Revenue Recognition (ASC 606)
February 10, 2015
Revenue Recognition
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Authoritative Literature
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Neither comprehensive nor easy to apply
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Over 200 separate documents published (ASC 605)
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Guidance is generally narrow in scope and only addresses specific
issues or types of transactions
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Industry-by-Industry basis
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Construction
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Software
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Investment companies
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Airlines
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State and local governments
New Guidance
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In May 2014, ASU 2014-09, Revenue from Contracts with Customers,
was issued. (ASC 606)
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Will replace virtually all the guidance that currently exists on revenue
recognition with a single model to be applied to all contracts with
customers
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The new standard includes a comprehensive revenue recognition
framework that provides broadly applicable guidance in the form of clear
principles that can be applied in addressing questions or issues as they
arise. The FASB hopes the new standard will reduce complexity, provide
more consistency in revenue recognition, and decrease the need for
transaction-specific revenue recognition guidance. Further, the new
standard will achieve almost complete global convergence in revenue
accounting, as there are very few differences between the new FASB
standard and IFRS 15 Revenue from Contracts with Customers , the IASB
standard resulting from the same joint project
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Currently effective in 2017 for public companies and 2018 for private
companies
New Guidance
Principle (ASC 606-10-05-3):
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Recognize revenue to depict the transfer of promised goods or services
via contracts with customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those goods or
services
Omitted from this principle:
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Matching of revenues and expenses
Concepts of earning process and realization/realizability have been eliminated.
Prior conceptual framework stressed these two concepts for revenue recognition.
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New Guidance
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Any entity that enters into a contract with a customer:
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“Contract” = any agreement
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Sale of some non-financial assets (no outputs)
Excludes:
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Financial instruments (Topic 825)
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Leases (Topic 840)
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Insurance contracts (Topic 944)
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Certain nonmonetary exchanges
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Certain put options on sale and repurchase agreements
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Guarantees in the scope of ASC 460
Step 1: Identify Contract
(ASC 606-10-25-1)
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No revenue until there is a contract as defined
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Approved agreement between two or more parties that creates
enforceable rights and obligations
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“Enforceable” is a legal (not accounting) determination
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Parties must intend to perform obligations
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Written, oral, implied by customary business practice
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Has commercial substance
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Identifies performance obligations and payment terms
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Collectability must be “probable”
Similar to “Persuasive Evidence of an Arrangement,” but, if contract
is enforceable as is, OK if not all signatures done.
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Step 1: Identify Contract- Combining Contracts
(ASC 606-10-25-9)
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Required in some circumstances
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Negotiated as a package with one objective, OR
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Goods/services are interrelated, OR
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Fee in one is affected by price/performance on other
If contracts are combined, evaluate combined contract as one
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Same (or related) customer, AND
Irrelevant which particular contract a performance obligation or payment
is covered in
Step 1: Identify Contract- Modification of Contracts
(ASC 606-10-25-10 through 13)
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New standard will provide guidance on accounting for modifications –
none today for most contracts
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If modification just adds goods or services at a reasonable fee, treat
as separate contract
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If more, consider remaining performance obligations in modified
contract
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If what remains is distinct, treat as new contract
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If not, redo allocation and accounting for partially completed performance
obligations taking into account modified contract and recognize
cumulative catch-up
Step 2: Identify Performance Obligations
(ASC 606-10-25-14)
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A promise in a contract with a customer to transfer a good or service
to the customer
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Explicit or implicit (due to business practice, published policies,
marketing, etc.)
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Doesn’t include activities that don’t transfer goods or services (set-up,
admin, etc.) (ASC 606-10-25-17)
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Examples include (ASC 606-10-25-18):
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Delivering a product, performing a task, granting a license
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Constructing or developing an asset
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Standing ready or arranging for another party to do the above
Generally the same as “deliverables” under current GAAP, but
can’t exclude “inconsequential or perfunctory” promises.
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Step 2: Identify Performance Obligations: “Distinct”
(ASC 606-10-25-19 through 22)
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A promise is accounted for separately if distinct
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If not, bundle with others until group is distinct
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Each distinct promise or group of promises is called a “performance
obligation”
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Step 2: Identify Performance Obligations: “Distinct”
(ASC 606-10-25-19 through 22)
A good or service is distinct if:
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Customer can benefit from it either alone or with readily available
resources, AND
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It is separately identifiable from other promises in the contract
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If seller integrates goods/services as part of the contract, obligations are
not distinct
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e.g., in contract to construct a house, the wood, paint and HVAC
are not “distinct”
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If a good/service modifies, customizes or depends on another
good/service, obligations are not separable
Step 3: Determine Transaction Price
(ASC 606-10-32-2)
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Amount that vendor expects to be entitled to for transferring goods or
services
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Excludes amounts collected on behalf of 3rd parties, such as some sales
taxes, shipping insurance, etc.
