The FASB/IASB Revenue Recognition Accounting Project

Transcription

1 June 16, 2011 Financial Reporting Brief The FASB/IASB Revenue Recognition Accounting Project On June 24, 2010, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) published for public comment separate exposure drafts (EDs), Revenue from Contracts with Customers. The separate exposure drafts are the same, except for minor differences in spelling, style, and format. This is the next step in the joint revenue recognition project to develop an entirely new revenue recognition standard. The proposed revenue recognition standard would affect all entities public, private, and not-for-profit that have contracts with customers, except for certain items, such as leases accounted for under FASB Accounting Standards Codification (ASC) 840, Leases; insurance contracts accounted for under FASB ASC 944, Financial Services Insurance; derivatives; and financial instruments. The core principle of the proposed revenue recognition standard is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration the entity receives, or expects to receive, in exchange for those goods or services. To apply the proposed revenue recognition standard, an entity should take the following actions. Step 1: Identify the contact(s) with a customer. Step 2: Identify the separate performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the separate performance obligations. Step 5: Recognize revenue when the entity satisfies each The revenue recognition project has the potential to affect every company s day-to-day accounting and, possibly, the way companies do business through contracts with customers. In reality, entities need to apply the proposed revenue recognition standard to their specific contracts to determine what will be the effect of the new accounting guidance. It is very difficult to truly know the effect of this accounting guidance without applying it directly to contracts and working through all the principles. The boards received nearly 1,000 comment letters on the EDs, expressing a variety of concerns. The boards have been redeliberating the EDs, and they have tentatively decided to significantly change some provisions of the EDs, refine others, and continue redeliberating still other provisions. Significant Changes to the EDs The following are some of the more significant changes the boards have tentatively agreed to make to the EDs. Step 1 Identify the Contract With the Customer Combining and Segmenting Contracts The EDs proposed that an entity should account for two or more contracts together if the prices of those contracts are interdependent. The EDs also proposed that an entity would

2 account for a single contract as two or more contracts if some goods or services are priced independently of other goods or services. The boards tentatively decided that an entity should combine, and account for as a single contract, multiple contracts that are entered into at or near the same time with the same customer if one or more of the following criteria are met: The contracts are negotiated as a package with a single commercial objective. The amount of consideration in one contract depends on the other contract. The goods and services in the contracts are interrelated in terms of design, technology, or function. The boards also tentatively decided that an entity would separate a contract only if the entity identifies separate performance obligations in the contract. Eliminating the criteria to segment if the price of some goods or services in the contract is independent of the price of other goods or services in the contract. Contract Modifications The EDs proposed that an entity should account for a contract modification together with the existing contract if the price of the modification and the existing contract are interdependent. If the prices of the contract modification are not interdependent, the entity should account for the contract modification as a separate contract. The boards tentatively decided that if a contract modification results in the addition of a separate performance obligation at a price that is commensurate with that additional performance obligation, the entity should account for the contract modification as a separate contract. Otherwise, the entity should combine the modification with the contract, reevaluate the performance obligation, and reallocate the transaction price to each separate Eliminating the price interdependence criteria. Step 2 Identify the Separate Performance Obligation Defining Performance Obligations The EDs proposed that a performance obligation is an enforceable promise (whether explicit or implicit) in a contract with a customer to transfer a good or service to the customer. The boards tentatively decided to amend the definition of a performance obligation by deleting the word enforceable. Identifying Separate Performance Obligations A key proposal in the EDs is that of distinct goods or services. The EDs proposed that if an entity promises to provide more than one good or service, it should account for a performance obligation separately only if the promised good or service is distinct. The EDs defined a good or service as distinct if either 1. the entity, or another entity, sells an identical or similar good or services separately, or 2. the entity could sell the good or service separately because the good or service has a distinct function and a distinct profit margin. The boards tentatively decided that an entity should account for a bundle of promised goods or services as one performance obligation if the entity provides a service of integrating those goods or services into a single item that the entity provides to the customer. The boards tentatively decided that an entity should account for a promised good or service as a separate performance obligation if 1. the pattern of transfer of the good or service is different from the pattern of transfer of other promised goods or services in the contract, and 2. the good or service has a distinct function. Eliminating the use of distinct profit margin. The boards also tentatively decided that a good or service has a distinct function if either 1. the entity regularly sells the good or service separately, or 2. the customer can use the good or service either on its own or together with resources that are readily available to the customer. Step 3 Determine the Transaction Price Time Value of Money The EDs proposed that in determining the transaction price, an entity should adjust the amount of promised consideration to reflect the time value of money if the contract includes a material financing component (whether explicit or implicit). The boards tentatively agreed that consideration should reflect the time value of money if the contract includes a financing

