenue and any impairment losses
recognized separately from other sources of revenue or
impairment losses from other contracts. (ASC 606-10-50-4;
see Section 15.2)
|
None.
|
A disaggregation of revenue to “depict how
the nature, amount, timing, and uncertainty of revenue and
cash flows are affected by economic factors” (the ASU also
provides implementation guidance). (ASC 606-10-50-5 and
50-6; see Section
15.2.2)
|
An entity may elect not to provide the
quantitative disclosure but should, at a minimum, provide
revenue disaggregated according to the timing of transfer of
goods or services (e.g., goods transferred at a point in
time and services transferred over time). (ASC 606-10-50-7;
see Section
15.2.2)
|
Information about (1) contract assets and
contract liabilities (including changes in those balances)
and the amount of revenue recognized in the current period
that was previously recognized as a contract liability (ASC
606-10-50-8 through 50-10) and (2) the amount of revenue
recognized that is related to performance obligations
satisfied in prior periods (ASC 606-10-50-12A). (See
Sections 15.2.3
and 15.2.4)
|
An entity may elect not to provide the
disclosures but should disclose the opening and closing
balances of receivables, contract assets, and contract
liabilities (if not separately presented or disclosed). (ASC
606-10-50-11; see Section
15.2.3.3)
|
Information about performance obligations
(e.g., types of goods or services, significant payment
terms, typical timing of satisfying obligations, and other
provisions). (ASC 606-10-50-12; see Section 15.2.4)
|
None.
|
Information about an entity’s transaction
price allocated to the remaining performance obligations,
including (in certain circumstances) the “aggregate amount
of the transaction price allocated to the [remaining]
performance obligations” and when the entity expects to
recognize that amount as revenue. (ASC 606-10-50-13 through
50-15; see Section
15.2.4.3)
|
An entity may elect not to provide these
disclosures. (ASC 606-10-50-16; see Section 15.2.4.3)
|
A description of the significant judgments, and changes in
those judgments, that affect the amount and timing of
revenue recognition (including information about the timing
of satisfaction of performance obligations, the
determination of the transaction price, and the allocation
of the transaction price to performance obligations). (ASC
606-10-50-17 through 50-20; see Sections 15.3 through 15.3.2)
|
In accordance with ASC 606-10-50-21, an entity may elect not
to provide any or all of the following disclosures:
(ASC 606-10-50-21; see Section
15.3.2)
|
Information about an entity’s accounting for costs of
obtaining or fulfilling a contract (including account
balances, judgments, amortization methods and amounts, and
impairment losses). (ASC 340-40-50-2 and 50-3; see Section 15.4)
|
An entity may elect not to provide these disclosures. (ASC
340-40-50-4; see Section
15.4)
|
Information about the entity’s policy
decisions (i.e., when the entity used the practical
expedients allowed by the ASU). (ASC 606-10-50-14 through
50-16, ASC 606-10-50-22, and ASC 340-40-50-5; see Sections
6.4.1, 15.2.4.3.1, and
15.5)
|
An entity may elect not to provide these
disclosures. (ASC 606-10-50-14 through 50-16, ASC
606-10-50-23, and ASC 340-40-50-6; see Sections
15.2.4.3.1 and 15.5). However,
private-company franchisors that elect to use the practical
expedient and policy election in ASC 952-606-25-2 and 25-3
must disclose those elections (ASC 952-606-50-1 and 50-2;
see Section 5.3.5).
|
Connecting the Dots
Interim reporting requirements, including those related to disclosure, are
outlined in ASC 270. In particular, public entities are required to
disclose, at a minimum, the financial information required under ASC
270-10-50-1. Revenue disclosures are specifically addressed in ASC
270-10-50-1(a), which requires the disclosure of “[s]ales or gross revenues,
provision for income taxes, net income, and comprehensive income.”
Section B of ASU 2014-09, Conforming
Amendments to Other Topics and Subtopics in the Codification and Status
Tables, expands this interim reporting requirement by
adding the following guidance:
50-1A Consistent with paragraph 270-10-50-1, a public business
entity, a not-for-profit entity that has issued, or is a conduit
bond obligor for, securities that are traded, listed, or quoted on
an exchange or an over-the-counter market, or an employee benefit
plan that files or furnishes financial statements with or to the
Securities and Exchange Commission, shall disclose all of the
following information about revenue from contracts with customers
consistent with the guidance in Topic 606:
-
A disaggregation of revenue for the period, see paragraphs 606-10-50-5 through 50-6 and paragraphs 606-10-55-89 through 55-91.
-
The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers (if not otherwise separately presented or disclosed), see paragraph 606-10-50-8(a).
-
Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period, see paragraph 606-10-50-8(b).
-
Revenue recognized in the reporting period from performance obligations satisfied (or partially satisfied) in previous periods (for example, changes in transaction price), see paragraph 606-10-50-12A.
-
Information about the entity’s remaining performance obligations as of the end of the reporting period, see paragraphs 606-10-50-13 through 50-15.
Many nonpublic entities are not subject to interim financial reporting
requirements and therefore would not be required to comply with the interim
disclosure requirements in ASC 270. In addition, the same entities that are
determined to be nonpublic for purposes of applying ASC 606 are outside the
scope of the requirements in ASC 270-10-50-1A. As a result, even if a
nonpublic entity produces interim financial information, it is not required
to provide the disclosures outlined above that are required to be presented
for public entities.
Chapter 17 — Sales of Nonfinancial Assets Within the Scope of ASC 610-20
Chapter 17 — Sales of Nonfinancial Assets Within the Scope of ASC 610-20
17.1 Overview and Background
ASC 610-20
05-1 This Subtopic provides
guidance on the recognition of gains and losses on transfers
of nonfinancial assets and in substance nonfinancial assets
to counterparties that are not customers. Although the
guidance in this Subtopic applies to contracts with
noncustomers, it refers to revenue recognition principles in
Topic 606 on revenue from contracts with customers.
ASU
2014-09 provides guidance on the
recognition and measurement of transfers of
nonfinancial assets, which is codified in ASC
610-20. The revenue standard amends or supersedes
the guidance in ASC 350 and ASC 360 on determining
the gain or loss recognized upon the derecognition
of nonfinancial assets, including in-substance
nonfinancial assets, that are not an output of an
entity’s ordinary activities, such as sales of (1)
property, plant, and equipment; (2) real estate;
or (3) intangible assets. ASC 610-20 does not
amend or supersede guidance that addresses how to
determine the gain or loss on the derecognition of
a subsidiary or group of assets that meets the
definition of a business. Gains or losses
associated with these transactions will continue
to be determined in accordance with ASC
810-10-40.
In response to stakeholder feedback indicating that (1) the meaning of the term
“in-substance nonfinancial asset” is unclear
because the revenue standard does not define it
and (2) the scope of the guidance on nonfinancial
assets is confusing and complex and does not
specify how a partial sales transaction should be
accounted for or which model entities should
apply, the FASB issued ASU
2017-05, which clarifies the scope
of ASC 610-20 as well as the accounting for
partial sales of nonfinancial assets. The newly
established guidance in ASC 610-20 (which consists
of guidance in ASU 2014-09, as amended by ASU
2017-05) conforms the derecognition guidance on
nonfinancial assets with the revenue model in ASC
606.
17.2 Scope of ASC 610-20
ASC 610-20
15-2 Except as described in paragraph 610-20-15-4, the guidance in this Subtopic applies to gains or losses
recognized upon the derecognition of nonfinancial assets and in substance nonfinancial assets. Nonfinancial
assets within the scope of this Subtopic include intangible assets, land, buildings, or materials and supplies
and may have a zero carrying value. In substance nonfinancial assets are described in paragraphs 610-20-15-5
through 15-8.
- Subparagraph superseded by Accounting Standards Update No. 2017-05.
- Subparagraph superseded by Accounting Standards Update No. 2017-05.
15-3 The guidance in this
Subtopic applies to a transfer of an ownership interest (or
a variable interest) in a consolidated subsidiary (that is
not a business or nonprofit activity) only if all of the
assets in the subsidiary are nonfinancial assets and/or in
substance nonfinancial assets.
-
Subparagraph superseded by Accounting Standards Update No. 2017-05.
-
Subparagraph superseded by Accounting Standards Update No. 2017-05.
-
Subparagraph superseded by Accounting Standards Update No. 2017-05.
-
Subparagraph superseded by Accounting Standards Update No. 2017-05.
-
Subparagraph superseded by Accounting Standards Update No. 2017-05.
15-4 The guidance in this
Subtopic does not apply to the following:
- A transfer of a nonfinancial asset or an in substance nonfinancial asset in a contract with a customer, see Topic 606 on revenue from contracts with customers
- A transfer of a subsidiary or group of assets that constitutes a business or nonprofit activity, see Section 810-10-40 on consolidation
- Sale and leaseback transactions within the scope of Subtopic 842-40 on leases
- A conveyance of oil and gas mineral rights within the scope of Subtopic 932-360 on extractive activities — oil and gas
- A transaction that is entirely accounted for in accordance with Topic 860 on transfers and servicing (for example, a transfer of investments accounted for under Topic 320 on investments — debt securities, Topic 321 on investments — equity securities, Topic 323 on investments — equity method and joint ventures, Topic 325 on investments — other, Topic 815 on derivatives and hedging, and Topic 825 on financial instruments)
- A transfer of nonfinancial assets that is part of the consideration in a business combination within the scope of Topic 805 on business combinations, see paragraph 805-30-30-8
- A nonmonetary transaction within the scope of Topic 845 on nonmonetary transactions
- A lease contract within the scope of Topic 842 on leases
- An exchange of takeoff and landing slots within the scope of Subtopic 908-350 on airlines — intangibles
- A contribution of cash and other assets, including a promise to give, within the scope of Subtopic 720-25 on other expenses — contributions made or within the scope of Subtopic 958-605 on not-for-profit entities — revenue recognition
- A transfer of an investment in a venture that is accounted for by proportionately consolidating the assets, liabilities, revenues, and expenses of the venture as described in paragraph 810-10-45-14
- A transfer of nonfinancial assets or in substance nonfinancial assets solely between entities or persons under common control, such as between a parent and its subsidiaries or between two subsidiaries of the same parent.
ASC 610-20 (as amended by ASU 2017-05) applies to all nonfinancial assets,
not only to those within the scope of ASC 350 and ASC 360, if there is no
other applicable guidance. For each nonfinancial asset, an entity would first
determine whether the transfer of the nonfinancial asset is within the scope of ASC
606, ASC 810, or any other U.S. GAAP. For example, if the nonfinancial asset is an
output of the entity’s ordinary business activities (e.g., a home builder’s sale of
real estate), the arrangement would be accounted for under ASC 606. However, if the
nonfinancial asset is not an output of the entity’s ordinary business
activities (e.g., a financial services company’s sale of its headquarters), and
not within the scope of other applicable guidance, ASC 610-20 would
apply.
Connecting the Dots
ASU 2014-09 replaces all of the real estate sales guidance in ASC 360-20 (formerly FASB Statement 66).
In their analysis of whether control has been transferred under the revenue
standard, entities need to critically evaluate (1) whether it is “probable”
that they will collect the consideration to which they will be entitled in
exchange for transferring the real estate and (2) whether a seller’s
postsale involvement should be accounted for as a separate performance
obligation (i.e., whether the postsale involvement is distinct from the real
estate).
An entity would continue to apply the derecognition guidance in ASC 810-10-40
when transfers or sales are not “in-substance nonfinancial assets” (see Section 17.2.1) and the
nonfinancial assets are held within a subsidiary or are a group of assets that meets
the definition of a business. Various types of transactions are subject to the scope
exception in ASC 610-20-15-4. Among the most common of these transactions are
sale-and-leaseback transactions (e.g., real estate sale-and-leaseback transactions),
in which an owner of an asset sells the asset and then leases it back from the
buyer. Sale-and-leaseback transactions should be accounted for under ASC 842-40,
which indicates that an entity should refer to the guidance in ASC 606-10-25-30 to
assess whether and, if so, when control of an in-substance nonfinancial asset has
been transferred to a buyer-lessor. Further, ASC 610-20 does not apply to certain
arrangements related to oil and gas mineral rights (i.e., those within the scope of
ASC 932-360) or nonmonetary transactions (i.e., those within the scope of ASC
845-10).
The decision tree below, which is adapted from ASU 2017-05, can help an entity determine whether
assets promised to a counterparty are within the scope of ASC 610-20.
17.2.1 In-Substance Nonfinancial Assets
In addition to nonfinancial assets, ASC 610-20 (as amended by ASU 2017-05)
applies to the derecognition of in-substance nonfinancial assets. The FASB added
the definition of an in-substance nonfinancial asset to the ASC master
glossary.
ASC 610-20
In Substance Nonfinancial Assets
15-5 An in substance nonfinancial asset is a financial asset (for example, a receivable) promised to a
counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) that
are promised to the counterparty in the contract is concentrated in nonfinancial assets. If substantially all of the
fair value of the assets that are promised to a counterparty in a contract is concentrated in nonfinancial assets,
then all of the financial assets promised to the counterparty in the contract are in substance nonfinancial
assets. For purposes of this evaluation, when a contract includes the transfer of ownership interests in one or
more consolidated subsidiaries that is not a business, an entity shall evaluate the underlying assets in those
subsidiaries.
15-6 When a contract includes the transfer of ownership interests in one or more consolidated subsidiaries
that is not a business, and substantially all of the fair value of the assets promised to a counterparty in the
contract is not concentrated in nonfinancial assets, an entity shall evaluate whether substantially all of the fair
value of the assets promised to the counterparty in an individual subsidiary within the contract is concentrated
in nonfinancial assets. If substantially all of the fair value of the assets in an individual subsidiary is concentrated
in nonfinancial assets, then the financial assets in that subsidiary are in substance nonfinancial assets. (See
Case C of Example 1 in paragraphs 610-20-55-9 through 55-10.)
15-7 When determining whether substantially all of the fair value of the assets promised to a counterparty in a
contract (or an individual consolidated subsidiary within a contract) is concentrated in nonfinancial assets, cash
or cash equivalents promised to the counterparty shall be excluded. Also, any liabilities assumed or relieved
by the counterparty shall not affect the determination of whether substantially all of the fair value of the assets
transferred is concentrated in nonfinancial assets.
15-8 If all of the assets promised to a counterparty in an individual consolidated subsidiary within a contract are
not nonfinancial assets and/or in substance nonfinancial assets, an entity shall apply the guidance in paragraph
810-10-40-3A(c) or 810-10-45-21A(b)(2) to determine the guidance applicable to that subsidiary.
On the basis of the above definition of an in-substance nonfinancial asset, all business or nonprofit
activities are excluded from the scope of ASC 610-20 and should be accounted for under the
consolidation guidance in ASC 810-10. Further, all investments should be accounted for under the
guidance in ASC 860 on transfers and servicing transactions, regardless of whether they are business or
nonprofit activities or are in-substance nonfinancial assets.
The examples below illustrate how an entity would determine whether a contract includes an
in-substance nonfinancial asset.
Example 17-1
An entity enters into a contract with a counterparty (not a customer) to transfer a piece of equipment subject
to a lease agreement (i.e., the equipment is presently being leased and used by an independent third party).
As of the sale date, the equipment has a fair value of $8 million. In addition, the sale contract transfers the
outstanding receivable balance of the lease (i.e., a financial asset) with a fair value of $250,000.
The assets transferred do not meet the definition of a business under ASU 2017-01. Since the entity concludes
that substantially all of the fair value of the assets promised in the contract is concentrated in nonfinancial
assets, the receivables promised in the contract meet the definition of in-substance nonfinancial assets. Thus,
the contract, including both assets (the equipment and the receivables), is within the scope of ASC 610-20 and
therefore should be accounted for in accordance with the derecognition guidance of that subtopic.
Example 17-2
Assume the same facts as in the example above, except that the fair value of the
receivables is $1.5 million. In this example, the entity
concludes that substantially all of the fair value of
the assets promised in the contract is not concentrated
in nonfinancial assets and that as a result, the
financial assets in the contract do not meet the
definition of in-substance nonfinancial assets.
Therefore, as further discussed in Section
17.2.2, the entity should apply the
guidance in ASC 606-10-15-4 in determining the
separation and measurement of the assets in the
contract. The equipment (a nonfinancial asset) is within
the scope of ASC 610-20 and therefore should be
accounted for in accordance with the derecognition
guidance of that subtopic, and the receivables should be
accounted for under ASC 860 or other U.S. GAAP, if
applicable.
17.2.2 Contracts Partially Within the Scope of Other U.S. GAAP
ASC 610-20
Contracts Partially Within the Scope of Other Topics
15-9 If the promises to a counterparty in a contract are not all nonfinancial assets or all nonfinancial assets
and in substance nonfinancial assets, a contract may be partially within the scope of this Subtopic and
partially within the scope of other Topics. For example, in addition to transferring nonfinancial assets and in
substance nonfinancial assets that are within the scope of this Subtopic, an entity may issue a guarantee to
the counterparty that is within the scope of Topic 460 on guarantees. An entity shall apply the guidance in
paragraph 606-10-15-4 to determine how to separate and measure one or more parts of a contract that are
within the scope of other Topics. (See also Case A of Example 1 in paragraphs 610-20-55-2 through 55-5 and
Case C of Example 1 in paragraphs 610-20-55-9 through 55-10.)
Assets in a legal contract or in a consolidated subsidiary can be transferred to a counterparty. The form
of the transaction affects which guidance an entity should apply when determining how to account for
a transaction in which not all assets promised to a counterparty are nonfinancial assets or in-substance
nonfinancial assets.
17.2.2.1 Sale or Transfer Through a Legal Contract
If assets are transferred to a counterparty in a legal contract and the contract is partially within the
scope of ASC 610-20 and partially within the scope of other guidance (i.e., not all assets promised in the
contract are nonfinancial and in-substance nonfinancial assets), an entity should identify each unit of
account and apply the separation and allocation guidance in ASC 606. Cases A and B of Example 1 in
ASC 610-20, which are reproduced below, illustrate the application of this guidance.
ASC 610-20
Example 1 — Scope
Case A — Nonfinancial Assets, In Substance Nonfinancial Assets, and a
Guarantee
55-2 Seller enters into a contract to transfer real estate, the related operating leases, and accounts receivable
to Buyer. Seller guarantees Buyer that the cash flows of the property will be sufficient to meet all of the
operating needs of the property for two years after the sale. In the event that the cash flows are not sufficient,
Seller is required to make a payment in the amount of the shortfall.
55-3 Seller concludes that the assets promised in the contract are not a business within the scope of Topic 810
on consolidation and are not an output of Seller’s ordinary activities within the scope of Topic 606 on revenue
from contracts with customers. In addition, assume that Seller concludes that substantially all of the fair value
of the assets promised in the contract is concentrated in nonfinancial assets (that is, substantially all of the fair
value is concentrated in the real estate and in-place lease intangible assets). Therefore, the accounts receivable
promised in the contract are in substance nonfinancial assets. In accordance with the guidance in this Subtopic,
all of the assets in the contract, including the accounts receivable, are within the scope of this Subtopic.
55-4 Seller concludes that the guarantee, which is a liability of Seller, is within the scope of Topic 460 on
guarantees. Therefore, Seller would apply the guidance in paragraph 606-10-15-4 to separate and measure the
guarantee as described in paragraph 610-20-15-9.
55-5 Seller’s conclusions would be the same if it transferred the real estate, leases, and receivables by
transferring ownership interests in a consolidated subsidiary. That is, Seller would still conclude that all of the
assets in the subsidiary are nonfinancial assets and in substance nonfinancial assets within the scope of this
Subtopic and that the guarantee is within the scope of Topic 460.
Case B — Nonfinancial Assets and Financial Assets
55-6 Entity X enters into a contract to transfer machinery and financial assets, both of which have significant
fair value. Entity X concludes that the assets promised in the contract are not a business within the scope of
Topic 810 and are not an output of the entity’s ordinary activities within the scope of Topic 606. Entity X also
concludes that substantially all of the fair value of the assets promised in the contract is not concentrated in
nonfinancial assets. Therefore, the financial assets promised in the contract are not in substance nonfinancial
assets.
55-7 In accordance with the guidance in paragraph 610-20-15-9, Entity X should derecognize only the
machinery in accordance with this Subtopic. Entity X should apply the guidance in paragraph 606-10-15-4 to
separate and measure the financial assets. . . .
17.2.2.2 Sale or Transfer Through One or More Subsidiaries
Unlike assets sold or transferred through a legal contract, the transferred
assets of an individual subsidiary should not be separated. For example,
when all or substantially all of the fair value of the transferred assets is
not concentrated in nonfinancial assets, in-substance nonfinancial assets,
or both, a transaction involving the transfer of ownership interests in a
subsidiary is entirely excluded from the scope of ASC 610-20 and should be
accounted for as an equity transaction in accordance with ASC 810. The
Codification excerpt below, which is a continuation of Example 1, Case B, in
ASC 610-20 as reproduced in the previous section, illustrates the
application of this guidance.
ASC 610-20
Example 1 — Scope . . .
Case B — Nonfinancial Assets and Financial Assets . . .
55-8 If Entity X transfers the machinery and financial assets by transferring ownership interests in a
consolidated subsidiary, it would still conclude that the financial assets are not in substance nonfinancial
assets. As described in paragraph 610-20-15-8, if all of the assets promised to the counterparty in an individual
consolidated subsidiary within a contract are not nonfinancial assets and/or in substance nonfinancial assets,
those assets should not be derecognized in accordance with this Subtopic. Instead, Entity X should apply the
guidance in paragraph 810-10-40-3A(c) or 810-10-45-21A(b)(2) to determine the guidance applicable to that
subsidiary.
Assets held in more than one subsidiary can also be transferred to a counterparty under a contract. To
determine the accounting, an entity should first assess whether substantially all of the fair value of all
assets under the contract is concentrated in nonfinancial assets. If it is not, the entity should evaluate
whether substantially all of the fair value of the assets in any individual subsidiary under the contract
is concentrated in nonfinancial assets, in which case the financial assets of that subsidiary are, in
substance, nonfinancial assets within the scope of ASC 610-20. Example 1, Case C, in ASC 610-20, which
is reproduced below, illustrates the application of this guidance.
ASC 610-20
Example 1 — Scope . . .
Case C — One Subsidiary That Holds Nonfinancial Assets and One Subsidiary That
Holds Financial Assets
55-9 Entity A enters into a contract to transfer ownership interests in two consolidated subsidiaries to a single
counterparty. Subsidiary 1 consists entirely of nonfinancial assets, and Subsidiary 2 consists entirely of financial
assets. Assume that the assets in Subsidiary 1 and Subsidiary 2 have an equal amount of fair value. Entity A
concludes that the transaction is not the transfer of a business within the scope of Topic 810 and that the
subsidiaries are not outputs of the entity’s ordinary activities within the scope of Topic 606.
55-10 Entity A first considers whether substantially all of the fair value of the assets promised to the
counterparty in the contract is concentrated in nonfinancial assets. Because the contract includes the transfer
of ownership interests in one or more consolidated subsidiaries, Entity A evaluates the underlying assets in
those subsidiaries. Entity A concludes that because both the financial assets and nonfinancial assets have an
equal amount of fair value, substantially all of the fair value of the assets promised to the counterparty in the
contract is not concentrated in nonfinancial assets. Entity A next considers whether substantially all of the
fair value of the assets within Subsidiary 1 or Subsidiary 2 is concentrated in nonfinancial assets. Because the
assets transferred within Subsidiary 1 are entirely nonfinancial assets, Entity A concludes that those assets are
within the scope of this Subtopic. Entity A also concludes that the financial assets in Subsidiary 2 are not in
substance nonfinancial assets and, therefore, are not within the scope of this Subtopic. Entity A should apply
the guidance in paragraph 606-10-15-4 to separate and measure the financial assets in Subsidiary 2 from the
nonfinancial assets in Subsidiary 1 that are derecognized within the scope of this Subtopic.
17.2.3 Partial Sales
As noted in Section
17.1, ASU 2017-05 clarifies the accounting for partial sales of
nonfinancial assets. Partial sales include sales or transfers of a nonfinancial
asset to another entity in exchange for a noncontrolling ownership interest in
that entity. Such sales are common in the real estate industry (e.g., a seller
transfers a building [or an asset] to a buyer but either retains an interest in
the building [or the asset] or has an interest in the buyer).
Any transfer of a nonfinancial asset in exchange for a noncontrolling ownership
interest in another entity (including a noncontrolling ownership interest in a
joint venture or other equity method investment) should be accounted for in
accordance with ASC 610-20.
17.3 Unit of Account
ASU 2017-05 clarifies that the unit of account is defined as a distinct
nonfinancial asset.1 At the inception of a contract, an entity should therefore identify each
distinct nonfinancial and in-substance nonfinancial asset in accordance with the
guidance on identifying distinct performance obligations in ASC 606 (see Chapter 5). The entity should
then, in a manner consistent with the approach outlined in ASC 606 (see Chapters 7 and 8), allocate consideration to
each distinct asset and derecognize the asset when a counterparty obtains control of
it.
Footnotes
1
In paragraph BC53 of ASU 2017-05, the FASB clarified that
for a partial sales transaction structured as the sale of an ownership
interest in a consolidated subsidiary, “an entity should evaluate whether it
transfers control of the distinct underlying asset and not the ownership
interest” in the legal entity that holds the asset.
17.4 Gain or Loss Recognition for Nonfinancial Assets
ASC 610-20 applies many of the same principles as ASC 606 for determining the
gain or loss to recognize when a nonfinancial asset or in-substance nonfinancial
asset is derecognized. Specifically, ASC 610-20 incorporates the requirements for
determining:
- When a contract exists (i.e., step 1).
- Which nonfinancial assets or in-substance nonfinancial assets are distinct (i.e., step 2).
- The amount of consideration to be included in the determination of the gain or loss recognized, including an estimate of variable consideration and the application of the “constraint” (i.e., step 3).
- How to allocate the amount of consideration determined in step 3 to each distinct nonfinancial asset or in-substance nonfinancial asset (i.e., step 4).
- When control of any nonfinancial asset or in-substance nonfinancial asset is transferred and results in the recognition of a gain or loss (i.e., step 5).
In a manner similar to the accounting for a contract with a customer, an entity would
apply the guidance in ASC 606-10-25-6 through 25-8 if an arrangement fails to meet
the criteria in ASC 606-10-25-1 for determining the existence of a contract (see
Sections 4.5 and
4.6). In this
situation, the nonfinancial asset would be (1) recognized in the statement of
financial position, (2) amortized through its useful life (except for
indefinite-lived intangible assets and property, plant, and equipment classified as
held for sale), and (3) assessed for impairment.
Substantially all sales of nonfinancial assets and in-substance
nonfinancial assets (that are not contracts with customers) will be recorded at a
point in time.2 If control is transferred at a point in time, a gain or loss is recognized
when the good or service is transferred to the customer. (See Section 8.6 for a discussion
of the requirements for recognizing revenue at a point in time.) Under the revenue
standard, entities determine whether they can derecognize nonfinancial assets such
as real estate by using a control-based model. However, the FASB decided to include
in ASC 606-10-25-30 “significant risks and rewards” as a factor for entities to
consider in evaluating the point in time at which control of a good or service is
transferred to a customer. Accordingly, although a seller of a nonfinancial asset
such as real estate would evaluate legal title and physical possession to determine
whether control has been transferred, it should also consider its exposure to the
risks and rewards of ownership of the property as part of its “control” analysis
under ASU 2014-09.
Connecting the Dots
Real estate sales in most jurisdictions (including the
United States) will typically not meet the criteria to be recognized over
time because it is uncommon for the seller to either (1) have an enforceable
right to payment for its cost plus a reasonable margin if the contract were
to be canceled at any point during the construction period or (2) be legally
restricted from transferring the asset to another customer even if the
contract were canceled at any point during the construction period. The
revenue standard contains an example (see Section 8.4.5.2) in which a real
estate developer enters into a contract to sell a specified condominium unit
in a multifamily residential complex once construction is complete.
17.4.1 Derecognition of Nonfinancial Assets or In-Substance Nonfinancial Assets
ASC 610-20
25-1 To recognize a gain or loss from the transfer of nonfinancial assets or in substance nonfinancial assets
within the scope of this Subtopic, an entity shall apply the guidance in Topic 810 on consolidation and in Topic
606 on revenue from contracts with customers as described in paragraphs 610-20-25-2 through 25-7.
Determining Whether an Entity Has a Controlling Financial Interest
25-2 An entity shall first evaluate whether it has (or continues to have) a controlling financial interest in the legal
entity that holds the nonfinancial assets and/or in substance nonfinancial assets by applying the guidance in
Topic 810 on consolidation. For example, if a parent transfers ownership interests in a consolidated subsidiary,
the parent shall evaluate whether it continues to have a controlling financial interest in that subsidiary. Similarly,
when an entity transfers assets directly to a counterparty (or a legal entity formed by the counterparty), the
entity shall evaluate whether it has a controlling financial interest in the counterparty (or the legal entity formed
by the counterparty).
25-3 If an entity determines it has (or continues to have) a controlling financial interest in the legal entity that
holds the nonfinancial assets or in substance nonfinancial assets, it shall not derecognize those assets and shall
apply the guidance in paragraphs 810-10-45-21A through 45-24.
