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The FASB/IASB Revenue Recognition Accounting Project

On November 14, 2011, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board published for public comment a revised joint exposure draft (ED), Revenue from Contracts with Customers. Comments on the revised ED are due by March 13, 2012, and the boards hope to issue a final standard later in 2012.

This is the next step in the joint revenue recognition project to develop an entirely new revenue recognition standard. The boards previously issued an exposure draft in June 2010, but after receiving nearly 1,000 comment letters and extensive redeliberation and outreach activities with respondents, it was decided that some items needed to clarified, simplified, or revised.

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.

Revenue Recognition—Principle

The core principle of the proposed revised revenue recognition standard remains to be that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those good 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 (or as) the entity satisfies a performance obligation.

If adopted in its current form, revenue would be recognized when a company satisfies a performance obligation by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service).

In its current form, the November 2011 ED could result in changes to the amount and timing of the revenue recognized by an entity, especially for long-term service contracts and multiple element arrangements.

The following is a summary of major changes to accounting and a comparison to the June 2010 ED.

Combining and Segmenting Contracts

The ED proposes that an entity should combine two or more contracts entered into at or near the same time with the same customer and account for the contracts as a single contract if one or more of the following criteria are met:

  1. The contracts are negotiated as a package with a single commercial objective.
  2. The amount of consideration in one contract depends on the other price or performance of the other contract.
  3. The goods and services promised in the contracts (or some goods or services promised in the contracts) are a single performance obligation, in accordance with the guidance in paragraphs 27–30 of the ED.


This is a change from the June 2010 EDs that eliminates 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 ED proposes that an entity should account for a contract modification as a separate contract if the contract modification results in the addition to the contract of both of the following:

  1. Promised goods or services that are distinct, in accordance with the guidance in paragraphs 27–30 of the ED
  2. An entity’s right to receive an amount of consideration that reflects the entity’s stand-alone selling price of the promised good(s) or service(s) and any appropriate adjustments to that price to reflect the circumstances of the particular contract


For a contract modification that is not a separate contract, an entity should evaluate the remaining goods or services in the modified contract (that is, the promised goods or services not yet transferred at the date of the contract modification) and should account for the modified contract as described in paragraph 22 of the ED, depending on whether the remaining goods or services are distinct or not distinct from the goods or services transferred on or before the date of the contract modification.

This is a change from the June 2010 ED that eliminates the criteria of price interdependence for a contract modification to be accounted for together with the existing contract.

Distinct Goods or Services

The ED proposes revised criteria for identifying separate performance obligations. The ED proposes that if an entity promises to transfer more than one good or service, the entity would account for each promised good or service as a separate performance obligation only if it is distinct.

If a promised good or service is not distinct, an entity would combine that good or service with other promised goods or services until the entity identifies a bundle of goods or services that is distinct.

A good or service is distinct if either of the following criteria is met:

  1. The entity regularly sells the good or service separately.
  2. The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.


A good or services in a bundle of promised goods or services is not distinct; therefore, the entity would account for the bundle as a separate performance obligation if both of the following criteria are met:

  1. The goods or services in the bundle are highly interrelated, and transferring them to the customer requires that the entity also provides a significant service of integrating the goods or services into the combined item(s) for which the customer has contracted.
  2. The bundle of goods or services is significantly modified or customized to fulfill the contract.


The ED also provides a practical expedient to allow an entity to account for two or more distinct goods or services promised in a contract as a single performance obligation if those goods and services have the same pattern of transfer to the customer.

The ED provided clarity on the proposed guidance from the June 2010 EDs by eliminating the distinct profit margin criterion, specifying when highly interrelated goods or services should be accounted for as a single performance obligation, and requiring an entity to consider only if it sells the good or service separately (not considering if other entities sell the goods or services separately).