3 component that is significant to the contract, but also provided a practical expedient that an entity would not be required to assess whether a contract has a significant financing component if the period between payment by the customer and the transfer of the promised good or service to the customer is one year or less. Practical expedient for time value of money if period between payment and transfer of the good or service is one year or less. Collectability The EDs proposed that in determining the transaction price, an entity should reduce the amount of promised consideration to reflect the customer s credit risk. The effects of changes in the assessment of credit risk associated with the right to consideration should be recognized as income or expense rather than as revenue. The boards tentatively decided that an entity should not reflect the effects of a customer s credit risk in the measurement of the transaction price and, hence, revenue upon transfer of a good or service to the customer. The entity would recognize revenue at the promised amount of consideration, not reduced to reflect the customer s credit risk. The boards also tentatively decided that an entity should recognize an allowance for any expected impairment loss from contracts with customers. The corresponding amount in profit or loss should be presented as a separate line item adjacent to the revenue line (as contra revenue). Eliminating the reduction in amount of promised consideration (and revenue) to reflect customer s credit risk and change to allowance for loss. Uncertain Consideration The EDs proposed that an entity would consider the terms of the contract and its customary business practice to determine the transaction price for the contract with the customer. The transaction price reflects the probability-weighted amount of consideration that an entity expects to receive from the customer in exchange for transferring goods or services. The boards tentatively decided that an entity should follow these steps when a contract has variable consideration: Determine the transaction price. Allocate the transaction price to the separate performance obligations in the contract. Limit the amount of revenue that may be recognized cumulatively on a contract to amounts that the entity is reasonably assured of being entitled to receive. The entity would estimate the transaction price using one of the following methods depending on which is most predictive of the amount of consideration to which the entity is entitled: The probability-weighted amount The most likely amount The EDs proposed that an entity should recognize revenue from satisfying a performance obligation only if the transaction price can be reasonably estimated. The transaction price can be reasonably estimated only if both of the following conditions are met: 1. The entity has experience with similar types of contracts (or access to the experience of other entities if it has no experience of its own). 2. The entity s experience is relevant to the contract because the entity does not expect significant changes in circumstances. The boards tentatively decided instead that an entity would recognize revenue at the amount allocated to a satisfied performance obligation unless the vendor is not reasonably assured to be entitled to that amount. The boards also provided the following list of examples of circumstances in which the entity is not reasonably assured of payment of the entitled amount: The customer could avoid paying an additional amount of consideration without breaching the contract. The entity has no experience with similar types of contracts (or no other persuasive evidence). The entity has experience, but that experience is not predictive of the outcome of the contract based on an evaluation of the factors proposed in the ED. Step 4 Allocate the Transaction Price to the Separate Performance Obligations Allocating Subsequent Changes in the Transaction Price The EDs proposed that after contract inception, an entity should allocate any changes in the transaction price to all performance obligations on the same basis as at contract inception. Amounts allocated to satisfied performance obligations should be

