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:
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. |
FASB and IASB have essentially achieved revenue recognition convergence, with some minor differences related to the following:
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.
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.
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.
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:
The following are outside the scope of FASB ASC 606:
The original effective dates of ASU No. 2014-09, Revenue from Contracts with Customers, were revised by the issuance of the following ASUs:
The revised effective dates are as follows:
This FASB ASU contains the following two transition methods to apply when adopting FASB ASC 606:
Disclosure of the practical expedient used and a qualitative assessment of the effect of using the practical expedient is required.
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:
In addition to the five-step process for recognizing revenue, FASB ASC 606 also addresses the following select areas:
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:
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:
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
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.
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:
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:
Here are several frequently identified variable consideration items, keeping in mind that the following is not all inclusive:
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.
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.
FASB ASC 606 specifically addresses the following topics:
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:
The revenue recognition standard allows nonpublic entities to elect not to provide specific disclosures related to the following:
The revenue recognition standard allows nonpublic entities elections to not to provide specific disclosures related to the following:
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
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.
The AICPA offers the following invaluable resources to assist CPAs in the transition and implementation of the revenue recognition standard:
Here is a link to the AICPA’s revenue recognition resources on their website: https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/revenuerecognition.html.
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:
Here is a listing of the 16 industry specific task forces that have provided specific illustrative examples in the guide:
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