25-4 Any nonfinancial assets or in substance nonfinancial assets transferred that are held in a legal entity in
which the entity does not have (or ceases to have) a controlling financial interest shall be further evaluated in
accordance with the guidance in paragraphs 610-20-25-5 through 25-7.
Applying Revenue Recognition Guidance
25-5 After applying the guidance in paragraphs 610-20-25-2 through 25-4, an entity shall next evaluate a
contract in accordance with the guidance in paragraphs 606-10-25-1 through 25-8. If a contract does not
meet all of the criteria in paragraph 606-10-25-1, an entity shall not derecognize the nonfinancial assets or in
substance nonfinancial assets transferred, and it shall apply the guidance in paragraph 350-10-40-3 to any
intangible assets and the guidance in paragraph 360-10-40-3C to any property, plant, and equipment. An
entity shall follow the guidance in paragraphs 606-10-25-6 through 25-8 to determine if and when a contract
subsequently meets all of the criteria in paragraph 606-10-25-1.
25-6 Once a contract meets all of the criteria in paragraph 606-10-25-1, an entity shall identify each distinct
nonfinancial asset and distinct in substance nonfinancial asset promised to a counterparty in accordance with
the guidance in paragraphs 606-10-25-19 through 25-22. An entity shall derecognize each distinct asset when
it transfers control of the asset in accordance with paragraph 606-10-25-30. In some cases, control of each
asset may transfer at the same time such that an entity may not need to separate and allocate consideration
to each distinct nonfinancial asset and in substance nonfinancial asset. That may be the case, for example,
when a parent transfers ownership interests in a consolidated subsidiary that holds nonfinancial assets (or
nonfinancial assets and in substance nonfinancial assets) and ceases to have a controlling financial interest
in the subsidiary in accordance with Topic 810. However, control of each asset may not transfer at the same
time if the parent has control of some of the assets in accordance with paragraph 606-10-25-30 (for example,
through repurchase agreements).
25-7 For purposes of evaluating the indicators of the transfer of control in paragraph 606-10-25-30, if an entity
has (or continues to have) a noncontrolling interest in the legal entity that holds the nonfinancial assets or in
substance nonfinancial assets as a result of the transaction, the entity shall evaluate the point in time at which
the legal entity holding the assets obtains (or has) control (for example, by evaluating whether the legal entity
can direct the use of, and obtain substantially all of the benefits from, each distinct nonfinancial asset or in
substance nonfinancial asset within it). (See Case A of Example 2 in paragraphs 610-20-55-11 through 55-14.)
If the entity does not have a noncontrolling interest in the legal entity that holds the nonfinancial assets or
in substance nonfinancial assets as a result of the transaction, it shall evaluate the point in time at which a
counterparty (or counterparties, collectively) obtains control of the assets in the legal entity (for example, by
evaluating whether a counterparty [or counterparties, collectively] can direct the use of, and obtain substantially
all of the benefits from, each distinct nonfinancial asset or in substance nonfinancial asset within the legal
entity).
To determine when to derecognize a nonfinancial asset or in-substance
nonfinancial asset, an entity should first assess whether it has lost a
controlling financial interest in the subsidiary (i.e., the legal entity that
holds the asset). If the entity obtains a controlling financial interest in a
new subsidiary that holds the nonfinancial asset after the transaction, or if
the entity retains a controlling financial interest in an existing subsidiary
that holds the asset (e.g., because the entity sold a noncontrolling ownership
interest in a consolidated subsidiary), the entity should not derecognize the
nonfinancial asset or in-substance nonfinancial asset. Instead, the entity
should account for the transaction as an equity transaction in accordance with
ASC 810.
However, if the entity has not obtained or retained a controlling financial
interest in such legal entity that holds the asset, it should derecognize the
nonfinancial asset or in-substance nonfinancial asset when it transfers control
of the asset in a manner consistent with the principles in ASC 606 (see
Chapter 8).
That is, when evaluating whether or in what circumstances it is appropriate to
derecognize the nonfinancial asset or in-substance nonfinancial asset, the
entity should first evaluate whether it has lost a controlling financial
interest in the legal entity by applying the guidance in ASC 810. If the entity
determines that it has lost a controlling financial interest in the legal entity
under ASC 810, it should then evaluate whether it has lost control of the
nonfinancial asset or in-substance nonfinancial asset by applying the guidance
in ASC 606. When evaluating whether control of the asset has been transferred
under ASC 606, the entity has to consider any repurchase agreements (e.g., a
call option to repurchase the ownership interest in the legal entity) and may
not be able to derecognize the nonfinancial asset, even though it no longer has
a controlling financial interest in a subsidiary in accordance with ASC 810.
Cases A and B of Example 2 in ASC 610-20, which are reproduced below, illustrate
the application of this guidance.
ASC 610-20
Example 2 — Transfer of Control
Case A — Control Transfers Under Topics 810 and 606
55-11 Entity A owns 100 percent of Entity B, a consolidated subsidiary. Entity B holds title to land with a carrying
amount of $5 million. Entity A concludes that the land is not an output of its ordinary activities within the scope
of Topic 606 and that Entity B does not meet the definition of a business within the scope of Topic 810.
55-12 Entity A enters into a contract to transfer 60 percent of Entity B to Entity X for $6 million cash due at
contract inception. For ease of illustration, assume that at contract inception the fair value of the 40 percent
interest retained by Entity A is $4 million. Because all of the assets (the land) promised to Entity X in the contract
are nonfinancial assets, Entity A concludes that it should derecognize the land in accordance with this Subtopic.
55-13 As described in paragraphs 610-20-25-2 through 25-7, Entity A first considers the guidance in Topic 810
and concludes that it no longer has a controlling financial interest in Entity B or in Entity X (the buyer). Entity A
then determines that the contract meets the criteria in paragraph 606-10-25-1 and that control of the land has
been transferred in accordance with the guidance in paragraph 606-10-25-30. Because Entity A continues to
have a noncontrolling interest in Entity B, it evaluates the point in time at which Entity B, its former subsidiary,
has control of the distinct nonfinancial asset as described in paragraph 610-20-25-7. Entity A concludes that
it has transferred control of the distinct nonfinancial asset because Entity B controls the distinct nonfinancial
asset. When evaluating the indicators of control in paragraph 606-10-25-30, Entity A concludes the following:
- It has the present right to payment.
- Entity B has legal title to the land.
- It does not have physical possession of the asset because it cannot restrict or prevent other entities from accessing the land.
- Entity B has the significant risks and rewards of ownership.
- There is no acceptance clause (assumption). . . .
Case B — Control Transfers Under Topic 810 but Not Under Topic 606
55-15 Assume the same facts as in Case A, except that Entity A has the right but not the obligation to
repurchase the 60 percent ownership interest in Entity B that it transferred to Entity X (that is, Entity A has a call
option). The call option gives Entity A the right to repurchase the 60 percent ownership interest in 2 years for
$7 million.
55-16 Entity A concludes that although the call option represents a variable interest in Entity B, it does not
have a controlling financial interest in Entity B in accordance with the guidance in Topic 810. However, when
evaluating whether control of the land has been transferred in accordance with the guidance in paragraph
606-10-25-30, Entity A considers the guidance on repurchase features in paragraphs 606-10-25-30(c) and
606-10-55-68 and concludes that it does not transfer control of the land. In addition, because the exercise
price on the call option is an amount that is greater than the original selling price, the transaction is considered
a financing agreement in accordance with the guidance in paragraph 606-10-55-68(b). Entity A does not
derecognize the land and records a financial liability of $6 million in accordance with the guidance in paragraph
606-10-55-70. Entity A does not recognize an investment for its retained 40 percent ownership interest until it
derecognizes the land.
Connecting the Dots
If the seller has an obligation or option to repurchase
a property it has sold (a forward or call option), it should account for
the sale as (1) a lease if the repurchase amount is less than the
original selling price or (2) a financing arrangement if the repurchase
price is more than the original selling price.
If the buyer has an option to require the seller to
repurchase the property (a put option), the seller would determine
whether to account for the transaction as a lease, a sale with a right
of return, or a financing arrangement by performing the following
analysis:
- If the repurchase price under the option is lower than the original selling price, the seller would need to consider at contract inception whether the buyer has a significant economic incentive to exercise its option. If the buyer has such an incentive, the contract should be treated as a lease (unless the transaction involves a leaseback and would result in a lease-leaseback transaction, in which case the entire transaction should be treated as a financing). Otherwise, the transaction should be accounted for as a sale with a right of return.
- If the repurchase price under the option is equal to or greater than the original selling price, the seller should treat the contract as a financing arrangement unless the expected fair value of the asset is greater than the repurchase price and the buyer does not have a significant economic incentive to exercise the option, in which case the transaction should be accounted for as a sale with a right of return.
If the seller of real estate is required to treat a
transaction as a financing arrangement, it would continue to recognize
the property (and associated depreciation) and record a liability for
the consideration received from the buyer. The difference between the
amount of consideration received from the buyer and the amount paid
under the repurchase agreement should be recorded as interest over the
term of the arrangement. If the seller is required to treat the
transaction as a lease, it would account for the arrangement in
accordance with ASC 842.
See Section 8.7 for further discussion of repurchase
agreements and their impact on transferring control.
17.4.2 Gain or Loss Measurement
ASC 610-20
32-2 When an entity meets the
criteria to derecognize a distinct nonfinancial asset or
a distinct in substance nonfinancial asset, it shall
recognize a gain or loss for the difference between the
amount of consideration measured and allocated to that
distinct asset in accordance with paragraphs 610-20-32-3
through 32-6 and the carrying amount of the distinct
asset. The amount of consideration promised in a
contract that is included in the calculation of a gain
or loss includes both the transaction price and the
carrying amount of liabilities assumed or relieved by a
counterparty.
32-3 To determine the
transaction price, an entity shall apply the following
paragraphs in Topic 606 on revenue from contracts with
customers:
-
Paragraphs 606-10-32-2 through 32-27 on determining the transaction price, including all of the following:
-
Estimating variable consideration
-
Constraining estimates of variable consideration
-
The existence of a significant financing component
-
Noncash consideration
-
Consideration payable to a customer.
-
-
Paragraphs 606-10-32-42 through 32-45 on accounting for changes in the transaction price.
32-4 If an entity transfers
control of a distinct nonfinancial asset or distinct in
substance nonfinancial asset in exchange for a
noncontrolling interest, the entity shall consider the
noncontrolling interest received from the counterparty
as noncash consideration and shall measure it in
accordance with the guidance in paragraphs 606-10-32-21
through 32-24. Similarly, if a parent transfers control
of a distinct nonfinancial asset or in substance
nonfinancial asset by transferring ownership interests
in a consolidated subsidiary but retains a
noncontrolling interest in its former subsidiary, the
entity shall consider the noncontrolling interest
retained as noncash consideration and shall measure it
in accordance with the guidance in paragraphs
606-10-32-21 through 32-24. (See Case A of Example 2 in
paragraphs 610-20-55-11 through 55-14.)
32-5 If a counterparty promises
to assume or relieve a liability of an entity in
exchange for a transfer of nonfinancial assets or in
substance nonfinancial assets within the scope of this
Subtopic, the transferring entity shall include the
carrying amount of the liability in the consideration
used to calculate the gain or loss. Although a liability
assumed or relieved by a counterparty shall be included
in the consideration used to calculate a gain or loss,
an entity shall not derecognize the liability until it
has been extinguished in accordance with the guidance in
paragraph 405-20-40-1 (see paragraph 610-20-45-3 on how
to present the liability if it is extinguished before or
after the entity transfers control of the nonfinancial
assets or in substance nonfinancial assets). If an
entity transfers control of the nonfinancial assets or
in substance nonfinancial assets before a liability is
extinguished, it shall apply the guidance on
constraining estimates of variable consideration in
paragraph 606-10-32-11 to determine the carrying amount
of the liability to be included in the gain or loss
calculation.
32-6 An entity shall allocate
the consideration calculated in accordance with the
guidance in paragraphs 610-20-32-2 through 32-5 to each
distinct nonfinancial asset or in substance nonfinancial
asset by applying the guidance in paragraphs
606-10-32-28 through 32-41.
If the derecognition criteria are met (see Section 17.4.1), an
entity should recognize a full gain or loss on derecognition of any nonfinancial
or in-substance nonfinancial assets. The entity should include in the
consideration received any liability assumed (or relieved) by the counterparty
(e.g., mortgage loan on the building) when determining the gain or loss on the
derecognition. In a manner consistent with the discussion in paragraph BC35 of
ASU 2017-05, the entity should account for the derecognition of the asset and
assumption of the liability together and accordingly recognize a single gain or
loss inclusive of any liability assumed by the counterparty. Further, the entity
should account for any noncontrolling ownership interest as noncash
consideration, which should be measured at fair value in a manner consistent
with the guidance on noncash consideration in ASC 606-10-32-21 through 32-24
(see Section 6.5).
Example 2, Case A, in ASC 610-20, which is reproduced below and is also
discussed in Section
17.4.1, illustrates the application of this guidance.
ASC 610-20
Example 2 —
Transfer of Control
Case A — Control Transfers Under Topics
810 and 606
55-11 Entity A owns 100 percent
of Entity B, a consolidated subsidiary. Entity B holds
title to land with a carrying amount of $5 million.
Entity A concludes that the land is not an output of its
ordinary activities within the scope of Topic 606 and
that Entity B does not meet the definition of a business
within the scope of Topic 810.
55-12 Entity A enters into a
contract to transfer 60 percent of Entity B to Entity X
for $6 million cash due at contract inception. For ease
of illustration, assume that at contract inception the
fair value of the 40 percent interest retained by Entity
A is $4 million. Because all of the assets (the land)
promised to Entity X in the contract are nonfinancial
assets, Entity A concludes that it should derecognize
the land in accordance with this Subtopic. . . .
55-14 Entity A derecognizes the
land and calculates the gain or loss as the difference
between the amount of consideration measured in
accordance with the guidance in paragraphs 610-20-32-2
and 610-20-32-6 and the carrying amount of the land. The
amount of the consideration is $10 million, which
includes $6 million in cash plus $4 million for the fair
value of the noncontrolling interest in Entity B. Entity
A recognizes a gain of $5 million ($10 million
consideration – $5 million carrying amount of the
assets) and presents the gain in the income statement in
accordance with the guidance in paragraph 360-10-45-5.
In accordance with the guidance in paragraph
610-20-32-4, Entity A records the noncontrolling
interest in Entity B at $4 million and subsequently
accounts for that interest in accordance with other
Topics.
17.4.2.1 Accounting for the Sale of a Nonfinancial Asset Within the Scope of ASC 610-20 That Involves a Guarantee
When a seller has entered into a contract to sell property and guarantee the
buyer’s return on the property, the seller must first identify all of the
elements in the contract to determine whether the contract is (1) within the
scope of ASC 610-20, (2) within the scope of other topics, or (3) partially
within the scope of both ASC 610-20 and other topics. A contract to sell
property to a counterparty that includes a guarantee of the buyer’s return
on the property contains both a nonfinancial asset within the scope of ASC
610-20 and a guarantee within the scope of ASC 460-10.
ASC 610-20-15-9 refers entities to ASC 606-10-15-4 for guidance on
determining how to separate and measure elements in a contract that is
within the scope of other topics. ASC 606-10-15-4(a) states, in part:
If
the other Topics specify how to separate and/or initially measure one or
more parts of the contract, then an entity shall first apply the
separation and/or measurement guidance in those Topics. An entity shall
exclude from the transaction price the amount of the part (or parts) of
the contract that are initially measured in accordance with other
Topics.
Accordingly, the seller would initially measure the guarantee at fair value
as required under ASC 460-10. The difference between the transaction price
and the guarantee’s fair value would be allocated to the identified
element(s) — which may include other assets or services in addition to the
property being sold — and any gain or loss would be recognized when (or as)
control of each element is transferred to the buyer.
However, if the seller determines that the contract (which
includes the guarantee) will result in a loss and if control of the
underlying nonfinancial asset has not yet been transferred to the
counterparty, the seller should evaluate whether an impairment has occurred
under relevant impairment guidance (e.g., ASC 330 on inventory, ASC 350 on
intangibles, or ASC 360 on property, plant, and equipment).
Example 17-3
Company X sells an office building
with a cost basis of $40,000 to Company Y for
$100,000. As part of the sales contract, X
guarantees that it will make payments of up to
$40,000 each year for two years based on the
proportion of the building that remains unleased at
the end of each year. Since X expects all space to
be rented within two months, it has determined that
its guarantee to Y has a fair value of $15,000.
Company X should separate and
initially measure the guarantee in accordance with
ASC 460-10 and then deduct the fair value of the
guarantee ($15,000) from the transaction price of
$100,000. After allocating the remaining $85,000 to
the sole nonfinancial asset (i.e., the building), X
would recognize a $45,000 gain ($85,000 allocated to
the building less X’s cost basis of $40,000) upon
transferring control of the building to Y.
Example 17-4
Assume the same facts as in the
example above, except that Company X (1) determines
on the basis of the current rental market that the
space will not be leased for the foreseeable future
and (2) calculates that the fair value of the
guarantee is $70,000.
Company X should separate and
initially measure the guarantee in accordance with
ASC 460-10 and then deduct the fair value of the
guarantee ($70,000) from the transaction price of
$100,000. Company X would allocate the remaining
$30,000 to the building. Since this allocation is
less than the building’s book value, if control of
the building has not yet been transferred to Company
Y, X should assess whether the building is impaired
on the basis of the requirements in ASC 360.
17.4.2.2 Variable or Contingent Consideration
Any contingent consideration included in the transaction price
should be estimated and constrained in a manner consistent with ASC 606, as
further discussed in Section
6.3.
Example 3 in ASC 610-20, which is reproduced below, illustrates
how an entity would account for a sale of a nonfinancial asset in exchange for
variable consideration.
ASC 610-20
Example 3 — Sale
of a Nonfinancial Asset for Variable
Consideration
55-17 An entity sells (that is,
does not out license) the rights to in-process research
and development that it recently acquired in a business
combination and measured at fair value of $50 million in
accordance with Topic 805 on business combinations. The
entity concludes that the transferred in-process
research and development is not a business. The buyer of
the in-process research and development agrees to pay a
nonrefundable amount of $5 million at inception plus 2
percent of sales of any products derived from the
in-process research and development over the next 20
years. The entity concludes that the sale of in-process
research and development is not a good or service that
is an output of the entity’s ordinary activities.
55-18 Topic 350 on goodwill and
other intangibles requires the entity to apply the
guidance in this Subtopic to determine the amount and
timing of income to be recognized. Therefore, the entity
applies the derecognition guidance in this Subtopic as
follows:
-
The entity concludes that it does not have a controlling financial interest in the buyer.
-
The entity concludes that the contract meets the criteria in paragraph 606-10-25-1.
-
The entity also concludes that on the basis of the guidance in paragraph 606-10-25-30, it has transferred control of the in-process research and development asset to the buyer. This is because the buyer can use the in-process research and development’s records, patents, and supporting documentation to develop potential products and the entity has relinquished all substantive rights to the in-process research and development asset.
-
In estimating the consideration received, the entity applies the guidance in Topic 606 on determining the transaction price, including estimating and constraining variable consideration. The entity estimates that the amount of consideration that it will receive from the sales-based royalty is $100 million over the 20-year royalty period. However, the entity cannot assert that it is probable that recognizing all of the estimated variable consideration in other income would not result in a significant reversal of that consideration. The entity reaches this conclusion on the basis of its assessment of factors in paragraph 606-10-32-12. In particular, the entity is aware that the variable consideration is highly susceptible to the actions and judgments of third parties, because it is based on the buyer completing the in-process research and development asset, obtaining regulatory approval for the output of the in-process research and development asset, and marketing and selling the output. For the same reasons, the entity also concludes that it could not include any amount, even a minimum amount, in the estimate of the consideration. Consequently, the entity concludes that the estimate of the consideration to be used in the calculation of the gain or loss upon the derecognition of the in-process research and development asset is limited to the $5 million fixed upfront payment.
55-19 At inception of the
contract, the entity recognizes a net loss of $45
million ($5 million of consideration, less the
in-process research and development asset of $50
million). The entity reassesses the transaction price at
each reporting period to determine whether it is
probable that a significant reversal would not occur
from recognizing the estimate as other income and, if
so, recognizes that amount as other income in accordance
with paragraphs 606-10-32-14 and 606-10-32-42 through
32-45.
17.4.2.3 Like-Kind Exchanges of Nonfinancial Assets
Entities may also enter into like-kind exchanges in which a
nonfinancial asset owned by one entity is exchanged for a nonfinancial asset
owned by another entity. These types of transactions may include the exchange of
real estate and are typically structured for tax purposes. Under the revenue
standard, a nonmonetary exchange of a nonfinancial asset is accounted for as a
sale of the nonfinancial asset for noncash consideration (i.e., the nonfinancial
asset received from another entity). Accordingly, if the transaction meets the
criteria to be accounted for as a sale (i.e., the existence of a contract and
the transfer of control of the nonfinancial asset), the entity would measure the
noncash consideration received in the transaction at fair value.3 The entity would recognize a gain or loss on the sale and record the
acquired nonmonetary consideration (i.e., the nonfinancial asset received) at
its fair value. Further, ASU 2017-05 eliminates the guidance in ASC 845 on
exchanges of nonfinancial assets for a noncontrolling interest. As a result, if
the derecognition criteria are met (see Section 17.4.1), the noncontrolling interest
received in connection with the partial sale is measured at fair value and
included in the transaction price (see Section 17.5).
However, the entity would continue to apply the guidance on
nonmonetary exchanges in ASC 845 if the exchange is between entities in the same
line of business to help facilitate sales to potential customers.
Footnotes
2
When recognizing a gain or loss on sales of nonfinancial
assets or in-substance nonfinancial assets that are not contracts with
customers, an entity must first consider whether, under ASC 810, it ceases
to have a controlling financial interest in the legal entity that holds the
nonfinancial assets or in-substance nonfinancial assets. If the controlling
financial interest is lost, the entity should then consider whether control
of the nonfinancial assets or in-substance nonfinancial assets is
transferred in accordance with ASC 606 (see Section 17.4.1).
3
As noted in Section 6.5, ASU 2016-12
clarifies that the measurement date for noncash consideration is the
contract inception date.
17.5 Exchanges of Nonfinancial Assets for Noncontrolling Interests
An entity should apply the guidance in ASC 610-20 to account for the
contribution of a nonfinancial asset in exchange for a noncontrolling ownership
interest in an investee.
In accordance with ASC 610-20-32-4, “the entity shall consider the
noncontrolling interest received from the counterparty as noncash consideration and
shall measure it in accordance with the guidance in paragraphs 606-10-32-21 through
32-24.” In a manner consistent with the guidance in ASC 606-10-32-21 through 32-24,
the entity would measure the noncontrolling interest at fair value at contract
inception. Any gain or loss resulting from the sale or transfer of the nonfinancial
asset should be recognized when the legal entity receiving the nonfinancial asset
obtains control of the asset (as determined on the basis of an evaluation of the
indicators in ASC 606-10-25-30). For additional information about recognizing gains
or losses on the sale (or contribution) of nonfinancial assets, see Section 17.4.
Example 17-5
Investor A and Investor B form a real estate venture.
Investor A contributes cash in exchange for a 50 percent
interest in the venture; B contributes real estate in
exchange for the other 50 percent of the venture and
receives the cash contribution made by A. Since the real
estate is neither a business nor a nonprofit activity, the
transaction is within the scope of ASC 610-20. First, B
considers whether, after the transaction, it retains a
controlling interest in the joint venture under ASC 810 and
concludes that it does not. Next, B determines that control
of the real estate has been transferred under ASC 606.
Accordingly, B derecognizes the real estate, recognizes the
full gain or loss for the difference between the
consideration received (i.e., both the cash consideration
and the fair value of the 50 percent interest in the
venture) and the carrying amount of the assets sold, and
records its investment in the real estate venture at fair
value.
Chapter 18 — SEC, FASB, and Other Stakeholder Activities
Chapter 18 — SEC, FASB, and Other Stakeholder Activities
18.1 Introduction
Since the issuance of ASU 2014-09, the FASB has issued
additional final ASUs to (1) defer the revenue standard’s original effective date,
(2) make certain technical corrections and improvements to the standard, (3) clarify
certain aspects of the standard’s guidance, (4) codify or rescind certain SEC
guidance on revenue, and (5) provide certain practical expedients. In addition,
there has been significant activity by the TRG and the AICPA revenue recognition
industry task forces, along with involvement from regulators, including the SEC and
the PCAOB. Stakeholders should continue to monitor activity at the FASB, SEC, and
other standard-setting or regulatory bodies for any relevant developments or
interpretations.
18.2 SEC Activities
The SEC is a critical stakeholder given its role in both standard
setting and regulating the U.S. capital markets. On August 18, 2017, the SEC staff
issued SAB
116, which conforms existing SEC staff guidance with the
guidance in ASC 606. As further discussed below, SAB 116 (1) supersedes both SAB
Topic 13 on revenue recognition and SAB Topic 8 on retail companies and (2)
modifies SAB Topic
11.A on the disclosure of operating-differential subsidies.
In addition, the SEC updated its interpretive guidance on
bill-and-hold arrangements and vaccine stockpiles.
18.2.1 SAB 116 Modifications to Previously Issued SEC Staff Guidance
SAB 116 modifies previously issued SEC staff guidance as
follows:
-
SAB Topic 13 — SAB 116 superseded SAB Topic 13 upon the adoption of ASC 606. SAB 116 notes that ASC 606 “provides a single set of revenue recognition principles governing all contracts with customers and supersedes the existing revenue recognition framework in [ASC 605], which eliminates the need for [SAB] Topic 13.” SAB 116 also states that upon adoption of ASC 606, “a registrant should no longer look to the guidance in Securities Exchange Act Release No. 23507 and Accounting and Auditing Enforcement Release No. 108 . . . for criteria to be met in order to recognize revenue” on a bill-and-hold basis.SEC registrants should note that the bill-and-hold guidance in SAB Topic 13 (which was applicable until the adoption of ASC 606) was more detailed than the bill-and-hold guidance in ASC 606. The most noticeable distinction is that SAB Topic 13 required bill-and-hold arrangements to include a fixed delivery schedule, whereas ASC 606 does not include this requirement.
-
SAB Topic 8 — SAB 116 superseded SAB Topic 8 upon the adoption of ASC 606. SAB 116 notes that SAB Topic 8, which was specific to retail companies, previously provided the SEC staff’s views on “the prohibition of presenting sales of a leased or licensed department within a retailer’s statement of comprehensive income consistent with the principles codified [in ASC 605]” and “the disclosure of finance charges imposed by retailers on credit sales.” SAB 116 further states that the guidance in ASC 606 on the identification of performance obligations in a contract with a customer, the presentation of revenue as a principal (on a gross basis) or as an agent (on a net basis), and the presentation of the effects of financing in the statement of comprehensive income “eliminates the need for the guidance in [SAB] Topic 8.”
-
SAB Topic 11.A — SAB 116 modifies SAB Topic 11.A to clarify that “revenues from operating-differential subsidies presented under a revenue caption should be presented separately from revenue from contracts with customers accounted for under [ASC 606].” Previously, as noted in SAB 116, SAB Topic 11.A “provided the [SEC] staff’s view that revenues from operating-differential subsidies be presented as a separate line item in the income statement either under a revenue caption or as credit in the costs and expenses section.”
On November 22, 2017, the FASB issued ASU 2017-14, which
rescinds certain SEC staff guidance in light of SAB 116. For additional
information about ASU 2017-14, see Section 18.3.3.8.
18.2.2 Guidance on Recognizing Revenue From Vaccines Placed in a Federal Government Stockpile
On August 18, 2017, the SEC issued an interpretive release (the “2017 release”) to update the
guidance in its 2005 release Commission Guidance Regarding Accounting for
Sales of Vaccines and Bioterror Countermeasures to the Federal Government
for Placement Into the Pediatric Vaccine Stockpile or the Strategic National
Stockpile. The update was provided to bring existing guidance into
conformity 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 vaccine stockpile programs discussed in
that release and is not applicable to any other transactions.
On November 22, 2017, the FASB issued ASU 2017-14, which
rescinds certain SEC guidance in legacy U.S. GAAP and codifies in ASC
606-10-S25-1 the text of the 2017 release. For additional information about ASU
2017-14, see Section
18.3.3.8.
