Joint Meeting on Revenue — January 2015

Many stakeholders have noted their belief that paragraph BC90 effectively removes from U.S. GAAP the guidance in SAB Topic 134 on “perfunctory or inconsequential“ performance obligations. Stakeholders have further noted that it is unclear whether the boards intended the concepts of “promised goods or services“ under the new revenue standard and “deliverable“ under current revenue guidance to be similar notions. With the removal of the concept of inconsequential or perfunctory, stakeholders believe that entities would be required to identify significantly more performance obligations under the new revenue standard than deliverables under current revenue guidance. Accordingly, stakeholders have questioned whether the boards intended that (1) entities would identify and account for more performance obligations and (2) certain activities that provide minor benefit would be considered performance obligations.

The discussion in TRG Agenda Paper 12 on identifying promised goods or services in a contract with a customer does not address (and was not intended to address) how to determine whether a performance obligation in a contract is distinct. See the agenda paper for additional details.

Summary: The TRG discussed various options, including whether to (1) specifically address “perfunctory or inconsequential“ items in the text of the new 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 new revenue standard, there appeared to be general agreement that such an addition would not be necessary. Although a TRG member noted that the new standard is different from current revenue guidance and in some cases may result in more (or different) performance obligations than under existing revenue guidance (e.g., some marketing activities), most TRG members believed that the evaluation of promised goods or services in a contract would lead to about the same number of deliverables that are identified today. Many TRG members were in favor of requiring the use of judgment and materiality to identify promised goods or services as performance obligations and supported clarifying the wording in the new revenue standard’s Background Information and Basis for Conclusions.

TRG members also discussed examples in which the application of the new revenue standard raises questions, including whether marketing and sales incentives provided to a customer and certain shipping arrangements are promises that give rise to performance obligations. Under existing guidance, an entity that provides an incentive — such as a bank that gives a customer golf clubs for opening an account — generally would treat the incentive as a marketing expense. Similarly, some entities may account for shipping arrangements as perfunctory and inconsequential under existing revenue guidance. One TRG member indicated that the only potentially necessary additional guidance would be to reinforce that such determinations require judgment and largely depend on the nature of the promise. However, other TRG members mentioned the need to clarify whether items of this nature are considered a performance obligation.

Questions have arisen about the following:

• Collectibility for a portfolio of contracts — Views differ on how much revenue to recognize when an entity has a history showing that it will not collect from some customers in a portfolio of contracts (e.g., 2 percent of invoiced amounts have not been collected historically). Some believe that an entity should record revenue net of uncollectible amounts (i.e., 98 percent of the invoiced amount if the remaining 2 percent is uncollectible); however, others believe that an entity should record revenue at the expected amount (i.e., 100 percent of the invoiced amount) and that it should record the uncollectible amount as an impairment loss (i.e., if 98 percent of the invoiced amount is collectible, the entity should record the remaining 2 percent as bad debt expense).
• Reassessments of collectibility — The new standard requires a reassessment of collectibility when there is a significant change in facts and circumstances after the initial assessment. Stakeholders have questioned how to evaluate this requirement to determine when to reassess whether a contract continues to meet the collectibility threshold.
• Subsequent assessments concluding that collectibility is not probable — Given that when collectibility is not probable, an entity is prohibited from recognizing revenue under the new revenue standard unless certain conditions are met (see above), stakeholders have questioned how to recognize revenue for a contract that initially met the collectibility threshold but was later determined not to meet the threshold. One view is that the reassessment has effectively “terminated“ the original contract (i.e., the contract term has been modified to end on the reassessment date when collection is no longer probable), and consideration received for performance obligations satisfied under the revised contract should be recognized as revenue. Consideration received for future goods or services should be recognized as a liability.
• Assessments of price concessions6 — The new revenue standard requires an entity to assess whether its contract includes a price concession by considering both its past practices and its current intentions. If the contract includes a price concession, the entity should reduce the consideration by the price concession it provides before performing the collectibility assessment. While the new revenue standard provides an example7 that illustrates the interaction between an entity’s assessment of price concessions and collectibility, stakeholders have noted that collectibility determinations involving price concessions are complex and require significant judgment.

See TRG Agenda Paper 13 for additional information.

Summary: TRG members generally agreed on the following:

• 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 or IFRS 9.8 Therefore, in the example above, the entity would recognize revenue for 100 percent of the expected amount and an impairment loss of 2 percent as bad debt expense.
• To determine when to reassess collectibility, an entity needs to exercise judgment on the basis of the facts and circumstances.
• The new 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 new revenue standard. TRG members questioned whether the deferral of revenue for cash received truly reflects the economics of certain transactions (e.g., long-term service contracts) and whether such deferral is an unintended consequence of the collectibility assessment’s inclusion in step 1 of the model instead of step 5.