(change from current GAAP, which allows gross or net for sales taxes
as policy choice)
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“Amount of consideration” may not be obvious
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Variable amounts
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Financing component
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Noncash consideration
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Consideration payable to customer
Step 3: Determine Transaction Price Variable Consideration
(ASC 606-10-32-5 through 14)
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Variable consideration must be estimated
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Applies to volume discounts, rebates, penalties, performance bonuses,
usage-based fees, etc.
Choose method that best predicts actual fee
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Probability-weighted (expected value) likely best for large population
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Most likely amount likely best for individual contracts
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Limit estimates to amounts that are “probable”
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Update each period (cumulative catch-up) as estimates of “probable”
consideration change
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Step 3: Determine Transaction Price -Variable
Consideration
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Include only if it is “probable” that significant revenue reversal will
not occur
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Factors that may make “probable” difficult to achieve:
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Depends on factors outside the entity’s control
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Period of uncertainty
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Limited experience with similar items
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Practice of offering prices concessions
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Significant range of number of potential outcomes
Could result in some variable amounts (e.g., minimum or low point in
range estimate) included in transaction price and some excluded
Step 3: Determine Transaction Price- Financing Component
(ASC 606-10-32-15 through 18)
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Adjust for significant financing component
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Advance payment = interest exp and more revenue
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Delayed payment = interest inc and less revenue
Significant financing component likely exists if:
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Promised consideration varies from cash price
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Delay between payment and transfer of goods/services
But may not exist if:
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Advance payment with delivery at customer discretion
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Delay to allow future event to resolve variable fee
Practical expedient: payment vs. transfer ≤ 1 year
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Step 3: Determine Transaction Price- Other Aspects of
“Transaction Price”
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Noncash consideration is at fair value (ASC 606-10-32-21)
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Amounts paid to customers reduce transaction price unless seller
(ASC 606-10-32-25):
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Receives distinct good or service from customer AND
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Can reasonably estimate fair value of good or service received
Same as current guidance.
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Step 4: Allocate the Transaction Price
(ASC 606-10-32-31 through 34)
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Allocation is based on relative standalone selling price (generally like
current guidance)
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Defined term: The price at which an entity would sell a promised good or
service separately to a customer
Use observable transactions if exist; otherwise:
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Expected cost plus margin
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Adjusted market assessment
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Residual approach OK (if highly variable or uncertain)
Applies to all industries, including software
Elimination of VSOE requirement big change for software.
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Step 4: Allocating the Transaction Price
Exceptions to standalone selling price:
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If the transaction price includes contingent consideration, apply entirely to
a distinct good/service if:
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The contingent payment relates directly to the efforts to transfer that good or
service, and
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Allocation to that distinct good/service is consistent with expectations
Any entity can allocate contingent consideration to more than one distinct
good or service in a contract
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Step 4: Allocating the Transaction Price
Exceptions to standalone selling price:
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If sum of standalone selling prices exceed the transaction price (i.e.,
discount), allocate discount to separate obligations based on standalone
selling price
EXCEPT:
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An entity must allocate a discount entirely to one (some) separate performance
obligation(s) if the following is met:
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The entity regularly sells each good or service on a standalone basis, and
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The observable selling prices provide evidence to where the entire discount belongs
And entity should allocate a discount before using a residual approach to
estimate a standalone selling price for a good or service with a highly
variable or uncertain selling price
Generally the same as current GAAP, except ability to target discount
with observable evidence.
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Step 4: Allocating the Transaction Price Variable
Consideration (ASC 606-10-32-39 through 41)
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Generally, allocate proportionally to all performance obligations
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Allocate to one performance obligation if:
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Terms of variable payment relate specifically to it, and
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Results in reasonable allocation to other performance obligations
Allocate changes in transaction price to all performance obligations
(including completed) on same basis as initial allocation
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Cumulative catch-up adjustment
Step 5: Recognize as Performance Obligation is Satisfied
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Obligation is satisfied when control over good or service is transferred
to customer
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Obtaining Control:
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Transfer of control is determined on the basis of indicators
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Control of an asset refers to the ability to direct the use and obtain
substantially all of the remaining benefits from the asset
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The benefits of an asset are the potential cash flows that can be obtained
directly or indirectly
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Control includes the ability to prevent other entities from directing the
use of and obtaining the benefits from the asset
Step 5: Recognizing Revenue
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Control may pass at a point in time or over time
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“Over time” generally earlier recognition for goods and service, as
delivery or completion not necessary
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“Point in time” generally earlier for IP licenses, as it would happen at
start of license, rather than over term
Focus on control, rather than risks and rewards, is a
significant difference from previous GAAP.
