Discussion by the TRG began on January 26th and, more recently, with the boards making tentative decisions on February 18th regarding Licenses of Intellectual Property and Identifying Performance Obligations.
Tentative Decisions reached by the Boards on February 18th 2015:
Licenses of Intellectual Property – The Boards discussed; Determining the Nature of the Entity’s Promise in Granting a License; Determining When an Entity Should Assess the Nature of the Entity’s Promise in Granting a License; Sales-Based and Usage-Based Royalties and Contractual Restrictions in License Arrangement. (Click here to read on FASB website)
1. Determining the Nature of the Entity’s Promise in Granting a License: Tentative decisions included:
a. Clarifying that the entity’s promise to the customer in granting a license is to provide a right to access the entity’s intellectual property (which is satisfied over time) when the contract requires or the customer reasonably expects the entity to undertake activities (that do not transfer a good or service to the customer) that significantly affect the utility of the intellectual property to which the customer has rights. The utility of the intellectual property to which the customer has rights is significantly affected when either:
1. The expected activities of the entity are expected to change the form (for example, the design) or the functionality (for example, the ability to perform a function or task) of the intellectual property to which the customer has rights; or
2. The value of the intellectual property to the customer is substantially derived from, or dependent upon, the expected activities of the entity. For example, the value of a brand or logo is typically derived from, and dependent upon, the entity’s ongoing activities that support or maintain the intellectual property.
b. Clarified that when intellectual property has significant standalone functionality (that is, the ability to process a transaction, perform a function or task, or be played or aired), such as software or media content, a substantial portion of its utility is derived from that functionality and is unaffected by activities of the entity that do not change that functionality (such as promotional activities).
c. The FASB further clarified the guidance that when an entity grants a license to symbolic intellectual property (that is, intellectual property that does not have significant standalone functionality, such as brands, team or trade names, or logos), it is presumed that the entity’s promise to the customer in granting a license includes undertaking activities that significantly affect the utility of the intellectual property to which the customer has rights.
2. Determining When an Entity Should Assess the Nature of the Entity’s Promise in Granting a License: Tentative decisions included:
The FASB decided to clarify when an entity would need to determine the nature of a license that is not a separate performance obligation in order to appropriately apply the general guidance on whether a performance obligation is satisfied over time or at a point in time and/or to determine the appropriate measure of progress for a combined performance obligation that includes a license. However, the IASB decided this was not necessary because there is adequate guidance in IFRS 15 and the accompanying Basis for Conclusions. In reaching this conclusion the IASB noted the analysis in paragraphs 59–64 of Agenda Paper 7B.
3. Sales-Based and Usage-Based Royalties
The Boards decided to clarify the scope and applicability of the implementation guidance on sales-based or usage-based royalties promised in exchange for a license of intellectual property as follows:
1. An entity should not split a single royalty into a portion subject to the sales-based and usage-based royalties exception and a portion that is not subject to the royalties constraint (and, therefore, would be subject to the general guidance on variable consideration, including the constraint on variable consideration).
2. The sales-based and usage-based royalties exception should apply whenever the predominant item to which the royalty relates is a license of intellectual property.
4.
Contractual Restrictions in License Arrangements –
The FASB decided to clarify that contractual restrictions of the nature described in paragraph 606-10-55-64 are attributes of the license and, therefore, do not affect the identification of the promised goods or services in the contract. For example, an entity would not identify a different number of promised licenses in a contract that grants a customer unlimited rights to use specified intellectual property for a defined period of time than it would in a contract that grants a license that restricts how often the intellectual property may be used during the license period. The IASB, however, decided that a clarification to the application guidance in IFRS was not necessary because there is adequate guidance in IFRS 15 and the accompanying Basis for Conclusions. In reaching this conclusion, the IASB noted the analysis in paragraphs 68–73 of Agenda Paper 7B.
Identifying Performance Obligations – the Boards decided to add some illustrative examples to the new revenue standard to clarify how the Boards intend the guidance on identifying performance obligations to be applied.
In addition, the FASB decided to incorporate further amendments in Topic 606 to address implementation issues about (1) identifying promised goods or services that would be subject to the separation guidance, (2) application of the distinct guidance, and (3) accounting for shipping and handling activities, as well as to make some technical corrections to Topic 606 in this area.
