Chapter 4
Recognizing Revenue Under the New Standard: Core Principles and Resources

Learning objectives

  • Identify the core principles of FASB ASU No. 2014-09.
  • Identify effective date and transition requirements.
  • Identify useful resources to assist you in the transition and implementation of FASB ASU No. 2014-09.

Overview

On May 28, 2014, the International Accounting Standards Board (IASB) and FASB issued a joint accounting standard on revenue recognition to address a number of concerns regarding the complexity and lack of consistency surrounding the accounting for revenue transactions. Consistent with each board’s policy, FASB issued FASB ASU No. 2014-09, Revenue from Contracts with Customers (FASB ASC 606) and IASB issued International Financial Reporting Standard (IFRS) 15, Revenue from Contracts with Customers.

FASB ASU No. 2014-09 created topic, 606, Revenue from Contracts with Customers, and subtopic, 340-40, “Other Assets and Deferred Costs — Contracts with Customers.”’

FASB ASC 606 brought about the following:

  • Provided a framework for revenue recognition
  • Superseded or amended several existing revenue recognition requirements and industry-specific topics within FASB ASC 900

As part of the boards’ efforts to converge GAAP and IFRS, well known and frequently used industry-specific revenue recognition guidance was eliminated and replaced with a principles-based approach for revenue recognition. This was done to avoid inconsistencies of accounting treatment across different geographies and industries. FASB’s goal was to improve the comparability of revenue recognition practices, and to provide more useful information to financial statement users through enhanced disclosure requirements.

Many entities realize that FASB ASC 606 affected their day-to-day accounting, and at times, the way they executed their contracts with customers.

Although this chapter focuses on the core principles of FASB ASC 606, it is worthwhile to identify the following recently-issued ASUs that subsequently amend the originally issued standard.

ASU No. ASU title ASU purpose
2015-14 Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date; Effective date deferral
2016-08 Revenue from Contracts with Customers (Topic 606) — Principal versus Agent Considerations (Reporting Revenue Gross versus Net); Clarification of implementation guidance on principal versus agent considerations
2016-10 Revenue from Contracts with Customers (Topic 606) — Identifying Performance Obligations and Licensing; Clarification of performance obligation identification and licensing implementation guidance
2016-11 Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815) — Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (SEC Update); Update of SEC sections in FASB ASC
2016-12 Revenue from Contracts with Customers (Topic 606) — Narrow-Scope Improvements and Practical Expedients; Clarification of specific issues in the guidance on assessing collectibility, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition
2016-20 Technical Corrections and Improvements to Revenue from Contracts with Customers (Topic 606); Correction of or improvement to narrow aspects of FASB ASC pertaining to FASB ASC 606
2017-13 Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments (SEC Update); Update of SEC sections in FASB ASC
2017-14 Income Statement — Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606) (SEC Update). Update of SEC sections in FASB ASC
2018-08 Not-for-Profit Entities (Topic 958), Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. Revised the scope of FASB ASC 606 by stating that an entity shall consider the guidance in FASB ASC 958-605 on not-for-profit entities — revenue recognition — contributions when determining whether a transaction is a contribution within the scope of FASB ASC 958-605 or a transaction within the scope of FASB ASC 606.
2018-18 Collaborative Arrangements (Topic 808) Clarifying the Interaction between Topic 808 and Topic 606 Clarifies when an entity will apply the guidance of FASB ASC 606 to a contract (other than a contract not within the scope of FASB ASC 606, if the counterparty in a collaborative arrangement is a customer.

Convergence

FASB and IASB have essentially achieved revenue recognition convergence, with some minor differences related to the following:

  • The collectibility threshold
  • Interim disclosure requirements
  • Early application
  • Effective dates
  • Impairment loss reversal
  • Nonpublic entity requirements

Scope and scope exceptions

Within the scope FASB ASC 606

FASB ASC 606 applies to any entity that enters into a contract with a customer to transfer goods or services, including the transfer of nonfinancial assets that are not within the scope of other authoritative guidance. The scope of FASB ASC 606 is very broad; entities may find that some parts of their contracts with customers are within the scope of FASB ASC 606 and other parts fall within the scope of other FASB ASC topics.