18.2.3 Removal of Certain SEC Observer Comments
ASU
2016-11 and ASU 2017-13 removed certain SEC
observer comments from the Codification (i.e., treated them as no longer
effective) upon the adoption of the revenue standard. The removed SEC observer
comments include ASC 605-45-S99-1 (formerly EITF Issue 00-10), which states that
(1) shipping and handling fees billed to a customer are required to be
classified as revenue and (2) the classification of shipping and handling costs
incurred by the seller is an accounting policy decision. It is important to note
that with the removal of this comment, we generally believe that it will remain
appropriate to present shipping and handling within costs of goods sold because
they are considered to be fulfillment costs. However, in certain instances, it
may be acceptable for an entity to present shipping and handling outside of
costs of goods sold. The presentation of shipping and handling costs was
discussed by Barry Kanczuker, associate chief accountant in the SEC’s Office of
the Chief Accountant, in a speech at the 2017 AICPA Conference on
Current SEC and PCAOB Developments, in which he stated:
Given the noted absence of any guidance, I believe an
entity will need to apply reasonable judgment in determining the
appropriate classification of shipping and handling expenses for those
shipping and handling activities that are accounted for as activities to
fulfill the promise to transfer the good. Hence, the staff noted it
would not object to the following approaches. First, the staff noted
that it would not object to classification of these expenses within cost
of sales. Second, given that there is no explicit guidance within Topic
606 related to the classification of shipping and handling expenses, the
staff noted that it also would not object to an entity continuing to
apply its previous policy regarding classification of these expenses,
which could potentially be outside of cost of sales. I believe that a
registrant that classifies significant shipping and handling costs
outside of cost of sales should consider whether it should disclose the
amount of such costs and the line item or items on the income statement
that include them, similar to the disclosures required under the
previous guidance.
See Sections
18.3.3.4 and 18.3.3.7 for further discussion of ASU 2016-11 and ASU 2017-13,
respectively, which detail the rescission of certain SEC guidance.
18.3 FASB Activities
18.3.1 TRG Update
Upon issuing the revenue standard, the FASB and IASB formed a joint revenue TRG.
The purpose of the TRG is not to issue guidance but instead to seek and provide feedback
on potential issues related to implementation of the revenue standard. By analyzing and
discussing potential implementation issues, the TRG helps the boards determine whether
they need to take additional action, such as providing clarification or issuing other
guidance. The TRG comprises financial statement preparers, auditors, and users from a
“wide spectrum of industries, geographic locations and public and private organizations,”
and board members of the FASB and IASB attend the TRG’s meetings. In addition,
representatives from the SEC, PCAOB, IOSCO, and AICPA are invited to observe the
meetings.
In January 2016, the IASB announced that it completed its decision-making
process related to clarifying the revenue standard and that it no longer plans to schedule
TRG meetings for IFRS constituents. Therefore, starting in April 2016, the TRG meetings
were FASB-only, but members of the IASB could participate as observers. However, it is
important for consistency and comparability of financial information that both domestic
registrants filing under U.S. GAAP and foreign private issuers filing under IFRS
Accounting Standards keep abreast of TRG developments in the United States in a manner
consistent with comments made by then SEC Deputy Chief Accountant
Wesley Bricker at the December 2015 AICPA Conference on Current SEC and PCAOB
Developments.
At the November 2016 TRG meeting — the last TRG meeting — the FASB announced
that no future TRG meetings were scheduled. However, the Board encouraged stakeholders to
submit implementation questions either directly to the TRG or through the FASB’s technical
inquiry process.
The FASB maintains a full list of questions discussed by the TRG, with links to the relevant
TRG Agenda Papers.
18.3.2 FASB Staff’s Revenue Recognition Implementation Q&As
In January 2020, the FASB issued its staff’s Revenue Recognition Implementation Q&As (the
“Implementation Q&As”). Compiled from TRG Agenda Papers and other previously issued
materials, the FASB staff’s Implementation Q&As are presented in a user-friendly
format.
For a topical listing of issues addressed in the Implementation Q&As, see Appendix C.
18.3.3 Final ASUs
As noted above, the FASB has issued a number of ASUs to amend and clarify the
guidance in the revenue standard. Largely the result of feedback provided by the TRG, the
Board’s updates to the revenue standard are discussed throughout this Roadmap as
applicable.
18.3.3.1 ASU 2015-14 on Deferral of the Effective Date
On August 12, 2015, the FASB issued ASU 2015-14, which deferred the effective date
of the Board’s revenue standard, ASU 2014-09, by one year for all entities and permitted
early adoption on a limited basis. Specifically:
-
For PBEs, the standard became effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2017. Early adoption was permitted as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within those annual periods.
-
For nonpublic entities, the standard became effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. Nonpublic entities were permitted to early adopt the standard as of the following:
-
Annual reporting periods beginning after December 15, 2016, including interim periods.
-
Annual reporting periods beginning after December 15, 2016, and interim periods within annual reporting periods beginning one year after the annual reporting period in which the standard was initially applied.
-
On June 3, 2020, the FASB issued ASU 2020-05, which permitted nonpublic entities
(i.e., entities that are not PBEs) that had not yet issued their financial statements or
made financial statements available for issuance as of June 3, 2020, to adopt ASC 606
for annual reporting periods beginning after December 15, 2019, and for interim
reporting periods within annual reporting periods beginning after December 15, 2020. See
Section 18.3.3.12 for
further details.
18.3.3.2 ASU 2016-08 on Principal-Versus-Agent Considerations
On March 17, 2016, the FASB issued ASU 2016-08, which amended the
principal-versus-agent implementation guidance and illustrations in the revenue
standard. The FASB issued the ASU in response to concerns identified by stakeholders,
including those related to (1) determining the appropriate unit of account under the
revenue standard’s principal-versus-agent guidance and (2) applying the indicators of
whether an entity is a principal or an agent in accordance with the revenue standard’s
control principle.
Key provisions of the ASU include:
- Assessing the nature of the entity’s promise to the customer — When a revenue transaction involves a third party in providing goods or services to a customer, the entity must determine whether the nature of its promise to the customer is to provide the underlying goods or services (i.e., the entity is the principal in the transaction) or to arrange for the third party to provide the underlying goods or services (i.e., the entity is the agent in the transaction). See Section 10.1 for further details.
- Identifying the specified goods or services — The ASU clarified that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. As defined in the ASU, a specified good or service is “a distinct good or service (or a distinct bundle of goods or services) to be provided to the customer.” Therefore, for contracts involving more than one specified good or service, the entity may be the principal for one or more specified goods or services and the agent for others. See Section 10.1.1 for further details.
- Application of the control principle — To help an entity determine whether it controls a specified good or service before the good or service is transferred to the customer (and therefore determine whether it is the principal), the ASU added ASC 606-10-55-37A. See Section 10.2 for further details.
- Indicators of control — The ASU removed from the revenue standard two of the five indicators used in the evaluation of control (i.e., exposure to credit risk and whether consideration is in the form of a commission). In addition, the ASU reframed the remaining three indicators to help an entity determine when it is acting as a principal rather than as an agent. Further, the ASU added language to the indicators that explains how they are related to the control principle under the revenue standard. See Section 10.2 for further details.
18.3.3.3 ASU 2016-10 on Identifying Performance Obligations and Licensing
On April 14, 2016, the FASB issued ASU 2016-10, which amended certain aspects of
the revenue standard, specifically the standard’s guidance on identifying performance
obligations and the implementation guidance on licensing. The amendments in the ASU
reflect feedback received by the TRG.
ASU 2016-10 amended the revenue standard as follows:
-
Identifying performance obligations:
-
Immaterial promised goods or services — Entities may disregard goods or services promised to a customer that are immaterial in the context of the contract. See Section 5.2.3 for further details.
-
Shipping and handling activities — Entities can elect to account for shipping or handling activities occurring after control of the related good has passed to the customer as a fulfillment cost rather than as a revenue element (i.e., a promised service in the contract). See Section 5.2.4.3 for further details.
-
Identifying when promises represent performance obligations — ASU 2016-10 refined the revenue standard’s separation criteria for assessing whether promised goods and services are distinct, specifically the “separately identifiable” principle (the “distinct within the context of the contract” criterion) and supporting factors. See Section 5.3.2.2 for further details.
-
-
Licensing implementation guidance:
-
Determining the nature of an entity’s promise in granting a license — Intellectual property (IP) is classified as either functional or symbolic, and such classification should generally dictate whether, for a license granted to that IP, revenue must be recognized at a point in time or over time, respectively. See Section 12.4 for further details.
-
Sales- or usage-based royalties — The sales- or usage-based royalty exception applies whenever the royalty is predominantly related to a license of IP. ASU 2016-10 therefore indicates that an “entity should not split a sales-based or usage-based royalty into a portion subject to the recognition guidance on sales-based and usage-based royalties and a portion that is not subject to that guidance.” See Section 12.7 for further details.
-
Restrictions of time, geographic location, and use — ASU 2016-10’s examples illustrate the distinction between restrictions that represent attributes of a license and provisions that specify that additional licenses (i.e., additional performance obligations) have been promised. See Section 12.3.2 for further details.
-
Renewals of licenses that provide a right to use IP — Revenue should not be recognized for renewals or extensions of licenses to use IP until the renewal period begins. See Section 12.6 for further details.
-
18.3.3.4 ASU 2016-11 on Rescission of SEC Guidance Because of ASUs 2014-09 and 2014-16
On May 3, 2016, the FASB issued ASU 2016-11, which rescinded certain SEC
guidance in light of ASUs 2014-09 and 2014-16. Specifically, ASU 2016-11 rescinded
the following SEC guidance upon the adoption of ASU 2014-09:
-
ASC 605-20-S99-2 (formerly EITF Issue 91-9) on revenue and expense recognition for freight services in process.
-
ASC 605-45-S99-1 (formerly EITF Issue 00-10) on accounting for shipping and handling fees and costs.
-
ASC 605-50-S99-1 (formerly EITF Issue 01-9) on accounting for consideration given by a vendor to a customer.
-
ASC 932-10-S99-5 (formerly EITF Issue 90-22) on accounting for gas-balancing arrangements.
18.3.3.5 ASU 2016-12 on Narrow-Scope Improvements and Practical Expedients
On May 9, 2016, the FASB issued ASU 2016-12, which amended certain aspects of
ASU 2014-09. The amendments address certain implementation issues identified by the TRG
and clarify, rather than change, the revenue standard’s core revenue recognition
principles. Changes include the following:
-
Collectibility — ASU 2016-12 clarified the objective of the entity’s collectibility assessment and provided additional guidance on when an entity would recognize as revenue consideration it receives if the entity concludes that collectibility is not probable. See Section 4.3.5.3 for further details.
-
Presentation of sales taxes and other similar taxes collected from customers — Entities are permitted to present revenue net of sales taxes collected on behalf of governmental authorities (i.e., to exclude from the transaction price sales taxes that meet certain criteria). See Section 6.7 for further details.
-
Noncash consideration — An entity’s calculation of the transaction price for contracts containing noncash consideration would include the fair value of the noncash consideration to be received as of the contract inception date. Further, subsequent changes in the fair value of noncash consideration after contract inception would be included in the transaction price as variable consideration (subject to the variable consideration constraint) only if the fair value varies for reasons other than its form. See Section 6.5 for further details.
-
Contract modifications and completed contracts at transition — The ASU established a practical expedient for contract modifications at transition and defined completed contracts as those for which all (or substantially all) revenue was recognized under the applicable revenue guidance before the revenue standard was initially applied.
-
Transition technical correction — Entities electing to use the full retrospective transition method to adopt the revenue standard were no longer required to disclose the effect of the change in accounting principle on the period of adoption (as historically required by ASC 250-10-50-1(b)(2)); however, entities were still required to disclose the effects on preadoption periods that were retrospectively adjusted.
18.3.3.6 ASU 2016-20 on Technical Corrections and Improvements
On December 21, 2016, the FASB issued ASU 2016-20, which amended certain aspects of
ASU 2014-09 and includes technical corrections intended to clarify, rather than change,
the revenue standard’s core revenue recognition principles.
Key provisions of the amendments are summarized in the table below, which is reproduced from ASU
2016-20.
Area for Correction or Improvement | Summary of Amendments |
---|---|
Issue 1: Loan Guarantee Fees
| |
Topic 606 specifically identifies a scope exception for
guarantees (other than product or service warranties) within the scope of
Topic 460, Guarantees. Stakeholders indicated that a few consequential
amendments included in Update 2014-09 are inconsistent on whether fees from
financial guarantees are within the scope of Topic 606.
|
The amendments in this Update clarify that guarantee fees
within the scope of Topic 460 (other than product or service warranties) are
not within the scope of Topic 606. Entities should see Topic 815,
Derivatives and Hedging, for guarantees accounted for as
derivatives.
|
Issue 2: Contract Costs — Impairment
Testing
| |
Subtopic 340-40, Other Assets and Deferred Costs —
Contracts with Customers, includes impairment guidance for costs
capitalized in accordance with the recognition provisions of that Subtopic.
Stakeholders raised some questions about the impairment testing of those
capitalized costs.
|
The amendments in this Update clarify that when performing
impairment testing an entity should (a) consider expected contract renewals
and extensions and (b) include both the amount of consideration it already
has received but has not recognized as revenue and the amount it expects to
receive in the future.
|
Issue 3: Contract Costs — Interaction
of Impairment Testing With Guidance in Other Topics
| |
Some stakeholders raised questions about the interaction
of the impairment testing in Subtopic 340-40 with guidance in other
Topics.
|
The amendments in this Update clarify that impairment
testing first should be performed on assets not within the scope of Topic
340, Topic 350, Intangibles — Goodwill and Other, or Topic 360,
Property, Plant, and Equipment (such as Topic 330,
Inventory), then assets within the scope of Topic 340, then asset
groups and reporting units within the scope of Topic 360 and Topic 350.
|
Issue 4: Provisions for Losses on
Construction-Type and Production-Type Contracts
| |
When issuing Update 2014-09, the Board decided to exclude
specific guidance in Topic 606 for onerous contracts. However, the Board
decided to retain the guidance on the provision for loss contracts in
Subtopic 605-35, Revenue Recognition — Construction-Type and
Production-Type Contracts. In the consequential amendments of Update
2014-09, the testing level was changed to the performance obligation level
(from the segment level). Stakeholders indicated that this amendment, in
some circumstances, may require an entity to perform the loss assessment at
a lower level than legacy practice.
|
The amendments in this Update require that the provision
for losses be determined at least at the contract level. However, the
amendments allow an entity to determine the provision for losses at the
performance obligation level as an accounting policy election.
|
Issue 5: Scope of Topic 606
| |
In Topic 606, a scope exception exists for insurance
contracts within the scope of Topic 944, Financial Services —
Insurance. The Board’s intention was to exclude from Topic 606 all
contracts that are within the scope of Topic 944, not only insurance
contracts (for example, investment contracts that do not subject an
insurance entity to insurance risk).
|
The amendments in this Update remove the term insurance
from the scope exception to clarify that all contracts within the scope of
Topic 944 are excluded from the scope of Topic 606.
|
Issue 6: Disclosure of Remaining
Performance Obligations
| |
Topic 606 requires an entity to disclose information about
its remaining performance obligations, including the aggregate amount of the
transaction price allocated to performance obligations that are unsatisfied
(or partially unsatisfied) as of the end of the reporting period. Topic 606
also includes optional exemptions from that disclosure for contracts with an
original duration of one year or less and performance obligations in which
revenue is recognized in accordance with paragraph 606-10-55-18.
Stakeholders questioned whether the Board intended for an entity to estimate
variable consideration for disclosure in other circumstances in which an
entity is not required to estimate variable consideration to recognize
revenue.
|
The amendments in this Update provide optional exemptions
from the disclosure requirement for remaining performance obligations for
specific situations in which an entity need not estimate variable
consideration to recognize revenue.
The amendments in this Update also expand the information
that is required to be disclosed when an entity applies one of the optional
exemptions.[1]
|
Issue 7: Disclosure of Prior-Period
Performance Obligations
| |
Topic 606 requires an entity to disclose revenue
recognized in the reporting period from performance obligations satisfied
(or partially satisfied) in previous periods. Stakeholders indicated that
the placement of the disclosure in the Codification results in confusion
about whether this disclosure applies only to performance obligations with
corresponding contract balances or to all performance obligations.
|
The amendments in this Update clarify that the disclosure
of revenue recognized from performance obligations satisfied (or partially
satisfied) in previous periods applies to all performance obligations and is
not limited to performance obligations with corresponding contract
balances.
|
Issue 8: Contract Modifications
Example
| |
Example 7 in Topic 606 illustrates the application of the
guidance on contract modifications. Some stakeholders perceived minor
inconsistencies with the contract modifications guidance in Topic 606.
|
The amendments in this Update better align Example 7 with
the principles in Topic 606.
|
Issue 9: Contract Asset Versus
Receivable
| |
Example 38, Case B in Topic 606 illustrates the
application of the presentation guidance on contract assets and receivables.
Some stakeholders expressed concern that the example indicates that an
entity cannot record a receivable before its due date.
|
The amendments in this Update provide a better link
between the analysis in Example 38, Case B and the receivables presentation
guidance in Topic 606.
|
Issue 10: Refund Liability
| |
Example 40 in Topic 606 illustrates the recognition of a
receivable and a refund liability. Some stakeholders expressed concern that
the example indicates that a refund liability should be characterized as a
contract liability.
|
The amendment in this Update removes the reference to the
term contract liability from the journal entry in Example 40.
|
Issue 11: Advertising Costs
| |
Update 2014-09 supersedes much of the guidance in Subtopic
340-20, Other Assets and Deferred Costs — Capitalized Advertising
Costs, because it would have conflicted with new cost capitalization
guidance in Subtopic 340-40. Therefore, an entity that previously
capitalized advertising costs in accordance with the guidance in Subtopic
340-20 would apply the capitalization guidance in Subtopic 340-40 upon the
adoption of Update 2014-09. Guidance on when to recognize a liability had
been included within Subtopic 340-20 and was inadvertently superseded by
Update 2014-09.
|
The amendments in this Update reinstate the guidance on
the accrual of advertising costs and also move the guidance to Topic 720,
Other Expenses.
|
Issue 12: Fixed-Odds Wagering
Contracts in the Casino Industry
| |
Subtopic 924-605, Entertainment — Casinos — Revenue
Recognition, [historically included] explicit guidance that
[identified] fixed-odds wagering as gaming revenue. That industry-specific
guidance was superseded by Update 2014-09, along with nearly all existing
industry-specific revenue guidance in GAAP. Therefore, some stakeholders
questioned whether fixed-odds wagering contracts are within the scope of
Topic 606 or, rather, whether they should be accounted for as derivatives
within the scope of Topic 815.
|
The amendments in this Update (a) create a new Subtopic
924-815, Entertainment — Casinos — Derivatives and Hedging, which
includes a scope exception from derivatives guidance for fixed-odds wagering
contracts and (b) includes a scope exception within Topic 815 for fixed-odds
wagering contracts issued by casino entities.
|
Issue 13: Cost Capitalization for
Advisors to Private Funds and Public Funds
| |
A consequential amendment included in Update 2014-09 moved
cost guidance from Subtopic 946-605, Financial Services — Investment
Companies — Revenue Recognition, to Subtopic 946-720, Financial
Services — Investment Companies — Other Expenses. This amendment was
intended to move the guidance only and was not intended to change practice.
However, the consequential amendment in Update 2014-09 could have resulted
in inconsistent accounting for offering costs among advisors to public funds
and private funds.
|
The amendments in this Update align the
cost-capitalization guidance for advisors to both public funds and private
funds in Topic 946.
|
ASU 2016-20 is based on two proposed ASUs. All except one of the amendments
proposed in those exposure drafts are included in the final ASU. For the exception,
which addresses preproduction costs related to long-term supply arrangements, the FASB
subsequently decided to discontinue reconsideration of that topic because the Board
concluded that additional guidance was not necessary. For more information about
accounting for preproduction costs of a long-term supply arrangement, see Section 13.3.4.
18.3.3.7 ASU 2017-13 on Amendments to SEC Paragraphs and Rescission of Prior SEC Staff Announcements and Observer Comments
On September 29, 2017, the FASB issued ASU 2017-13, which amended the transition
guidance in ASC 606-10-65 to include the SEC staff announcement at the July 20, 2017,
EITF meeting regarding the ability of certain PBEs to use the non-PBE effective date
when adopting the revenue standard.
In addition, ASU 2017-13 rescinded the SEC staff guidance in ASC 605-20-S99-1 (formerly EITF Topic D-96) on accounting for management fees based on a formula upon
adoption of the revenue standard.
18.3.3.8 ASU 2017-14 on Amendments to SEC Paragraphs Pursuant to SAB 116 and SEC Release No. 33-10403
On November 22, 2017, the FASB issued ASU 2017-14, which codified certain SEC
guidance on revenue and rescinds other such guidance that is superseded. Specifically,
the ASU codified in ASC 606-10-S25-1 the text of the SEC’s 2017 release on recognizing revenue from vaccines placed in a federal
government stockpile and rescinded the legacy SEC guidance in ASC 605-15-S99-1 on this
topic. For more information about the SEC’s 2017 release, see Section 18.2.2.
In addition, ASU 2017-14 rescinded certain SEC staff guidance in light of SAB
116. As discussed in Section 18.2.1, SAB 116
rendered SAB Topics 8 and 13 inapplicable upon the adoption of ASC 606. Accordingly, ASU
2017-14 rescinded the following SEC staff guidance upon the adoption of ASU 2014-09:
-
ASC 605-10-S99-1, in which the text of SAB Topic 13 was codified to reflect the SEC staff’s views on general recognition guidance.
-
ASC 605-15-S99-2, in which the text of SAB Topic 8.A was codified to reflect the SEC staff’s views on retailers’ recognition of revenue from (1) sales of leased or licensed departments and (2) fees on commissions in a service arrangement.
-
ASC 605-15-S99-3, in which the text of SAB Topic 8.B was codified to reflect the SEC staff’s views on disclosures related to finance charges imposed by department stores and other retailers on credit sales.
Further, ASU 2017-14 amended ASC 220-10-S99-7 to reflect SAB 116’s amendments to
SAB Topic 11.A, as discussed in Section 18.2.1.
Those amendments to SAB Topic 11.A clarify that operating-differential subsidies
presented under a revenue caption must be presented separately from revenue from
contracts with customers accounted for under ASC 606.
18.3.3.9 ASU 2018-08 on Accounting for Contributions Received and Made
On June 21, 2018, the FASB issued ASU 2018-08, which clarified the scope and
accounting guidance for contributions received and made. Specifically, the ASU indicates
that its amendments are intended, in part, to help entities evaluate “whether
transactions should be accounted for as contributions (nonreciprocal transactions)
within the scope of [ASC 958] or as exchange (reciprocal) transactions subject to other
guidance,” such as ASC 606. The ASU explains that while the issues it aims to address
have been long-standing, “the amendments in [ASU 2014-09] place an increased focus on
the issues because those amendments add new disclosure requirements and eliminate
certain limited exchange transaction guidance that was previously contained in [ASC]
958-605.”
18.3.3.10 ASU 2018-18 on Clarifying the Interaction Between ASC 808 and ASC 606
On November 5, 2018, the FASB issued ASU 2018-18, which made targeted improvements
to the guidance on collaborative arrangements in ASC 808. See Section 3.2.9 for further discussion of
collaborative arrangements and the ASU’s amendment to ASC 606-10-15-3.
18.3.3.11 ASU 2019-08 on Share-Based Consideration Payable to a Customer
On November 11, 2019, the FASB issued ASU 2019-08, which clarified the accounting for
share-based payments issued as consideration payable to a customer in accordance with
ASC 606. Under the ASU, entities apply the guidance in ASC 718 to measure and classify
share-based payments issued to a customer that are not in exchange for a distinct good
or service (i.e., share-based sales incentives). See Section 6.6 for further details.
18.3.3.12 ASU 2020-05 on Deferral of the Effective Date for Certain Entities
On June 3, 2020, the FASB issued ASU 2020-05, which amended the effective dates
of the Board’s standards on revenue (ASC 606) and leasing (ASC 842) to give immediate
relief to certain entities as a result of the widespread adverse economic effects and
business disruptions caused by the COVID-19 pandemic. Specifically, the Board deferred
the effective dates of (1) ASC 606 for private companies and private not-for-profit
entities and (2) ASC 842 for private companies, private not-for-profit entities, and
public not-for-profit entities. Nonpublic entities (i.e., entities that are not PBEs)
were permitted to adopt ASC 606 for annual reporting periods beginning after December
15, 2019, and for interim reporting periods within annual reporting periods beginning
after December 15, 2020. However, the deferrals applied only if those entities had not
yet issued their financial statements (or made their financial statements available for
issuance) as of June 3, 2020.
18.3.3.13 ASU 2021-02 on Practical Expedient for Private-Company Franchisors on the Identification of Performance Obligations
On January 28, 2021, the FASB issued ASU 2021-02, which allows a franchisor that is
not a PBE (a “private-company franchisor”) to use a practical expedient when identifying
performance obligations in its contracts with customers (i.e., franchisees) under ASC
606. When using the practical expedient, a private-company franchisor that has entered
into a franchise agreement would treat certain preopening services provided to its
franchisee as distinct from the franchise license. In addition, a private-company
franchisor that applies the practical expedient must make a policy election to either
(1) apply the guidance in ASC 606 to determine whether the preopening services that are
subject to the practical expedient are distinct from one another or (2) account for
those preopening services as a single performance obligation. The practical expedient
and policy election are intended to reduce the cost and complexity of applying ASC 606
to preopening services associated with initial franchise fees. See Section 5.3.5 for further
details.
18.3.3.14 ASU 2021-08 on Contract Assets and Contract Liabilities From Contracts With Customers Acquired in a Business Combination
In October 2021, the FASB issued ASU 2021-08, which amended ASC 805 to address
inconsistencies and diversity in practice related to the accounting for revenue
contracts with customers acquired in a business combination. The ASU requires an entity
to apply the guidance in ASC 606 when recognizing and measuring contract assets and
contract liabilities arising from those contracts. See Section 3.2.13 for further details.
18.3.4 Postimplementation Review
After the FASB issues a major new accounting standard, it begins a
postimplementation review (PIR) process to evaluate whether the standard is achieving its
objective by providing users of financial statements with relevant information that
justifies the costs of providing it. This process enables the Board to solicit and
consider stakeholder input and FASB staff research.
The FASB is currently performing a PIR of the revenue standard. The PIR
process is conducted in three stages: (1) post-issuance-date implementation monitoring,
(2) post-effective-date evaluation of costs and benefits, and (3) summary of research and
reporting. The first stage of the revenue standard’s PIR consisted of various activities,
including public meetings of the TRG, responses to technical inquiries, public webcasts,
and the issuance of multiple ASUs to address effective-date deferrals and clarification or
simplification of the revenue standard.2
The FASB staff has completed most of its PIR outreach and research. At
the July 28, 2021, and September 21, 2022, FASB meetings, the Board discussed
feedback received and research performed to date on the revenue standard. In handouts
prepared for the Board’s July
2021 and September 2022 meetings, the FASB staff noted that stakeholder feedback
on the revenue standard was positive overall, particularly from users of financial
statements since the standard results in more useful and transparent information, improved
disclosures, and comparability across entities and industries. The staff further observed
that while many preparers noted significant one-time costs associated with implementation
of the standard, they also highlighted that the standard has been beneficial in the long
run. Since the Board’s July 2021 meeting, the FASB staff has performed research on various
topics identified during its post-effective-date stakeholder outreach, including (1)
principal-versus-agent considerations, (2) licensing, (3) variable consideration, (4)
short-cycle manufacturing, and (5) disclosures. Although applying the revenue standard in
these areas still requires significant judgment, additional standard setting is not
currently on the FASB’s technical agenda and may not occur as a result of the FASB staff’s
research.
The FASB staff will continue to monitor implementation of the revenue
standard and provide updates to the Board on any emerging issues identified. As the PIR of
the revenue standard progresses, the Board and its staff may identify areas of improvement
that could result in future standard setting.
Footnotes
[1]
At its October 19, 2016, meeting, the FASB
redeliberated its original technical correction on disclosures of
remaining performance obligations, which was discussed at the August 31,
2016, meeting but for which no tentative decision was reached. At the
October 19 meeting, the staff presented five alternatives on the issue,
which were compiled after additional outreach was performed at the
request of the Board. After extensive deliberation, the Board ultimately
decided to move forward with the amendments as originally proposed.
However, the Board noted the importance of monitoring adoption of the
disclosure requirements to determine what information preparers were
disclosing and what information investors were using so that the Board
could assess whether additional amendments were necessary once
implementation reviews were completed.
2
See Section
18.3.3 for an overview of the ASUs issued.
18.4 AICPA Revenue Recognition Industry Task Forces
The AICPA formed 16 industry task forces to help develop an accounting guide on revenue recognition for entities in the following industries:
|
|
The AICPA publication Revenue Recognition Task Force — Status of Implementation
Issues summarizes the implementation issues that were
discussed by each industry task force. Each implementation issue summarized therein
has been finalized and included in the AICPA Audit and Accounting Guide
Revenue Recognition.
18.5 AICPA Digital Assets Working Group
The AICPA Digital Assets Working Group has provided nonauthoritative
interpretative guidance on how to account for and audit digital assets. A digital
asset is defined in the AICPA’s Blockchain Universal Glossary as follows:
A digital record made using cryptography for verification and
security purposes on a digital decentralized ledger (referred to as a
blockchain). A digital asset is characterized by its ability to be used for a
variety of purposes, including as a means of exchange, as a representation to
provide or access goods or services, or as a financing vehicle, such as a
security, among other uses.
The AICPA Digital Assets Working Group’s guidance is available in the AICPA Practice
Aid Accounting for and Auditing of Digital Assets (the
“AICPA Practice Aid”). Among the accounting and auditing issues addressed in the
AICPA Practice Aid are various revenue recognition topics, including those related
to crypto-asset lending and mining transactions.