The FASB staff will begin drafting a proposed Update based on the tentative decisions reached. However, the IASB decided that it would develop a single Exposure Draft of proposed clarifications to IFRS 15.
Transition Resource Group discussions on January 26th 2015:
Transition Resource Group for Revenue Recognition (TRG) for ASC 606 Revenue from Contracts with Customers (ASU 2014-09). They began the discussion with a recap of improvements they have made for materials provided and summaries that will be issued for these meetings. (For a summary of the October 2014 meeting please click here). The FASB staff is still in the process of outreach with prepares as well as other stakeholders, such as auditors, etc in order to determine if a deferral of the standard is necessary.
The topics discussed included:
Identifying Promised Goods or Services: Step 2 of ASU 2014-09 requires an entity to Identify the performance obligation in a contract with a customer. The standard defines a performance obligation as a promised good or service that is distinct or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. If not distinct, it is combined with other promised goods or services until a bundle of promised goods or services is considered distinct.
There have been implementation issues with the new standard regarding determining whether or not some items or activities should be accounted for as promised goods or services in a contract with a customer because they appear to provide something of benefit, even if only minor, to the customer. The guidance in 606-10-25-17 of the standard suggest that the Boards intent is not to explicitly exclude perfunctory or inconsequential promised goods or services, and further does not allow an entity to ignore an item or activity that provides a good or service to the customer. The question to the TRG then became:
- Do the TRG members think the guidance in the new revenue standard requires the identification of promised goods or services that are generally not identified as deliverables under existing revenue guidance?
- Do the TRG members think the Boards’ intent to not identify significant numbers of new promised goods or services (that is, beyond those identified as deliverables under existing revenue guidance), is not sufficiently clear in the new revenue standard? If not, what might more clearly communicate the Boards’ intent with respect to identifying the promised goods or services in a contract with a customer?
The TRG members concluded; this was not a major problem and may require judgment from the standpoint of materiality – which may result in addition performance obligation under the new standard (the free items are now a performance obligation) or increase in audit steps to quantify immateriality.
(See tentative decision above)
Collectability: Stakeholders have raised questions regarding collectability within the new standard as compared to existing guidance which resulted in four TRG topics. Current guidance within ASC 605-10-S99-1 includes criteria that must be met in order for a public (& non-public) entity to recognize revenue. Under the new standard, the collectability assessment is based only on the customer’s ability and intention to pay the amount of consideration when it is due. It is not an assessment of whether an entity may collect less than the stated price in the contract due to other factors. If the entity assessment reveals that it is not probable that it will collect, then revenue would not be recognized and the entity would continue to assess the contract to determine when collectability criteria is met.
The new standard does not, however, change the accounting for receivables in accordance with ASC 310 Receivables or IFRS 9 Financial Instruments. Differences between initial receivables compared to corresponding revenue should be recognized as an expense (bad debt).
The TRG Board was presented with four questions regarding the new standards guidance around collectability for their feedback.
- How should an entity assess collectability for a portfolio of contracts? – A TRG member felt that the standard does not do enough to take into consideration deterioration of credit circumstances.
- When should an entity re-assess collectability?
- How should an entity recognize revenue on contracts that are subsequently re-assessed as not probable of collection (that is, after being assessed as collectible at contract inception)?
- How should an entity assess whether a contract includes a price concession?
For the first question, the TRG members agreed that judgment is required to determine whether something is a concession or credit risk. As the same judgment exists today, therefore, they did not think much more can be done to the new standard. For question two, the TRG had the same response as the first question in that judgment will still be required. However, in response to the third and fourth question, the TRG members suggested that new standard is clear but may be overly punitive or the wrong answer may be arrived at because it will not reflect the economic substance of the transaction. This topic will be revisited by the FASB/IASB Boards.