4 recognized as revenue, or a reduction in revenue, in the period in which the transaction price changes. An entity should not reallocate the transaction price to reflect changes in standalone selling prices after contract inception. The boards tentatively decided that an entity should allocate a portion of the transaction price entirely to one (or more) performance obligation(s) if both of the following conditions are met: The contingent payment terms of the contract relate specifically to the entity s efforts to satisfy that performance obligation or a specific outcome from satisfying that separate The amount allocated (including the change in the transaction price) to that particular performance obligation is reasonable relative to all of the performance obligations and payment terms (including other potential contingent payments) in the contract. Step 5 Recognize Revenue Obtaining Control The EDs proposed that an entity would recognize revenue when it satisfies a performance obligation by transferring the promised good or service to the customer, which is when the customer obtains control of the promised good or service. Transferring Services The boards tentatively decided that an entity should identify performance obligations within a contract and then assess whether each performance obligation is a good or service. For a service, a continuous revenue recognition model would be used (revenue recognized as the service is performed). For a good, a discrete transfer model would be used (revenue recognized when control of the good is transferred to the customer). If a single performance obligation includes both goods and services, a vendor would treat that performance obligation as a service. The boards tentatively decided that to recognize revenue for a service, an entity must determine that a performance obligation is satisfied continuously and then must select a method of measuring progress toward complete satisfaction of the The boards tentatively decided that an entity satisfies a performance obligation continuously if at least one of the following two criteria is met: 1. The entity s performance creates or enhances an asset that the customer controls as the asset is created or enhanced. 2. The entity s performance does not create an asset with alternative use to the entity, and at least one of the following is met: a. The customer receives a benefit as the entity performs each task. b. Another entity would not need to reperform the task performed to date if that other entity were to fulfill the remaining obligation to the customer. c. The entity has the right to payment for performance to date even if the customer could cancel the contract for convenience. Separate guidance provided for transfer of good and transfer of services, and criteria for determining continuous transfer. Other Areas Contract Costs Costs of Obtaining a Contract The EDs proposed that all costs of obtaining a contract should be expensed as incurred. The board tentatively decided that an entity should recognize an asset for the incremental costs of obtaining the contract that the entity expects to recover. Incremental costs of obtaining a contract are costs that the entity would not have incurred if the contract had not been obtained. As a practical expedient, the boards tentatively decided that for contracts with a duration of one year or less, an entity should be permitted to recognize contract acquisition costs as an expense when incurred. Eliminating the requirement to expense all costs of obtaining a contract as incurred, and a practical expedient that short-term contracts do not have to capitalize costs of obtaining a contract.

5 Warranties The EDs proposed that an entity should assess the objective of the product warranty. If the objective is to provide a customer with coverage for latent defects in the product, that warranty does not give rise to a performance obligation in addition to the performance obligation to transfer the promised product. If the objective of a warranty is to provide a customer with coverage for faults that arise after the product is transferred to the customer, that warranty gives rise to a performance obligation for warranty services in addition to the performance obligation to transfer the promised product. The boards tentatively decided that an entity should account for a product warranty that relates to quality assurance by accruing warranty costs at the time revenue is recognized rather than by deferring revenue. amount of the transaction price allocated to that performance obligation. The boards tentatively decided that the onerous test would be applied only to those performance obligations that a vendor satisfies over time. The costs a vendor should consider when applying the onerous test are the lesser of the costs that relate directly to satisfying the performance obligation (as defined in paragraph 58 of the EDs); and any amounts the vendor would have to pay to cancel the contract. The boards refer to this as the least-cost model. Onerous test only to performance obligations that are satisfied over time. The boards also tentatively decided that an entity should account for a warranty as a separate performance obligation if a customer has the option to purchase the warranty separately from the vendor, or the warranty provides a service to the customer in addition to assurance that the vendor s past performance occurred as specified in the contract. Onerous Contracts The EDs proposed that a performance obligation is onerous if the present value of the probability-weighted costs that relate directly to satisfying that performance obligation exceeds the Timing On June 15, 2011, the boards announced they would reexpose their revised proposals for a common revenue recognition standard. It was the unanimous view of the boards that although there was no formal due process requirement to reexpose the proposals, it was appropriate to go beyond established due process given the importance of the revenue number to all companies and the need to take all possible steps to avoid unintended consequences. The boards intend to reexpose their work in the third quarter of 2011 for a comment period of 120 days. DISCLAIMER: This publication has not been approved, disapproved or otherwise acted upon by any senior technical committees of, and does not represent an official position of, the American Institute of Certified Public Accountants. It is distributed with the understanding that the contributing authors and editors, and the publisher, are not rendering legal, accounting, or other professional services in this publication. If legal advice or other expert assistance is required, the services of a competent professional should be sought.