United States: New Developments Summary - Revenue Recognition Project Nearing End

Boards complete substantive redeliberations

Summary

For several years, the FASB and the IASB have been discussing their joint revenue recognition project with the objective of developing a single comprehensive, converged revenue recognition model. Those discussions have resulted in a Discussion Paper followed by two Exposure Drafts, with the most recent in 2011, Revenue from Contracts with Customers (2011 ED). The Boards received numerous comment letters on all three documents and have engaged in other outreach efforts throughout the process to solicit feedback on the proposed revenue model. The Boards considered that feedback in their redeliberations of the 2011 ED, and as a result of those redeliberations tentatively decided to revise some of the proposed revenue guidance. At the conclusion of the February 2013 joint meeting, the Boards have completed their substantive redeliberations on the 2011 ED.

The Boards plan to issue a final standard by the middle of 2013, which would be effective for reporting periods beginning on or after December 15, 2016 for public entities reporting under U.S. GAAP. An entity could apply the new guidance retrospectively or alternatively, it could elect an alternative transition method. Early adoption would not be permitted. The new revenue guidance would be effective for nonpublic entities for annual reporting periods beginning after December 15, 2017 and interim and annual periods thereafter. Early adoption would be permitted for nonpublic entities in fiscal years beginning after December 15, 2016.

This bulletin summarizes the current status of the proposed revenue recognition model reflecting tentative decisions made by the Boards through March 2013.

A. Introduction

More than five years ago, the FASB and IASB embarked on a joint project to develop a single model for recognizing revenue and to streamline substantially all revenue recognition guidance. That project began taking shape in 2008 with the issuance of the joint Discussion Paper, Preliminary Views on Revenue Recognition in Contracts with Customers. Then, in June 2010, the Boards issued a joint exposure draft (ED), Revenue from Contracts with Customers, for public comment. After performing extensive outreach with constituents and reviewing nearly 1,000 comment letters on the 2010 ED, the Boards decided to revise their original proposal and to re-expose it for public comment in November 2011.

The Boards have performed extensive outreach on various aspects of the revised revenue recognition proposals and gathered feedback in response to specific questions raised in the 2011 ED. As a result of that process, the Boards identified a number of topics for redeliberation, such as performance obligations satisfied over time, identification of separate performance obligations, constraining the cumulative amount of revenue recognized, customer credit risk, licenses, and disclosures.

This bulletin updates the proposals included in the 2011 ED to reflect the tentative decisions reached by the Boards in redeliberations through the February 2013 joint meeting and for the effective date decisions reached by the FASB at its March 2013 meeting.

Barring any unforeseen problems, the Boards plan to issue a final standard with converged guidance on revenue recognition in the middle of 2013. When finalized, the proposed guidance would replace most of the guidance in FASB Accounting Standards Codification® (ASC or Codification) 605, Revenue Recognition, and supersede most industry-specific revenue guidance.

B. Proposed revenue recognition model

The proposed revenue model is based on the core principle that requires an entity to recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. A “customer” is defined as “a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities.”

To apply this principle, an entity would perform the following five steps:

1. Identify the contract with a customer.

2. Identify separate performance obligations.

3. Determine the transaction price.

4. Allocate the transaction price to separate performance obligations.

5. Recognize revenue when or as an entity satisfies performance obligations.

The proposed guidance would apply to contracts with customers to provide goods or services. It would not apply to certain contracts that are within the scope of other U.S. GAAP, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantees other than product warranties, and nonmonetary exchanges between entities in the same line of business to facilitate sales to third-party customers.

The proposed guidance also would cover transfers of nonfinancial assets that are not part of an entity’s ordinary activities. In such an arrangement, an entity would be required to apply the control and measurement requirements in the proposed guidance, including the requirements on constraining revenue, in determining when to derecognize the asset and the amount of consideration to be included in the gain or loss on the transfer. An entity would also apply to those transactions the requirements in the proposed guidance to determine when a contract exists (Step 1 as discussed below).

Step 1: Identify the contract with a customer

The first step in the proposed model is to identify the “contract,” which the proposed guidance defines as “an agreement between two or more parties that creates enforceable rights and obligations.” A contract can be written, oral, or implied by an entity’s customary business practices. According to the proposed guidance, a contract with a customer must satisfy all of the following criteria:

• The contract has commercial substance.

• The parties have approved the contract and are committed to perform.

• The entity can identify each party’s rights and the payment terms for the goods and services to be transferred.

For purposes of applying the proposed guidance, a contract would not exist if each party has a unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party.

In response to concerns about recognizing revenue for transactions that contain nonrecourse seller-based financing, the Boards tentatively agreed to provide additional guidance to determine whether a contract with a customer exists based on the customer’s commitment to perform under the contract.

Combining contracts

An entity would combine two or more contracts and account for them as a single contract if they are entered into at or near the same time and meet one of the following criteria:

• The contracts were negotiated as a package with one commercial objective.

• The amount paid under one contract is dependent on the price or performance under another contract.