In addition, the AICPA Practice Aid contains nonauthoritative interpretative
guidance, based on the AICPA Digital Assets Working Group’s discussions with the SEC
staff, on how to apply SAB
121. Issued on March 31, 2022, SAB 121 provides the SEC staff’s
views on accounting for obligations to safeguard crypto assets, although it does not
have direct revenue implications. For more information about SAB 121, see Deloitte’s
April 6, 2022 (updated July 28, 2022), Financial
Reporting Alert.
Entities should continue to monitor changes in interpretations related to accounting
for digital assets and consider consulting with their accounting advisers.
Appendix A — Differences Between U.S. GAAP and IFRS Accounting Standards
Appendix A — Differences Between U.S. GAAP and IFRS Accounting Standards
Although the FASB’s guidance on revenue from contracts with customers is nearly
fully converged with that of the IASB, there are differences between U.S. GAAP and
IFRS Accounting Standards on revenue-related topics. Some of those differences are
reflected in the table below.
Topic | U.S. GAAP | IFRS Accounting Standards |
---|---|---|
Step 1 — the collectibility threshold for contracts | The guidance establishes a probable collectibility threshold, meaning
likely to occur.1
| The guidance establishes a probable collectibility threshold, meaning
more likely than not.2 |
Reversal of impairment losses | An entity cannot reverse an impairment loss on capitalized costs to obtain or fulfill a contract. | An entity is required to reverse an impairment loss on capitalized costs to obtain or fulfill a contract if the impairment conditions no longer exist or have improved. |
Interim disclosures | In addition to those required by ASC 270, an entity must provide interim disclosures about each of the following:
| IFRS 15 amended IAS 34 to require an entity to provide interim disclosures about the disaggregation of revenue. |
Requirements for nonpublic entities | The guidance applies to nonpublic entities, with some specific relief related to
disclosure. Refer to Chapter
16 for additional information. | The guidance applies to all entities reporting under IFRS Accounting Standards,
including nonpublic entities. |
After the FASB and IASB issued ASU 2014-09 and IFRS 15, respectively,
the boards decided to amend certain aspects of the revenue standard. In some cases,
the amendments retained convergence; in other cases, however, the FASB decided on a
solution that differs from the IASB’s. The table below outlines some additional
differences between U.S. GAAP and IFRS Accounting Standards that have arisen as a
result of the amendments.
Topic | U.S. GAAP | IFRS Accounting Standards |
---|---|---|
Licensing — determining the nature of an entity’s promise (see paragraphs BC51 through BC65 of ASU 2016-10) | An entity’s determination of whether a license is a right to use (for which revenue is recognized at a point in time) versus a right to access (for which revenue is recognized over time) is based on its classification of the intellectual property (IP) underlying the license as either functional or symbolic. | An entity’s determination of whether a license is a right to use versus a right to access is based on whether the customer can direct the use of, and obtain substantially all of the benefits from, the license at the point in time at which the license is granted. The customer can direct the use of, and obtain substantially all of the benefits from, the license if the underlying IP is not significantly affected by the entity’s ongoing activities. |
Licensing — renewals (see paragraphs BC48 through BC50 of ASU 2016-10) | The amendment specifies that a renewal or extension is subject to the “use and benefit” guidance in ASC 606-10-55-58C, the application of which will generally result in revenue recognition at the beginning of the renewal period. | The “use and benefit” guidance does not explicitly refer to renewals.
Consequently, revenue may be recognized earlier than it
would be under U.S. GAAP. |
Shipping and handling activities (see paragraphs BC19 through BC25 of ASU 2016-10) | The amendment provides an accounting policy election that permits an entity to account for shipping and handling activities that occur after the customer has obtained control of the related good as a fulfillment expense. | IFRS 15 does not provide an accounting policy election. If an entity performs
shipping and handling services after the customer has
obtained control of the related good, the shipping and
handling activities will typically be accounted for as a
separate performance obligation. |
Noncash consideration (see paragraphs BC36 through BC43 of ASU 2016-12) | Under the amendments in ASU 2016-12, noncash consideration is measured at
contract inception. | IFRS 15 does not prescribe a measurement date for noncash consideration. |
Presentation of sales (and other similar) taxes (see paragraphs BC29 through BC35 of ASU 2016-12) | The amendment provides an accounting policy election that permits an entity to exclude all sales (and other similar) taxes from the measurement of the transaction price. | IFRS 15 does not provide an accounting policy election. An entity is required to
identify whether it has a primary responsibility to pay the
taxes or is acting only as a collection agent. If it is the
primary obligor, it must include those taxes in the
transaction price. |
Provisions for losses on
construction-type and production-type
contracts | ASU 2016-20 amends the legacy
guidance in ASC 605-35-25-47
to clarify that provisions for
losses on construction-type and
production-type contracts may be
determined at either the contract
or performance obligation level. | In accordance with IAS 37, the onerous test should be performed at the contract level. |
Private-company franchisor
|
ASU 2021-02
allows a franchisor that is not a public business entity (a
“private-company franchisor”) to use a practical expedient
when identifying performance obligations in its contracts
with customers (i.e., franchisees) under ASC 606. When using
the practical expedient, a private-company franchisor that
has entered into a franchise agreement would treat certain
preopening services provided to its franchisee as distinct
from the franchise license. In addition, a private-company
franchisor that applies the practical expedient must make a
policy election to either (1) apply the guidance in ASC 606
to determine whether the preopening services that are
subject to the practical expedient are distinct from one
another or (2) account for those preopening services as a
single performance obligation. The practical expedient and
policy election are intended to reduce the cost and
complexity of applying ASC 606 to preopening services
associated with initial franchise fees.
|
IFRS Accounting Standards do not include a
similar practical expedient.
|
Disclosure of remaining
performance obligations | ASU 2016-20 provides entities
with an optional exemption from
the requirement to disclose
information about remaining
performance obligations (ASC
606-10-50-13) for variable
consideration if either (1) the
variable consideration is a sales- or
usage-based royalty promised
in exchange for a license of IP
or (2) the variable consideration
is allocated entirely to a wholly
unsatisfied performance obligation
or to a wholly unsatisfied promise
to transfer a distinct good or
service that forms part of a single
performance obligation. | IFRS 15 was not amended to
provide similar disclosure relief. |
Consideration payable to a customer —
share-based payments to customers
|
ASU 2019-08
clarifies the accounting for share-based payments to
customers and requires the application of ASC 718 for
measurement and classification purposes (e.g., share-based
consideration payable to a customer is calculated by using
its fair-value-based measure as of the grant date).
|
IFRS 15 does not specify whether equity
instruments granted by an entity to a customer are a type of
consideration paid or payable to a customer. Further, IFRS
15 does not address how equity instruments granted to a
customer in a revenue arrangement should be accounted for
with regard to initial and subsequent measurement.
Therefore, an entity should consider which standard (e.g.,
IFRS 2, IFRS 15, IAS 32), or combination of standards, could
be applicable.
|
Further, some of the boards’ respective amendments to the revenue standard are
generally expected to produce similar outcomes under U.S. GAAP and IFRS Accounting
Standards despite differences between the FASB’s wording and that of the IASB. The
table below provides examples of differently articulated but similar guidance under
U.S. GAAP and IFRS Accounting Standards, as amended.
Topic | U.S. GAAP | IFRS Accounting Standards |
---|---|---|
Collectibility — criterion explanation and examples (see paragraphs BC9 through BC20 of ASU 2016-12) | ASU 2016-12 provides an additional explanation of the collectibility threshold’s objective, as well as implementation guidance and examples. | No additional guidance provided. |
Collectibility — recognition criterion for contracts that fail step 1 (see paragraphs BC21 through BC28 of ASU 2016-12) | ASU 2016-12 adds a third criterion to allow revenue recognition when a contract fails step 1 (ASC 606-10-25-1). | Additional criterion not provided. |
Immaterial goods or services (see paragraphs BC8 through BC18 of ASU 2016-10) | When identifying performance obligations, an entity is not required to assess immaterial items in the context of the contract as promised goods or services. | Overall materiality considerations should be used in the evaluation of items
under IFRS Accounting Standards. |
Licensing — when to consider the nature of an entity’s promise in granting a license (see paragraphs BC66 through BC69 of ASU 2016-10) | ASU 2016-10 contains explicit guidance to indicate that when a bundle of goods or services is determined to be a single performance obligation that includes a license of IP, an entity should apply the license implementation guidance to determine whether revenue related to the performance obligation should be recognized over time (including an appropriate measure of progress) or at a point in time. | No guidance added to IFRS 15; however, the Basis for Conclusions on IFRS 15 explains that the licensing implementation guidance does not override the general model — specifically, the requirements for identifying performance obligations before applying the criteria to determine the nature of an entity’s promise in granting a license. |
Licensing — contractual restrictions (see paragraphs BC41 through BC47 of ASU 2016-10) | ASU 2016-10 contains explicit guidance to indicate that contractual provisions that explicitly or implicitly require an entity to transfer control of additional goods or services to the customer (e.g., additional rights) should be distinguished from contractual provisions that define attributes of a single promised license (e.g., restrictions of time or geography). | No guidance added to IFRS 15; however, the Basis for Conclusions on IFRS 15 explains that the license implementation guidance does not override the general model — specifically, the requirements for identifying performance obligations before applying the criteria to determine the nature of an entity’s promise in granting a license. |
Licensing — hosting arrangements (see paragraph BC37 of ASU
2016-10)
|
ASU 2016-10 contains explicit guidance to indicate that the
license implementation guidance is not applicable to
software subject to a hosting arrangement that does not
contain a license in accordance with the guidance in ASC
985-20-15-5.
|
No guidance added to IFRS 15; however, the Basis for
Conclusions on IFRS 15 explains that the license
implementation guidance does not override the general model
— specifically, the requirements for identifying performance
obligations before applying the criteria to determine the
nature of an entity’s promise in granting a license.
|
Contract costs — impairment
testing | ASU 2016-20 clarifies that
when an entity tests capitalized
contract costs for impairment,
it should (1) consider expected
contract renewals and extensions
and (2) include any amount of
consideration not yet recognized as
revenue (i.e., consideration already
received and amounts expected to
be received in the future). | No additional guidance provided on specific factors that an entity should consider when testing capitalized contract costs for impairment. |
Disclosure of prior-period
performance obligations | ASU 2016-20 provides additional guidance to clarify that the disclosure of revenue from performance obligations satisfied (or partially satisfied) in prior periods applies to all performance obligations (i.e., the disclosure is not isolated to performance obligations with corresponding contract liability balances). | No additional guidance provided. |
Contract modifications example | ASU 2016-20 amends Example 7 in
ASC 606-10-55-125 through 55-128
to better align the wording with the
contract modification guidance in
ASC 606-10-25-10 through 25-13. | No amendments made to Example 7 in IFRS 15. |
Contract asset versus receivable | ASU 2016-20 amends Example
38, Case B, in ASC 606-10-55-285
and 55-286 to provide a better
link between the analysis and the
receivables presentation guidance
in ASC 606. | No amendments made to Example 38, Case B, in IFRS 15. |
Refund liability | ASU 2016-20 amends Example 40
in ASC 606-10-55-293 to remove
the reference to a contract liability
as related to refund liabilities. | No amendments made to Example 40 in IFRS 15. |
In addition, there are certain differences between legacy U.S. GAAP and IFRS
Accounting Standards. While certain of the boards’ respective amendments —
especially the FASB’s amendments in ASU 2016-20 — are not expected to create a new
difference between U.S. GAAP and IFRS Accounting Standards, these amendments are
also not expected to result in convergence between U.S. GAAP and IFRS Accounting
Standards. The table below provides examples of where existing differences have been
carried forward under the revenue standard.
Topic | U.S. GAAP | IFRS Accounting Standards |
---|---|---|
Onerous contracts
|
Although the guidance is silent on the topic
of onerous contracts, it does not supersede existing
provisions in other ASC subtopics, including ASC 605-20, ASC
605-35, and ASC 985-20, that require the recognition of
losses for certain types of contracts with customers.
|
Under IAS 37, losses are recognized for all onerous contracts
with customers.
|
Financial guarantee contracts
|
ASU 2016-20 clarifies that guarantee fees
(other than product or service warranties) within the scope
of ASC 460 are not within the scope of ASC 606.
|
In accordance with IFRS 9, the issuer of a
financial guarantee contract should initially recognize the
contract at fair value and subsequently measure it at the
higher of (1) the amount of the loss allowance determined in
accordance with IFRS 9 or (2) the amount initially
recognized less, when appropriate, the cumulative amount of
income recognized in accordance with IFRS 15.
|
Contract costs — interaction of
impairment testing with guidance in
other ASC topics | ASU 2016-20 clarifies that
impairment testing on assets
should be performed in the
following order: (1) assets not
within the scope of ASC 340, ASC
350, or ASC 360; (2) assets within
the scope of ASC 340 (including
contract costs capitalized under
ASC 340-40); (3) asset groups and
reporting units within the scope of
ASC 360 and ASC 350. | Under IFRS 15, before an entity recognizes any impairment loss for a capitalized
contract cost, it should recognize any impairment loss for
assets related to the contract that are recognized in
accordance with another IFRS Accounting Standard (e.g., IAS
2, IAS 16, or IAS 38). The resulting carrying amount of the
asset should be included in the carrying amount of the
cash-generating unit to which it belongs when IAS 36 is
applied. |
Scope of the revenue standard | ASU 2016-20 clarifies that all
contracts within the scope of
ASC 944 are not within the
scope of ASC 606 by removing
the term “insurance” from ASC
606-10-15-2(b). | IFRS 15 as originally issued excludes insurance contracts within the scope of
IFRS 4 (or IFRS 17 when adopted) from the scope of IFRS
15. |
Advertising costs | ASU 2016-20 reinstates the
guidance on the accrual of
advertising costs that was
previously in ASC 340-20 and
superseded by ASU 2014-09. The
reinstated guidance is in ASC 720-35. | No additional guidance provided. |
Cost capitalization for advisers to
private funds and public funds | ASU 2016-20 amends the guidance
in ASC 946-720 to align the cost
capitalization guidance for advisers
to both public and private funds. | IFRS Accounting Standards do not contain prescriptive guidance on the accounting
for costs incurred by advisers to public and private
funds. |
Fixed-odds wagering contracts in
the casino industry | ASU 2016-20 clarifies that fixed-odds wagering contracts in the casino industry
should be accounted for under the revenue standard by
providing in ASC 924-815 (added by the ASU) a scope
exception to the derivatives guidance. | The IFRS Interpretations Committee previously noted that when a gaming entity
takes a position against a customer, the resulting unsettled
wager is a financial instrument that is likely to meet the
definition of a derivative and should therefore be accounted
for under IAS 39 (or IFRS 9, if adopted). At the November
2015 TRG meeting, the IASB commented that wagering contracts
that meet the definition of a financial instrument within
the scope of IAS 39 or IFRS 9 are excluded from the scope of
IFRS 15. |
Footnotes
Appendix B — Codification Example Index
Appendix B — Codification Example Index
Index of Codification Examples | |||
---|---|---|---|
Example | Paragraphs | Title | Roadmap Section(s) |
ASC 340-40 | |||
Example
1 | 340-40-55-2–4 | Incremental Costs of Obtaining a Contract | |
Example
2 | 340-40-55-5–9 | Costs
That Give Rise to an Asset | |
ASC 606 | |||
Example 1 | Collectibility of the
Consideration | ||
Case A | 606-10-55-95–98 | Collectibility Is Not Probable | |
Case B | 606-10-55-98A–98E | Credit
Risk Is Mitigated | |
Case C | 606-10-55-98F–98I | Credit
Risk Is Not Mitigated | |
Case D | 606-10-55-98J–98L | Advance
Payment | |
Example
2 | 606-10-55-99–101 | Consideration Is Not the Stated Price — Implicit Price
Concession | |
Example
3 | 606-10-55-102–105 | Implicit
Price Concession | |
Example
4 | 606-10-55-106–109 | Reassessing the Criteria for Identifying a
Contract | |
Example
5 | 606-10-55-111 | Modification of a Contract for Goods | |
Case A | 606-10-55-112–113 | Additional Products for a Price That Reflects the
Standalone Selling Price | |
Case B | 606-10-55-114–116 | Additional Products for a Price That Does Not Reflect the
Standalone Selling Price | |
Example
6 | 606-10-55-117–124 | Change in the Transaction Price After a Contract Modification | |
Example
7 | 606-10-55-125–128 | Modification of a Services Contract | |
Example
8 | 606-10-55-129–133 | Modification Resulting in a Cumulative Catch-Up Adjustment
to Revenue | |
Example
9 | 606-10-55-134–135 | Unapproved Change in Scope and Price | |
Example 10 | Goods and
Services Are Not Distinct | ||
Case A | 606-10-55-137–140 | Significant Integration Service | |
Case B | 606-10-55-140A–140C | Significant Integration Service | |
Case C | 606-10-55-140D–140F | Combined
Item | |
Example 11 | Determining Whether Goods or Services Are
Distinct | ||
Case A | 606-10-55-141–145 | Distinct
Goods or Services | |
Case B | 606-10-55-146–150 | Significant Customization | |
Case C | 606-10-55-150A–150D | Promises
Are Separately Identifiable (Installation) | |
Case D | 606-10-55-150E–150F | Promises
Are Separately Identifiable (Contractual
Restrictions) | |
Case
E | 606-10-55-150G–150K | Promises
Are Separately Identifiable (Consumables) | |
Example
12 | 606-10-55-151 | Explicit
and Implicit Promises in a Contract | |
Case A | 606-10-55-152–153A | Explicit
Promise of Service | |
Case B | 606-10-55-154–155 | Implicit
Promise of Service | |
Case C | 606-10-55-156–157A | Services
Are Not a Promised Service | |
Example
12A | 606-10-55-157B–157E | Series of
Distinct Goods or Services | |
Example
13 | 606-10-55-159–160 | Customer
Simultaneously Receives and Consumes the
Benefits | |
Example
14 | 606-10-55-161–164 | Assessing
Alternative Use and Right to Payment | |
Example
15 | 606-10-55-165–168 | Asset Has
No Alternative Use to the Entity | |
Example
16 | 606-10-55-169–172 | Enforceable Right to Payment for Performance Completed to
Date | |
Example
17 | 606-10-55-173 | Assessing
Whether a Performance Obligation Is Satisfied at a Point in
Time or Over Time | |
Case A | 606-10-55-174–175 | Entity
Does Not Have an Enforceable Right to Payment for
Performance Completed to Date | |
Case B | 606-10-55-176–180 | Entity
Has an Enforceable Right to Payment for Performance
Completed to Date | |
Case C | 606-10-55-181–182 | Entity
Has an Enforceable Right to Payment for Performance
Completed to Date | |
Example
18 | 606-10-55-184–186 | Measuring
Progress When Making Goods or Services Available | |
Example
19 | 606-10-55-187–192 | Uninstalled Materials | |
Example
20 | 606-10-55-194–196 | Penalty Gives Rise to Variable Consideration | |
Example
21 | 606-10-55-197–200 | Estimating Variable Consideration | |
Example
22 | 606-10-55-202–207 | Right of Return | |
Example
23 | 606-10-55-208–209 | Price Concessions | |
Case A | 606-10-55-210–212 | Estimate
of Variable Consideration Is Not Constrained | |
Case B | 606-10-55-213–215 | Estimate
of Variable Consideration Is Constrained | |
Example
24 | 606-10-55-216–220 | Volume
Discount Incentive | |
Example
25 | 606-10-55-221–225 | Management Fees Subject to the Constraint | |
Example
26 | 606-10-55-227–232 | Significant Financing Component and Right of
Return | |
Example
27 | 606-10-55-233–234 | Withheld
Payments on a Long-Term Contract | |
Example
28 | 606-10-55-235 | Determining the Discount Rate | |
Case A | 606-10-55-236–237 | Contractual Discount Rate Reflects the Rate in a Separate Financing
Transaction | |
Case B | 606-10-55-238–239 | Contractual Discount Rate Does Not Reflect the Rate in a
Separate Financing Transaction | |
Example
29 | 606-10-55-240–243 | Advance
Payment and Assessment of Discount Rate | |
Example
30 | 606-10-55-244–246 | Advance
Payment | |
Example
31 | 606-10-55-248–250 | Entitlement to Noncash Consideration | |
Example
32 | 606-10-55-252–254 | Consideration Payable to a Customer | |
Example
33 | 606-10-55-256–258 | Allocation Methodology | |
Example
34 | 606-10-55-259–260 | Allocating a Discount | |
Case A | 606-10-55-261–264 | Allocating a Discount to One or More Performance
Obligations | |
Case B | 606-10-55-265–268 | Residual
Approach Is Appropriate | |
Case C | 606-10-55-269 | Residual
Approach Is Inappropriate | |
Example
35 | 606-10-55-270 | Allocation of Variable Consideration | |
Case A | 606-10-55-271–274 | Variable
Consideration Allocated Entirely to One Performance
Obligation | |
Case B | 606-10-55-275–279 | Variable
Consideration Allocated on the Basis of Standalone Selling
Prices | |
Example
38 | Contract
Liability and Receivable | ||
Case A | 606-10-55-284 | Cancellable Contract | |
Case B | 606-10-55-285–286 | Noncancellable Contract | |
Example
39 | 606-10-55-287–290 | Contract
Asset Recognized for the Entity’s Performance | |
Example
40 | 606-10-55-291–294 | Receivable Recognized for the Entity’s
Performance | |
Example
41 | 606-10-55-296–297 | Disaggregation of Revenue — Quantitative
Disclosure | |
Example
42 | 606-10-55-298–305A | Disclosure of the Transaction Price Allocated to the
Remaining Performance Obligations | |
Example
43 | 606-10-55-306–307 | Disclosure of the Transaction Price Allocated to the
Remaining Performance Obligations — Qualitative
Disclosure | |
Example
44 | 606-10-55-309–315 | Warranties | |
Example
45 | 606-10-55-317–319 | Arranging
for the Provision of Goods or Services (Entity Is an
Agent) | |
Example
46 | 606-10-55-320–324 | Promise
to Provide Goods or Services (Entity Is a
Principal) | |
Example
46A | 606-10-55-324A–324G | Promise
to Provide Goods or Services (Entity Is a
Principal) | |
Example
47 | 606-10-55-325–329 | Promise
to Provide Goods or Services (Entity Is a
Principal) | |
Example
48 | 606-10-55-330–334 | Arranging
for the Provision of Goods or Services (Entity Is an
Agent) | |
Example
48A | 606-10-55-334A–334F | Entity Is
a Principal and an Agent in the Same Contract | |
Example
49 | 606-10-55-336–339 | Option
That Provides the Customer With a Material Right (Discount
Voucher) | |
Example
50 | 606-10-55-340–342 | Option
That Does Not Provide the Customer With a Material Right
(Additional Goods or Services) | |
Example
51 | 606-10-55-343–352 | Option
That Provides the Customer With a Material Right (Renewal
Option) | |
Example
52 | 606-10-55-353–356 | Customer
Loyalty Program | |
Example
53 | 606-10-55-358–360 | Nonrefundable Upfront Fees | |
Example 54
|
606-10-55-362–363B
|
Right to Use Intellectual Property
| |
Example
55 | 606-10-55-364–366 | License
of Intellectual Property | |
Example
56 | 606-10-55-367 | Identifying a Distinct License | |
Case A | 606-10-55-368–370 | License
Is Not Distinct | |
Case B | 606-10-55-371–374 | License
Is Distinct | |
Example
57 | 606-10-55-375–382 | Franchise
Rights | |
Example
58 | 606-10-55-383–388 | Access to
Intellectual Property | |
Example
59 | Right to
Use Intellectual Property | ||
Case A | 606-10-55-389–392 | Initial
License | |
Case B | 606-10-55-392A–392D | Renewal
of the License | |
Example
60 | 606-10-55-393–394 | Sales-Based Royalty Promised in Exchange for a License of
Intellectual Property and Other Goods and
Services | |
Example
61 | 606-10-55-395–399 | Access to
Intellectual Property | |
Example
61A | 606-10-55-399A | Right to
Use Intellectual Property | |
Case A | 606-10-55-399B–399E | License
Is the Only Promise in the Contract | |
Case B | 606-10-55-399F–399J | Contract
Includes Two Promises | |
Example
61B | 606-10-55-399K–399O | Distinguishing Multiple Licenses From Attributes of a
Single License | |
Example
62 | 606-10-55-401 | Repurchase Agreements | |
Case A | 606-10-55-402–404 | Call
Option: Financing | |
Case B | 606-10-55-405–407 | Put
Option: Lease | |
Example
63 | 606-10-55-409–413 | Bill-and-Hold Arrangement | |
ASC 610-20 | |||
Example 1
| Scope | ||
Case
A | 610-20-55-2–5 | Nonfinancial Assets, In Substance Nonfinancial Assets, and
a Guarantee | |
Case
B | 610-20-55-6–8 | Nonfinancial Assets and Financial Assets | |
Case
C | 610-20-55-9–10 | One
Subsidiary That Holds Nonfinancial Assets and One Subsidiary
That Holds Financial Assets | |
Example
2 | Transfer
of Control | ||
Case
A | 610-20-55-11–14 | Control
Transfers Under Topics 810 and 606 | |
Case
B | 610-20-55-15–16 | Control
Transfers Under Topic 810 but Not Under Topic
606 | |
Example
3 | 610-20-55-17–19 | Sale of a
Nonfinancial Asset for Variable Consideration | |
ASC 952-606 | |||
Example 1
|
952-606-55-1–5
|
Identifying Performance Obligations
|
Appendix C — Summary of Issues Addressed in the FASB Staff’s Revenue Recognition Implementation Q&As and/or by the TRG
Appendix C — Summary of Issues Addressed in the FASB Staff’s Revenue Recognition Implementation Q&As and/or by the TRG
C.1 Introduction
This appendix summarizes issues addressed in the FASB staff’s
January 2020 document Revenue Recognition Implementation Q&As, which
contains Q&As (the “Implementation Q&As”) compiled from previously issued
materials, including TRG Agenda Papers. In addition, this appendix summarizes other
issues raised in TRG Agenda Papers that are not discussed in the Implementation
Q&As but remain relevant to the analysis of revenue-related matters that require
judgment.
The issues summarized herein are organized topically in a manner
consistent with their arrangement in this Roadmap. Note that the FASB maintains a
full list of questions discussed by the TRG, with links to the
relevant TRG Agenda Papers.
C.2 Scope (Chapter 3 of the Roadmap)
C.2.1 Fees and Reward Programs Related to Bank-Issued Credit Cards — Implementation Q&As 1 and 2 (Compiled From TRG Agenda Papers 36 and 44)
Because banks have accounted for fees and reward programs related to credit
cards they issue under ASC 310, questions have arisen about whether such fees
and programs would be within the scope of ASC 606 or ASC 310:
- Credit card fees — The FASB staff noted that all credit card fees have historically been accounted for under ASC 310 because they are related to credit lending activities (i.e., akin to loan origination fees). The staff also noted that the revenue standard does not include consequential amendments to ASC 310. Accordingly, the staff believes that entities would continue to account for services exchanged for credit card fees under ASC 310 rather than ASC 606. However, the staff noted that as an anti-abuse measure, entities need to assess whether credit card fees and services should be accounted for under ASC 606 when the issuance of a credit card appears incidental to the arrangement (e.g., when a card is issued in connection with the transfer of (1) an automobile or (2) asset management services).
- Credit card reward programs — The FASB staff indicated that if an entity concludes that the credit card arrangement is within the scope of ASC 310, the associated reward program would also be within the scope of ASC 310.
Outcomes under U.S. GAAP may differ from those under IFRS
Accounting Standards because of differences between ASC 310 and IFRS 9.
C.2.2 Whether Fixed-Odds Wagering Contracts Are Revenue or Derivative Transactions — TRG Agenda Papers 47 and 49
Partly because of the revenue standard’s elimination of ASC 924-605 and partly
because of comments that the IFRS Interpretations Committee made in its 2007
agenda decision related to accounting for fixed-odds wagering1 contracts,2 stakeholders reporting under U.S. GAAP questioned whether fixed-odds
wagering contracts should be accounted for as revenue transactions (i.e., when
or as control is transferred in accordance with the revenue standard) or as
derivatives under ASC 815 (i.e., adjusted to fair value through net income each
reporting period).
Many TRG members in the United States did not object to the FASB staff’s view
that entities should continue to account for fixed-odds wagering contracts as
revenue transactions after the revenue standard becomes effective. However, TRG
members expressed concern that the wording in the revenue standard (as
originally issued) did not support the staff’s view. Accordingly, TRG members
recommended that the Board either (1) clarify its intent to include such
contracts within the scope of ASC 606 (by issuing a technical correction
excluding them from the scope of ASC 815) or (2) evaluate further whether its
objective was to require entities to account for these contracts under ASC
815.