Not-for-profit entities

An entity will need to consider the guidance in FASB ASC 958-605 on not-for-profit entities — revenue recognition — contributions when determining whether a transaction is a contribution within the scope of FASB ASC 958-605 or a transaction within the scope of FASB ASC 606.

Collaborative arrangements

An entity shall apply the guidance in FASB ASC 606 to a contract (other than those contracts outside the scope of FASB ASC 606), only if the counterparty to the contract is a customer. A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.

Contracts partially within the scope of FASB ASC 606

A contract with a customer may be partially within the scope of FASB ASC 606 and partially within the scope of other FASB ASC topics. When this occurs, do the following:

  • If the other FASB ASC topics specify how to separate and initially measure one or more parts of the contract, apply that guidance first. An entity should exclude from the transaction price the amount of the part (or parts) of the contract that are initially measured in accordance with other FASB ASC topics and allocate to the other parts of the contract the amount of the transaction price that remains (if any) to each performance obligation within the scope of FASB ASC 606.
  • If the other FASB ASC topics do not specify how to separate and initially measure one or more parts of the contract, apply the guidance in FASB ASC 606.

Scope exceptions

The following are outside the scope of FASB ASC 606:

  • Lease contracts within the scope of FASB ASC 840, Leases, and when effective, FASB ASC 842, Leases
  • Contracts within the scope of FASB ASC 944, Financial Services — Insurance.
  • Certain financial instruments and other contractual rights or obligations within the scope of
    • FASB ASC 310, Receivables
    • FASB ASC 320, Investments – Debt and Equity Securities
    • FASB ASC 321, Investments – Equity Securities (when effective)
    • FASB ASC 323, Investments – Equity Method and Joint Ventures
    • FASB ASC 325, Investments – Other
    • FASB ASC 405, Liabilities
    • FASB ASC 470, Debt
    • FASB ASC 815, Derivatives and Hedging
    • FASB ASC 825, Financial Instruments, and
    • FASB ASC 860, Transfers and Servicing
  • Guarantees other than product or service warranties within the scope of FASB ASC 460, Guarantees
  • Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers (that is, two oil entities that agree to an exchange of oil to fulfill a demand from their customers in different specified locations on a timely basis)

Effective dates and transition

The original effective dates of ASU No. 2014-09, Revenue from Contracts with Customers, were revised by the issuance of the following ASUs:

  • ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
  • ASU No. 2017-13. Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments (SEC Update)

The revised effective dates are as follows:

  • For public entities, ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2017 (meaning January 1, 2018, for calendar year-end entities), including interim periods within that reporting period. Early application was permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.
  • For nonpublic entities, ASU No. 2014-09 is ASU is effective for annual reporting periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. Nonpublic entities may elect to adopt ASU No. 2014-09 earlier, only as of either of the following:
    • An annual reporting period beginning after December 15, 2016, including interim periods within that reporting period
    • An annual reporting period beginning after December 15, 2016, and interim reporting periods within annual periods beginning one year after the annual reporting period in which an entity first applied ASU No. 2014-09
  • Special consideration for certain public business entities, ASU No. 2017-13 explains that the SEC staff has stated that they would not object to a public business entity using the nonpublic entity’s effectives providing the public business entity would not otherwise meet the definition of a public business entity except for a requirement to include or the inclusion of its financial statements or financial information in another entity’s filing with the SEC.

This FASB ASU contains the following two transition methods to apply when adopting FASB ASC 606:

  • Retrospective application to each prior reporting period presented in conjunction with one of the practical expedients, in accordance with guidance for accounting changes and corrections.

    Disclosure of the practical expedient used and a qualitative assessment of the effect of using the practical expedient is required.