Variable Consideration

The ED proposes that if the promised amount of consideration in a contract is variable, an entity should estimate that total amount to which the entity will be entitled in exchange for transferring the promised goods or services to a customer. To estimate the transaction price, an entity should use either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled:

  1. The expected value. The sum of probability-weighted amounts in a range of possible consideration amounts.
  2. The most likely amount. The single most likely amount in a range of possible consideration amounts.


This is a change from the June 2010 ED that eliminates the requirement to use the probability-weighted approach in all circumstances.

Time Value of Money

The ED proposes that consideration should reflect the time value of money if the contract includes a financing component that is significant to the contract but also provides 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.

Collectability

The ED proposes that an entity should recognize revenue at the amount of consideration to which the entity expects to be entitled. The entity would recognize revenue at the promised amount of consideration not reduced to reflect the customer’s credit risk.

This is a significant change from the June 2010 ED that 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 would be recognized as income or expense, rather than revenue.

The ED also proposes 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 contrarevenue).

Allocating the Transaction Price to Separate Performance Obligations

The ED proposes that, for a contract that has more than one separate performance obligation, an entity should allocate the transaction price to each separate performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each separate performance obligation.

To allocate an appropriate amount of consideration to each separate performance obligation, an entity should determine the stand-alone selling price at contract inception of the good or service underlying each separate performance obligation and allocate the transaction price on a relative stand-alone selling price basis.

If a stand-alone selling price is not directly observable, an entity should estimate it. The ED includes a list of suitable estimation methods: adjusted market assessment approach, expected cost plus a margin approach, and the residual approach. The residual approach would be appropriate only if the stand-alone selling price of a good or service is highly variable or uncertain, and the stand-alone selling prices of the other performance obligations in the contract are observable.

Transfer of Control

The ED proposes revised guidance for determining whether a performance obligation is satisfied over time or at a point in time.

For each separate performance obligation, an entity would determine whether the entity satisfies the performance obligation over time by transferring control of a good or service over time. If the entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time.

An entity transfers control of a good or service over time and satisfies a performance obligation and recognizes revenue over time 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:
    1. The customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs.
    2. Another entity would not need to substantially reperform the work that the entity has completed to date if that other entity were to fulfill the remaining obligation to the customer.
    3. The entity has the right to payment for performance completed to date, and it expects to fulfill the contract as promised.


If a performance obligation is satisfied over time, the entity would recognize revenue over time by consistently applying a method of measuring the progress toward complete satisfaction of that performance obligation (using either an output or input method).

If a performance obligation is not satisfied over time, an entity satisfies the performance obligation at a point in time. To determine the point in time when a customer obtains control of a promised asset, and an entity satisfies a performance obligation, the entity would consider indicators of the transfer of control that include, but are not limited to, the following:

  1. The entity has a present right to payment for the asset.
  2. The customer has legal title to the asset.
  3. The entity has transferred physical possession of the asset.
  4. The customer has the significant risks and rewards of ownership of the asset.
  5. The customer has accepted the asset.


Constraining the Cumulative Amount of Revenue Recognized
The ED proposes that if the amount of consideration to which an entity expects to be entitled is variable, the cumulative amount of revenue that the entity recognizes to date should not exceed the amount to which the entity is reasonably assured to be entitled. An entity is reasonably assured to be entitled to the amount of consideration allocated to satisfied performance obligations only if both of the following criteria are met:

  1. The entity has experience with similar types of performance obligations (or has other evidence, such as access to the experience of other entities).
  2. The entity’s experience (or other evidence) is predictive of the amount of consideration to which the entity will be entitled in exchange for satisfying those performance obligations.


The ED also proposes that if an entity licenses intellectual property to a customer, and the customer promises to pay an additional amount of consideration that varies on the basis of the customer’s subsequent sales of a good or service (for example, a sales-based royalty), the entity is not reasonably assured to be entitled to the additional amount of consideration until the uncertainty is resolved (that is, when the customer’s subsequent sales occur).