• The goods or services to be transferred under the contracts constitute a single performance obligation.

Contract modifications

A contract modification results when the parties to a contract agree on a change in the scope and/or the price of a contract. If the parties approve a change in scope but the corresponding price has not yet been determined, the entity would apply the proposed revenue guidance to the modified contract when the entity has an expectation that the price of the modification has been approved.

The Boards tentatively decided that contract modifications, including contract claims where changes in scope and price are either unapproved or in dispute as described in ASC 605-35, Revenue Recognition –Construction-Type and Production-Type Contracts, would be considered approved when the modification creates or changes the enforceable rights and obligations of the parties to the contract. Approval could be made orally or in writing or could be implied by customary business practice.

An entity would account for a modification as a separate contract, which would affect future revenues only, if the modification results in both of the following:

• Promised goods or services that are “distinct,” as defined

• The right to receive consideration reflecting the goods’ or services’ stand-alone selling prices under the circumstances of the modified contract

If a contract modification is not a separate contract, the entity would evaluate the remaining goods and services to be delivered under the modified contract to determine how to account for the modification, as follows:

• If the remaining goods or services are distinct from those delivered before the contract was modified, the entity would treat the modification as a termination of the original contract and the creation of a new contract. As such, the transaction price available for allocation to the remaining separate performance obligations would equal the amount of consideration received from the customer but not yet recognized as revenue, plus the amount of any remaining consideration the customer has promised to pay that has not been recognized as revenue.

• If the remaining goods or services are not distinct and are part of a single performance obligation that is partially satisfied as of the modification date, the entity would treat the modification as part of the original contract by adjusting both the transaction price and the measure of progress toward completion of the performance obligation. The revenue recognized to date would be adjusted for the contract modification on a cumulative catch-up basis.

• If the modification represents a combination of the two preceding scenarios, the entity would allocate the consideration received but not yet recognized as revenue, and any remaining consideration the customer has promised to pay, to the remaining performance obligations, including those partially satisfied. The entity would also update the transaction price and remeasure the progress toward completion for any performance obligation that is satisfied over time. The entity would neither reallocate consideration to, nor adjust the amount of revenue recognized for, separate performance obligations satisfied on or before the contract modification date.

• If the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification and there is a subsequent change in the estimated transaction price, an entity would account for the modification prospectively, unless the change in transaction price relates to satisfied performance obligations. Amounts allocated to a satisfied performance obligation would be recognized either as revenue or as a reduction of revenue in the period the transaction price changes.

Step 2: Identify separate performance obligations

Once an entity has identified a contract, it would identify separate performance obligations within that contract. The proposed guidance defines a “performance obligation” as a promise to transfer goods or services to the customer. This includes promises explicitly identified in the contract, as well as promises implied by an entity’s (1) customary business practices, (2) published policies, or (3) specific statements that create a valid customer expectation that goods or services will be transferred under the contract.

In arrangements commonly found in distribution networks, manufacturers often transfer control of products to dealers or retailers (intermediaries) and also promise other goods or services as sales incentives to encourage the sales of those products. The Boards tentatively decided that if a promise to transfer additional goods or services as sales incentives is made in the original contract with an intermediary or is implied, as noted above, those promised goods or services would constitute a performance obligation. On the other hand, if the promise to transfer additional goods or services is made after a manufacturer transfers control of the contracted products or services to an intermediary, that promise would not be considered a performance obligation.

An entity would account for a promised good or service as a separate performance obligation only if the promised good or service is both

• Capable of being distinct because the customer can benefit from the good or service either on its own or with other resources readily available to the customer

• Distinct within the context of the contract because the good or service is not highly dependent on, or highly interrelated with, other promised goods or services in the contract

The following indicators would be used to assist entities in determining whether a promised good or service is distinct:

• Significant integration services are not provided—that is, the entity is not using the good or service merely as an input to produce the specific output called for in the contract.

• The purchase of the good or service does not significantly affect other promised goods or services in the contract.

• The good or service does not significantly modify or customize other promised goods or services in the contract.

• The good or service is not part of a series of consecutively delivered promised goods or services in a contract that meets both of the following conditions:

• Promises to transfer those goods or services to the customer are performance obligations that are satisfied over time.

• The entity uses the same method to measure the progress of transferring each of those goods and services to the customer.

Comparison of proposed guidance to U.S. GAAP

Under the proposed guidance, an entity might identify and separately account for more performance obligations under a single contract than under current U.S. GAAP. For example, the proposed guidance might require an entity to account for the following as separate performance obligations:

• Service-type warranties

• When-and-if available software upgrades

• Free products or services

• Discounts on future sales

Step 3: Determine the transaction price

Under the proposed guidance, the “transaction price” is defined as the amount of consideration an entity expects to be entitled to in exchange for the goods or services promised under a contract. The transaction price would exclude the amounts collected on behalf of third parties (for example, sales taxes) and the effects of the customer’s credit risk. An entity would consider the effects of all the following factors in determining the transaction price:

• Variable consideration

• Time value of money

• Noncash consideration

• Consideration payable to the customer

Variable consideration

The amount of consideration received under a contract might vary due to discounts, rebates, refunds, performance bonuses, and other similar provisions.