In December 2016, the FASB issued ASU 2016-20 on technical corrections
to the revenue standard, which includes a derivatives guidance scope exception
in ASC 924 for fixed-odds wagering contracts by adding a new Codification
subtopic (ASC 924-815, Entertainment — Casinos: Derivatives and Hedging)
that clarifies that such contracts are revenue contracts within the scope of ASC
606. For additional information, see Chapter 3.
C.2.3 Whether Contributions Are Within the Scope of the Revenue Standard — Implementation Q&A 6 (Compiled From TRG Agenda Papers 26 and 34)
Contributions3 are not explicitly excluded from the scope of the revenue standard.4 As a result, some stakeholders have questioned whether contributions are
within the scope of the standard. The FASB staff affirmed its belief that
because contributions are nonreciprocal transfers (i.e., they do not involve the
transfer of goods or services to a customer), they are outside the scope of the
guidance.
If a not-for-profit entity transfers a good or service for part or all of a
contribution (i.e., a reciprocal transfer), the entity should evaluate the facts
and circumstances to determine whether the reciprocal transfer should be
accounted for under ASC 606. As part of the evaluation, it may be helpful for
the entity to evaluate how the five-step model would be applied to the
transaction. An inability to identify promised goods or services or to determine
when control is transferred to the counterparty may be an indicator that the
transaction is not a revenue transaction with a customer.
In June 2018, the FASB issued ASU
2018-08, which provides guidance to help entities determine
whether transactions are nonreciprocal contributions or exchange transactions
(i.e., reciprocal transfers).
C.2.4 Scope Considerations for Incentive-Based Capital Allocations, Such as Carried Interests — Implementation Q&A 3 (Compiled From TRG Agenda Papers 50 and 55)
Compensation for asset managers commonly consists of both management fees (usually a percentage of assets under management) and incentive-based fees (i.e., fees based on the extent to which a fund’s performance exceeds predetermined thresholds). Often, private-equity or real estate fund managers (who may be the general partner and have a small ownership percentage in the fund) will receive incentive-based fees by way of an allocation of capital from a fund’s limited partnership interests (commonly referred to as “carried interests”).
While Example 25 in the revenue standard contains implementation guidance that
demonstrates how to apply the variable consideration constraint to an asset
management contract, the example does not specify “whether the example applies
to equity-based arrangements in which the asset manager is compensated for
performance-based fees via an equity interest (that is, incentive-based capital
allocations such as carried interest).”5 Consequently, stakeholders have expressed the following views on whether
carried interests are within the scope of the revenue standard:
-
View A — Carried interests are within the scope of the revenue standard.
-
View B — Carried interests are outside the scope of the revenue standard.
-
View C — An entity’s accounting for carried interests may vary in accordance with the nature and substance of the arrangement.
The Board’s view is that these arrangements are within the scope of ASC 606
because the Board regards the incentive-based fees as compensation for services
provided (i.e., part of revenue transactions). Many TRG members agreed that the
arrangements are within the scope of ASC 606.
However, some TRG members expressed an alternative view that a carried interest could be regarded as an equity arrangement, because it is, in form, an interest in the entity. As a result of this view, those TRG members noted that if the arrangements are considered equity interests outside the scope of ASC 606, questions could arise in a consolidation analysis — specifically, questions related to whether the asset managers should consolidate the funds.
The SEC staff’s view is characterized in Implementation Q&A 3 as follows:
The SEC staff observer at the TRG meeting indicated that he
anticipates the SEC staff would accept an application of Topic 606 for those
arrangements. However, the observer noted that there may be a basis for
following an ownership model. If an entity were to apply an ownership model,
then the SEC staff would expect the full application of the ownership model,
including an analysis of the consolidation model under Topic 810, the equity
method of accounting under Topic 323, or other relevant guidance.
C.2.5 Scope Considerations for Financial Institutions
To clarify which guidance applies to the fees associated with
certain common financial institution transactions, the FASB staff compiled
Q&As regarding whether (1) mortgage servicing rights6 should be accounted for under ASC 860 and (2) deposit-related fees7 should be accounted for under ASC 405. In addition, the TRG discussed
whether fees from financial guarantees8 should be accounted for under ASC 460 or ASC 815.
C.2.5.1 Mortgage Servicing Rights — Implementation Q&A 4 (Compiled From TRG Agenda Papers 52 and 55)
Assets and liabilities associated with mortgage servicing rights traditionally
have been accounted for under ASC 860, and such practice will not change
under the revenue standard. Servicing arrangements within the scope of ASC
860 are not within the scope of ASC 606, and ASC 860 addresses both the
initial recognition and subsequent measurement of mortgage servicing assets
and liabilities. In addition, because the subsequent measurement of the
mortgage servicing assets and liabilities depends on the cash flows
associated with the mortgage servicing rights, ASC 860 should be used to
account for such cash flows.9
C.2.5.2 Deposit-Related Fees — Implementation Q&A 5 (Compiled From TRG Agenda Papers 52 and 55)
Entities should account for revenue from deposit-related fees in accordance with
ASC 606. Financial institutions should continue to (1) record liabilities
for customer deposits because the deposits meet the definition of a
liability and (2) account for customer deposits in accordance with ASC 405.
However, because ASC 405 does not contain specific guidance on how to
account for deposit fees, financial institutions should apply ASC 606 for
deposit-related fees (i.e., in a manner similar to the application of
existing SEC revenue guidance by some financial institutions to account for
deposit-related fees). The FASB staff suggests that implementation concerns
raised by some stakeholders could be alleviated by careful analysis of the
contract terms between the financial institution and the customer. Because
customers generally have the right to cancel their depository arrangement at
any time, the FASB staff believes that most contracts would be short term
(e.g., day to day or minute to minute). As a result, revenue recognition
patterns would be similar regardless of the number of performance
obligations identified.
C.2.5.3 Fees Related to Financial Guarantees — TRG Agenda Papers 52 and 55
The TRG generally agreed that fees related to financial guarantees should be
accounted for in accordance with either ASC 460 or ASC 815. The basis for
the TRG’s view is partly due to its belief that “the fee would not be
received unless the guarantee was made, and the guarantee liability is
typically reduced (by a credit to earnings) as the guarantor is released
from the risk under the guarantee.”10 Further, ASC 460 or ASC 815 provides a framework that addresses both
initial recognition and subsequent measurement of the guarantee. In
addition, the FASB staff cited paragraph BC61 of ASU 2014-09 as
further evidence of the Board’s intent to exclude guarantees from the scope
of ASC 606. The FASB staff also noted that it may suggest technical
corrections to the Board to clarify the scope for fees from financial
guarantees in ASC 942-825-50-2 and ASC 310-10-60-4. See also Chapter 18.
Footnotes
1
Fixed-odds wagers are wagers placed by bettors (i.e.,
customers) who typically know the odds of winning in gaming activities
(e.g., table games, slot machines, keno, bingo, and sports and race
betting) at the time the bets are placed with gaming industry
entities.
2
In its 2007 agenda decision (reported in the July 2007
IFRIC Update), the IFRS Interpretations
Committee noted that an unsettled wager is a financial instrument that
is likely to meet the definition of a derivative financial instrument
under IAS 39. Currently, an entity that is required to adopt IFRS 9
should apply IFRS 9 rather than IAS 39 when accounting for
derivatives.
3
Contributions are defined as nonreciprocal transfers to
a not-for-profit entity. They are distinguishable from exchange
transactions, which are reciprocal transfers.
4
This topic applies only to U.S. GAAP because IFRS
Accounting Standards do not provide industry-specific guidance for
not-for-profit entities. See ASC 958-605 for guidance on revenue
recognition by not-for-profit entities under existing U.S. GAAP.
5
Quoted from paragraph 12 of TRG Agenda Paper 50.
6
After originating a loan (or selling an originated loan
but retaining rights to service the loan), a financial institution may
perform services that include communicating with the borrower;
collecting payments for interest, principal, and other escrow amounts;
and performing recordkeeping activities.
7
Deposit-related fees are those that a financial
institution charges to a customer for amounts on deposit with the
financial institution. Fees may be charged to give customers access to
their funds and to cover other activities, including recordkeeping and
reporting. In addition, fees may be transaction-based (such as fees to
withdraw funds through an automated teller machine) or may not be
transaction-based (such as account maintenance fees).
8
Fees charged by a financial institution to a borrower on
a loan, for example, in return for the financial institution’s acting as
a third-party guarantor on the borrower’s debt.
9
Paragraph 11 of TRG Agenda Paper 52 notes that some entities
believe that there is a close link between ASC 860’s asset and
liability remeasurement requirements and the collection of servicing
fees (which gives rise to mortgage servicing income).
10
Quoted from paragraph 61 of TRG Agenda Paper 52.
C.3 Step 1 — Identify the Contract With the Customer (Chapter 4 of the Roadmap)
C.3.1 Contract Enforceability and Termination Clauses — Implementation Q&As 7 and 8 (Compiled From TRG Agenda Papers 10, 11, 48, and 49)
The duration of a contract is predicated on the contract’s enforceable rights and
obligations. Accordingly, regardless of whether one or both parties have the
right to terminate the contract, an entity would need to evaluate the nature of
the termination provisions, including whether they are substantive. For example,
an entity would assess factors such as (1) whether the terminating party is
required to pay compensation, (2) the amount of such compensation, and (3) the
reason for the compensation (i.e., whether the compensation is in addition to
amounts due for goods and services already delivered).
The determination of whether a termination provision is substantive will require
judgment and would be evaluated both quantitatively and qualitatively. Data
about the frequency of contract terminations may be useful in such a
determination (i.e., a high frequency of payments made to terminate contracts
may suggest that the termination provision is not substantive).
When the term of a contract is less than the contract’s stated term (e.g., when
a 12-month contract is determined to be a month-to-month contract rather than
for a year, indicating that the penalty is not substantive), an entity would
have to (1) reassess the allocation of the transaction price, (2) include the
termination penalty in the transaction price (subject to the constraint on
variable consideration, if appropriate), and (3) assess whether the termination
provisions provide the customer with a material right (similarly to how the
entity would assess renewal options in a contract).
C.3.2 Collectibility — Implementation Q&As 9 and 10 (Compiled From TRG Agenda Papers 13 and 25)
A collectibility assessment should take the following considerations into
account:
-
When collectibility is probable for a portfolio of contracts, the expected amount should be recognized as revenue, and the uncollectible amount should be recorded as an impairment loss in accordance with ASC 310.
-
In determining when to reassess collectibility, an entity needs to exercise judgment on the basis of the facts and circumstances.
In May 2016, the FASB issued ASU 2016-12, which amends certain
aspects of the revenue standard. ASU 2016-12 clarifies the objective of the
entity’s collectibility assessment and contains new guidance on when an entity
would recognize as revenue consideration it receives if the entity concludes
that collectibility is not probable.
The following issues were discussed by the TRG but are not addressed in the
Implementation Q&As:
- The revenue standard clearly prohibits entities from recognizing revenue when collectibility is not probable despite any nonrefundable cash payments that may have been received. Essentially, cash-based accounting will no longer be permitted under the revenue standard.
- An assessment of whether a price adjustment is due to collectibility (i.e., credit) or a price concession is complex but can be performed in practice.
For additional information, see Chapter 4.
C.3.3 Legal Determination of Contract Enforceability — Implementation Q&A 11
As a result of various third-party published interpretations, and because the
guidance in ASC 606 refers to enforceability of rights and obligations as a
matter of law, some stakeholders have raised questions about whether legal
consultation is required as part of step 1. Although it is not a U.S. GAAP
requirement to consult with legal counsel for all revenue contracts, it may
sometimes be difficult to determine whether enforceable rights and obligations
have been established (e.g., when a contract is not written). In these cases, an
entity may need to perform additional steps, which may involve consultation with
legal counsel, to determine whether a contract exists for purposes of ASC 606.
In accordance with ASC 606-10-25-6, if the definition of a contract within the
scope of ASC 606 is not met at inception, the entity should continually reassess
its contract to determine whether the criteria for establishing the existence of
a contract under ASC 606 are subsequently met.
C.4 Step 2 — Identify Performance Obligations (Chapter 5 of the Roadmap)
C.4.1 Immaterial Goods or Services — TRG Agenda Papers 12 and 25
Paragraph BC87 of ASU 2014-09 indicates that before an entity
can identify performance obligations in a contract with its customers, it must
first identify all promised goods or services in the contract. Paragraph BC89
notes that the FASB and IASB “decided that all goods or services promised to a
customer as a result of a contract give rise to performance obligations.”
Further, paragraph BC90 states that the boards “decided not to exempt an entity
from accounting for performance obligations that the entity might regard as
being perfunctory or inconsequential.”
TRG members discussed various options, including whether to (1)
specifically address “perfunctory or inconsequential” items in the text of the
revenue standard, (2) delete the wording from paragraph BC90 (as quoted above),
and (3) add other implementation guidance.
While some TRG members discussed the potential need to add the
concept of “inconsequential or perfunctory” to the revenue standard, there
appeared to be general agreement that such an addition would not be necessary.
Further, most TRG members believed that the evaluation of promised goods or
services in a contract would lead to about the same number of deliverables as
under legacy U.S. GAAP.
In April 2016, the FASB issued ASU 2016-10, which amends certain
aspects of the revenue standard, including the guidance on identifying
performance obligations. ASU 2016-10 states that an entity “is not required to
assess whether promised goods or services are performance obligations if they
are immaterial in the context of the contract with the customer.” In addition,
the ASU indicates that an entity should consider materiality of items or
activities only at the contract level (as opposed to aggregating such items and
performing an assessment at the financial statement level). For additional
information, see Chapter
5.
C.4.2 Stand-Ready Obligations — Implementation Q&A 22 (Compiled From TRG Agenda Papers 16 and 25)
The revenue standard notes that promises in a contract with a
customer may be explicit or implicit and lists examples of promised goods or
services. One such example is “[p]roviding a service of standing ready to
provide goods or services . . . or of making goods or services available for a
customer to use as and when the customer decides,”11 referred to as stand-ready obligations.
The following broad types of promises or arrangements may
constitute stand-ready obligations:
-
Type A — The obligation to deliver goods or services is within the entity’s control, but additional development of the goods, services, or intellectual property (IP) is required.
-
Type B — The obligation to deliver goods or services is outside both the entity’s and the customer’s control.
-
Type C — The obligation to deliver goods or services is solely within the customer’s control.
-
Type D — The obligation is a promise to make goods or services available to the customer continuously over the contractual period.
The principle in the revenue standard requires an entity to
understand the nature of the promise. For example, in a contract to provide a
specified number of goods or services, the nature of the promise to the customer
is to provide those specified goods or services regardless of whether the
customer was able to specify the timing of transfer.
Further, Type A promises (e.g., a promise in a software or
biotechnology licensing arrangement to provide updates or upgrades when and if
available) should be closely evaluated to determine whether, in addition to a
stand-ready obligation, there are implicit promises to provide specified goods
or services. An implicit promise to provide a specified good or service may
result from the entity’s customary business practices, specific statements, or
other communications. All facts and circumstances should be evaluated to
determine the nature of the promise in the contract.
C.4.3 Distinct in the Context of the Contract — TRG Agenda Papers 9 and 11
ASC 606-10-25-21 lists three factors (not all-inclusive) to help
entities assess whether goods or services are distinct in the context of the
contract.
Stakeholder views differ on whether (and, if so, to what extent)
the existence of factors such as a customized or complex design, an entity’s
learning curve to produce the contractual goods or services, or the customer’s
motivation for purchasing the goods or services affects whether goods or
services are distinct in the context of the contract.
While TRG members generally agreed that such factors are not
individually determinative of whether goods or services are distinct in the
context of the contract, there were inconsistent views on whether the evaluation
should be performed (1) from the customer’s perspective, (2) from the entity’s
perspective, or (3) only on the basis of the contract. Some TRG members believed
that the entity should consider what items the customer has been promised and
whether the promised items will be integrated in some way. For example, many TRG
members agreed that an entity would need to evaluate the impact of design
services it performs in determining the performance obligations under a contract
(e.g., if the customer obtains control of the rights to the manufacturing
process developed by the entity).
The TRG also discussed how the entity’s knowledge of its
customer’s intended use of the goods or services would affect the determination
of whether the goods or services were highly interrelated. Many TRG members
expressed the view that an entity should consider whether the goods or services
could fulfill their intended purpose on a stand-alone basis or whether they are
inseparable because they affect the ability of the customer to use the combined
output for which it has contracted.
ASU 2016-10 refines the criteria for assessing whether promised
goods and services are distinct, specifically the “separately identifiable”
principle (the “distinct within the context of the contract” criterion) and
supporting factors. To further clarify this principle and the supporting
factors, the ASU adds six new examples and amends other examples to demonstrate
the application of the guidance to several different industries and fact
patterns. For further information, see Chapter 5.
C.4.4 Series of Distinct Goods or Services — Implementation Q&As 19 and 20 (Compiled From TRG Agenda Papers 27 and 34)
To promote simplicity and consistency in application,12 the revenue standard includes the concept of a series of distinct goods or
services that are substantially the same and have the same pattern of transfer
(the “series provision”).13 Accordingly, goods and services constitute a single performance obligation
if (1) they are “bundled” together because they are not distinct or (2) they are
distinct but meet the criteria that require the entity to account for them as a
series (and thus as a single performance obligation).
The FASB staff noted that:
-
Goods or services do not need to be transferred consecutively (i.e., an entity should look to the series provision criteria in ASC 606-10-25-15 to determine whether the goods or services are a series of distinct goods or services for which the entity is not explicitly required to identify a consecutive pattern of performance). Further, while the term “consecutively” is used in the Background Information and Basis for Conclusions of ASU 2014-09, the FASB staff noted that whether the pattern of performance is consecutive is not determinative of whether the series provision applies.
-
The accounting result for the series of distinct goods or services as a single performance obligation does not need to be the same as if each underlying good or service were accounted for as a separate performance obligation. Implementation Q&A 20 states that “[s]uch a requirement would almost certainly make it more difficult for entities to meet the requirement, and because the series provision is not optional, it likely would require entities to undertake a ‘with and without’ type analysis in a large number of circumstances to prove whether the series provision applies or not.”
C.4.5 Application of the Series Provision — Implementation Q&A 18 (Compiled From TRG Agenda Papers 39 and 44)
Stakeholders raised questions related to whether performance
obligations in long-term contracts meet the criteria to be accounted for under
the series guidance. Implementation Q&A 18 addresses how entities should
determine whether distinct goods or services are substantially the same. An
entity’s first step is to determine the nature of its promise of providing
services to its customer. For example, an entity will need to determine whether
the nature of the promise is to stand ready to perform or to provide a specified
quantity of a service. If the nature of the promise is to provide a single
service over a specified period or to stand ready, the evaluation would then
focus on whether each time increment is distinct and substantially the same.
Implementation Q&A 18 provides four examples that illustrate
the application of the framework for determining whether an entity is required
to apply the series guidance. The FASB staff’s analysis of one of those examples
in relation to step 2 of the revenue standard is summarized below.
Example and Analysis
A
provider of hotel management services enters into a
20-year contract to manage a customer’s properties. The
service provider receives consideration based on 1
percent of monthly rental revenue, reimbursement of
labor costs incurred, and an annual incentive fee of 8
percent of gross operating profit.
Step 2 —
Identifying a Performance Obligation
An entity would need to determine (1)
the nature of the services promised to the customer and
(2) whether the promised services are distinct and
substantially the same. The nature of the promised
service in the example was believed to be a single
integrated management service comprising distinct
activities (e.g., management of hotel employees,
accounting services, training, and procurement).
Day-to-day activities do not need to be identical to be
substantially the same. Therefore, while these
activities could vary from day to day, the nature of the
service is one that provides an integrated management
service and represents a single performance obligation
instead of multiple performance obligations (for each
underlying activity or different combinations of
activities).
C.4.6 Determining the Period Over Which an Entity Should Recognize a Nonrefundable Up-Front Fee — Implementation Q&A 52 (Compiled From TRG Agenda Papers 18, 25, 32, and 34)
A nonrefundable up-front fee (e.g., a one-time activation fee in
a month-to-month service contract) should be recognized over the contract period
if the entity concludes that the fee does not provide a material right.
Conversely, if the nonrefundable up-front fee provides the customer with a
material right, the fee should be recognized over the expected service period to
which the material right is related. An entity should consider both qualitative
and quantitative factors to determine whether a nonrefundable up-front fee
provides the customer with a material right. Factors to consider include the
price a new customer would pay for the same service, availability and pricing of
service alternatives, and the entity’s average customer life.
C.4.7 Assessing Whether Preproduction Activities Are a Promised Good or Service — Implementation Q&A 16 (Compiled From TRG Agenda Papers 46 and 49)
An entity should first evaluate the nature of its promise to the
customer and, in doing so, consider whether a preproduction activity is a
promised good or service (i.e., the preproduction activity transfers control of
a good or service to the customer) or a fulfillment activity. Further, the
criteria for determining whether an entity transfers control of a good or
service over time14 may be helpful in this assessment. If an entity determines that a
preproduction activity transfers control of a good or service to a customer over
time, it should include the preproduction activity in its measure of progress
toward complete satisfaction of its performance obligation(s).
C.4.8 Warranties — Implementation Q&A 17 (Compiled From TRG Agenda Papers 29 and 34)
The revenue standard provides guidance on when an entity should
account for a warranty as a performance obligation (e.g., if a customer has a
choice to purchase a warranty or the warranty provides a service in addition to
the assurance that the product complies with agreed-upon specifications). If the
warranty is a performance obligation, the entity would account for the warranty
by allocating a portion of the transaction price to that performance
obligation.15 The guidance includes three factors that the entity would consider in
making such a determination: (1) whether the warranty is required by law, (2)
the length of the coverage period, and (3) the nature of the tasks that are
promised.16
Questions continually arise about how an entity would determine
whether a product warranty that is not separately priced is a performance
obligation (i.e., whether the warranty represents a service rather than a
guarantee of the product’s intended functionality). For illustrative purposes,
the FASB staff offered an example in which a luggage company provides a lifetime
warranty to repair any damage to the luggage free of charge and noted that such
a warranty would be a separate performance obligation because the company agreed
to fix repairs for any damage (i.e., repairs extend beyond those that fix
defects preventing the luggage from functioning as intended).
The luggage example illustrates a relatively straightforward set of facts and
circumstances. However, the conclusion for other warranty arrangements may be
less clear. Accordingly, an entity will need to assess the substance of the
promises in a warranty arrangement and exercise judgment on the basis of the
entity’s specific facts and circumstances.
In addition, while the duration of the warranty (e.g., the lifetime warranty in
the luggage company example discussed) may be an indicator of whether a warranty
is a separate performance obligation, it is not determinative.
C.4.9 Identifying Performance Obligations in the Franchisor Industry — Implementation Q&A 24
Before the adoption of the revenue standard, franchisors would
generally recognize initial franchise fees when the franchisee location opened
in accordance with industry-specific GAAP. Under ASC 606, franchisors will need
to determine whether any preopening activities represent distinct goods or
services in addition to the right to use the franchisor’s IP. The transaction
price is allocated to distinct goods or services on the basis of their relative
stand-alone selling prices, and revenue is recognized when or as control of
those distinct goods or services is transferred. There is no presumption about
the number of performance obligations in a franchisor arrangement, and entities
should apply judgment to individual franchisor arrangements to determine the
number of performance obligations.
In January 2021, the FASB issued ASU 2021-02, which allows a
franchisor that is not a PBE (a “private-company franchisor”) to use a practical
expedient when identifying performance obligations in its contracts with
customers (i.e., franchisees) under ASC 606. When using the practical expedient,
a private-company franchisor that has entered into a franchise agreement would
treat certain preopening services provided to its franchisee as distinct from
the franchise license. In addition, a private-company franchisor that applies
the practical expedient must make a policy election to either (1) apply the
guidance in ASC 606 to determine whether the preopening services that are
subject to the practical expedient are distinct from one another or (2) account
for those preopening services as a single performance obligation. The practical
expedient and policy election are intended to reduce the cost and complexity of
applying ASC 606 to preopening services associated with initial franchise fees.
For additional information, see Section 5.3.5.
Footnotes
C.5 Step 3 — Determine the Transaction Price (Chapter 6 of the Roadmap)
C.5.1 Presentation of Amounts Billed to Customers (Gross or Net) — Implementation Q&A 27 (Compiled From TRG Agenda Papers 2 and 5)
In determining the transaction price under the revenue standard, an entity
should exclude “amounts collected on behalf of third parties” (e.g., some sales
taxes) in accordance with ASC 606-10-32-2. In many scenarios, however, it may be
unclear whether amounts billed to an entity’s customer (e.g., shipping and
handling fees, out-of-pocket expenses, taxes and other assessments remitted to
governmental authorities) are collected on behalf of third parties.
An entity can apply the principal-versus-agent implementation guidance in the
standard to the payments of shipping and handling fees, other out-of-pocket
expenses, and taxes (by analogy) to determine whether the nature of the entity’s
promise is to provide the specified good or service itself or to arrange for
another party to provide the good or service. The FASB staff outlined
considerations related to the application of the principal-versus-agent guidance
to these fees. An entity may consider whether it (1) is responsible for directly
providing or procuring the service, (2) has discretion in setting the price
charged (including whether the profit margin it earns is variable or fixed), and
(3) bears credit risk.
An entity that elects to exclude sales taxes from the transaction price, as
allowed under ASC 606-10-32-2A, is required to provide the accounting policy
disclosures in ASC 235-10-50-1 through 50-6. For additional information, see
Chapter 6.
C.5.2 Variable Consideration
C.5.2.1 Level of Application of the Constraint on Variable Consideration — Implementation Q&A 30 (Compiled From TRG Agenda Papers 14 and 25)
Stakeholders have questioned the unit of account for
recognizing variable consideration (i.e., whether variable consideration
should be assessed at the contract level or at the performance obligation
level). Variable consideration is included in the transaction price if the
entity concludes that it will not result in a significant revenue reversal.
An entity may reach a different conclusion depending on whether the
evaluation of significance is performed against the transaction price
allocated to a single performance obligation or against the total contract
transaction price. The evaluation of the constraint on variable
consideration should be applied at the contract level because the contract
is the unit of account for determining the transaction price.
C.5.2.2 Application of the Portfolio Practical Expedient to Variable Consideration — Implementation Q&A 39 (Compiled From TRG Agenda Papers 38 and 44)
When an entity applies the expected value method in
estimating variable consideration, it may consider evidence from similar
contracts to form its estimate of expected value. In a manner consistent
with the overall objective of the revenue standard, an entity is also
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 to be materially
different from applying the guidance to individual contracts.17
Stakeholders have questioned whether the evaluation of evidence from similar
contracts would mean that an entity is applying the portfolio practical
expedient (and would therefore need to meet the condition of reasonably
expecting that the results would not differ materially).
An entity is not necessarily applying the portfolio practical expedient when
it considers evidence from similar contracts to develop an estimate under
the expected value method.
C.5.2.3 Application of the Variable Consideration Constraint — Implementation Q&A 40 (Compiled From TRG Agenda Papers 38 and 44)
Stakeholders have questioned whether a transaction price estimated under the
expected value method can be an amount that is not a possible outcome for an
individual contract. If an entity applies the expected value method by using
a portfolio of data, the transaction price may be an amount that is not one
of the possible outcomes because the entity is not required to switch from
the expected value method to the most likely amount method when applying the
constraint. However, the entity must still consider the constraint on
variable consideration when determining the transaction price.
C.5.2.4 Assessing Whether a Contract Includes a Price Concession — Implementation Q&A 28 (Compiled From TRG Agenda Papers 13 and 25)
When an entity determines that it will collect less than the stated contract
price, it must use judgment to determine whether this lower amount is
attributable to a price concession (and should be accounted for as variable
consideration) or to credit risk (which may affect the collectibility
assessment as part of step 1). ASC 606-10-32-7 provides factors for an
entity to consider in making this determination, including historical
experience. Example 3 in ASC 606-10-55-102 through 55-105 also provides
factors for an entity to consider, including (1) the customer’s intention
and ability to pay and (2) the entity’s intentions and acceptance of
consideration. Implementation Q&A 28 further notes that paragraph BC193
of ASU 2014-09 “discusses how an entity should consider its intentions and
not only refer to past experience in assessing if a price concession has
been granted to a customer.”
C.5.2.5 Accounting for an Undefined Quantity of Outputs With a Fixed Contractual Rate per Unit — Implementation Q&A 41 (Compiled From TRG Agenda Papers 39 and 44)
The determination of whether a contract with an undefined quantity of outputs
and a fixed contractual rate per unit contains variable consideration
depends on an evaluation of the entity’s promise. If the promise is to
provide a daily integrated service or to stand ready to deliver an undefined
quantity of goods or services, the consideration is variable. If the
contract includes a defined number of goods or services to be delivered at a
stated rate, the consideration is not variable. Implementation Q&A 41
states that an entity should consider all substantive contractual terms,
including “contractual minimums or other clauses that would make some or all
of the consideration fixed.”
C.5.3 Consideration Payable to a Customer
C.5.3.1 Assessing Which Payments to a Customer Are Within the Scope of the Guidance on Consideration Payable to a Customer — Implementation Q&A 25 (Compiled From TRG Agenda Papers 19, 25, 28, 34, 37, and 44)
The TRG and the FASB staff considered the following views:
- An entity should assess all consideration payable (broadly, all payments) to a customer.
- An entity should assess only payments within the current contract (or combined contracts, if the revenue standard’s contract combination requirements are met).
TRG members generally concluded that an entity should not be required to
strictly apply either of these views. Instead, a reasonable application that
considers both views should lead to an appropriate outcome.