  • Retrospective application with a cumulative effect adjustment recognized at the date of application in accordance with transition guidance in FASB ASC 606-10-65.

Knowledge check

  1. By issuing ASU No. 2014-09 and IFRS 15, FASB and IASB achieved their convergence goals with only minor differences remaining. Which is one of them?
    1. Public entity requirements.
    2. Effective dates.
    3. Annual disclosure requirements.
    4. Scope requirements.

The core principles

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 goods or services. To achieve the recognition of revenue, an entity should apply the following five steps:

  • Identify the contracts with a customer.
  • Identify the performance obligations in the contract.
  • Determine the transaction price.
  • Allocate the transaction price to the performance obligations in the contract.
  • Recognize revenue when (or as) the entity satisfies a performance obligation.

In addition to the five-step process for recognizing revenue, FASB ASC 606 also addresses the following select areas:

  • Accounting for incremental costs of obtaining a contract, as well as costs incurred to fulfill a contract
  • Licenses
  • Warranties

Step 1 — Identify the contracts with a customer

FASB ASU defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations,” and affects contracts with a customer that meet all of the following criteria:

  • Has approval (in writing, orally, or in accordance with other customary business practices) and commitment of all the parties
  • Identifies the rights of the parties
  • Identifies the payment terms
  • Has commercial substance
  • It is probable that the entity will collect substantially all of the consideration to which it will be entitled when goods or services are transferred to the customer

A contract does not exist if each party to the contract has the unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party or parties.

At times contracts may be modified for changes in scope, price, or both. A contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties involved in the contract.

An entity should combine two or more contracts if the contracts were entered into at or near the same time with the same customer or related parties of the customer, if at least one of the following applies:

  • The contracts are negotiated as a package with a single commercial objective.
  • The amount of consideration in one contract depends on the price or performance of the other contract.
  • The goods or services are a single performance obligation.

Step 2 — Identify the performance obligations in the contract

A performance obligation is a promise in a contract with a customer to transfer a good or service to the customer. At the inception of a contract, an entity shall assess the goods or services promised in the contract with a customer and should identify as a performance obligation each promise to transfer to the customer either

  • a good or service (or bundle of goods or services) 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.

When a good or service is not distinct it should be combined with other promised goods or services until an entity identifies a bundle of goods or services that are distinct. In some cases this would result in accounting for all the goods or services promised in a contract as a single performance obligation.

Step 3 — Determine the transaction price

The transaction price is the amount of consideration the entity expects to receive in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. The amount of consideration may involve both fixed and variable components. In order to determine the transaction price, an entity should consider the effects of the following:

  • Variable consideration
  • Constraining estimates of variable consideration
  • The existence of a significant financing component

If the consideration promised in a contract includes a variable amount, then an entity should estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer.

To estimate variable compensation, an entity may use either of the following methods:

  • Expected value method
  • Most likely method

Here are several frequently identified variable consideration items, keeping in mind that the following is not all inclusive:

  • Performance bonuses
  • Penalties
  • Price concessions
  • Discounts
  • Rebates
  • Refunds
  • The existence of a significant financing component
  • Noncash consideration
  • Consideration payable to a customer

Step 4 — Allocate the transaction price to the performance obligations in the contract

The transaction price is allocated to separate performance obligations in proportion to the relative standalone selling price of the promised goods or services. If a standalone selling price is not directly observable, then an entity should estimate it. When estimating the standalone selling price, entities can use various methods including the adjusted market assessment approach, expected cost plus a margin approach, and residual approach (only if the selling price is highly variable and uncertain or has not yet been established).

The following example illustrates step 4 (FASB ASC 606-10-55-256 258):

An entity enters into a contract with a customer to sell products A, B, and C in exchange for $100. (The customer received a discount for purchasing the goods in a bundle because the standalone selling prices of each totaled $150 and exceeded the selling price.) The entity will satisfy the performance obligations for each of the products at different points in time. The entity regularly sells product A separately, and, therefore the standalone selling price is directly observable. The standalone selling prices of products B and C are not directly observable.