This is a change from the June 2010 ED that would have allowed variable fees to be included in the transaction price if they were reasonably estimable (as compared with the requirement for the entity to be reasonably assured to be entitled to the amount of consideration).

Costs of Fulfilling a Contract

The ED proposes that costs incurred in fulfilling a contract are capitalized if they are eligible under another standard or if those costs meet all of the following criteria:

  1. The costs relate directly to a contract (or a specific anticipated contract).
  2. The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future.
  3. The costs are expected to be recovered.


Incremental Costs of Obtaining a Contract

The ED proposes that an entity should capitalize incremental costs of obtaining a contract with a customer if the entity expects to recover those costs, but as a practical expedient, an entity may recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the entity otherwise would have recognized is one year or less.

Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained should be recognized as an expense when incurred, unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained.

Warranties

The ED proposes that a warranty should be accounted for 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.

Other types of warranties should be accounted for under current warranty accounting guidance.

This is a significant change from the June 2010 ED that proposed that an entity should assess the objective of the product warranty to determine if a separate performance obligation exists, as follows:

  • 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.

Onerous Contracts

The ED continues to propose that an entity should recognize a liability for performance obligations that are onerous.

The ED clarifies that a performance obligation is onerous if the lowest cost of settling the performance obligation exceeds the amount of the transaction price allocated to that performance obligation. The ED also modifies the scope of the onerous test by limiting it to performance obligations that are satisfied over time and over a period of time greater than one year.

Retrospective Application

The ED continues to propose retrospective application to ensure that all contracts with customers are recognized and measured consistently in the current period and comparative periods but does provide some relief that companies can elect to use when they initially apply the standard.

The ED also clarifies that, in determining the effective date, the boards will ensure that the start of the earliest comparative period presented will be a few months after the standard is issued.

AICPA Activity

The AICPA has been closely monitoring the progress of the joint revenue recognition project, as well as advocating our positions and providing feedback to the boards.

The Financial Reporting Executive Committee (FinREC) (formerly known as the Accounting Standards Executive Committee) issued a comment letter on the June 2010 exposure draft, which is available at www.aicpa.org/Advocacy/FinancialReporting/DownloadableDocuments/
December_13_2010_FinRec_Revenue_Recognition.pdf.

FinREC plans to issue a comment letter on the proposed revised revenue recognition standard. The AICPA's Private Companies Practice Section Technical Issues Committee (TIC) issued a comment letter on the June 2010 exposure draft, which is available at http://www.aicpa.org/interestareas/
privatecompaniespracticesection/resources/keepingup/ticadvocacy/ticcommentletters/pages/accountingstandards.aspx. TIC plans to issue a comment letter on the proposed revised revenue recognition standard.

The AICPA also is preparing to update all our accounting products (including guides, continuing professional education materials, and conferences) to include any new revenue recognition guidance when a standard is finalized.

Although the AICPA will comment on the proposed revenue recognition standard, it is recommended that members should determine how the proposed guidance will affect their current business models and transactions and provide feedback. It would be useful for all entities to try to implement the guidance to their most common transactions and determine if the proposed revenue recognition standard is operational.

Private Company Financial Reporting Committee

The Private Company Financial Reporting Committee (PCFRC) plans to comment on the proposed revised revenue recognition standard and has commented on the June 2010 exposure draft, which is available at www.pcfr.org/downloads/PCFRC__final_letter_on_revenue_recognition_ED_10-29-10.pdf.
Members should refer to the PCFRC website at www.pcfr.org for further information.
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Copyright © 2011 by American Institute of Certified Public Accountants, Inc. New York, NY 10036-8775. All rights reserved. For information about the procedure for requesting permission to make copies of any part of this work, please email copyright@aicpa.org with your request. Otherwise, requests should be written and mailed to the Permissions Department, AICPA, 220 Leigh Farm Road, Durham, NC 27707-8110.

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