Variable Consideration
Step 3 (Determining the Transaction Price) of the new standard requires the entity to consider the terms of the contract and its customary business practices to determine the transaction price. In determining the transaction price, the entity is required to consider variable consideration and constraints on estimates of variable consideration. Paragraph 606-10-32-5 [50] states that if the consideration in a contract includes variable consideration, the entity is required to estimate the amount of variable consideration to which it is entitled to in exchange for transferring the promised good or service to the customer. Paragraphs 606-10-32-11[64] through 32-12 [65] provide guidance on constraining estimates of variable consideration. The transaction price includes an entity’s estimate of variable consideration only to the extent that it is probable [highly probable] that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Additionally, the new revenue standard provides a list of factors to consider when evaluating whether the revenue reversal is probable [highly probable].
Based on this guidance, the stakeholders have asked the following two questions related to variable consideration and the constraint:
a. When should an entity recognize consideration payable to a customer?
b. Whether the constraint on variable consideration should be applied at the contract level or the performance obligation level.
As for the first question, some TRG members view paragraph 20 of Agenda 14 to clarify the guidance within the new standard which states:
"Regardless of whether an entity was following the guidance on variable consideration or consideration payable to the customer (including consideration of the guidance on changes in transaction price), the recognition of the sale incentive, (the coupon) would result in a reversal of revenue – the reversal of revenue should be made at the earlier of the date that there is a change in the transaction price (ASC 606-10-32-25) or the date at which the consideration payable to the customer is promised in accordance with paragraph ASC 606-10-32-27."
Others believe that there is still inconsistency with guidance in the standard, however, do not believe that the new standard should necessarily change as a result.
Noncash Consideration
As it is not uncommon that company’s may promise consideration in another form than cash – or noncash consideration.
Stakeholders felt that there were different interpretations in the new standard for determining the measurement date and application of constraints on variable consideration of noncash considerations.
The first issue discussed was the measurement date for promised consideration in a form other than cash. (i.e, shares, options, or advertising). The staff provided three views within Agenda 15 of which a stakeholder may interpret the standard as: View A – Noncash consideration is measured at contract inception, View B – Noncash consideration is measured when the noncash consideration is received (or is receivable) or; View C Noncash consideration is measured at the earlier of (i) when the noncash consideration is received (or is receivable) and (ii) when the related performance obligation is satisfied (or the performance obligation is satisfied, if satisfied over time). Even though all three views had supporters, there seemed to be more that supported View C, as they believed that it achieved the objective of the new standard, but they still suggested that further clarification is necessary.
Another concern was how the constraint applied to transaction in which the fair value of noncash consideration might vary due to both the form of the consideration and for reasons other than the form of the consideration. The two views are: View A – The constraint applies to variability resulting from both the form of the consideration and for reasons other than the form of consideration or; View B – The constraint applies only to variability resulting from other than the form of consideration. The TRG was also split on this, but thought that bifurcation of the form of the consideration from other variability would be complicated in practice, and may not be as important to investors.
Stand Ready Obligations
How to determine the nature of the good or service an entity is promising to transfer to the customer is fundamental to properly accounting for a performance obligation (ASC 606-10-25-33) was the next agenda item for the TRG members. Stakeholders raised questions regarding determining the nature of the good or service in stand ready performance obligation, and appropriate measure of progress to apply.
Within Agenda paper 16, the staff provided four different types of promises that could be considered stand ready obligations as examples.
The staff’s message was that entities need to assess the “nature of the promise” and whether the promise is guaranteed that the customer will have the service available would define the stand ready obligation (i.e. a gym membership that is used three months out of a year or snow plowing service).
As for the measurement, the TRG members believed that you cannot default to straight-line but prove that you will provide the services over time. However, in some cases, straight-line application is appropriate. Judgment will be required.
There will be no further action on this topic.
The next three topics were provided by TRG members directly. No analysis has been conducted on these topics. They were presented to ascertain whether view expressed within the Agenda paper were appropriate and whether the topics need to be on future TRG agendas. These topics were: Material Rights, Consideration Payable to a Customer, & Significant Financing Components: Other items discuss at this TRG meeting were Incremental costs to obtain a contract, Evaluating Contract Modifications Prior to the Date of Initial Application and Islamic Financing Transactions. (Please click on topics to review the agenda papers provided by the TRG Board’s staff). To listen to any of these topics, please click here.
The next TRG meeting will be held on March 30, 2015.
Leena Roselli senior manager of research at the Financial Executives Research Foundation and Lorraine Malonza is director of accounting advocacy and financial research at Financial Executives International.