Under the proposed model, if the amount of consideration is variable, an entity would estimate the total consideration it would receive under the contract, assuming that (1) it delivers all of the promised goods or services to the customer and (2) the customer does not cancel, renew, or modify the contract. The estimated transaction price would be updated each reporting period to reflect any changes in circumstances that occur during the reporting period.

To estimate the transaction price in a contract that includes variable consideration, an entity would determine either the expected value or the most likely amount of consideration to be received, depending on which method better predicts the amount of consideration to which the entity will be entitled. The expected value, which equals the sum of probability-weighted amounts, might be the appropriate method in situations where an entity has a large number of contracts with similar characteristics. The most likely amount, which represents the single most likely outcome of the contract, might be the appropriate method in situations where a contract has only two possible outcomes (for example, a bonus for early delivery that either would be fully received or not at all). An entity should use the same method to estimate the transaction price throughout the life of a contract.

An entity that expects to refund a portion of the consideration to the customer would recognize a liability for the amount of consideration it reasonably expects to refund. The entity would update the refund liability each reporting period based on current facts and circumstances.

Constraint on cumulative revenue recognized

If the amount of consideration from a customer contract is variable, an entity would be required to evaluate whether the cumulative amount of revenue recognized should be constrained. The Boards tentatively decided that this constraint would also apply to contracts with a fixed price if there is uncertainty about whether the entity would be entitled to the fixed price after satisfying the related performance obligation, such as when a vendor provides price concessions.

In addition, the Boards tentatively decided that the objective of the constraint on revenue recognition would be for an entity to recognize revenue at an amount that should not be subject to the risk of significant reversals as a result of subsequent changes in the estimate of variable consideration to which the entity is entitled. To meet the objective, an entity would need to have sufficient experience or evidence to support its assessment that revenue recognized would not be subject to a risk of significant revenue reversal. The assessment would be qualitative and should consider all of the facts and circumstances associated with both the risk of a revenue reversal arising from an uncertain future event and the magnitude of the reversal if that uncertain event were to occur or fail to occur. An entity would reassess the objective as subsequent facts and circumstances change.

Although the Boards did not establish a level of confidence necessary for an entity to recognize revenue for variable consideration, they indicated that the level of confidence would need to be relatively high.

The following indicators would be used to help an entity assess whether to recognize revenue based on estimates of variable consideration:

• The amount of consideration is highly susceptible to factors outside the entity’s influence.

• The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.

• The entity has limited experience with similar types of performance obligations.

• There are a large number and wide range of possible consideration amounts in the contract.

Comparison of proposed guidance to U.S. GAAP

In general, under existing U.S. GAAP, the consideration from a customer contract must be fixed or determinable before an entity can recognize revenue. Therefore, if an arrangement includes variable consideration, an entity generally does not include the variable amounts in the transaction price until the variability is resolved, except for contracts accounted for under the percentage-of-completion method.

For example, if an arrangement includes a performance bonus, the entity would not include any amount of the performance bonus in the transaction price until the performance bonus is earned.

Under the revenue proposals, an entity would estimate and include in the transaction price the most predictive amount of a performance bonus that would not be subject to risk of significant reversal as a result of subsequent changes in the estimate of variable consideration to which the entity is entitled.

Time value of money

Under the proposed model, an entity must reflect the time value of money in its estimate of the transaction price if the contract includes a significant financing component. The objective in adjusting the transaction price for the time value of money is to reflect an amount for the selling price as though the customer had paid cash for the goods or services when they were transferred.

To determine whether a financing component is significant, an entity would consider several factors, including, but not limited to, the following:

• The expected length of time between delivery of the goods or services and receipt of payment

• Whether the amount of consideration would be substantially different if the customer paid cash under normal credit terms

• The interest rate in the contract and prevailing market rates

A vendor would not adjust advance payments for the effects of the time value of money, however, if the transfer of control of the good or service is at the customer’s discretion.

As a practical expedient, an entity could ignore the impact of the time value of money on a contract if it expects, at contract inception, that less than one year will elapse between the delivery of goods or services and the customer payment. The Boards clarified that the practical expedient would also apply to contracts with a duration of greater than one year if the period between performance and the corresponding payment for that performance is one year or less.

To adjust the amount of consideration for the time value of money, an entity would use the discount rate reflected in a separate financing transaction between the entity and the customer at contract inception. That rate would reflect the borrower’s (customer’s) credit risk and any collateral or security provided by the customer or the entity, including assets transferred under the contract.

An entity would present the effects of financing separately from revenue as interest expense or interest income in the statement of comprehensive income. However, the Boards tentatively decided that a vendor would not be precluded from presenting interest income recognized from contracts with a significant financing component as revenue.

