Project Updates

Revenue Recognition—Joint Project of the FASB and IASB

Last Updated: February 26, 2010 (Updated sections are indicated with an asterisk *)

This project update summarizes the project activities and decisions of the FASB and IASB (the Boards). It was prepared by the staff and is for the information and convenience of the Boards’ constituents. All decisions of the Boards are tentative, may change at future Board meetings, and do not change current accounting and reporting requirements. Decisions of the Boards become final only after extensive due process.

 Project Objective 
 Due Process Documents 
*Decisions Reached at the Last Meeting 
*Summary of Decisions Reached to Date
Next Steps 
*Board/Other Public Meeting Dates 
Related FASB Documents 
Background Information 
Contact Information 

*SUMMARY OF DECISIONS REACHED TO DATE (As of February 3, 2010)

Effects of the proposed model on existing cost guidance

The Board considered the accounting for costs in contracts with customers. The Board decided that an entity should recognize as expenses all costs of obtaining a contract (for example, the costs of selling and marketing, including direct-response advertising). The Board also decided to develop guidance on how an entity should account for the costs of setting up and fulfilling a contract. The Board will consider the nature of that guidance at a future meeting.

Disclosure

The Boards considered the disclosure requirements for the proposed revenue recognition model and tentatively decided:

1. To specify a high-level disclosure objective similar to the objectives in FASB Accounting Standards Codification™ Section 605-25-50, Revenue Recognition—Multiple-Element Arrangements—Disclosure, and IFRS 7, Financial Instruments: Disclosures
2. To require an entity to disclose:
   1. The nature of contracts that it enters into with customers and the related accounting policies
   2. The principal judgments used in accounting for contracts with customers
   3. A reconciliation of the beginning and ending net contract position(s)
   4. The total amount of outstanding performance obligations and the expected timing of their satisfaction
   5. Information about onerous contracts, including the extent and amount of such contracts and the reasons for them becoming onerous.

• Reconsidered whether all product warranties give rise to separate performance obligations, as proposed in the Discussion Paper Preliminary Views on Revenue Recognition in Contracts with Customers;
• Considered whether product liability laws give rise to performance obligations.

• If the objective of a warranty is to provide a customer with cover for latent defects (i.e. those that exist when the asset is transferred to the customer but which are not yet apparent), that warranty does not give rise to a separate performance obligation. Instead it acknowledges the possibility that the entity has not satisfied its performance obligation to transfer the asset specified in the contract. Therefore, on the basis of all the available evidence, the entity would determine at the end of the reporting period the likelihood and extent of defects in the assets it has sold to customers and, hence, the amount of unsatisfied performance obligations with respect to those assets. Consequently:
  (a) If the entity will be required to replace defective assets, it does not recognize revenue for those assets
  (b) If the entity will be required to repair defective assets, it does not recognize the portion of revenue that can be attributed to components that need to be replaced in the repair process.
• If the objective of a warranty is to provide a customer with cover for faults that arise after the product is transferred to the customer, that warranty gives rise to a separate performance obligation. Therefore, the entity allocates part of the transaction price to that warranty performance obligation.
• If the law requires an entity to pay compensation if its products cause harm or damage, that requirement does not give rise to a performance obligation. The entity accounts for such obligations in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets or FASB Accounting Standards Codification Subtopic 450-20, Loss Contingencies.

The Boards considered how an entity should account for the sale of goods with a right of return. The Boards decided tentatively that:

• An entity should not recognize revenue for the goods that are expected to be returned, but instead should recognize a refund liability for the expected (probability weighted) amount of refunds to customers.
• Subsequently, an entity should update the refund liability for changes in expectations about the amount of refunds and make a corresponding adjustment to the amount allocated to the performance obligations.
• An entity should recognize an asset (and corresponding adjustment to cost of sales) for its right to recover goods from customers on settling the refund liability, initially measured at the original cost of the goods (that is, the former carrying amount in inventory).
• The promised return service should not be accounted for as a separate performance obligation in addition to the refund obligation.

The Boards considered when an entity should include estimated amounts of uncertain consideration in the transaction price and hence recognize those amounts as revenue when it satisfies performance obligations in a contract. The Boards decided tentatively that:

• An entity should include an estimated amount of uncertain consideration in the transaction price only if it can identify the possible outcomes of a contract (i.e. consideration amounts) and reasonably estimate the probabilities of those outcomes.
• In the context of revenue recognition, an entity can identify the possible outcomes of a contract and reasonably estimate the related probabilities only if it:
  (a) Has experience with identical or similar types of contracts, and
  (b) Does not expect circumstances surrounding those types of contracts to change significantly.
• The Exposure Draft should provide some factors for an entity to consider when assessing whether to include estimated consideration amounts in the transaction price.