One TRG member challenged the presentation of nonrefundable consideration received from a customer as a liability because in most cases involving a collectibility issue, an entity would neither refund cash it received nor recoup goods or services provided to a customer. TRG members also noted difficulties in applying the collectibility threshold to service contracts when a customer pays on a monthly basis for the services it receives from the entity but collectibility in future months may not be probable. In such a situation, the new revenue standard would require an entity to defer revenue until collectibility is probable regardless of the cash it received.

Discussion also centered on the punitive nature of the collectibility threshold in the new revenue standard, but board members reminded TRG members that the inclusion of collectibility in step 1 was intentional since revenue recognition is precluded when a valid contract does not exist (i.e., when the criteria in step 1, including the condition that collectibility must be probable, are not met). However, certain TRG members noted that it seems odd to conclude that revenue recognition is prohibited when a contract that may be valid from a legal perspective is invalid for accounting purposes simply because the collectibility criterion has not been met.

The TRG also acknowledged that 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.

Several questions regarding the application of the new revenue standard have arisen related to consideration payable to a customer and the level (contract or performance obligation) at which the constraint should be applied to variable consideration.

In addition, stakeholders have indicated that it is unclear from the new revenue standard (1) 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 and reasons other than the form of consideration and (2) 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. Views on this topic include (1) applying the constraint to variability attributable to both the form of consideration and reasons other than the form of consideration and (2) applying the constraint only to variability attributable to reasons other than the form of consideration.

For additional details, see TRG Agenda Paper 15.

Summary: Much of the TRG’s discussion focused on the measurement date for noncash consideration. As noted in TRG Agenda Paper 15, several TRG members expressed the view that noncash consideration should be measured at the earlier of (1) when the noncash consideration is received (or is receivable) or (2) when the related performance obligation is satisfied; however, they noted that this interpretation may be difficult to apply, especially for determining the intervals for assessment when performance in a contract occurs over time. Other TRG members suggested support for the other two views. In addition, many TRG members noted that they can understand how entities might arrive at one of the other positions identified in TRG Agenda Paper 15 and that the boards should therefore clarify the guidance for practicality and to reduce potential diversity in practice.

Those who expressed views on variability attributable to the form of consideration and reasons other than the form of consideration agreed that the standard was unclear on this topic and some expressed uncertainty about whether the topic would be sufficiently prevalent to require further clarification of the guidance. However, participants at the meeting noted that while bifurcating noncash consideration may be the preferred method from a conceptual standpoint, it raises practicality issues in application.

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 intellectual property is required (“Type A“).
• Outside both the entity’s and 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 a stand-ready obligation in the new revenue standard12 (“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 or makes its goods or services available to the customer on a constant basis over the contract period.

Because the new 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 standready obligation (e.g., a time-based, input, or output method).

For additional information, see TRG Agenda Paper 16.

Summary: TRG members generally agreed that the related guidance in the new revenue standard seems operational, especially when considered in light of the discussion and illustrations in TRG Agenda Paper 16. The principle in the new revenue standard requires an entity to understand the nature of the promise, and the agenda paper helps illustrate considerations for making that judgment. Some TRG members thought that additional language in the boards’ summary of the January 2015 TRG meeting, specifically in connection with the discussion of specified and unspecified upgrades of software (see below), would be helpful in application.

One TRG member expressed the concern that paragraph 14 of TRG Agenda Paper 16, in which the FASB and IASB staffs indicate that an entity may promise a customer both specified and unspecified upgrades of software (i.e., although a contract refers only to unspecified upgrades on a when-and-if-available basis), may be interpreted to mean that unspecified upgrades should be recognized at a point in time rather than ratably over time13 as in current practice. The TRG member thought that such an outcome could arise as a result of requiring an entity to determine whether a plan to provide functionality enhancements that has not been communicated to the customer is a specified upgrade, which could potentially change what have historically been considered specified and unspecified upgrades. The FASB staff clarified that although ASU 2014-0914 removes the term “specified upgrade“ from the Codification Master Glossary, step 2 in the new revenue standard states that an entity needs to consider when it has promised additional goods or services to a customer. Further, the FASB staff noted that it did not intend to change how to view specified and unspecified upgrades discussed in paragraph 14 of the agenda paper; rather, if an entity makes another promise to a customer, the additional promise needs to be accounted for (i.e., if there is a specified upgrade, it would need to be evaluated as a separate performance obligation).

A FASB member expressed the concern that the TRG’s discussion may give rise to interpretations that result in too many stand-ready obligations. The Board member offered that the form of payment may help entities determine whether an arrangement is a stand-ready obligation. For example, if snow removal is paid on the basis of a fixed fee for a fixed period, such an arrangement may represent a stand-ready obligation (i.e., regardless of the number of times snow removal is performed). However, such a conclusion may not be appropriate for a pay-for-performance structure (e.g., a payment of $50 each time the snow removal service is performed).