Noncash consideration

If a customer promises consideration in a form other than cash, an entity would measure the noncash consideration at fair value in determining the transaction price. If an entity is unable to reasonably measure the fair value of noncash consideration, it would indirectly measure the consideration by referring to the stand-alone selling price of the goods or services promised under the contract.

Consideration payable to a customer

Consideration payable to a customer includes amounts that an entity pays or expects to pay to a customer in the form of cash or noncash items, which the customer can apply against amounts owed to the entity. An entity would reduce the transaction price by the amount it owes to the customer, unless the consideration owed is in exchange for distinct goods or services transferred from the customer to the entity.

If the customer transfers distinct goods or services to an entity in exchange for payment, the entity would account for the purchase of these goods or services similarly to purchases from suppliers. If the amount of consideration owed to the customer exceeds the fair value of those goods or services, the entity would reduce the transaction price by the amount of the excess. If the entity cannot estimate the fair value of the goods or services it receives from the customer, it would reduce the transaction price by the total consideration owed to the customer.

An entity would recognize the reduction in revenue associated with adjusting the transaction price for consideration payable to a customer at the later of the following dates:

• The date the entity recognizes revenue for the transfer of goods or services to the customer

• The date the entity pays or promises to pay the consideration to the customer, a promise that might be implied by the entity’s customary business practices

Collectibility

A customer’s credit risk would neither be reflected in the measurement of the transaction price nor be used as a recognition threshold. However, the Boards emphasized that an entity would consider a customer’s credit risk in determining whether a contract with a customer exists based on the customer’s commitment to perform its obligations under the contract. Significant uncertainty at contract inception about a customer’s ability to pay the promised amount may indicate that the parties are not committed to perform their respective obligations, in which case there would be no contract.

Under the revenue proposals, customer credit risk losses would be accounted for using the guidance in ASC 310, Receivables. The Boards tentatively decided that an entity would present such initial and subsequent losses prominently as an expense in the statement of comprehensive income rather than adjacent to revenues as proposed in the 2011 ED.

Comparison of proposed guidance to U.S. GAAP

Under existing U.S. GAAP, collectibility is a recognition principle. That is, an entity cannot recognize revenue until collectibility is reasonably assured (or probable, if an entity is applying the software guidance). Under the proposed model, however, collectibility would not be considered in determining when revenue is recognized. Its effect on net income would be presented prominently as an expense in the statement of comprehensive income.

Step 4: Allocate the transaction price to separate performance obligations

Under the proposed guidance, an entity would allocate a contract’s transaction price to each separate performance obligation within that contract on a relative stand-alone selling price basis at contract inception. The proposed guidance defines a “stand-alone selling price” as “the price at which an entity would sell a promised good or service separately to a customer.” An entity would use the observable selling price of the good or service underlying each separate performance obligation, if available, as the stand-alone selling price. If the stand-alone selling price is not observable, then an entity would estimate it. To estimate a stand-alone selling price, an entity would consider all reasonably available information, including market conditions, entity-specific factors, and information about the customer or class of customer, and would maximize the use of observable inputs.

The proposed guidance suggests, but does not require, the following three suitable methods to estimate the stand-alone selling price:

1. An adjusted market assessment approach, which involves evaluating the market in which the entity sells goods or services and estimating the price that customers in that market would pay for those goods or services. An entity might also consider price information from its competitors and adjust that information for the entity’s particular costs and margins.

2. An expected cost plus margin approach, under which an entity would forecast its expected costs to provide goods or services and add an appropriate margin to estimate the selling price.

3. A residual approach, which involves subtracting the sum of observable stand-alone selling prices for other goods and services promised under the contract from the total transaction price to arrive at an estimated selling price for a performance obligation. An entity would use this approach if the stand-alone selling price of a good or service is highly variable or uncertain.

The Boards reached a tentative decision to clarify that the residual approach may be used for two or more goods or services with highly variable or uncertain stand-alone selling prices if one or more other goods or services in the contract do not have highly variable or uncertain stand-alone selling prices. In addition, a combination of techniques could be used when estimating stand-alone selling prices of two or more goods or services with highly variable or uncertain stand-alone selling prices, as follows:

• First, an entity would apply the residual approach to estimate the aggregate stand-alone selling prices of all goods and services with highly variable or uncertain selling prices.

• Then, it would utilize another technique to allocate that aggregate stand-alone selling price to those individual goods and services.

If the sum of the stand-alone selling price for the promised goods or services exceeds the contract’s total consideration, an entity would treat the excess as a discount that would be allocated to the separate performance obligations on a relative stand-alone selling price basis.

However, an entity would allocate a discount to a single performance obligation if it both

• Regularly sells each good or service in the contract on a stand-alone basis

• Has evidence based on stand-alone selling prices that the discount is associated with a certain performance obligation

An entity would allocate contingent consideration to a distinct good or service if both

• The contingent payment terms relate specifically to the entity’s efforts to transfer that distinct good or service

• Such allocation would depict the amount of consideration the entity expects to be entitled to in exchange for satisfying the performance obligation associated with that good or service

The Boards tentatively decided that an entity would allocate a discount before using a residual approach to estimate a stand-alone selling price for a good or service with a highly variable or uncertain stand-alone selling price. Also, contingent consideration could be allocated to more than one distinct good or service.