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Step 5: Recognizing Revenue Transfer of Control at
Point in Time (ASC 606-10-25-30)
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Control has transferred when customer can direct the use of and
obtain benefits of asset
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Customer has legal title
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Vendor has right to non-refundable payment
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Customer has physical possession
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Customer has significant risks/rewards of ownership
Customer acceptance (ASC 606-10-55-85 through 87)
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Control transfers ahead of acceptance only if vendor can objectively
determine that terms are met
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Otherwise, wait for acceptance
Step 5: Recognizing Revenue Transfer of Control Occurs
Over Time If: (ASC 606-10-25-17)
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Customer benefits as performance occurs
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e.g., replacement provider wouldn’t have to start over
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Customer controls asset that vendor’s performance is creating or
enhancing
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Work does not create an asset with alternative use to vendor and
vendor has right to payment for performance to date if customer
cancels
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Contractual and practical considerations affect “alternative use”
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Legal remedies affect “right to payment”
Likely to be more recognition before delivery for goods than
there is today.
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Step 5: Recognizing Revenue
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Appropriate methods of measuring progress over time include:
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Input methods: recognized based on effort to satisfy (labor, materials,
etc.)
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Output methods: direct measurement of the value to the customer for
transfers to date (milestones, appraisals)
Intellectual Property Licenses: Distinct
(ASC 606-10-55-54 through 57)
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Applies to software, technology, copyrights, media entertainment,
franchises, patents, trademarks
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Need to first consider whether license is distinct
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If not, combine with other goods/services in contract
Examples of licenses that are not distinct:
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IP is part of a tangible good
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License is only useful along with ongoing service
If distinct, need to distinguish between:
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“Right to use IP” which transfers at a start of license
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“Access to IP” which transfers over term
IP Licenses: Over Time or Point in Time
(ASC 606-10-55-58 through 64)
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Depends on whether IP is “static” vs. “dynamic”
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Static = IP does not change after customer gets license  Right to use
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Dynamic = customer is exposed to effects of ongoing seller activities
related to IP  Access to IP
Right of access if all are true:
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Licensor activities will significantly affect IP
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Licensor activities will not transfer more good/service
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Customer is exposed to effects of licensor activities
Will cause some license fees to be recognized over term rather than
up front (franchises, film and TV rights, etc.).
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Warranties (ASC 606-10-55-30 through 35)
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Standard usually not performance obligations
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Accrue expected costs
Evaluate if warranty provides service in addition to assurance that
product works as promised
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Ongoing service (e.g., maintenance) is an obligation
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Long warranty period may indicate insurance against future loss, which
would be separate obligation
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If sold separately, treat as separate obligation
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Revenue for separate obligations over term
Generally same as current GAAP except for possible
“insurance” element.
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Rights of Return (ASC 606-10-55-22 through 29)
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Treat right of return like variable consideration
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Record revenue for amounts that are probable of not being returned
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Record refund liability (and asset for goods to be returned) for amounts
that are not probable of not being returned
Similar to current GAAP, but with more flexibility to recognize at lease
minimum amount of revenue.
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Customer Options (ASC 606-10-55-41 through 45)
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Allocate revenue to options for additional goods or services if at discount
not otherwise available
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Estimate price of option based on:
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Terms of offer
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Likelihood of customer exercising option
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Price customer would pay if option didn’t exist
If option is for additional quantity or time period for same goods or
services:
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Entity may just estimate total goods/services to be provided, and allocate
accordingly
Similar to some current practice, but much diversity today.
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Presentation (ASC 606-10-45)
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If vendor performs (i.e., recognizes revenue) ahead of payment,
recognize a “contract asset”
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If customer pays ahead of performance
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“Contract liability” for amounts probable of being kept
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“Refund liability” for other amounts
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Does not trigger revenue (ASC 606-10-55-51)
Recognize receivable if right to payment conditional only upon
passage of time
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If receivable is recognized without revenue, adjust contract asset/liability
Transition
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Methods:
1.
Retrospectively to all periods
2.
Retrospectively to all periods but with permitted practical expedients
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3.
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Example: Use transaction price at completion rather than estimating variable
consideration in comparative periods
Cumulative effect at date of initial application to reflect effect of new standard
on contracts not completed at adoption, plus disclosures
No alternative transition method for private companies
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Transition Considerations
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Industries likely to be significantly affected
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Software
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Elimination of restrictive criteria (e.g., “VSOE” and extended payment terms) provides
opportunities to rethink business practices, contracts, processes
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Also, requires significantly more judgment
Real Estate
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Entertainment and media
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PAGE 33
Elimination of rules on down payments and continuing involvement will require
significantly more judgment
New approach to licenses for IP will likely be very challenging
Transition Considerations
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Industries likely to be significantly affected
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Telecommunications
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PAGE 34
Bundled goods/services (handset plus service) could result in more upfront
revenue because new guidance recognizes revenue in proportion to relative
selling prices
Manufactures that Sell through Distributors/Retailers
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No more “sell-through” method
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Effects of rights of return estimated even for new products
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Construction or other contracts with early delivery bonuses or
performance based incentive fees
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Technology and other companies that license intellectual property with
fixed (or up front) fees