• If a customer obtains control of the entire licensed intellectual property, the contract should be considered a sale, rather than a license or lease, of the intellectual property. That would be the case, for instance, if an entity grants a customer the exclusive right to use its intellectual property for the duration of its economic life.
  • If a customer does not obtain control of the entire licensed intellectual property and the entity has promised to grant an exclusive license, the promised asset is similar to the asset that a lessor promises in a lease. Therefore, consistently with the Boards’ tentative decisions in the leases project, the entity has a series of performance obligations. It satisfies those obligations over time as it permits the customer to use its intellectual property.
  • In all other cases, the promised asset is the license. The promise to grant that license is a single performance obligation. The entity satisfies that obligation when it enables the customer to use the license and benefit from it. If there are other performance obligations in the contract, an entity should consider whether the performance obligation for the license is a separate contract segment or should be combined with those other performance obligations.

• An entity should conduct the onerous test at the level of contract segments.
• An entity should compare the amount of the transaction price allocated to the remaining performance obligations in a segment with the expected costs to satisfy those performance obligations (rather than the current value of the goods and services underlying those performance obligations).
• If the expected costs to satisfy the remaining performance obligations in a segment exceed the amount of the transaction price allocated to those performance obligations, an entity should recognize a liability and a corresponding contract loss. The entity should measure the liability at the expected costs to satisfy the remaining performance obligations in that contract segment less the transaction price allocated to those performance obligations.
• At each subsequent financial statement date, an entity should update the measurement of the liability for the onerous segment.
• For the onerous test, costs are the direct costs (that is, all costs that relate directly to the specific contract or that were incurred only because the entity entered into the contract).

1. To implement the concepts in the Discussion Paper, an entity should allocate the transaction price to segments of a contract rather than to individual performance obligations. A segment includes one or more performance obligations for which the entity has evidence of a market—that is, evidence that a segment of the contract could be sold separately.
2. When segmenting a contract, an entity should consider when the promised goods and services are transferred to the customer, the margins for those goods and services, and materiality.
3. An entity should estimate standalone selling prices if they are not observable, and an entity should maximize the use of observable inputs.
4. The Exposure Draft should not prescribe or preclude any particular method of estimating a standalone selling price.

When goods and services in a contract segment are transferred at different times (or continuously), an entity must determine how much revenue to recognize as each performance obligation is satisfied. The Boards decided tentatively that:

1. An entity should select a method of measuring performance that best depicts the transfer of goods and services to the customer. Acceptable methods include methods based on units of output, units of input, or the passage of time.
2. An entity should select one method per segment and apply that method consistently throughout the contract and across segments with similar characteristics in other contracts.

The Proposed Model and Receivables Accounting

The proposed revenue recognition model focuses on contracts with customers. A contract comprises rights and performance obligations. The Board affirmed its preliminary view in the Discussion Paper, Preliminary Views on Revenue Recognition in Contracts with Customers, that unperformed rights and performance obligations of a contract should be reported on a net basis as either a contract asset or a contract liability.

The Board considered the relationship between accounts receivable and a contract asset or contract liability. The Board decided that an entity should account for an unconditional right to consideration in accordance with existing guidance on receivables. A right to consideration is unconditional when nothing other than the passage of time makes payment of that consideration due.

Control

The Discussion Paper proposed that an entity should recognize revenue when it satisfies its performance obligations to a customer by transferring goods or services to the customer. An entity has transferred a good or a service when the customer obtains control of it.

The Board decided that the proposed standard would require an entity to assess whether control has been transferred from the perspective of the customer. The proposed standard also would provide a definition of control and accompanying indicators to help entities assess the transfer of control from a customer perspective.

The Board considered the following working definition of control and related indicators:

Control of a good or a service is an entity’s present ability to direct the use of and receive the benefit from that good or service.

1. The customer has an unconditional obligation to pay for the asset (and the payment is nonrefundable).
2. The customer has legal title to the asset.
3. The customer can sell the asset to (or exchange the asset with) another party.
4. The customer has physical possession of the asset.
5. The customer has the practical ability to take possession of the asset.
6. The customer specifies the design or function of the asset.
7. The customer has continuing managerial involvement with the asset.

1. The discount that the customer could receive without exercising the option
2. The likelihood that the option would be exercised.

1. When, if ever, an entity should present contractual rights and obligations as assets and liabilities, respectively
2. Whether an entity should present net contract assets separately from net contract liabilities
3. Whether and how an entity should present short-term contracts separately from long-term contracts
4. The relationship between an entity’s contract position and accounts receivable.

The Board did not reach any decisions and asked the staff to further analyze these issues for a future meeting.

Comment Letter Summary

At the July 23 joint Board meeting, the Boards considered a summary of the responses to the Discussion Paper, Preliminary Views on Revenue Recognition in Contracts with Customers. After reviewing those responses, the Boards affirmed the objective of the project to develop a single revenue recognition model for IFRSs and U.S. GAAP that can be applied consistently across various industries and transactions. They agreed to focus on developing the model proposed in the Discussion Paper and clarifying how that model would apply to continuous delivery contracts (for example, some construction contracts). The Boards will then decide whether to exclude any specific industries from the scope of that model.