In effect, an entity should evaluate a payment to a customer (or to a
customer’s customer) — particularly when no goods or services have been
transferred — to determine the commercial substance of the payment and
whether the payment is linked (economically) to a revenue contract with the
customer.
C.5.3.2 Determining Who Constitute an Entity’s Customers — Implementation Q&A 26 (Compiled From TRG Agenda Papers 19, 25, 28, 34, 37, and 44)
An entity’s customers include customers in the distribution
chain and might include a customer’s customer beyond the distribution chain.
In addition, a contractual obligation to provide consideration to a
customer’s customer (e.g., beyond the distribution chain) would be
considered a payment to a customer.
C.5.3.3 Determining the Timing of Recognition of Variable Consideration Payable to a Customer — Implementation Q&A 29 (Compiled From TRG Agenda Papers 19, 25, 28, 34, 37, and 44)
Although the revenue standard’s variable consideration
guidance would arguably apply to consideration payable to a customer if such
consideration is variable, some stakeholders believe that a requirement to
include variable consideration payable to a customer in the transaction
price may be inconsistent with the requirement to delay the recognition of
consideration payable to a customer until the entity pays or promises to
pay.
Implementation Q&A 29 states that the reversal of revenue from variable
consideration or consideration payable to a customer “should be made at the
earlier of the date that there is a change in the transaction price in
accordance with paragraph 606-10-32-25 or the date at which the
consideration payable to a customer is promised in accordance with paragraph
606-10-32-27.” The determination of when the transaction price changes will
require judgment. In addition, the promise to pay consideration may occur
before a formal offer is made because there could be an implied promise
based on customary business practice.
C.5.3.4 Up-Front Payments to Customers and Potential Customers — Implementation Q&A 43 (Compiled From TRG Agenda Papers 59 and 60)
The FASB staff believes that the revenue standard is clear
about the accounting for payments made to a customer when the payments are
made entirely as part of a current contract with the customer. However, the
FASB staff believes that the revenue standard is less clear about the timing
of recognizing an up-front payment as a reduction of revenue when either (1)
a revenue contract does not exist (i.e., an entity makes a payment to
incentivize the 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.
Accordingly, stakeholders have articulated the following two views about
when an up-front payment to a customer should be recognized as a reduction
of revenue:
-
View A — Up-front payments to customers should be recognized as an asset and “amortized” as a reduction of revenue as the related goods or services are provided to the customer, which may continue beyond the current contract term.
-
View B — Up-front payments to customers should be recognized as a reduction of revenue only over the current contract term (i.e., recognition of the up-front payment should not extend beyond the current contract term). If a contract does not exist, the up-front payments should be recognized as a reduction of revenue immediately.
View A would be appropriate in many circumstances. However, when applying
View A, an entity should consider whether the payment meets the definition
of an asset, which requires consideration of whether the payment results in
a probable future economic benefit. Consequently, TRG members acknowledged
that View B would be appropriate in some situations. The accounting for
up-front payments to customers under View A or View B is not a policy
election. Rather, as stated in Implementation Q&A 43, “an entity should
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.”
C.5.4 Noncash Consideration — TRG Agenda Papers 15 and 25
Stakeholders have noted that there are different interpretations regarding when noncash consideration should be measured and that the measurement date for noncash consideration has been variously viewed as (1) the time of contract inception, (2) the time at which the noncash consideration is received (or is receivable), and (3) the earlier of when the noncash consideration is received (or is receivable) or when the related performance obligation is satisfied (or as the performance obligation is satisfied, if satisfied over time).
In addition, stakeholders have indicated that it is unclear from the revenue
standard:
-
How to apply the guidance on the inclusion of variable consideration in the transaction price when variability in fair value is attributable to both the form of consideration (e.g., changes in the share price of publicly traded shares of stock received as noncash consideration) and reasons other than the form of consideration (e.g., the number of shares of publicly traded stock that can be given as noncash consideration may change).
-
How to apply the constraint to transactions in which variability in the fair value of noncash consideration is attributable to both the form of consideration and reasons other than the form of consideration.
The TRG did not reach general agreement on how the revenue standard should be
applied to address the implementation issues noted. As a result, TRG members
noted that additional clarification would be helpful.
ASU 2016-12 clarifies that an entity’s calculation of the transaction price for contracts containing noncash consideration would include the fair value of the noncash consideration to be received as of the contract inception date. Further, subsequent changes in the fair value of noncash consideration after contract inception would be included in the transaction price as variable consideration (subject to the variable consideration constraint) only if the fair value varies for reasons other than its form. For additional information, see Chapter 6.
C.5.5 Significant Financing Components
C.5.5.1 How Broadly to Interpret the Factor in ASC 606-10-32-17(c) 18 — Implementation Q&A 31 (Compiled From TRG Agenda Papers 20, 25, 30, and 34)
ASC 606-10-32-17(c) does not contain a rebuttable presumption that an entity
would need to overcome (e.g., regarding the existence or nonexistence of a
significant financing component). Rather, an entity will need to use
judgment to evaluate the facts and circumstances of a transaction when there
is a difference in timing between when goods and services are transferred
and when the promised consideration is paid. An entity should consider both
advance payments and payments in arrears to determine whether there is a
significant financing benefit to the customer or itself. When an entity
makes this assessment, it must consider whether any difference between the
cash selling price and the promised consideration is proportional to the
reason for the difference before concluding that the difference arises for
reasons other than providing financing.
C.5.5.2 How to Apply the Guidance When the Promised Consideration Is Equal to the Cash Selling Price — Implementation Q&A 32 (Compiled From TRG Agenda Papers 20, 25, 30, and 34)
An entity should not automatically presume that no significant financing
component exists if the list price, cash selling price, and promised
consideration are the same. Further, a difference in those amounts does not
create a presumption that a significant financing component exists; rather,
it would require an evaluation.
C.5.5.3 Whether an Entity Can Account for Financing Components That Are Not Significant — Implementation Q&A 33 (Compiled From TRG Agenda Papers 30 and 34)
The revenue standard neither requires entities to account for insignificant
financing components nor precludes them from doing so.
C.5.5.4 Whether the Practical Expedient 19 Can Be Applied When There Is a Single Payment Stream for Multiple Performance Obligations — Implementation Q&A 34 (Compiled From TRG Agenda Papers 30 and 34)
The FASB staff cited an example of a two-year customer contract under which an
entity delivers a device at contract inception and provides a service over
the two-year term, with monthly payments. There are two alternative views on
determining whether the practical expedient applies in this situation (i.e.,
determining the period between the transfer of goods or services and the
receipt of payment):
- View A — An entity would first allocate the monthly consideration to only the first item delivered (i.e., the device in the example, which would be delivered at contract inception). In this situation, because the timing of the transfer of the goods and services and receipt of the customer’s payment is less than one year (i.e., monthly revenue was first allocated to the device), the entity could apply the practical expedient.
- View B — An entity would proportionately allocate the monthly consideration to the device and services. Use of the practical expedient in this situation would not be permitted because the period between the transfer of goods and services (collectively) and the receipt of payment is greater than a year (i.e., two years).
In some cases, it may be clear that cash collected is related to specific
performance obligations; in other cases, that may not be clear. For the
example discussed, the FASB and IASB staffs indicated in TRG Agenda Paper 30
that View B is appropriate because they believed that View A did not
appropriately reflect the economics of the transaction. Further, the staffs
acknowledged, and TRG members generally agreed with the staffs, that
assessing whether an entity can apply the practical expedient when there is
a single payment stream for multiple performance obligations may be complex
and will require judgment on the basis of the facts and circumstances.
C.5.5.5 How to Calculate Interest for a Significant Financing Component — Implementation Q&A 36 (Compiled From TRG Agenda Papers 30 and 34)
The revenue standard does not explicitly address subsequent measurement, but
entities should apply the guidance in ASC 835-30.
C.5.6 Accounting for Restocking Fees and Related Costs — Implementation Q&As 42 and 77 (Compiled From TRG Agenda Papers 35 and 44)
Stakeholders have raised questions regarding the appropriate accounting for
restocking fees collected from customers and restocking costs (e.g., estimated
shipping or repackaging) for expected returns.
An entity should include restocking fees for expected returns as part of the
transaction price when control is transferred. In addition, a returned product
subject to a restocking fee should be accounted for in a manner similar to how
an entity would account for a partial return right (i.e., the restocking fee
should be included in the transaction price if the entity is entitled to that
amount).
Further, Implementation Q&A 77 states that an entity’s restocking costs for
expected returns “should be recognized as a reduction of the carrying amount of
the asset expected to be recovered at the point in time control of the product
transfers to the customer.”
Footnotes
17
ASC 606-10-10-4.
18
The guidance states that there is no significant
financing component when the “difference between the promised
consideration and the cash selling price of the good or service (as
described in [ASC] 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.”
19
ASC 606-10-32-18 states, “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.”
C.6 Step 4 — Allocate the Transaction Price (Chapter 7 of the Roadmap)
C.6.1 Allocating Discounts and Variable Consideration — Implementation Q&A 38 (Compiled From TRG Agenda Papers 31 and 34)
Because discounts may be variable consideration, stakeholders have questioned which guidance should be applied when an entity’s contract with a customer includes a discount.
TRG members generally agreed with the FASB and IASB staffs that ASC 606-10-32-41
establishes a hierarchy that requires an entity to identify, and allocate
variable consideration to, performance obligations before applying other
guidance (e.g., the guidance on allocating a discount). Accordingly, an entity
would first determine whether a discount is variable consideration. If the
entity concludes that the discount is variable consideration, it would apply the
variable consideration allocation guidance if the related criteria are met.
Otherwise, the entity would look to the discount allocation guidance to
determine how to allocate the discount.
C.6.2 Allocating Variable Consideration to a Series of Distinct Services — Implementation Q&A 45 (Compiled From TRG Agenda Papers 39 and 44)
Stakeholders have questioned whether an entity is required to allocate variable
consideration on the basis of the relative stand-alone selling price of each
distinct good or service in a series accounted for as a single performance
obligation under ASC 606-10-25-14(b) (i.e., the series guidance).
As stated in ASC 606-10-32-29, the general allocation principle does not apply if the
criteria in ASC 606-10-32-39 through 32-41 are met. A relative stand-alone selling
price allocation is not required for an entity to assess whether the criteria in ASC
606-10-32-40 are met. Entities should use reasonable judgment to determine a
reasonable allocation. Implementation Q&A 45 includes illustrative examples,
which are summarized as follows:
- Example A — An entity provides services under a multiyear IT outsourcing arrangement with continuous delivery of various activities over the contract term. The price per unit declines over time, reflecting the expected decreasing level of effort required. In addition, price benchmarking will be performed at various points during the contract, and pricing will be updated prospectively if market prices are significantly below the contract prices. The allocation objective may be met because the pricing is based on market terms and the decreasing prices are associated with declining costs of fulfilling the obligation.
- Example B — An entity provides transaction processing over a multiyear term, with fees due that are based on a percentage of the dollar value processed in each transaction. The allocation objective may be met for each month of service if the fees are priced consistently throughout the contract and the rates are consistent with prices charged to other similar customers.
- Example C — An entity provides hotel management services during a multiyear term, with fees due that are based on (1) a percentage of monthly rental revenue, (2) reimbursement of labor costs, and (3) a percentage of gross operating profit. The fees based on monthly rental revenue in this example are similar to fees in the hotel management example in paragraph BC285 of ASU 2014-09, which are based on occupancy rates. Accordingly, those fees may meet the allocation objective for each month of service because they reflect the value transferred to the customer in each period. In addition, the reimbursement fees may meet the allocation objective if they are representative of the costs incurred to fulfill the contract each period. Further, the fees based on a percentage of gross operating profit may meet the allocation objective if they reflect the value transferred to the customer in each period.
- Example D — An entity provides a franchisee with the right to use its trade name and sell its products over a multiyear term. The entity will receive a sales-based royalty based on a fixed percentage of the franchisee’s sales. The allocation objective may be met because the fee earned each day is based on a consistent formula and percentage throughout the term and represents the value transferred to the customer each period.
C.6.3 How to Apply the Significant Financing Component Guidance to Contracts With Multiple Performance Obligations — Implementation Q&A 37 (Compiled From TRG Agenda Papers 30 and 34)
An entity will need to use judgment when attributing a
significant financing component to one or more performance obligations. It may
be more consistent with the overall allocation objective in ASC 606-10-32-28 to
attribute the effect of a significant financing component to one or more (but
not all) performance obligations in a contract by analogizing to the guidance on
allocating variable consideration or to the guidance on allocating a
discount.
C.7 Step 5 — Recognize Revenue (Chapter 8 of the Roadmap)
C.7.1 Revenue Recognition Over Time
Because the guidance in ASC 606-10-25-27 on recognizing revenue
over time (specifically, the criterion in ASC 606-10-25-27(c)) introduces new
concepts, stakeholders have raised the following issues regarding whether an
entity should recognize revenue over time:
-
Whether an entity that has recognized revenue at a point in time under legacy U.S. GAAP can be required to recognize revenue over time under the revenue standard.
-
Whether the alternative-use assessment in ASC 606-10-25-27(c) should be based on the completed asset or the in-production asset.
-
How and when an entity should determine whether it has an enforceable right to payment in accordance with ASC 606-10-25-27(c).
C.7.1.1 Recognition of Revenue That Has Historically Been Recorded at a Point in Time — Implementation Q&A 54 (Compiled From TRG Agenda Papers 56 and 60)
Revenue from certain contracts (e.g., production-of-goods
contracts) that has historically been accounted for on a point-in-time basis
may need to be accounted for over time under the revenue standard because
the goods in such contracts have no alternative use to the entity and the
entity has an enforceable right to payment. Each contract should be
evaluated, and an entity should not presume that it will continue to
recognize revenue at a point in time (or over time) because it did so under
legacy revenue guidance.
C.7.1.2 Alternative-Use Assessment — Implementation Q&A 55 (Compiled From TRG Agenda Papers 56 and 60)
The alternative-use assessment should be performed at contract inception and
should take into account the characteristics of the asset that will
ultimately be transferred to the customer.
C.7.1.3 Enforceable Right to Payment — Implementation Q&As 56 and 57 (Compiled From TRG Agenda Papers 56 and 60)
Depending on the facts and circumstances, an enforceable right to payment may
not be required before customization for the contract to qualify for revenue
recognition over time (e.g., an entity need not obtain an enforceable right
to payment for standardized raw materials needed in the final customized
product). In such circumstances, performance on the customer’s contract may
begin only once those standardized raw materials are placed into the
customization phase of the product. That is, for purposes of assessing
whether an enforceable right to payment exists, the customer’s contract may
begin only when the customization commences and continues through the final
completion of the product.
An entity should determine whether there is an enforceable right to payment
by using the contractual terms and relevant legal precedent regardless of
the entity’s history or intention of enforcing those terms.
Stakeholders have noted that private companies may not have the processes and
internal controls in place to obtain legal determinations for all revenue
contracts. There is no requirement in the revenue standard that companies
consult with legal counsel to determine whether there is an enforceable
right to payment. Implementation Q&A 57 states that “[i]n the [FASB]
staff’s view, a reasonable interpretation of the guidance is that when a
contract’s written terms do not specify the entity’s right to payment upon
contract termination, an enforceable right to payment is presumed not to
exist.”
C.7.2 Evaluating How Control Is Transferred Over Time — Implementation Q&A 51 (Compiled From TRG Agenda Papers 53 and 55)
Stakeholders have questioned whether an entity that is performing over time can
transfer control of a good or service underlying a performance obligation at
discrete points in time. Satisfaction of any of the requirements for recognition
over time implies that control is not transferred at discrete points in time.
Therefore, an entity’s use of an appropriate measure of progress should not
result in its recognition of a material asset (e.g., work in progress) for
performance the entity has completed. This is supported by paragraphs BC125,
BC128, BC130, BC131, BC135, and BC142 of ASU 2014-09, which clarify that control
of any asset (such as work in progress) is transferred to the customer as
progress is made.
There could be times when an entity may recognize an immaterial asset (e.g., work
in progress) under a recognition-over-time model because the entity’s selected
measure of progress may not perfectly match its performance.
C.7.3 Practical Expedient for Measuring Progress Toward Complete Satisfaction of a Performance Obligation — Implementation Q&A 46 (Compiled From TRG Agenda Papers 40 and 44)
Stakeholders have asked whether the invoice practical expedient may be used for
contracts in which the unit price or rate varies during the contract period. In
analyzing the question, the FASB staff referred to two examples: (1) a six-year
contract in which an electric power company sells energy to a buyer at rates
that increase every two years and (2) an IT outsourcing contract in which the
prices decrease over the contract period.20
The invoice practical expedient could be used for both contract examples because
the respective price and rate changes reflect the “value to the customer of each
incremental good or service that the entity transfers to the customer.”21 For the energy contract, the changing prices “reflect the value to the
customer because the rates are based on one or more market indicators”;22 and the changing prices in the IT outsourcing contract “reflect the value
to the customer, which is corroborated [through] (1) the benchmarking (market)
adjustment and (2) declining costs (and level of effort) of providing the tasks
that correspond with the declining pricing of the activities.”23
In addition, the FASB staff discussed up-front and back-end fees, noting that
while such fees do not preclude application of the invoice practical expedient,
entities must use judgment in determining whether the value of the fee to the
customer corresponds to the amount transferred to the customer.
C.7.4 Measuring Progress When Multiple Goods or Services Are Included in a Single Combined Performance Obligation — Implementation Q&As 47 and 48 (Compiled From TRG Agenda Papers 41 and 44)
Stakeholders have questioned:
- Whether an entity may apply more than one method to measure the progress of a performance obligation containing multiple goods or services that are bundled and recognized over time.
- How to measure progress toward satisfaction of a performance obligation involving a bundle of goods or services. For example, if multiple promised goods or services in a performance obligation are delivered in various periods, there are questions about how an entity should select a single method by which to measure progress for the respective goods and services.
A common (i.e., single) measure of progress is required for a single performance
obligation. Selecting a common measure of progress may be challenging when a
single performance obligation contains more than one good or service or has
multiple payment streams, and the selection is not a free choice. Further, while
a common measure of progress that does not depict the economics of the contract
may indicate that the arrangement contains more than one performance obligation,
it is not determinative.
C.7.5 Partial Satisfaction of Performance Obligations Before the Contract Is Identified — Implementation Q&As 53 and 76 (Compiled From TRG Agenda Papers 33 and 34)
Entities sometimes begin activities on a specific anticipated contract with
their customer before (1) they agree to the contract or (2) the contract meets
the criteria in step 1 of the revenue standard. The FASB staff refers to the
date on which the contract meets the step 1 criteria as the “contract
establishment date” (CED) and refers to activities performed before the CED as
“pre-CED activities.”24
The FASB staff noted that stakeholders have identified two issues with respect to
pre-CED activities: (1) how to recognize revenue from pre-CED activities and (2)
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 that transfer a good or service to the customer 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.
Certain fulfillment costs incurred before the CED are capitalized as costs of
fulfilling an anticipated contract. However, these costs would be expensed
immediately as of the CED if they are related to progress made to date because
the goods or services constituting a performance obligation have already been
transferred to the customer. The remaining asset would be amortized over the
period in which the related goods or services will be transferred to the
customer.
C.7.6 Determining When Control of a Commodity Is Transferred — Implementation Q&A 50 (Compiled From TRG Agenda Papers 43 and 44)
Stakeholders have raised questions regarding the determination of when an entity
transfers control of a commodity. Specifically, they have questioned whether
revenue for delivery of a commodity should be recognized at a point in time or
over time. One of the criteria for recognizing revenue over time is the
customer’s simultaneous receipt and consumption of the benefits of the commodity
as the entity performs.25
Before evaluating the criteria in ASC 606-10-25-27, an entity will need to
consider all relevant facts and circumstances to determine the nature of the
promise to the customer in the contract. For example, the nature of a promise to
deliver a commodity on demand may differ from that of a promise to deliver a
specified quantity of a commodity into a customer’s storage. Implementation
Q&A 50 states that the relevant facts and circumstances to be considered
include “the inherent characteristics of the commodity, the contract terms, and
information about infrastructure or other delivery mechanisms.”
C.7.7 Measuring Progress Toward Complete Satisfaction of a Stand-Ready Performance Obligation — Implementation Q&A 49 (Compiled From TRG Agenda Papers 16 and 25)
Although ASC 606 does not permit an entity to use by default a straight-line
measure of progress based on the passage of time (because a straight-line
measure of progress may not faithfully depict the pattern of transfer), ASC 606
does not prohibit the use of a straight-line measure of progress, and such a
time-based method may be reasonable in some cases depending on the facts and
circumstances. An entity would need to use judgment to select an appropriate
measure of progress on the basis of the arrangement’s particular facts and
circumstances.
Example 18 in ASC 606-10-55-184 through 55-186 illustrates a health club
membership involving an entity’s stand-ready obligation to provide a customer
with one year of access to any of the entity’s health clubs. In the example, the
entity determines that the customer benefits from the stand-ready obligation
evenly throughout the year. Therefore, a time-based measure of progress is
appropriate.
Implementation Q&A 49 provides additional examples of stand-ready obligations
and discusses considerations related to selecting an appropriate measure of
progress as follows:
- Example A — An entity providing helpdesk support services does not know when a customer will call and require services. The customer benefits evenly throughout the period from the availability of the service. In addition, since the entity’s costs may be fixed throughout the term regardless of the level of activity from customers, a time-based input measure of progress may also result in the same pattern of recognition.
- Example B — An entity providing snow removal services does not know when it will snow, and the entity’s promise is to stand ready to provide services when and if it snows. However, the entity may conclude that because the likelihood of snow will fluctuate throughout the year, it should select a more reasonable measure of progress based on its expectation of increased efforts during winter months.
- Example C — An entity providing a cable television service does not know when the customer will access the content by using the entity’s service. The customer benefits evenly throughout the period from the availability of the service.
Implementation Q&A 49 notes that similarly, a software vendor may provide
unspecified updates or upgrades over a defined term but may not know when or to
what extent they will be made available. Because the customer benefits evenly
throughout the period from the promise that any updates or upgrades developed
will be made available to the customer, a time-based measure of progress is
generally appropriate.
Footnotes
20
Considered in TRG Agenda Paper 40.
21
Quoted from paragraph BC167 of ASU 2014-09. The FASB
staff also clarified that the phrase “value to the customer” has a
context in ASC 606-10-55-17 that differs from its context in ASC
606-10-55-18.
22
Quoted from Implementation Q&A 46.
23
See footnote 22.
24
Implementation Q&A 53 states that pre-CED activities
may include (1) “administrative tasks that neither result in the
transfer of a good or service to the customer, nor fulfill the
anticipated contract”; (2) “[a]ctivities to fulfill the anticipated
contract but which do not result in the transfer of a good or service,
such as set-up costs”; or (3) “[a]ctivities that transfer a good or
service to the customer at or after the CED.”
25
See ASC 606-10-25-27(a).
C.8 Contract Modifications (Chapter 9 of the Roadmap)
C.8.1 Contract Asset Treatment in Contract Modifications — Implementation Q&A 81 (Compiled From TRG Agenda Papers 51 and 55)
The revenue standard provides an overall framework for modification
accounting.26 For example, when a contract modification meets the conditions in ASC
606-10-25-13(a), the modification is accounted for prospectively as a
termination of the existing contract and creation of a new one. The revenue
standard also requires entities to record contract assets27 in certain circumstances, and these assets may still be recorded at the
time of a contract modification.
When a contract modification meets the conditions in ASC
606-10-25-13(a), contract assets that existed before the modification should be
carried forward to the new contract and realized as receivables28 are recognized (i.e., revenue is not reversed, leading to prospective
accounting for the effects of the contract assets).
This accounting reflects the objective of ASC 606-10-25-13. As noted in
Implementation Q&A 81, ASC 606-10-25-13(a)(1) “explicitly states that the
starting point for the determination [of the allocation in a modification] is
the transaction price in the original contract less what had already been
recognized as revenue.” Further, this accounting is consistent with paragraph
BC78 of ASU 2014-09, which notes that the intent of ASC 606-10-25-13(a) is to
avoid adjusting revenue for performance obligations that have been satisfied
(i.e., such modifications would be accounted for prospectively).
Footnotes
C.9 Principal-Versus-Agent Considerations (Chapter 10 of the Roadmap)
C.9.1 Assessing Whether an Entity Is a Principal or an Agent — TRG Agenda Papers 1 and 5
Arrangements involving “virtual” goods and services — intangible goods and services that continue to be offered on the Internet through social networking Web sites and mobile application stores — may complicate the assessment of whether an entity is a principal or an agent. Because of the nature of such arrangements (and others, such as arrangements involving rights conveyed through gift cards), the TRG discussed the following implementation issues:
- How control would be assessed with respect to the originator and intermediary, including the impact on the principal-agent assessment when an originator has no knowledge of the amount an intermediary charged a customer for virtual goods or services.
- The order of steps for determining whether an entity is a principal or an agent. For example, it is unclear whether (1) the agency indicators in the revenue standard are intended to help an entity initially assess who controls the goods or services or (2) the entity would apply the agency indicators only after it cannot readily determine who controls the goods or services.
- How to apply the agency indicators to the originator and intermediary (e.g., if certain indicators apply to both the originator and the intermediary).
- Whether certain indicators either are more important or should be discounted (e.g., whether inventory risk would be applicable in arrangements involving virtual goods or services).
In addition, the revenue standard requires an entity to allocate the total
consideration in a contract with a customer to each of the entity’s performance
obligations under the contract, including discounts. Stakeholders have
questioned whether discounts should be allocated to all performance obligations
and whether consideration should be allocated on a gross or net basis if the
entity is a principal for certain performance obligations but an agent for
others.
TRG members did not reach general agreement on the issues discussed and believed
that clarifications to principal-versus-agent guidance in the revenue standard
would be helpful.
In March 2016, the FASB issued ASU 2016-08 to address issues raised
regarding how an entity should assess whether it is the principal or the agent
in contracts that include three or more parties. Specifically, the guidance in
ASU 2016-08 requires an entity to determine:
-
The nature of its promise to the customer. If the entity’s obligation is to provide the customer with a specified good or service, it is the principal. Otherwise, if the entity’s obligation is to arrange for the specified good or service to be provided to the customer by a third party, the entity is an agent.
-
Who controls the specified good or service before it is transferred to the customer. ASC 606-10-55-37, as amended by ASU 2016-08, states, in part, that an “entity is a principal if it controls the specified good or service before that good or service is transferred to a customer.”
Further, ASU 2016-08 clarifies that the unit of account is a specified good or
service (which is a distinct good or service or a bundle of distinct goods or
services) and that an entity may be the principal with respect to certain
specified goods or services in a contract but may be an agent with respect to
others.
The ASU also adds clarifying guidance on the types of goods or services that a
principal may control29 and reframes the principal-versus-agent indicators in the revenue standard
to (1) illustrate when an entity may be acting as a principal instead of when an
entity acts as an agent and (2) explain how each indicator is related to the
control principle.
ASU 2016-08 does not amend the guidance in ASC 606 as originally issued to
directly address the accounting for situations in which the originator has no
knowledge of the amount an intermediary charges a customer for goods or
services. However, paragraph BC38 of the ASU clarifies that the guidance in ASC
606 on variable consideration is helpful in the determination of what amounts
should be included in the transaction price. Specifically, paragraph BC38(c)
states, in part:
A key tenet of variable consideration is that at some point the
uncertainty in the transaction price ultimately will be resolved. When
the uncertainty is not expected to ultimately be resolved, the guidance
indicates that the difference between the amount to which the entity is
entitled from the intermediary and the amount charged by the
intermediary to the end customer is not variable consideration and,
therefore, is not part of the entity’s transaction price.
For additional information, see Chapter 10.
C.9.2 Allocation of the Transaction Price When an Entity Is a Principal for Some Goods or Services and an Agent for Others — Implementation Q&A 44 (Compiled From TRG Agenda Papers 1 and 5)
Stakeholders have questioned how the transaction price should be allocated in a
contract when an entity is a principal for some promised goods or services and
an agent that is arranging for the transfer of other goods or services.
First, an entity should consider whether its arrangement involves a single
customer or multiple customers. If the entity identifies two or more customers,
it may not be appropriate to allocate a discount to all goods or services in the
contract because the contract combination guidance does not apply to contracts
with more than one customer. In this scenario, the discount would be allocated
entirely to one contract (e.g., in which the entity is acting as a
principal).
If there is a single customer in the arrangement (i.e., the entity is acting as
both a principal and an agent in a contract with a customer), the entity will
need to consider whether it can allocate the discount to one or more, but not
all, performance obligations in the contract. If it does not meet the criteria
to allocate the discount to one or more, but not all, performance obligations,
the entity may conclude that it is appropriate to allocate the discount to all
performance obligations in the contract.
Footnotes
29
See ASC 606-10-55-37A (added by the ASU).
C.10 Material Rights (Chapter 11 of the Roadmap)
C.10.1 Relevant Factors to Evaluate in Assessing Customer Options for Material Rights — Implementation Q&As 12 and 13 (Compiled From TRG Agenda Papers 6 and 11)
In determining whether an option for future goods or services is
a material right, an entity should (1) consider factors outside the current
transaction (e.g., the current class of customer30) and (2) assess both quantitative and qualitative factors. An entity
should also evaluate incentives and programs to understand whether they are
customer options designed to influence customer behavior (i.e., an entity should
consider incentives and programs from the customer’s perspective) because this
could be an indicator that an option is a material right.