Changes in the stand-alone selling price of goods or services after contract inception would not require reallocation of the transaction price.

Changes in transaction price

If the transaction price changes, an entity would allocate the change to separate performance obligations in the same manner that it allocates the transaction price at contract inception. Any change in transaction price allocated to a satisfied performance obligation would be recognized either as revenue or as a reduction in revenue in the period the change occurs. If the following criteria are met, an entity would allocate a change in transaction price to a single distinct good or service, using the same criteria applied to contingent consideration:

• The change in transaction price relates specifically to either (1) the entity’s efforts to transfer goods or services, or (2) a specific outcome of transferring the goods or services.

• Allocation of the change in transaction price entirely to the distinct good or service is consistent with the general allocation principle described above, considering all of the performance obligations and payment terms in the contract.

Step 5: Recognize revenue when or as an entity satisfies performance obligations

Under the proposed guidance, an entity would recognize revenue when or as it transfers promised goods or services to a customer. A “transfer” occurs when the customer obtains control of the good or service (that is, an asset).

A customer would obtain “control” when it can either (1) direct the use of, and obtain substantially all the benefits from, an asset, or (2) prevent other entities from directing the use of, and obtaining the benefits from, an asset. The proposed guidance defines the “benefits” of an asset as the potential cash flows that can be obtained directly or indirectly from the asset.

Control transferred over time

An entity would determine at contract inception whether each separate performance obligation will be satisfied (that is, control will be transferred) over time or at a specific point in time.

Control would be considered transferred over time if one of the following conditions exists:

• The customer controls the asset as it is created or enhanced by the entity’s performance under the contract.

• The customer receives and consumes the benefits of the entity’s performance as the entity performs. A customer would receive a benefit from the entity’s performance as the entity performs if another entity does not have to substantially reperform the work completed to date if it stepped in to complete the remaining obligation under the contract.

• The entity’s performance creates or enhances an asset that has no alternative use to the entity, and the entity has the right to receive payment for work performed to date and expects to fulfill the contract as promised. An entity would evaluate whether a promised asset has an alternative use to the entity at contract inception by considering whether it can readily redirect the partially completed asset to another customer throughout the production process. In addition, the right to payment should be enforceable, and a vendor would consider the contractual terms, as well as any legislation or legal precedent that could override those terms, in assessing the enforceability of that right.

An entity would recognize over time revenue that is associated with a performance obligation that is satisfied over time by measuring its progress toward completion of that performance obligation. The objective of this measurement is to depict the pattern by which the entity transfers control of the goods or services to the customer. The entity would update this measurement over time as circumstances change and would account for these changes as a change in accounting estimate, under the guidance in ASC 250, Accounting Changes and Error Corrections.

The proposed guidance discusses two methods that are appropriate for measuring an entity’s progress toward completion of a performance obligation: output methods and input methods.

Output methods

Under an output method, an entity would recognize revenue by directly measuring the value of the goods and services transferred to date to the customer (for example, milestones reached or units produced). When applying an output method, it would be appropriate for an entity to recognize revenue in the amount it is entitled to invoice the customer, provided that the amount corresponds directly with the value of the goods or services transferred to date. Although output methods might be the most faithful depiction of an entity’s performance, there are challenges in applying output methods. For instance, outputs often are not readily observable, and the information required to use them may not be available to an entity without undue cost.

The units produced method of measuring progress toward satisfying a performance obligation could provide a reasonable proxy for the entity’s performance if the value of any work-in-progress at the end of the reporting period is immaterial. In addition, a units delivered method could provide a reasonable proxy for the entity’s performance in satisfying a performance obligation if both of the following conditions exist:

• The value of any work-in-progress at the end of the reporting period is immaterial.

• The value of any units produced but not yet delivered to the customer at the end of the reporting period is immaterial.

Input methods

With an input method, an entity would recognize revenue based on the extent of its efforts or inputs toward satisfying a performance obligation compared to the expected total efforts or inputs needed to satisfy the performance obligation. Examples of input measures include labor hours expended, machine hours used, and costs incurred. It might be appropriate for an entity to recognize revenue on a straight-line basis if its efforts or inputs are expended evenly throughout the performance period. The Boards tentatively decided that if an entity selects an input method such as costs incurred to measure its progress, it would be required to make adjustments to that measure of progress if including some of those costs (for example, wasted materials) would distort the entity’s performance under the contract.

If a performance obligation consists of goods and related services and the customer obtains control of the goods (uninstalled materials) significantly before receiving the related services, an entity might best depict its performance by recognizing revenue associated with the goods in an amount equal to their cost when the goods are transferred to the customer. To recognize revenue in this manner, both of the following conditions must exist at contract inception:

• The cost of the goods is significant compared to the total expected costs associated with the performance obligation.