Gross versus net presentation of revenues

When other parties are involved in providing goods and services to an entity’s customer, the entity must determine what amounts to recognize as revenue; that is, whether to recognize revenue in the gross amount collected from the customer or the net amount the entity retains after compensating those other parties for their goods and services.  

The Board decided that the amount an entity recognizes as revenue depends on the identification of performance obligations. In other words, the entity must determine whether its performance obligation is to provide goods and services itself or to arrange for another party to provide those goods and services. The Board directed the staff to further develop application guidance that would help entities to identify performance obligations consistently.

The Board decided that an entity should disclose separately revenue in the same line of business from (1) providing goods and services itself and (2) arranging for the provision of goods and services. The Board also decided that an entity should disclose the basis for its assessment and any significant judgment in identifying performance obligations when other parties are involved in providing goods and services to the entity’s customer.

The Board also agreed that if an entity transfers a performance obligation to another party so that the entity is no longer obliged to provide the underlying good or service to the customer, the entity should not recognize revenue for that performance obligation.

Combination, segmentation, and modification of contracts

The Boards’ proposed revenue recognition model applies to contracts with customers. In most cases, a single contract gives rise to a single net contract position when applying the proposed model. However, in some cases, an entity’s pattern of revenue (and profit) recognition can vary depending on how an entity combines contracts (or segments of a contract) into net contract positions.

The Board tentatively decided that two or more contracts with the same customer should be accounted for as a single net contract position if the prices of those contracts are interdependent.   An entity should consider various indicators and exercise judgment when determining whether prices are interdependent.

The Board tentatively decided that an entity should account for a single contract with a customer as multiple contracts only if each contract segment is priced independently. At future meetings, the Board will further discuss some related issues involving the identification and measurement of performance obligations.

The Board also decided that when an entity modifies an existing contract, the modification should be accounted for as a separate contract if it is priced independently from the original contract. If the prices are interdependent, an entity should account for the original contract and modification as a single net contract position, recognizing the effect of the modification on a cumulative catch-up basis.

Nonmonetary exchanges

The Board decided that an entity should recognize revenue for a nonmonetary exchange transaction only if the transaction has commercial substance. The Board also decided an entity should not recognize revenue from a nonmonetary exchange transaction if the purpose was to facilitate a sale to another party.

The Board decided that an entity should measure the nonmonetary consideration received at its fair value or, if it cannot be estimated reliably, by reference to the selling price of the promised goods and services. If neither of those amounts can be estimated reliably, then the transaction would not generate revenue.   The Board also decided that a new revenue recognition standard should not provide additional guidance on specific barter transactions.

Measurement of Rights

At the April 1, 2009, meeting, the Board discussed an issue that was not included in the Discussion Paper, that is, how an entity would determine the transaction price when the promised consideration is payable at a time significantly different from performance by the entity, uncertain (variable) in amount, or in a form other than cash.

Payable at a time significantly different from performance by the entity

The Board decided that when measuring a net contract position, an entity would reflect the time value of money whenever that effect would be material. It would use the discount rate that would be reflected in a financing transaction between the entity and its customer that did not involve the provision of other goods and services. The reporting entity would report the effect of financing separately from the revenue from other goods and services.

Uncertain in amount

The Board decided that when the customer consideration is uncertain (variable) in amount, the transaction price at inception is the amount of the expected customer consideration, defined as the probability-weighted estimate of customer consideration. An entity would update the measurement of rights to reflect changes in the transaction price and allocate those changes to all the performance obligations. The effects of those changes on satisfied performance obligations would be recognized as revenue in the period of change.

At a joint meeting with the IASB on May 21, the Boards tentatively agreed that revenue recognition should be constrained only if the consideration amount cannot be reliably estimated.   The Boards directed the staff to develop proposed application guidance that an entity would use to determine whether an estimate is reliable.   The Boards also asked the staff to develop potential disclosures that an entity might provide about contracts with uncertain consideration and the estimates used in the financial statements.

In a form other than cash

The Board tentatively decided that an entity should measure noncash consideration at fair value. If an entity cannot reliably estimate the fair value of noncash consideration, it should measure the consideration indirectly by reference to the selling price of the promised goods and services.

Discussion Paper

See the FASB Discussion Paper, Preliminary Views on Revenue Recognition in Contracts with Customers for decisions prior to December 19, 2008.

NEXT STEPS

Over the next few months, the staff plans to further develop the proposed revenue recognition model, taking into consideration the input received from respondents. The staff and Boards will then consider how the model will be applied to various industries and will begin writing an Exposure Draft, along with any necessary application guidance. The Boards expect to publish the Exposure Draft in 2010.