For example, regarding certain offers, such as buy three and get
one free, an entity would consider the fact that its customer has “earned”
one-third of a free product, as well as whether the customer is likely to
purchase the additional two products that would entitle it to the free product.
Such an indicator may lead an entity to conclude that a customer option is a
material right.
Similarly, an entity would consider loyalty programs that have
an accumulation feature. Through the presence of an accumulation feature in a
loyalty program, the entity may give its customers a material right. In its
evaluation, the entity should consider that an element of the right granted to
the customer in the current transaction is the customer’s ability to accumulate
loyalty points that will entitle the customer to a free product.
C.10.2 Considering the Class of Customer in the Evaluation of Whether a Customer Option Gives Rise to a Material Right — Implementation Q&A 14 (Compiled From TRG Agenda Papers 54 and 55)
Stakeholder views have differed regarding how the class of
customer should be considered in an entity’s evaluation of whether a customer
option gives rise to a material right.
TRG members debated the application of concepts in the framework
the staff used to analyze the examples in TRG Agenda Paper 54 but did not reach
general agreement on (1) how or when to consider past transactions in
determining the class of customer and (2) how the class of customer should be
evaluated in the determination of the stand-alone selling price of an optional
good or service.
A few TRG members maintained that discounts or status achieved
through past transactions is akin to accumulating features in loyalty programs
(and that such features therefore represent material rights). However, others
indicated that these programs represent marketing inducements (i.e., discounts)
for future transactions that should be evaluated in relation to those offered to
other similar customers or potential customers (e.g., other high-volume
customers or potential high-volume customers). The TRG members who viewed the
programs as marketing inducements believed that considering a customer’s past
transactions, among other factors, is appropriate in the evaluation of whether a
good or service being offered to the customer reflects the stand-alone selling
price for that class of customer in accordance with ASC 606-10-55-42
(particularly for entities that have limited alternative sources of information
available upon which to establish a customer’s class). Further, these TRG
members focused on the facts that (1) similar discounts on future transactions
(like those provided in the form of benefits and other offers in status programs
for no additional fees) may be given to other customers who did not make or have
the same level of prior purchases with the entity and (2) such discounts may be
provided at the stand-alone selling price for that class of customer (i.e., the
good or service is not priced at a discount that is incremental to the range of
discounts typically offered to that class of customer and therefore does not
represent a material right).
Because general agreement was not reached, certain Board members
recommended that the staff perform additional outreach, particularly with
preparers in the travel and entertainment industries and with procurement
personnel in large organizations, to understand how discounts and tier status
programs are negotiated and structured.
Implementation Q&A 14 includes three examples that
illustrate the FASB staff’s view on how the class of customer is considered in
the evaluation of whether a customer option gives rise to a material right. The
examples outline the view that an option offered to a customer should be
compared with offers made to similar customers (e.g., similar high-volume
customers) at prices independent of a prior contract (i.e., offers made to
customers who do not have a prior contractual relationship with the entity).
Significant judgment will be required to determine whether customers are
comparable.
C.10.3 Distinguishing Optional Purchases From Variable Consideration — Implementation Q&A 23 (Compiled From TRG Agenda Papers 48 and 49)
Implementation Q&A 23 outlines a framework under which an
entity would perform an evaluation of the nature of its promises in a contract
with a customer. Such evaluation would include a careful assessment 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. 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.
C.10.4 When Optional Goods and Services Would Be Considered Separate Performance Obligations — Implementation Q&A 21 (Compiled From TRG Agenda Papers 48 and 49)
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). Accordingly, optional goods and services would be accounted for in
the current contract if they represent material rights or are considered
variable consideration because the entity has legal rights and obligations under
the contract.
C.10.5 How to Evaluate a Material Right for the Existence of a Significant Financing Component — Implementation Q&A 35 (Compiled From TRG Agenda Papers 18, 25, 32, and 34)
While the determination of whether there is a significant
financing component associated with a material right depends on the facts and
circumstances, entities would need to evaluate material rights for the existence
of significant financing components in a manner similar to how they would
evaluate any other performance obligation. In accordance with ASC
606-10-32-17(a), if the timing of when the customer will exercise an option that
provides it with a material right is at the customer’s discretion, no
significant financing component would exist. In addition, under the practical
expedient in ASC 606-10-32-18, an entity would not adjust the transaction price
for a significant financing component if the entity expects, at contract
inception, that the promised good or service will be delivered within one year
of customer payment.
C.10.6 Accounting for a Customer’s Exercise of a Material Right — Implementation Q&A 15 (Compiled From TRG Agenda Papers 18, 25, 32, and 34)
In Implementation Q&A 15, the FASB staff states that the
guidance in ASC 606 can reasonably be interpreted to allow an entity to account
for a customer’s exercise of a material right in either of the following
ways:
-
As a change in the contract’s transaction price31 (i.e., a continuation of the contract, whereby the additional consideration would be allocated to the performance obligation associated with the material right).
-
As a contract modification32(which may require reallocation of consideration between remaining performance obligations from the original contract and the performance obligation associated with the exercised material right).
The FASB staff adds that the entity’s chosen approach “should be
applied consistently . . . to similar types of material rights with similar
facts and circumstances.”
Although Implementation Q&A 15 does not discuss TRG members’
views, TRG Agenda Paper 34 notes that TRG members generally preferred that
entities account for the exercise of a material right as a change in the
contract’s transaction price but believed that it would be acceptable for an
entity to account for the exercise of a material right as a contract
modification.
Footnotes
C.11 Licensing (Chapter 12 of the Roadmap)
C.11.1 Licenses of IP — TRG Agenda Papers 8 and 11
Because of the impact of a licensor’s ongoing activities on the determination of whether a license of IP is a right-to-use or right-to-access license, the TRG discussed how entities should evaluate such ongoing activities. Issues noted by stakeholders include whether:
- An entity is required to identify the nature of a license when the license is not distinct (i.e., determine whether the license is satisfied over time or at a point in time when it is not a separate performance obligation).
- A license may be classified as a right to access:
- Only if the licensor’s contractual or expected activities change the form or functionality of the underlying IP.
- If there are significant changes in the value of the IP (because such changes alone would constitute a change to the IP).
- In the case of a license that does not require the customer to use the most recent version of the underlying IP, the licensor’s activities directly expose the customer to positive or negative effects of the IP.
- Activities transferring a good or service that is not separable from a license of IP should be considered to determine the nature of the license.
- Restrictions in a contract for a license of IP affect the determination of the number of performance obligations in the contract (i.e., the number of distinct licenses).
TRG members did not reach general agreement on these topics and believed that clarifications to the guidance would be helpful.
In April 2016, as noted in Section C.4.1, the FASB issued ASU 2016-10, which amends certain
aspects of the revenue standard, including the implementation guidance on
licensing. The ASU revises the guidance in ASC 606 to distinguish between two
types of licenses: (1) functional IP and (2) symbolic IP, which are classified
according to whether the underlying IP has significant stand-alone functionality
(e.g., the ability to process a transaction, perform a function or task, or be
played or aired). For additional information, see Chapter 12.
C.11.2 Licenses (Restrictions and Renewals) — TRG Agenda Papers 45 and 49
The TRG discussed the following issues related to point-in-time licenses:
- Renewals of time-based right-to-use (point-in-time) licenses — Whether a term extension represents a change in an attribute of a license that has already been transferred to a customer.
- Distinct rights in a current contract versus those added through a contract modification —Whether the removal of restrictions on the use of the underlying IP in a multiyear license (e.g., geographic and product-class restrictions) conveys additional rights to the customer and thus represents distinct licenses. In addition, there are questions regarding how an entity would account for such releases affected through a contract modification (i.e., whether an entity would follow the revenue standard’s modification guidance).
- Accounting for a customer’s option to purchase or use additional copies of software — Whether options to acquire additional software rights should be accounted for (1) in accordance with the royalty constraint guidance because they are related to licenses of IP or (2) in a manner similar to the accounting for options to purchase additional goods because control is transferred at a point in time.
TRG members generally agreed that:
- The evaluation of whether an entity has provided a single license of IP or multiple licenses to a customer (either in a single contract or through contract modifications) would depend on whether it has granted the customer additional rights (i.e., new or expanded rights).
- The modification of a license arrangement should be treated no differently from the modification of a contract for goods or services. Therefore, an entity should apply the contract modification guidance in the revenue standard.
However, the TRG did not reach general agreement about:
-
Why a time-based restriction would be treated differently from a geographic or product-based restriction. That is, many TRG members viewed the extension of time (i.e., through the contract renewal) as granting a customer an additional right rather than the continued use of the same rights under a license that the entity already delivered to the customer and from which the customer is currently benefiting.
- Whether additional copies of software would be accounted for as a customer option or as a usage-based royalty.
ASU 2016-10 includes additional illustrative examples to clarify that
restrictions of time, geographic region, or use affect the scope of the
customer’s right to use or right to access the entity’s IP (i.e., they are
attributes of a license) and do not define the nature of the license (i.e.,
functional vs. symbolic). However, restrictions should be distinguished from
contractual provisions that, explicitly or implicitly, require the entity to
transfer additional goods or services (including additional licenses) to the
customer.
In addition, ASU 2016-10 clarifies that revenue should not be recognized for renewals or extensions of licenses to use IP until the renewal period begins.
For additional information on restrictions and renewals, see Chapter 12.
C.11.3 Options to Purchase or Use Additional Copies of Software — Implementation Q&A 58 (Compiled From TRG Agenda Papers 45 and 49)
Stakeholders have questioned whether options to acquire additional software users
or usage of the software should be (1) subject to the sales- or usage-based
royalty constraint because the variability is related to licenses of IP already
transferred to the customer or (2) treated in a manner similar to the accounting
for options to purchase additional goods that will be transferred at a point in
time (if and when the options are exercised). If the guidance on sales- or
usage-based royalties is applied, revenue would be recognized when the
additional usage occurs. If the additional consideration is due as a result of
an option to purchase additional goods, the entity should perform an assessment
to determine whether a material right exists at contract inception. Depending on
the entity’s determination, a portion of the transaction price may need to be
allocated to a material right.
The application of one of the above methods is not a choice; rather, it is a
determination that requires judgment based on a consideration of the relevant
facts and circumstances. Entities should assess whether the additional
consideration is due (1) as a result of additional usage of rights already
transferred to the customer or (2) only once a customer exercises an option to
acquire additional rights not already transferred.
The requirement to provide additional copies of software is not determinative.
Entities will need to assess whether (1) the availability of additional copies
of the software is provided as a convenience to the customer and therefore
represents variable consideration for rights already delivered or (2) the facts
and circumstances indicate that the additional use of the software (e.g., added
users) represents additional rights that the customer can obtain, which should
be accounted for as an option.
C.11.4 Sales- and Usage-Based Royalties — TRG Agenda Papers 3 and 5
The TRG discussed issues regarding how the royalty constraint
would apply when a license of IP is offered with other goods or services in a
contract (e.g., software licenses with postcontract customer support, franchise
licenses with training services, biotechnology and pharmaceutical licenses sold
with R&D services or a promise to manufacture a drug for the customer).
Views differ on whether the royalty constraint should apply to circumstances in
which a royalty is related to (1) both a distinct license and nonlicense goods
or services that are distinct from the license and (2) a license combined with
other nonlicense goods or services in the contract (i.e., the license is not
distinct).
TRG members did not reach general agreement and noted their
belief that stakeholders would benefit from additional clarifications to the
revenue standard.
ASU 2016-10 clarifies that the sales- or usage-based royalty exception applies
whenever the royalty is predominantly related to a license of IP, regardless of
whether the license is distinct. The ASU therefore indicates that an “entity
should not split a sales-based or usage-based royalty into a portion subject to
the recognition guidance on sales-based and usage-based royalties and a portion
that is not subject to that guidance.”
C.11.4.1 Sales- or Usage-Based Royalties With a Minimum Guarantee for a License of Functional IP — Implementation Q&A 60 (Compiled From TRG Agenda Papers 58 and 60)
For licenses of functional IP, a minimum guarantee should be recognized as
revenue at the point in time when the entity transfers control of the
license to the customer. Any royalties that exceed the minimum guarantee
should be recognized as the subsequent sales or usage occurs in accordance
with ASC 606-10-55-65.
C.11.4.2 Sales- or Usage-Based Royalties With a Minimum Guarantee for a License of Symbolic IP — Implementation Q&A 59 (Compiled From TRG Agenda Papers 58 and 60)
For licenses of symbolic IP, the FASB staff articulated three views:
- View A — Recognize revenue as the subsequent sales or usage occurs in accordance with ASC 606-10-55-65 if the entity expects that the total royalties will exceed the minimum guarantee.
- View B — Estimate the transaction price (as fixed consideration plus expected royalties to be earned over the license term) and recognize revenue over time by using an appropriate measure of progress, subject to the royalty constraint.
- View C — Recognize the minimum guarantee over time by using an appropriate measure of progress. Once the minimum guarantee has been met, recognize the incremental royalties as the subsequent sales or usage occurs.
The revenue standard does not require application of a
single approach in all situations in which a sales- or usage-based royalty
contract with a customer includes a minimum guaranteed amount of
consideration and the entity expects that the royalties will exceed the
guaranteed minimum. An entity should evaluate its facts and circumstances to
determine which method under the standard best depicts its progress toward
completion.
The three views could be reasonable interpretations of the
revenue standard, subject to the following “guard rails”:
-
In the application of View A or View B, the estimated sales- or usage-based royalties must exceed the minimum guarantee.
-
If View B is applied, the entity will need to periodically revisit its estimate of the total consideration (fixed and variable) and update its measure of progress accordingly, which may result in a cumulative adjustment to revenue.
C.12 Contract Costs (Chapter 13 of the Roadmap)
C.12.1 Capitalization and Amortization of Incremental Costs of Obtaining a Contract — TRG Agenda Papers 23, 25, 57, and 60
Because many entities pay sales commissions to obtain contracts
with customers, questions have arisen regarding how to apply the revenue
standard’s cost guidance to such commissions, including:
-
Whether certain commissions (e.g., commissions on contract renewals or modifications, commission payments that are contingent on future events, and commission payments that are subject to “clawback” or thresholds) qualify as contract assets.
-
The types of costs to capitalize (e.g., whether and, if so, how an entity should consider fringe benefits such as payroll taxes, pension, or 401(k) match) in determining the amount of commissions to record as incremental costs.
The accounting for sales commissions is generally straightforward when (1) the
commission is a fixed amount or a percentage of contract value and (2) the
contract is not expected to be (or cannot be) renewed. However, if compensation
plans are complex, it may be difficult to determine which costs are truly
incremental and to estimate the period of amortization related to them. Examples
of complex scenarios include:
-
Plans with significant fringe benefits.
-
Salaries based on the employee’s prior-year signed contracts.
-
Commissions paid in different periods or to multiple employees for the sale of the same contract.
-
Commissions based on the number of contracts the salesperson has obtained during a specific period.
-
Legal and travel costs incurred in the process of obtaining a contract as well as anticipated contract renewals.
In these instances, stakeholders have questioned:
-
Whether certain costs incurred to obtain a contract are incremental.
-
How an entity should determine the amortization period for an asset recognized for the incremental costs of obtaining a contract with a customer, and more specifically:
-
How an entity should determine whether a sales commission is related to goods or services to be transferred under a specific anticipated contract.
-
If a sales commission is paid for an initial contract and also paid for contract renewals, how an entity should evaluate whether the sales commission paid on the contract renewal is commensurate with the sales commission paid on the initial contract.
-
C.12.1.1 Commission Payments Subject to Clawback — Implementation Q&As 67 and 68 (Compiled From TRG Agenda Papers 23 and 25)
Stakeholders have questioned whether commission payments
that are contingent on future customer performance under the contract should
be capitalized as incremental costs of obtaining a contract. If a contract
has qualified for recognition under step 1 (ASC 606-10-25-1), the entity has
concluded that the “parties to the contract . . . are committed to perform
their respective obligations.”33 Therefore, the entire commission payment (or obligation, if the
commission is not paid) should be capitalized at contract inception. If
circumstances change over time, the entity should reassess whether there is
a valid revenue contract and assess the contract cost asset for
impairment.
C.12.1.2 Commissions Paid on Contract Modifications — Implementation Q&A 73 (Compiled From TRG Agenda Papers 23 and 25)
When a commission is paid on a contract modification that is not accounted
for as a separate contract, the commission should still be capitalized if it
is an incremental cost of obtaining a contract.
C.12.1.3 Capitalization of Fringe Benefits — Implementation Q&A 74 (Compiled From TRG Agenda Papers 23, 25, 57, and 60)
When fringe benefits are incurred as a direct result of
incurring the commission (such as payroll taxes or pension costs based on
the incremental commission amount paid), the fringe benefits should be
capitalized because they are costs “that [the entity] would not have
incurred if the contract had not been obtained.”34
C.12.1.4 Commissions Based on Achievement of Cumulative Targets — Implementation Q&A 69 (Compiled From TRG Agenda Papers 23 and 25)
Stakeholders have raised questions regarding the application
of the revenue standard’s cost guidance to commission plans that contain
cumulative targets. For example, a salesperson may earn (1) a 5 percent
commission on all contracts signed in the period if 1 through 5 contracts
are signed and (2) a 10 percent commission on all contracts signed in the
period if 6 through 10 contracts are signed. Implementation Q&A 69
contains examples illustrating variations of commission plans with similar
cumulative targets and discusses two acceptable views on how to account for
the commissions. Under those views, the commissions in the fact pattern
described above may be accounted for as follows:
- View 1 — The commission paid as a result of signing contract 6 includes the incremental 5 percent commission on contracts 1 through 5. The entity should capitalize this incremental cost upon signing contract 6. If the entity applies this view, the entity may determine that the commission it paid upon signing contract 6 should be allocated to contracts 1 through 6 for purposes of determining the period of amortization.
- View 2 — The entity should estimate the amount of commission that will ultimately be paid for each contract and recognize that amount upon signing each contract. If the entity estimated that it would sign 7 contracts during the period, a commission of 10 percent of the value of contract 1 would be accrued upon signing.
C.12.1.5 Determining Which Costs Incurred to Obtain a Contract Are Incremental — Implementation Q&A 78 (Compiled From TRG Agenda Papers 57 and 60)
An entity should consider whether costs would have been incurred if the
customer (or the entity) decided that it would not enter into the contract
just as the parties were about to sign the contract. If the costs (e.g.,
legal costs to draft the contract) would have been incurred even though the
contract was not executed, they would not be incremental costs of obtaining
a contract.
The TRG cautioned that entities would need to use judgment to determine
whether certain costs, such as commissions paid to multiple employees for
the signing of a contract, are truly incremental. The FASB staff encouraged
entities to apply additional skepticism to understand whether an employee’s
compensation (i.e., commissions or bonus) — particularly for individuals in
different positions in the organization and employees who are ranked higher
in an organization — is related solely to executed contracts or is also
influenced by other factors or metrics (e.g., employee general performance
or customer satisfaction ratings). TRG members emphasized that only those
costs that are incremental (i.e., the result of obtaining the contract) may
be capitalized (if other asset recognition criteria are met).
Implementation Q&A 78 includes the following illustrative fact patterns
and conclusions:
- Employee salary — An entity pays an employee an annual salary that is based on contracts signed in the prior year. The salary amount will not change on the basis of contracts signed in the current year, but salary in the subsequent year will be based on current-year contracts signed. No portion of the current-year salary should be capitalized as an incremental cost of obtaining a contract because the costs would be incurred regardless of the contracts signed in the current year.
- Identifying incremental costs — An entity pays an employee a 5 percent sales commission when a new contract with a customer is signed. In negotiating the contract, the entity incurs legal and travel costs. The entity should capitalize the sales commission because it is an incremental cost that the entity would not have incurred if the contract had not been signed. Because the legal and travel costs would still have been incurred if the contract had not ultimately been signed, they are not considered incremental costs of obtaining a contract and therefore should not be capitalized.
- Timing of payment — An employee earns a 4 percent sales commission when a new contract with a customer is signed. The entity pays half of the commission to the employee immediately upon signing, and the remaining half is paid to the employee six months later even if the employee is no longer employed by the entity at the time. The full sales commission should be capitalized upon signing because the only requirement for the employee to receive the second payment is the passage of time. There may be other fact patterns with additional contingencies to consider, including customer satisfaction surveys, incremental sales, or continued employment, which may need to be assessed further.
- Level of employee — When a contract with a customer is signed, an entity pays a 10 percent commission to the salesperson, a 5 percent commission to the manager, and a 3 percent commission to the regional manager. All of these commissions should be capitalized because they would not have been incurred if the contract had not been signed.
- Payments subject to a threshold — An entity has a sales commission plan under which the amount a salesperson receives increases on the basis of the cumulative number of contracts obtained during a period. If 0 through 9 contracts are obtained during a period, the salesperson receives no commission. If 10 through 19 contracts are obtained during a period, the salesperson receives a 2 percent commission based on the total value of contracts signed in the period. The commission costs are incremental costs of obtaining a contract, and the entity should apply other GAAP to determine whether a liability should be recognized.
C.12.1.6 Determining the Amortization Period for the Incremental Costs of Obtaining a Contract — Implementation Q&A 79 (Compiled From TRG Agenda Papers 57 and 60)
The amortization period should reflect the period in which the entity expects
to receive benefits from the underlying goods or services to which the asset
is related. In estimating an amortization period, entities will need to
apply judgment to determine the related goods and services and assess which
contracts (i.e., initial contract and renewals) include those goods and
services. An entity would need to make judgments similar to those it made
when determining the amortization or depreciation period for other
long-lived assets.
In Implementation Q&A 79, the FASB staff notes that although an entity’s
particular facts and circumstances may support a determination that the best
estimate of the amortization period is the average customer term, such term
is not necessarily identical to the average period in which third parties
have been customers (i.e., the average customer life). The staff observes
that “[i]n most industries, the goods and services that an entity was
providing two decades ago are very different from the goods and services the
entity currently provides to its customers.” Since “it is unlikely that a
commission paid twenty years ago has any relationship to the goods or
services provided today,” it is doubtful that amortizing the commission over
a period of 20 years would be consistent with the requirement in ASC
340-40-35-1 to amortize an asset “on a systematic basis that is consistent
with the transfer to the customer of the goods or services to which the
asset relates.”
C.12.1.7 Amortization of Commissions Paid on the Initial Contract and Renewals — Implementation Q&As 70, 71, and 72 (Compiled From TRG Agenda Papers 23, 25, 57, and 60)
When a commission plan provides an employee with a commission (that is an
incremental cost) for an initial contract with a customer as well as for
renewals, the costs incurred at inception (and upon renewals) should be
capitalized on their respective initial (and renewal) contract inception
dates because they are costs that would not have been incurred if the
initial contract (and renewals) had not been obtained.
When the commission paid upon renewal is not commensurate with the commission
paid for the initial contract with the customer and there are anticipated
renewals, there are two acceptable alternatives for recording the
amortization of the commission asset:
-
Amortize the initial capitalized cost over the original contract period and the period of anticipated renewals. Amortize the capitalized costs for renewals over their respective renewal periods.
-
Amortize (1) the portion of the initial capitalized cost that is equal to commissions paid upon renewal over the initial contract period and (2) the remainder over the initial contract period and anticipated renewals. Amortize the capitalized costs for renewals over their respective renewal periods.
Either of the above alternatives could be acceptable if applied consistently
to similar circumstances. If there are no specifically anticipated future
contracts, it would be appropriate to amortize the full contract cost at
inception over the original contract term and any subsequent renewal costs
over their respective terms.
To determine whether the commission paid for a contract renewal is
commensurate with commissions paid for initial contracts, an entity should
perform an analysis to determine whether the two commission amounts are
reasonably proportional to the value of their respective contracts. The
analysis should not be based on the level of effort required to obtain the
initial and renewal contracts.
C.12.1.8 Determining Whether a Sales Commission Is Related to Goods or Services to Be Transferred Under a Specific Anticipated Contract — Implementation Q&A 80 (Compiled From TRG Agenda Papers 57 and 60)
The asset recognized for incremental costs of obtaining a
contract may be related to goods or services under a specific anticipated
contract and therefore may be amortized over the related period. If the
entity expects that an initial contract will not be renewed on the basis of
the relevant facts and circumstances, amortizing the asset over only the
initial contract term would be an appropriate application of the revenue
standard. Alternatively, if the entity expects that renewal of the initial
contract is likely, the amortization period for the asset may be longer than
the initial contract term. Entities will need to evaluate the relevant facts
and circumstances, including historical experience, to make a reasonable
judgment.
C.12.1.9 Determining the Pattern of Amortization for a Contract Cost Asset Related to Multiple Performance Obligations — Implementation Q&A 75 (Compiled From TRG Agenda Papers 23 and 25)
ASC 340-40-35-1 states that capitalized costs should be amortized “on a
systematic basis that is consistent with the transfer to the customer of the
goods or services to which the asset relates.” Stakeholders have questioned
the appropriate pattern of amortization when the contract asset is related
to multiple performance obligations that are satisfied over disparate points
or periods. There are two views that, depending on the relevant facts and
circumstances, may satisfy the requirement in the guidance:
- View A — The contract cost asset should be allocated in proportion to the amount of the transaction price allocated to each performance obligation and amortized on the basis of the pattern of revenue recognition for each performance obligation.
- View B — The contract cost asset should be amortized by using one measure of performance that best reflects the use of the asset and takes into account all performance obligations in the contract. View B would not require allocation on a relative stand-alone selling price basis, but the accounting outcomes under View A and View B should be reasonably similar.
Either approach can be applied to contract cost assets that also include
specifically anticipated future contracts. In such instances, the pattern of
amortization should reflect the expected pattern of revenue recognition for
the initial and expected future contracts.
C.12.2 Impairment Testing of Capitalized Contract Costs — TRG Agenda Papers 4 and 5
To test contract assets for impairment, an entity must consider
the total period over which it expects to receive an economic benefit from the
contract asset. Accordingly, to estimate the amount of remaining consideration
that it expects to receive, the entity would also need to consider goods or
services under a specific anticipated contract (i.e., including renewals).
However, the impairment guidance as originally issued appeared to contradict
itself because it also indicated that entities should apply the principles used
to determine the transaction price when calculating the “amount of consideration
that an entity expects to receive.”35 The determination of the transaction price would exclude renewals.36
TRG members generally agreed that when testing a contract asset for impairment,
an entity would consider the economic benefits from anticipated contract
extensions or renewals if the asset is related to the goods and services that
would be transferred during those extension or renewal periods.
In December 2016, as noted in Section C.2.2, the FASB issued ASU 2016-20
on technical corrections to the revenue standard, which amends ASC 340-40 to
clarify that for impairment testing, an entity should:
-
Consider contract renewals and extensions when measuring the remaining amount of consideration the entity expects to receive.
-
Include in the amount of consideration the entity expects to receive both (1) the amount of cash expected to be received and (2) the amount of cash already received but not yet recognized as revenue.
-
Test for and recognize impairment in the following order: (1) assets outside the scope of ASC 340-40 (such as inventory under ASC 330), (2) assets accounted for under ASC 340-40, and (3) reporting units and asset groups under ASC 350 and ASC 360.
Refer to Chapter 13 for additional
information.
C.12.3 Preproduction Activities
The revenue standard contains guidance on fulfillment costs that are
outside the scope of other Codification topics, including costs related to an
entity’s preproduction activities. The Background Information and Basis for
Conclusions of ASU 2014-09 indicates that in developing such cost guidance, the FASB
and IASB did not intend to holistically reconsider cost accounting. Rather, they
aimed to:
- Fill gaps resulting from the absence of superseded guidance on revenue (and certain contract costs).
- Improve consistency in the application of certain cost guidance.
- Promote convergence between U.S. GAAP and IFRS Accounting Standards.
Summarized below are issues related to how an entity should apply the new cost
guidance when assessing preproduction activities, including questions related to the
scope of the guidance (i.e., the costs to which such guidance would apply).
C.12.3.1 Whether Entities Should Continue to Account for Certain Preproduction Costs Under ASC 340-10, and Whether Preproduction Costs for Contracts Previously Within the Scope of ASC 605-35 Will Be Within the Scope of ASC 340-10 or ASC 340-40 — Implementation Q&A 66 (Compiled From TRG Agenda Papers 46 and 49)
Since the revenue standard did not amend the guidance in ASC
340-10, entities that have historically accounted for preproduction costs in
accordance with ASC 340-10 should continue to do so. See Chapter 3 for further
developments on this matter.
Preproduction activities related to contracts historically
within the scope of ASC 605-35 should be accounted for in accordance with
ASC 340-40 because (1) the revenue standard supersedes ASC 605-35 (and its
related cost guidance) and (2) ASC 340-10 does not provide guidance on costs
related to such contracts. However, entities should continue to account for
preproduction costs related to long-term supply arrangements that are within
the scope of ASC 340-10 in accordance with ASC 340-10. For additional
information, see Chapters
3 and 13.