• The entity obtains the goods from another entity and is not significantly involved in their design or manufacture.

The adjustment to the input method for uninstalled materials is to ensure that the input method meets the objective of measuring progress in paragraph 38 of the 2011 ED—that is, to depict an entity’s performance.

Ability to reasonably measure progress

An entity would recognize revenue for a performance obligation satisfied over time only if it can reasonably measure its progress toward completion. As a result, an entity would not be able to reasonably measure its progress toward completion if it lacks reliable information that is required to apply an appropriate method of measurement. In some cases, such as during the early stages of a contract, an entity might not be able to reasonably measure its progress toward completion, but would still expect to recover costs incurred in satisfying the performance obligation. In these situations, an entity would be permitted to recognize revenue to the extent of costs incurred until (1) it is reasonably able to measure its progress or (2) the performance obligation becomes onerous.

Control transferred at a point in time

In situations where control over an asset (goods or services) is transferred at a single point in time, an entity would recognize revenue by evaluating when the customer obtains control of the asset. In performing the evaluation, an entity should consider indicators of control, including, but not limited to, the following:

• The entity has a present right to receive payment for the asset.

• The customer has legal title to the asset.

• The customer has physical possession of the asset.

• The customer has assumed the significant risks and rewards of owning the asset.

• The customer has accepted the asset.

Repurchase agreements

Sometimes an entity will enter into a contract to sell an asset and also promises or has the option to repurchase the asset, an asset that is substantially the same as that asset or another asset of which the asset that was originally sold is a component. An entity will need to evaluate the form of the promise to repurchase the asset in determining the accounting (for example, a forward, call or put option).

If a contract includes a forward (entity obligation to repurchase) or a call option (entity right to repurchase), an entity would account for the contract (1) as a lease if it expects to repurchase the asset for an amount that is less than the original selling price of the asset or (2) as a financing arrangement if it expects to repurchase the asset for an amount that is equal to or more than the original selling price of the asset. The Boards clarified in redeliberations that in a product financing arrangement in which an entity sells a product to another entity (such as a contract manufacturer) and later repurchases the product as part of a larger component for a higher price, the processing costs would not be included in the repurchase price when determining the amount of interest.

If a customer is granted a right to require an entity to repurchase the asset (put option) at a price that is lower than the original selling price of the asset, the entity would consider whether the customer has a significant economic incentive to exercise that right. If the customer has a significant economic incentive to exercise the right, the agreement would be accounted for as a lease because the customer is effectively paying the entity for the right to use the asset for a period of time. If the customer does not have a significant economic incentive to exercise the right, the entity would account for the agreement as a sale with a right of return.

If a contract grants the customer a put option and the repurchase price of the asset exceeds the original selling price and is more than the expected market value of the asset, the contract would be considered a financing arrangement and the entity would continue to recognize the asset and would recognize a liability initially measured at the original selling price of the asset.

Sale-leaseback transactions

A sale-leaseback transaction with a put option that has an exercise price less than the original sales price would be accounted for as a financing transaction rather than as a lease if the holder of the put option has a significant economic incentive to exercise the option.

C. Other topics

Contract costs

Incremental costs of obtaining a contract

Under the proposed model, an entity would capitalize the incremental costs of obtaining a contract if it expects to recover those costs. The “incremental costs” of obtaining a contract are defined as costs that an entity would not have incurred if it had not obtained the contract (for example, a sales commission). Costs that an entity incurs regardless of whether it obtains a contract would be expensed as incurred, unless the costs are explicitly chargeable to the customer regardless of whether the entity obtains the contract. As a practical expedient, the proposed guidance would allow an entity to expense the incremental costs of obtaining a contract as incurred if the amortization period of the asset that the entity would have otherwise recognized is one year or less.

Costs to fulfill a contract

If costs incurred in fulfilling a contract with a customer are covered under a Codification Topic other than ASC 605 (such as ASC 330, Inventory, or ASC 360, Property, Plant, and Equipment), an entity would account for those costs in accordance with the guidance in the other Topic. If such costs do not fall within the scope of another Topic, however, an entity would recognize an asset for such costs, provided all of the following criteria are met:

• The costs relate directly to a contract. Examples of costs that relate directly to a contract include the following:

• Direct labor

• Direct materials

• Allocated costs that relate directly to the contract or contract activities (for example, contract management and supervision costs and depreciation of tools and equipment used in fulfilling the contract)

• Costs that are chargeable to the customer

• Other costs that the entity incurs only because it entered into the contract

• The costs generate or enhance resources that the entity will use to satisfy performance obligations in the future.

• The entity expects to recover the costs.