The types of transactions in question all possess the following three characteristics:

• For the seller, the transactions are in the form of cash purchases and, in almost all cases, immediate sales (i.e., sales within approximately 24 hours) with deferred payment.
• For the purchaser, the transactions are in the form of purchases on deferred payments.
• The financial instruments created by the transactions are within the scope of IFRS 9 and IAS 32,15 as are financing contracts provided to the customers of a business.

The new revenue standard’s scope includes “all contracts with customers“ other than those that are excluded. Questions have arisen regarding whether the deferred-payment transactions described above are within the scope of the new revenue standard since an Islamic financial institution must possess the underlying assets and retain all the risks and rewards of ownership of the assets, even if only for a short period, before the subsequent sale to the institution’s customer.

See TRG Agenda Paper 17 for additional details.

Summary: TRG members primarily focused on whether the accounting for the transactions described above should reflect the economic substance of the transactions (i.e., a financing) or the legal form of the transaction (i.e., a sale of goods legally owned by the Islamic financial institution). The TRG also noted that there are inconsistent views on whether an Islamic financial institution’s ordinary activities are solely the provision of Shariah-compliant financing or the sales of cars, real estate, or other commodities, which would affect whether the transactions were within the scope of the new revenue standard’s guidance. Ultimately, no consensus was reached by the TRG on whether such transactions were within the scope of the new revenue guidance, but one TRG member noted that an early-stage analysis by a group of accounting firms located in the Asia-Pacific region indicated that, in a manner consistent with current practice, the transactions are likely to be within the scope of IFRS 9 and therefore would be outside the scope of the new revenue standard (and thus not subject to its disclosure and presentation requirements).

Because many entities pay sales commissions to obtain contracts with customers, questions have arisen regarding how to apply the new revenue standard’s cost guidance to such commissions, including whether certain commissions qualify as contract assets.

Questions related to the following topics were submitted to the TRG for discussion:

• Commissions paid on renewals after the initial contract is obtained.
• Commissions on contract modifications.
• Commission payments that are contingent on future events.
• Commission payments subject to clawback.
• Commission payments subject to a threshold.
• Types of costs to capitalize. For example, should an entity consider fringe benefits in determining the amount of commissions to record as incremental costs (e.g., payroll taxes, pension, or 401(k) match)?
• Pattern of amortization for contract assets related to multiple performance obligations. For example, how should an entity determine the pattern of amortization for a contract cost asset related to multiple performance obligations that are satisfied over disparate points or periods of time?

For additional information and details, see TRG Agenda Paper 23.

Summary: Rather than discussing each topic and related question in detail, TRG members generally noted that they agreed with the FASB and IASB staffs’ views in TRG Agenda Paper 23. They also noted that the examples outlined by the staffs may not reflect the level of complexity observed in practice.

Instead, discussion centered on the principles associated with capitalizing costs. Specifically, TRG members discussed whether the new revenue standard supersedes other GAAP related to liability accounting. Some TRG members noted that stakeholders may have concluded that the guidance in the new revenue standard overrides existing guidance on liability recognition, but a majority of TRG members agreed that entities would continue to first refer to existing GAAP on liability recognition to determine whether and, if so, when a liability needs to be recorded from a contract with a customer. For example, an entity would apply the specific 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.

TRG members also noted that there is no need for prescriptive guidance on amortization periods and methods and that the standard is clear that an entity’s method should be on a systematic basis and period should reflect the pattern of transfer of goods and services to a customer.

Under the standard, a contract modification is accounted for as (1) a separate contract (if the modification is distinct and priced at the stand-alone selling price), (2) a termination of the old contract and creation of a new contract (if the modification is distinct but not priced at the stand-alone selling price), or (3) a cumulative catch-up adjustment (if the modification is not distinct).

Given the high volume and long duration of customer contracts for some entities that are frequently modified, stakeholders have expressed concerns that applying the guidance will be challenging — if not impracticable17 — regardless of the transition method an entity applies. Furthermore, some believe that the costs may exceed the benefits because of the limited usefulness in applying the contract modification guidance to periods before the date of initial application. Accordingly, some stakeholders have requested that the FASB and IASB add practical expedients to the standard’s contract modification guidance to address the issue.

For additional information, see TRG Agenda Paper 24.

Summary: TRG members generally agreed that assessing contract modifications for transition under the new revenue standard would be onerous and perhaps impracticable. Some TRG members challenged whether it would be impracticable, noting that impracticability is a high threshold under existing guidance. TRG members were supportive of ways to simplify the treatment of contract modifications for transition, particularly for contracts that may have been modified numerous times over many years.

The TRG’s next meeting is scheduled for March 30, 2015.