The entity estimates the standalone selling prices as follows:

Product Standalone selling price
Product A $50
Product B 25
Product C 75
Total $150

The entity will allocate the contract price of $100 based on the relative standalone values as follows:

Product Allocated transaction price
Product A $ 33 ($50 ÷ $150 × $100)
Product B 17 ($25 ÷ $150 × $100)
Product C 50 ($75 ÷ $150 × $100)
Total $100

Sometimes, the transaction price includes a discount or a variable amount of consideration that relates entirely to one of the performance obligations in a contract. The ASU specifies when an entity should allocate the discount or variable consideration to one (or some) performance obligation(s) rather than to all of the performance obligations in the contract.

Step 5 — Recognize revenue when (or as) the entity satisfies a performance obligation

The amount of revenue recognized when transferring the promised good or service to a customer is equal to the amount allocated to the satisfied performance obligation, which may be satisfied at a point in time (goods) or over time (services).

The following examples illustrate step 5 (paragraphs 173–180 of FASB ASC 606-10-55).

Case 1:

An entity is developing a multiunit residential complex. A customer enters into a sales contract for a specified unit under construction. Each unit has a similar floor plan and is of a similar size, but other attributes of the units are different (for example, the location of the unit within the complex).

The customer pays a deposit upon entering into the contract, and the deposit is refundable only if the entity fails to complete construction of the unit in accordance with the contract. The remainder of the contract price is payable upon obtaining physical possession of the unit. If the customer defaults on the contract before completion of the unit, the entity only has the right to retain the deposit.

Is the performance obligation satisfied over time? No, at the inception of the contract the entity does not have an enforceable right to payment. The right to payment begins when the construction of the unit is complete.

Case 2:

The customer pays a nonrefundable deposit upon entering into the contract and will make progress payment during construction of the unit. The contract has substantive terms that preclude the entity from being able to direct the unit to another customer. In addition, the customer does not have the right to terminate the contract unless the entity fails to perform as promised. If the customer defaults on its obligations by failing to make the promised progress payments as and when they are due, the entity would have a right to all of the consideration promised in the contract if it completes the construction of the unit.

Is the performance obligation satisfied over time? Yes, because the asset does not have alternate use because the contract precludes the transfer to another customer. In addition, the entity does have an enforceable right to payment for the work performed to date.

When performance obligations are satisfied over time, the entity should select an appropriate method for measuring its progress toward complete satisfaction of that performance obligation. FASB ASU discusses methods of measuring progress including input and output methods, and how to determine which method is appropriate.

Other areas of interest

FASB ASC 606 specifically addresses the following topics:

  • Licensing, including hosting and sales-based or usage-based royalties
  • Warranties
  • Acting as a principal verse acting as an agent
  • Incremental costs of obtaining a contract
  • Repurchase agreements
  • Consignment arrangements
  • Bill-and-hold arrangements

Disclosure

FASB ASC 606-10-50-1 through 50-23 and 340-40-50-1 through 340-40-50-6

The revenue recognition standard states that the objective of the disclosure requirements is to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers and assets recognized from the costs to obtain or fulfill a contract with a customer.

Qualitative and quantitative information is required about the following:

  1. Contracts with customers — including revenue and impairments recognized, disaggregation of revenue, and information about contract balances and performance obligations (including the transaction price allocated to the remaining performance obligations)
  2. Significant judgments and changes in judgments — determining the timing of satisfaction of performance obligations (over time or at a point in time), and determining the transaction price and amounts allocated to performance obligations
  3. Assets recognized from the costs to obtain or fulfill a contract

The revenue recognition standard allows nonpublic entities to elect not to provide specific disclosures related to the following:

  • Contracts with customers — including revenue and impairments recognized, disaggregation of revenue, and information about contract balances and performance obligations (including the transaction price allocated to the remaining performance obligations)
  • Significant judgments and changes in judgments — determining the timing of satisfaction of performance obligations (over time or at a point in time), and determining the transaction price and amounts allocated to performance obligations; and
  • Assets recognized from the costs to obtain or fulfill a contract

The revenue recognition standard allows nonpublic entities elections to not to provide specific disclosures related to the following:

  1. Quantitative disaggregation disclosures (FASB ASC 606-10-50-7)
  2. Contract balances (FASB ASC 606-10-50-11)
  3. Transaction price allocated to remaining performance obligations (FASB ASC 606-10-50-15)
  4. Certain information related to significant judgments (FASB ASC 606-10-50-21)
  5. Use of practical expedients (FASB ASC 606-10-50-23 and 340-40-50-6)
  6. Certain information related to costs incurred to obtain or fulfill a contract with a customer (FASB ASC 340-40-50-4)

Knowledge check

  1. In order to achieve its core principles, how many steps are described in FASB ASC 606?
    1. Two.
    2. Three.
    3. Four.
    4. Five.
  2. Which is outside the scope of FASB ASC 606?
    1. Software and technology.
    2. Motion pictures, music, and other forms of media and entertainment.
    3. Franchises.
    4. Insurance contracts.

Transition Resource Group

On June 3, 2014, FASB and the IASB announced the creation of a joint Transition Resource Group for revenue recognition, commonly referred to as the TRG. The TRG members are volunteers and include financial statement preparers, auditors, and users. They represent a variety of industries, geographic locations, public and private entities, and organizations. The purpose of the TRG is to

  • discuss potential issues arising from the implementation of the revenue recognition standard, and
  • share their views with FASB and IASB.

The TRG does not issue authoritative guidance. To assist in the implementation of the standard, they have issued several issue papers that can be found on FASB’s website at the following link:

http://fasb.org/jsp/FASB/Page/SectionPage&cid=1176164066683.

Resources

The AICPA offers the following invaluable resources to assist CPAs in the transition and implementation of the revenue recognition standard:

  • Financial reporting briefs
  • Revenue Recognition Primer for Audit Committees
  • Tax Effects of ASU No. 2014-09 (AICPA login required)
  • Roadmap to Understanding the New Revenue Recognition Standard
  • A learning and implementation plan
  • Revenue recognition news
  • Various products, webcasts, and continuing professional education courses

Here is a link to the AICPA’s revenue recognition resources on their website: https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/revenuerecognition.html.

AICPA revenue recognition audit and accounting guide (guide)

This guide on revenue recognition encompasses the efforts of the AICPA's 16 industry task forces that were created back in 2014 to address industry-specific accounting implementation issues as a result of the issuance of the new standard. The intention of the guide is to assist practitioners in performing and reporting on their audit engagements and to assist management in the preparation of their financial statements in accordance with U.S. generally accepted accounting principles (GAAP). Specifically, this guide is intended to help entities and auditors prepare for changes related to revenue recognition as a result of FASB ASC 606.

Here is a link to the guide for purchase:

https://www.aicpastore.com/Accounting/IndustryspecificGuidance/DepositLending/revenue-recognition---audit-and-accounting-guide/PRDOVR~PC-012516/PC-012516.jsp

Here is a listing of the 16 industry specific task forces that have provided specific illustrative examples in the guide:

  • Aerospace and defense
  • Airlines
  • Asset management
  • Broker-dealers
  • Construction contractors
  • Depository institutions
  • Gaming
  • Health care
  • Hospitality
  • Insurance
  • Not-for-profit
  • Oil and gas
  • Power and utility
  • Software
  • Telecommunications
  • Timeshare

Practice questions

  1. In order to determine the transaction price in the new revenue recognition standard, what should an entity take into consideration?

     

     

  2. How are you preparing for the implementation of FASB ASC 606?

     

     

Note

  1. 1   Exercise fact pattern originated from paragraphs 95-98 of FASB ASC 606-10-55.
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