An entity would expense the following costs as incurred:

• General and administrative costs that are not explicitly chargeable to the customer

• Costs of wasted materials, labor, or other resources that were not reflected in the contract price

• Costs that relate to satisfied performance obligations

• Costs related to remaining performance obligations that cannot be distinguished from costs related to satisfied performance obligations

Amortization and impairment

Under the proposed revenue model, an entity would amortize capitalized contract costs on a systematic basis consistent with the pattern of transferring the goods or services related to those costs. If an entity identifies a significant change to the expected pattern of transfer, it would update its amortization to reflect that change in estimate in accordance with ASC 250, Accounting Changes and Error Corrections.

An entity would recognize an impairment loss in earnings if the carrying amount of an asset exceeds its recoverable amount. Under the proposed guidance, the recoverable amount equals the remaining amount of consideration the entity expects to be entitled to in exchange for the goods or services associated with the capitalized contract costs, minus the costs directly related to those goods or services.

Before recognizing an impairment loss under the proposed revenue recognition guidance, an entity would recognize impairment losses associated with assets related to the contract that are accounted for under other Codification guidance, such as ASC 330, Inventory. An entity would not be permitted to reverse a previously recognized impairment loss.

Comparison of proposed guidance to U.S. GAAP

Under the proposed guidance, entities would likely capitalize more contract costs than under existing U.S. GAAP. Outside of current guidance on accounting for long-term construction contracts and certain industry-specific guidance, U.S. GAAP does not address how an entity should account for many costs of obtaining and fulfilling customer contracts. Accordingly, entities often analogize to the industry-specific guidance when making accounting policy elections about whether to defer or expense contract costs. Under the proposed guidance, an entity that currently elects to expense eligible contract costs as incurred might be required to defer those costs.

Warranties

If a customer has the option to separately purchase a warranty, then an entity would account for that warranty as a separate performance obligation. If a customer does not have the option to separately purchase a warranty, then the entity would account for the warranty using the cost accrual guidance in ASC 460, Guarantees, unless all or part of the warranty provides the customer with an additional service beyond the assurance that the product will comply with agreed-upon specifications.

The proposed guidance lists the following factors that an entity would consider in determining whether a warranty provides a customer with an additional service:

• Whether the warranty is required by law – A legal requirement to provide a warranty indicates that the warranty is intended to protect the customer from purchasing a defective product. Therefore, such a warranty would not likely represent a performance obligation.

• The term of the warranty coverage period – The longer the coverage period, the more likely a warranty is a performance obligation.

• The nature of the tasks the entity promises to perform under the warranty – If an entity must perform certain tasks to provide assurance to the customer that the product complies with agreed-upon specifications, those services would not likely constitute a separate performance obligation.

If an entity determines that a warranty provides a service that is separate from the assurance of the product’s compliance with agreed-upon specifications, the service would be considered a separate performance obligation. The entity would allocate a portion of the transaction price to that service unless it cannot reasonably account for the assurance and service portions of the warranty separately. If an entity determines that it cannot reasonably separate the assurance and service components of a warranty, it would account for both together as a single performance obligation.

Comparison of proposed guidance to U.S. GAAP

Under existing U.S. GAAP, entities generally account for standard warranty obligations under the guidance in ASC 460, Guarantees, which refers to the guidance in ASC 450, Contingencies. That is, an entity accrues a liability for its expected costs associated with performing under a warranty when the obligation is probable and reasonably estimable. For separately priced extended warranties, entities currently look to the guidance in ASC 605-20, Revenue Recognition: Services.

Under the proposed guidance, an entity would be required to distinguish between warranty obligations that represent assurance of a product’s performance and those that represent a separate performance obligation. Therefore, an entity offering a standard warranty that is not separately priced might determine that all or a portion of its warranty obligation constitutes a separate performance obligation.

Licensing and rights to use

The Boards tentatively decided to amend the proposed implementation guidance for licenses in the ED.

The Boards tentatively concluded that some license arrangements represent a promise to transfer a right while others represent a promise to provide access to the entity’s intellectual property. Therefore, an entity would be required to assess the nature of the promise for the license before applying the proposed revenue recognition model to license arrangements.

For a license that is distinct, the nature of the assessment of the promise is relevant in determining whether the license results in a performance obligation that is satisfied at a point in time or over time. If the license is a promise to provide a right, the performance obligation would be satisfied at a point in time. If the license is a promise to provide access to the entity’s intellectual property, the performance obligation would be satisfied over time.

An entity would consider the characteristics of a license to determine the nature of the promise. The following characteristics may indicate that the nature of the promise in a license represents a promise to provide a right:

• The right transferred in the license represents an output of the entity’s intellectual property similar to a tangible good.

• The entity can easily reproduce the license with little or no effect on the value of the entity’s intellectual property.

• The customer can determine when and how to use the right and does not require any future performance from the entity to be able to consume the benefits from that right.

If these characteristics are not present, the license would instead represent a promise to provide access to the entity’s intellectual property.