C.12.3.2 Accounting for Customer Reimbursement of Preproduction Costs — Implementation Q&A 65 (Compiled From TRG Agenda Papers 46 and 49)
Under legacy U.S. GAAP, some entities presented customer
reimbursements for preproduction or nonrecurring engineering (NRE) costs as
revenue and others as contra-expense. Under the revenue standard, an entity
will first determine whether the contract is within the scope of ASC 606.
The entity will then determine whether the preproduction (or NRE) activities
are a performance obligation. Depending on that determination, the
reimbursement for the costs is accounted for as follows:
- If the preproduction activities are a set-up or administrative task that does not transfer a good or service, the reimbursement is included in the transaction price and recognized as control of the related production units is transferred.
- If the preproduction activities are a distinct performance obligation, the reimbursement is recognized as revenue when or as control is transferred.
- If the preproduction activities are part of a combined performance obligation, the reimbursement is included in the transaction price and recognized by using a single measure of progress for the combined single performance obligation.
C.12.4 Accounting for Reimbursements From Customers for Out-of-Pocket Expenses — Implementation Q&A 64
Because the revenue standard does not contain any guidance that
explicitly addresses the accounting for reimbursement from customers of
out-of-pocket expenses, the FASB staff decided to address key considerations
related to that issue in Implementation Q&A 64. Specifically, stakeholders
have questioned when an entity would be required to estimate reimbursements for
out-of-pocket expenses from customers as a form of variable consideration.
Implementation Q&A 64 includes analysis of the guidance on variable
consideration and notes that variable consideration would not need to be estimated in the following circumstances:
- The entity is an agent with respect to the performance obligation.
- The variable consideration is fully constrained on the basis of an analysis of the entity’s facts and circumstances.
- The variable consideration is related to a performance obligation or to distinct good or service in a series, and allocating the consideration to the specific good or service would meet the allocation objective.
- The entity recognizes the related revenue over time and applies either (1) the “as invoiced” practical expedient or (2) an input cost-to-cost method.
Although materiality is not specifically contemplated in the accounting guidance,
Implementation Q&A 64 also notes that in the FASB staff’s view, an entity
may be able to conclude in many circumstances that the impact of out-of-pocket
reimbursements is immaterial.
Footnotes
33
Quoted from ASC 606-10-25-1(a).
34
Quoted from ASC 340-40-25-2.
35
Quoted from ASC 340-40-35-4 as originally worded.
36
ASC 606-10-32-4 states, “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.”
C.13 Presentation (Chapter 14 of the Roadmap)
C.13.1 Presentation of Contract Assets and Contract Liabilities — Implementation Q&As 61, 62, and 63 (Compiled From TRG Agenda Papers 7 and 11)
Issues have been identified regarding how contract assets and contract
liabilities should be presented under the revenue standard. These issues
include:
-
Determining the unit of account — The contract, and not individual performance obligations, is the appropriate unit of account for presenting contract assets and contract liabilities.
-
Presenting contract assets and contract liabilities for individual contracts — Contract assets or contract liabilities should be presented for each contract on a net basis.
-
Presenting contract assets and contract liabilities for combined contracts — When contracts meet the requirement for combination under the revenue standard, a net contract asset or net contract liability should be presented for the combined contract.
-
Offsetting other assets and contract liabilities against contract assets and contract liabilities — Entities should look to existing guidance to determine whether they have the right of offset.37
Footnotes
37
ASC 210-20.
Appendix D — Titles of Standards and Other Literature
Appendix D — Titles of Standards and Other Literature
AICPA Literature
Audit and Accounting Guide
Revenue
Recognition
FASB Literature
ASC Topics
ASC 210, Balance
Sheet
ASC 220, Income Statement
— Reporting Comprehensive Income
ASC 235, Notes to
Financial Statements
ASC 250, Accounting
Changes and Error Corrections
ASC 270, Interim
Reporting
ASC 275, Risks and
Uncertainties
ASC 280, Segment
Reporting
ASC 310,
Receivables
ASC 320, Investments —
Debt Securities
ASC 321, Investments —
Equity Securities
ASC 323, Investments —
Equity Method and Joint Ventures
ASC 325, Investments —
Other
ASC 326, Financial
Instruments — Credit Losses
ASC 330,
Inventory
ASC 340, Other Assets and
Deferred Costs
ASC 350, Intangibles —
Goodwill and Other
ASC 360, Property, Plant,
and Equipment
ASC 405,
Liabilities
ASC 450,
Contingencies
ASC 460,
Guarantees
ASC 470, Debt
ASC 605, Revenue
Recognition
ASC 606, Revenue From
Contracts With Customers
ASC 610, Other
Income
ASC 705, Cost of Sales
and Services
ASC 710, Compensation —
General
ASC 712, Compensation —
Nonretirement Postemployment Benefits
ASC 715, Compensation —
Retirement Benefits
ASC 718, Compensation —
Stock Compensation
ASC 720, Other
Expenses
ASC 730, Research and
Development
ASC 805, Business
Combinations
ASC 808, Collaborative
Arrangements
ASC 810,
Consolidation
ASC 815, Derivatives and
Hedging
ASC 825, Financial
Instruments
ASC 830, Foreign Currency
Matters
ASC 835, Interest
ASC 842, Leases
ASC 845, Nonmonetary
Transactions
ASC 855, Subsequent
Events
ASC 860, Transfers and
Servicing
ASC 908, Airlines
ASC 912, Contractors —
Federal Government
ASC 924, Entertainment —
Casinos
ASC 932, Extractive
Activities — Oil and Gas
ASC 942, Financial
Services — Depository and Lending
ASC 944, Financial
Services — Insurance
ASC 946, Financial
Services — Investment Companies
ASC 952,
Franchisors
ASC 954, Health Care
Entities
ASC 958, Not-for-Profit
Entities
ASC 970, Real Estate —
General
ASC 980, Regulated
Operations
ASC 985, Software
ASUs
ASU 2013-12, Definition
of a Public Business Entity — An Addition to the Master Glossary
ASU 2014-09, Revenue From
Contracts With Customers (Topic 606)
ASU 2014-16, Derivatives
and Hedging (Topic 815): Determining Whether the Host Contract in a
Hybrid Financial Instrument Issued in the Form of a Share Is More Akin
to Debt or to Equity — a consensus of the FASB Emerging Issues Task
Force
ASU 2015-02,
Consolidation (Topic 810)
ASU 2015-14, Revenue From
Contracts With Customers (Topic 606): Deferral of the Effective
Date
ASU 2016-08, Revenue From
Contracts With Customers (Topic 606): Principal Versus Agent
Considerations (Reporting Revenue Gross Versus Net)
ASU 2016-10, Revenue From
Contracts With Customers (Topic 606): Identifying Performance
Obligations and Licensing
ASU 2016-11, Revenue
Recognition (Topic 605) and Derivatives and Hedging (Topic 815):
Rescission of SEC Guidance Because of Accounting Standards Updates
2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016
EITF Meeting
ASU 2016-12, Revenue From
Contracts With Customers (Topic 606): Narrow-Scope Improvements and
Practical Expedients
ASU 2016-20, Technical
Corrections and Improvements to Topic 606, Revenue From Contracts
With Customers
ASU 2017-01, Business
Combinations (Topic 805): Clarifying the Definition of a
Business
ASU 2017-05, Other Income
— Gains and Losses From the Derecognition of Nonfinancial Assets
(Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance
and Accounting for Partial Sales of Nonfinancial Assets
ASU 2017-13, Revenue
Recognition (Topic 605), Revenue From Contracts With Customers (Topic
606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC
Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF
Meeting and Rescission of Prior SEC Staff Announcements and Observer
Comments
ASU 2017-14, Income
Statement — Reporting Comprehensive Income (Topic 220), Revenue
Recognition (Topic 605), and Revenue From Contracts With Customers
(Topic 606): Amendments to SEC Paragraphs Pursuant to Staff Accounting
Bulletin No. 116 and SEC Release No. 33-10403
ASU 2018-07, Compensation
— Stock Compensation (Topic 718): Improvements to Nonemployee
Share-Based Payment Accounting
ASU 2018-08,
Not-for-Profit Entities (Topic 958): Clarifying the Scope and
Accounting Guidance for Contributions Received and Contributions
Made
ASU 2018-11, Leases
(Topic 842): Targeted Improvements
ASU 2018-18,
Collaborative Arrangements (Topic 808): Clarifying the Interaction
Between Topic 808 and Topic 606
ASU 2019-08, Financial
Services — Insurance (Topic 944): Effective Date
ASU 2020-05, Revenue From
Contracts With Customers (Topic 606) and Leases (Topic 842): Effective
Dates for Certain Entities
ASU 2021-02, Franchisors
— Revenue From Contracts With Customers (Subtopic 952-606): Practical
Expedient
ASU 2021-08, Business Combinations (Topic
805): Accounting for Contract Assets and Contract Liabilities From
Contracts With Customers
Proposed ASUs
Proposed ASU 1820-100,
Revenue Recognition (Topic (605): Revenue From Contracts With
Customers
Proposed ASU 2011-230
(Revised), Revenue Recognition (Topic 605):
Revenue From Contracts With Customers
Concepts Statement
No. 8, Conceptual Framework for Financial
Reporting — Chapter 4, Elements of Financial
Statements
IFRS Literature
IFRS 4, Insurance
Contracts
IFRS 5, Non-Current Assets
Held for Sale and Discontinued Operations
IFRS 9, Financial
Instruments
IFRS 10, Consolidated
Financial Statements
IFRS 11, Joint
Arrangements
IFRS 15, Revenue From
Contracts With Customers
IFRS 17, Insurance
Contracts
IAS 2, Inventories
IAS 10, Events After the
Reporting Period
IAS 16, Property, Plant and Equipment
IAS 34, Interim Financial
Reporting
IAS 36, Impairment of
Assets
IAS 37, Provisions,
Contingent Liabilities and Contingent Assets
IAS 38, Intangible
Assets
IAS 39, Financial
Instruments: Recognition and Measurement
Federal Regulation
Internal Revenue Code (U.S. Code)
Section 1031, “Exchange”
SEC Literature
Interpretive Release
No. 33-10403, Updates to
Commission Guidance Regarding Accounting for Sales of Vaccines and
Bioterror Countermeasures to the Federal Government for Placement Into
the Pediatric Vaccine Stockpile or the Strategic National
Stockpile
Regulation S-X
Rule 5-03, “Statements of
Comprehensive Income”
Rule 5-04, “What Schedules Are to Be
Filed”
Rule 12-09, “Valuation and
Qualifying Accounts”
SAB Topics
SAB Topic 1.M, “Financial
Statements; Materiality”
SAB Topic 8, “Retail
Companies”
-
SAB Topic 8.A, “Sales of Leased or Licensed Departments”
-
SAB Topic 8.B, “Finance Charges”
SAB Topic 11, “Miscellaneous
Disclosure”
-
SAB Topic 11.A, “Operating-Differential Subsidies”
SAB Topic 13, “Revenue
Recognition”
SAB No. 101, “Revenue
Recognition in Financial Statements”
Other Literature
United States Code
Title 17, ”Copyrights”;
Chapter 1, ”Subject Matter and Scope of Copyright”; Section 109,
”Limitations on Exclusive Rights: Effect of Transfer of Particular Copy or
Phonorecord”
TRG Agenda Papers
TRG Agenda Paper 1, Gross
Versus Net Revenue
TRG Agenda Paper 2, Gross
Versus Net Revenue: Amounts Billed to Customers
TRG Agenda Paper 3,
Sales-Based and Usage-Based Royalties in Contracts With Licenses and
Goods or Services Other Than Licenses
TRG Agenda Paper 4,
Impairment Testing of Capitalised Contract Costs
TRG Agenda Paper 5, July 2014
Meeting — Summary of Issues Discussed and Next Steps
TRG Agenda Paper 6, Customer
Options for Additional Goods and Services and Nonrefundable Upfront
Fees
TRG Agenda Paper 7,
Presentation of a Contract as a Contract Asset or a Contract
Liability
TRG Agenda Paper 8,
Determining the Nature of a License of Intellectual Property
TRG Agenda Paper 9, Distinct
in the Context of the Contract
TRG Agenda Paper 10, Contract
Enforceability and Termination Clauses
TRG Agenda Paper 11, October
2014 Meeting — Summary of Issues Discussed and Next Steps
TRG Agenda Paper 12,
Identifying Promised Goods or Services in a Contract With a
Customer
TRG Agenda Paper 13,
Collectibility
TRG Agenda Paper 14, Variable
Consideration
TRG Agenda Paper 15, Noncash
Consideration
TRG Agenda Paper 16,
Stand-Ready Performance Obligations
TRG Agenda Paper 18, Material
Right
TRG Agenda Paper 19,
Consideration Payable to a Customer
TRG Agenda Paper 20,
Significant Financing Components
TRG Agenda Paper 23,
Incremental Costs of Obtaining a Contract
TRG Agenda Paper 25, January
2015 Meeting — Summary of Issues Discussed and Next Steps
TRG Agenda Paper 26, Whether
Contributions Are Included or Excluded From the Scope
TRG Agenda Paper 27, Series
of Distinct Goods or Services
TRG Agenda Paper 28,
Consideration Payable to a Customer
TRG Agenda Paper 29,
Warranties
TRG Agenda Paper 30,
Significant Financing Components
TRG Agenda Paper 31,
Allocation of the Transaction Price for Discounts and Variable
Consideration
TRG Agenda Paper 32,
Accounting for a Customer’s Exercise of a Material Right
TRG Agenda Paper 33, Partial
Satisfaction of Performance Obligations Prior to Identifying the
Contract
TRG Agenda Paper 34, March
2015 Meeting — Summary of Issues Discussed and Next Steps
TRG Agenda Paper 35,
Accounting for Restocking Fees and Related Costs
TRG Agenda Paper 36, Scope:
Credit Cards
TRG Agenda Paper 37,
Consideration Payable to a Customer
TRG Agenda Paper 38,
Portfolio Practical Expedient and Application of Variable Consideration
Constraint
TRG Agenda Paper 39,
Application of the Series Provision and Allocation of Variable
Consideration
TRG Agenda Paper 40,
Practical Expedient for Measuring Progress Toward Complete Satisfaction
of a Performance Obligation
TRG Agenda Paper 41,
Measuring Progress When Multiple Goods or Services Are Included in a
Single Performance Obligation
TRG Agenda Paper 43,
Determining When Control of a Commodity Transfers
TRG Agenda Paper 44, July
2015 Meeting — Summary of Issues Discussed and Next Steps
TRG Agenda Paper 45, Licenses
— Specific Application Issues About Restrictions and Renewals
TRG Agenda Paper 46,
Pre-Production Activities
TRG Agenda Paper 47, Whether
Fixed Odds Wagering Contracts Are Included or Excluded From the Scope of
Topic 606
TRG Agenda Paper 48, Customer
Options for Additional Goods and Services
TRG Agenda Paper 49, November
2015 Meeting — Summary of Issues Discussed and Next Steps
TRG Agenda Paper 50, Scoping
Considerations for Incentive-Based Capital Allocations, Such as Carried
Interest
TRG Agenda Paper 51, Contract
Asset Treatment in Contract Modifications
TRG Agenda Paper 52, Scoping
Considerations for Financial Institutions
TRG Agenda Paper 53,
Evaluating How Control Transfers Over Time
TRG Agenda Paper 54,
Considering Class of Customer When Evaluating Whether a Customer Option
Gives Rise to a Material Right
TRG Agenda Paper 55, April
2016 Meeting — Summary of Issues Discussed and Next Steps
TRG Agenda Paper 56, Over
Time Revenue Recognition
TRG Agenda Paper 57,
Capitalization and Amortization of Incremental Costs of Obtaining a
Contract
TRG Agenda Paper 58,
Sales-Based or Usage-Based Royalty With Minimum Guarantee
TRG Agenda Paper 59, Payments
to Customers
TRG Agenda Paper 60, November
2016 Meeting — Summary of Issues Discussed and Next Steps
Superseded Literature
AICPA Technical Questions and Answers
Section 5100.68, “Revenue
Recognition: Fair Value of PCS in Perpetual and
Multi-Year Time-Based Licenses and Software Revenue
Recognition”
EITF Abstracts
Issue No. 90-22, “Accounting
for Gas-Balancing Arrangements”
Issue No. 91-9, “Revenue and
Expense Recognition for Freight Services in Process”
Issue No. 00-10, “Accounting
for Shipping and Handling Fees and Costs”
Issue No. 01-9, “Accounting
for Consideration Given by a Vendor to a Customer (Including a Reseller of
the Vendor’s Products)”
Topic No. D-96, “Accounting
for Management Fees Based on a Formula”
FASB Concepts Statement
No. 6, Elements of
Financial Statements — a replacement of FASB Concepts Statement No.
3 (incorporating an amendment of FASB Concepts Statement No. 2)
FASB Statements
No. 5, Accounting for
Contingencies
No. 66, Accounting for
Sales of Real Estate
Appendix E — Abbreviations
Appendix E — Abbreviations
Abbreviation
|
Description
|
---|---|
AI
|
artificial
intelligence
|
AICPA
|
American
Institute of Certified Public Accountants
|
ASC
|
FASB
Accounting Standards Codification
|
ASU
|
FASB
Accounting Standards Update
|
B&E
|
blend-and-extend
|
BC
|
Basis for
Conclusions
|
CED
|
contract
establishment date
|
CIMA
|
Chartered Institute of
Management Accountants
|
CODM
|
chief
operating decision maker
|
CPM
|
cost per mille
|
CRM
|
customer
relationship management
|
EAC
|
estimated
total costs at completion
|
ED
|
exposure
draft
|
EITF
|
Emerging
Issues Task Force
|
EOR
|
employer of record
|
FASB
|
Financial
Accounting Standards Board
|
FOB
|
free on
board
|
GAAP
|
generally
accepted accounting principles
|
IAS
|
International Accounting Standard
|
IASB
|
International Accounting Standards Board
|
IC
|
independent contractor
|
IFRIC
|
IFRS
Interpretations Committee
|
IFRS
|
International Financial Reporting Standard
|
IOSCO
|
International Organization of Securities Commissions
|
IP
|
intellectual
property
|
IT
|
information
technology
|
MD&A
|
Management’s
Discussion and Analysis
|
NRE
|
nonrecurring
engineering
|
OCA
|
SEC’s Office
of the Chief Accountant
|
OEM
|
original
equipment manufacturer
|
P&U
|
power and
utilities
|
PBE
|
public
business entity
|
PCAOB
|
Public
Company Accounting Oversight Board
|
PCS
|
postcontract
customer support
|
PEO
|
professional employer
organization
|
PIR
|
postimplementation review
|
PSO
|
professional services organization
|
Q&A
|
question and
answer
|
R&D
|
research and
development
|
RMN
|
retail media network
|
ROFO
|
right of first offer
|
ROFR
|
right of first refusal
|
SaaS
|
software as
a service
|
SAB
|
SEC Staff
Accounting Bulletin
|
SEC
|
U.S.
Securities and Exchange Commission
|
SG&A
|
selling,
general, and administrative
|
SSP
|
stand-alone
selling price
|
TRG
|
FASB/IASB
transition resource group for revenue recognition
|
UCC
|
Uniform
Commercial Code
|
U.S.C.
|
United
States Code
|
Appendix F — Roadmap Updates for 2023
Appendix F — Roadmap Updates for 2023
Throughout the 2023 edition of this
Roadmap, references to ASC 840 have been removed to reflect the FASB's removal of
the ASC 842 transition guidance and ASC 840 legacy guidance from the Codification.
Other substantive changes made in the 2023 edition are summarized in the tables
below.
New Content
Section
|
Title
|
Description
|
---|---|---|
Identifying and Accounting for Boot in
an Inventory Buy/Sell Arrangement
|
New section that discusses the
accounting for inventory buy/sell arrangements that are
within the scope of ASC 845 and include cash in the
exchange. The section includes new Example 3-9; subsequent
examples have been renumbered accordingly.
| |
Nonmonetary Exchange Involving Cash
|
New section that discusses the
accounting for nonmonetary exchanges that include
significant monetary consideration. One of its
subsections includes new Example 3-10; subsequent examples have
been renumbered accordingly.
| |
Nonmonetary Exchange Transactions
|
New section that discusses the
accounting for the sale of goods or services in exchange
for primarily nonmonetary assets. The section includes
new Examples 3-11
and 3-12;
subsequent examples have been renumbered
accordingly.
| |
Termination Clauses That Include Refunds
for Prepayments in Software Arrangements
|
New section that discusses accounting
considerations related to software arrangements in which
a customer prepays for a term-based license and PCS but
can terminate all or part of the arrangement and receive
a refund. The section includes new Examples 4-6 through
4-11.
| |
License Keys and Termination
Provisions
|
New section that discusses how
termination provisions in a software licensing
arrangement that requires the delivery of a license key
for the customer to use the software affect the contract
term and the recognition of revenue. The section
includes new Example
4-12.
| |
Determining Whether a SaaS Arrangement
Represents a Stand-Ready Obligation or an Obligation to
Provide a Specified Amount of Services
|
New section that includes indicators for
an entity to consider when determining whether a SaaS
arrangement represents a stand-ready obligation or an
obligation to provide a specified amount of
services.
| |
Termination Clauses and Nonrefundable
Up-Front Fees in Software Arrangements
|
New section that discusses how to
account for termination provisions and nonrefundable
up-front fees in software arrangements. The section
includes new Examples 5-16
through 5-19.
| |
Retail Industry Considerations
|
New section that combines content moved
from Section 6.6.2.1 (including examples renumbered to
6-24 through 6-26) with additional discussion of
consideration payable to a customer in the retail
industry, especially in connection with advertising. One
of its subsections includes new Examples 6-27 and
6-28;
subsequent examples have been renumbered
accordingly.
| |
Appropriateness of Using the Residual
Approach
|
New section that discusses when the
residual approach should be used. The section includes
new Examples 7-1 through
7-3; subsequent examples have been
renumbered accordingly.
| |
Material Right
|
New section that clarifies that a
customer option to purchase additional goods or services
may give rise to a material right even if the selling
prices of those goods or services are highly variable or
uncertain and the residual approach was therefore
applied.
| |
Methods for Establishing the Stand-Alone
Selling Price for Term Licenses and PCS
|
New section that discusses how to
determine stand-alone selling prices for term-based
software licenses and PCS when observable pricing from
stand-alone sales does not exist. The section includes
new Examples 7-7 through
7-12; subsequent examples have been
renumbered accordingly.
| |
Allocating Variable Consideration in
Cloud-Based or Hosted Software Arrangements
|
New section that discusses accounting
considerations related to SaaS arrangements that require
customers to pay a variable amount, usually based on the
underlying usage of the technology. One of its
subsections includes new Examples 7-18 through 7-24; subsequent
examples have been renumbered accordingly.
| |
Blend-and-Extend Contract Modifications
Related to a SaaS Arrangement
|
New section that discusses three
approaches to accounting for B&E contract
modifications related to a SaaS arrangement. The section
includes new Example
9-4; subsequent examples have been
renumbered accordingly.
| |
Initial Contract Includes a Cloud
Conversion Right
|
New section that discusses the
accounting for on-premise term-based software license
contracts that include the right to convert the
on-premise software license to a SaaS arrangement. The
section includes new Example
12-24; subsequent examples have been
renumbered accordingly.
| |
Initial Contract Is Modified to Convert a Term-Based
License to SaaS
|
New section that discusses the accounting for on-premise
term-based software license contracts that initially do
not include the right to convert the on-premise software
license to a SaaS arrangement but are subsequently
modified to immediately convert the on-premise software
license to a SaaS arrangement. The section includes new
Example 12-25;
subsequent examples have been renumbered
accordingly.
| |
Initial Contract Is Modified to Add a Cloud Conversion
Right
|
New section that discusses the accounting for on-premise
term-based software license contracts that initially do
not include the right to convert the on-premise software
license to a SaaS arrangement but are subsequently
modified to add a right to convert the on-premise
software license to a SaaS arrangement. The section
includes new Example
12-26; subsequent examples have been
renumbered accordingly.
| |
Initial Contract Includes Cloud Mixing Rights With a
Cap
|
New section that discusses the accounting for a contract
that gives the customer the right to use licensed
software on an on-premise basis and a cloud basis,
subject to a cap on the total number of seats. The
section includes new Example
12-27; subsequent examples have been
renumbered accordingly.
| |
Relationship Between ASC 985-20 and ASC 340-40
|
New section that discusses how to account for costs of
software developed in connection with contracts that
require significant production, modification, or
customization of the software.
| |
Providing for Anticipated Losses
|
New section that discusses the application of the
guidance in ASC 605-35 on onerous contracts, which has
remained in effect after the adoption of ASC 606.
| |
Separately Priced Extended Warranty Contracts and Product
Maintenance Contracts
|
New section that discusses the recognition of losses
resulting from separately priced extended warranty or
product maintenance contracts.
|
Amended or Deleted Content
Section
|
Title
|
Description
|
---|---|---|
Added a discussion of the November 10,
2023, public roundtable on the FASB’s postimplementation
review of ASC 606 and removed the video “FASB
Postimplementation Review.”
| ||
Barter Credit Transactions
|
Content moved from Section 3.2.5 and
expanded to include a discussion of the substance,
purpose, and economic benefit of barter credit
transactions.
| |
Each Party Has Approved the Contract and
Is Committed to Perform
|
Added a discussion of trial periods and
factors for an entity to consider when determining
whether a contract with a customer exists during a trial
period.
| |
Termination Clauses and Penalties
|
Expanded the discussion to clarify that
the economic considerations related to forgoing a
discount on optional purchases would not be viewed as a
substantive penalty suggesting that the parties’ rights
and obligations extend for a longer contract term.
| |
License Keys and Termination
Provisions
|
Renumbered from Section 12.3.4;
subsequent sections have been renumbered
accordingly.
| |
Assessing Whether a Promise Is a
Stand-Ready Performance Obligation
|
Added a bullet point about SaaS to the
list of examples of stand-ready performance
obligations.
| |
Meaning of “Distinct” Goods or
Services
|
Some content (including examples
renumbered to 6-24 through 6-26) moved into new
Section
6.6.2.5 and a subsection thereof on
consideration payable to a customer in the retail
industry, especially in connection with advertising.
| |
Allocating the Transaction Price When a
Value Relationship Exists
|
Content moved from Section 7.3.3.2.
| |
Residual Value Guarantees
|
Added a discussion to clarify whether a
residual value guarantee should be accounted for under
ASC 460.
| |
Right of First Refusal and Right of
First Offer in Connection With a Sale
|
Added a discussion related to right of
first offer clauses in sale-and-leaseback
arrangements.
| |
Blend-and-Extend Contract Modifications
in the Power and Utilities Industry
|
Content moved from Section 9.2.2.2.
| |
Timing of Revenue Recognition When the
Entity Is An Agent
|
Added Examples 10-7 and 10-8 to illustrate how
the timing of revenue recognition by an entity acting as
an agent may vary depending on whether the entity’s
promise of arranging for goods or services to be
transferred by the seller is satisfied when the
arrangement is made or when the specified goods or
services are transferred by the seller to the buyer.
Subsequent examples have been renumbered
accordingly.
| |
12.3.4
|
License Keys and Termination Provisions
|
Deleted; subsequent sections have been renumbered
accordingly.
|
Identifying Performance Obligations in a
Hybrid Software Arrangement
|
Renumbered from Section 12.3.6. Added an
excerpt from Example 9-2-3 of the AICPA Audit and
Accounting Guide Revenue Recognition.
| |
Application of the Sales- or Usage-Based
Royalty Exception to Guaranteed Minimum Royalties
Related to Symbolic IP
|
Added Example
12-38 to illustrate the applicability of
three approaches to recognizing revenue over time when a
sales- or usage-based royalty contract with a customer
includes a minimum guaranteed amount of
consideration.
| |
Refund Liabilities
|
Added a discussion to clarify that funds
received in advance that are associated with a
cancelable term (with a termination right without
penalty) should be presented separately from any
contract liability as a refund liability, or similar
liability.
| |
Refund Liabilities
|
Added a discussion of how to determine
whether refund liabilities should be classified as
current or noncurrent.
| |
Offsetting Refund Liabilities Against
Accounts Receivable
|
Added a discussion of accounting for
refund liabilities and accounts receivables for
contracts with termination clauses.
| |
Interaction Between ASC 606 and SEC
Regulation S-X, Rule 5-03(b)
|
Content moved from Section 15.2.1.
| |
Interaction Between ASC 606 and SEC
Regulation S-X, Rule 5-03(b)
|
Updated to clarify that the line item
presentation requirements of SEC Regulation S-X, Rule
5-03(b), cannot be satisfied solely by meeting the
requirements of ASC 606 related to the disaggregation of
revenue.
| |
Disaggregation of Revenue
|
Added a discussion of the types of
comments the SEC staff issued to registrants regarding
the disaggregation of revenue.
| |
Differences Between U.S. GAAP and IFRS
Accounting Standards
|
Updated to clarify differences between
U.S. GAAP and IFRS Accounting Standards in their
treatment of (1) shipping and handling activities and
the presentation of sales (and other similar) taxes, for
which an accounting policy election is available only
under U.S. GAAP, and (2) share-based payments to
customers.
|