After an entity determines the nature of the promise related to the license, it would need to assess the following factors:

• Whether other goods or services have been promised in addition to the license and, if so, whether the license is distinct from those other goods or services

• Whether the separate performance obligations are satisfied over time or at a point in time

• Whether the cumulative amount of revenue recognized is subject to the constraint

Comparison of proposed guidance to U.S. GAAP

U.S. GAAP provides limited guidance on accounting for revenue associated with licensing arrangements outside of certain industries, such as software, motion pictures, and music. The proposed guidance would standardize the process used for evaluating how to recognize revenue associated with licenses and rights to use. An entity that currently recognizes license revenue over time might, under the proposed model, be required to recognize such revenue “up front” if it determines that the licensing arrangement is a promise to provide a right and is a separate performance obligation.

The Boards tentatively decided to remove paragraph 85 of the 2011 ED, which would have precluded revenue recognition for intellectual property licensed to a customer if consideration paid to the licensor varies based on the customer’s subsequent sales (for example, a sales based royalty). Instead, the Boards tentatively agreed that these licenses would be subject to the same proposed general principles of revenue constraint applicable to all other licenses.

One proposed indicator in those general principles (described in “Constraint on cumulative revenue” above) describes factors outside an entity’s influence that may constrain revenue recognized. The Boards tentatively decided to refine this indicator to include the actions of third parties (for example, the customer’s subsequent sales) as a factor that might constrain revenue. Accordingly, when a license arrangement begins and the licensor estimates the minimum amount of revenue to which it expects to be entitled, in some cases the entity may conclude its best estimate is zero.

Onerous performance obligations

The Boards reconsidered the proposed guidance in the ED on onerous performance obligations and tentatively decided that the proposed revenue recognition standard would not include new guidance for onerous contracts. Therefore, entities would use existing guidance, such as ASC 605-35, Revenue Recognition: Construction-Type and Production-Type Contracts, to identify and account for losses arising from contracts with customers.

D. Presentation and disclosure

Presentation

Under the proposed guidance, an entity would present a contract in its statement of financial position as a contract liability, a contract asset, or a receivable, depending on the relationship between the entity’s performance and the customer’s performance at the reporting date.

An entity would present a contract as a contract liability if the customer has paid consideration, or if payment is due as of the reporting date but the entity has not yet satisfied a performance obligation by transferring a good or service. Conversely, if the entity has transferred goods or services as of the reporting date but the customer has not yet paid, the entity would recognize either a contract asset or a receivable. An entity would recognize a contract asset if its right to consideration is conditioned on something other than the passage of time; otherwise, an entity would recognize a receivable.

Disclosure

The proposed guidance would require many new disclosures about contracts with customers for both public and nonpublic companies, including the following:

• Revenue disaggregated according to the nature, amount, timing, and uncertainty of revenue and cash flows

• Information about performance obligations, including

• When the entity typically satisfies performance obligations

• Significant payment terms, including a qualitative discussion about any significant variable consideration that was not included in the disclosure of remaining performance obligations

• Nature of goods and services

• Obligations for returns, refunds, and similar obligations

• Types of warranties and related obligations

In addition, public entities would be required to disclose the following information:

• Quantitative and qualitative information about contract balances, including the following:

• Opening and closing balances of contract assets, contract liabilities, and receivables from contracts with customers (if not separately presented)

• An explanation of significant changes in the balances of contract assets and liabilities

• Revenue recognized in the period that arises from amounts allocated to performance obligations satisfied (or partially satisfied) in previous periods (for example, as a result of changes in transaction price or estimates related to the constraint on revenue recognized)

• Certain information about contracts with an original expected duration in excess of one year, including

• The aggregate transaction price allocated to the remaining performance obligations

• An explanation of when the entity expects to recognize as revenue the transaction price allocated to the remaining performance obligations

• Information about significant judgments, such as

• The expected timing of satisfying performance obligations

• The transaction price and amounts allocated to performance obligations

• Quantitative and qualitative information about assets recognized from costs incurred to obtain or fulfill a contract with a customer, including by main category of asset, the closing balances of those assets.

E. Effective date and transition

The FASB tentatively decided that the proposed guidance would be effective for reporting periods beginning on or after December 15, 2016. Early adoption would not be permitted for public entities. The effective date for nonpublic entities would be deferred for one year to annual reporting periods beginning after December 15, 2017 and interim and annual periods thereafter. Early adoption would be permitted for nonpublic entities in fiscal years beginning after December 15, 2016. The IASB tentatively decided to allow early adoption for all entities.

Entities would be permitted to apply the new revenue standard either retrospectively subject to some practical expedients or through an alternative transition method. The alternative transition method would require an entity to apply the proposed guidance only to contracts not completed under existing U.S. GAAP at the date of initial application and recognize the cumulative effect of adoption as an adjustment to the opening balance of retained earnings in the year of initial application. An entity that chooses to apply the alternative transition method, would not restate comparative years however, it would be required to provide the following additional disclosures in the initial year of adoption:

• By income statement line item, the current year impact of applying the new revenue standard

• An explanation of the significant changes between the reported results under legacy U.S. GAAP and the new revenue standard

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.