ASU 2014-09, Revenue from Contracts with Customers
, was issued in May 2014. The amended effective date of implementation is for reporting periods beginning after Dec. 15, 2017, for public companies, and for reporting periods beginning after Dec. 15, 2018, for nonpublic entities. The standard’s revenue principle, and guidance therein, provides for the recognition of revenue so as to depict the transfer of promised goods or services via contracts with customers, reflecting the amounts of consideration to which the entity expects to be entitled in exchange for those goods and services via a five-step, principles-based process model.1
To assist in applying ASU 2014-09, the Financial Accounting Standards Board (FASB) established a Transition Resource Group for Revenue Recognition (TRG), which has resulted in three additional ASUs being issued in 2016 that amend and clarify the 2014 standard. These amending ASUs principally affect steps one through three of the model, and are the focus of this column. Step 1: Identify the contract with the customer
– ASU 2016-12, Narrow Scope Improvements and Practical Expedients
, addresses, in part, ASU 2014-09’s requirement that for a contract to exist, collectability must be probable. Here, some presumed an all-or-nothing collectability assessment (whereby if total collectability was uncertain, then the transaction would not be deemed a contract, and there would be no recognition until all goods and services had been provided), which would create a volatile recognition/nonrecognition policy.
ASU 2016-12 establishes that when evaluating the collectability of the contract, the objective is to determine whether there is a substantive transaction between the parties. This assessment is a partial “forward-looking” assessment that requires judgment and consideration of all facts and circumstances, including customary business practices surrounding collectability. Simply, the entity should determine whether the terms of the contract and its customary business practices indicate that the entity’s exposure to credit risk (collectability) is less than the entire consideration promised in the contract because the entity has the ability to mitigate its credit risk.2 Step 2: Identify the performance obligations in the contract
– ASU 2014-09 requires that, at contract inception, the entity should evaluate the goods and services promised to transfer to the customer by identifying each “distinct” good or service to be delivered. Each distinct good or service constitutes a separate performance obligation. ASU 2016-10, Identifying Performance Obligations and Licensing
, was designed/issued to clarify the term “distinct.”
ASU 2016-10 provides two practical expedients that permit the disregarding as a performance obligation: any promised activities that are “immaterial within the context of the contract” and any commitments to ship or deliver goods performed before the customer obtains control of the goods. These activities are not promises to the customer, but rather activities to fulfill the promise of transfer. Further, if shipping and handling activities are performed after a customer obtains control of the goods, the entity may elect to account for these as fulfillment activities for the transfer promise.
Additionally, ASU 2014-09 indicates that a distinct, promised item is a “performance obligation.” If an item is not distinct it is bundled with other items until the bundle is distinct. However, a repetitive service is one performance obligation, even if each instance is distinct. ASU 2016-10 indicates that when determining “distinct” the objective is to determine whether the activity was to transfer a good or service individually (the goods or services are desired outputs the customer wanted/contracted for), or whether they are inputs to be combined with other goods/services (to complete the desired output the customer wanted/contracted). ASU 2016-10 provides guidance on indicators that promises are inputs (not distinct):
- When seller integrates goods/services into a combined output. (For example, in a contract to build a house, the wood, paint, and HVAC are not distinct.)
- When one good/service significantly modifies another. (For example, in a contract for customized software, the base software and the customization services are not distinct.)
- When two goods/services are highly interrelated. (For example, in a hotel management contract, the individual activities are not distinct.)
ASU 2016-10 also addresses the issue of licensing, providing more guidance in the area of the timing of revenue recognition for intellectual property (IP) – whether revenue is recognized at a point in time versus over time. ASU 2016-10 draws a new distinction by assessing whether the IP is “symbolic” (valuable largely because of its association with licensor) or the IP is “functional” (valuable because it can stand alone). Thus, if the licensor doesn’t affect the IP usefulness, the revenue is recognized at a point in time (generally up front). But if the licensor activities do affect the licensed IP, the revenue is recognized over time (term).
Finally, in ASU 2016-08, Principal vs. Agent Considerations, FASB distinguishes principal from an agent. ASU 2014-09 indicates that when another party is involved in providing goods and services to a customer, the entity should determine whether the nature of the promise is a performance obligation to provide the specified goods or services (acting as a principal) or to arrange for the other party to provide those goods or services (acting as an agent).
ASU 2016-08 helps with the determination by setting increased focus on control. Thus, an entity is a principal if it controls the specific good or service before that good or service is transferred to a customer. However, an entity does not necessarily control a good if the entity obtains legal title to that good only momentarily before legal title is transferred to a customer. Some indicators of control are whether the entity is the primary obligor, has inventory risk, or establishes the price. While this still relies on professional judgment, “control of goods or services” may add consistency.
Step 3: Determine the transaction price of the contract – ASU 2016-12 provides an accounting policy option to exclude any sales taxes collected from the transaction price. Additionally, 2016-12 clarifies that noncash consideration is measured at fair value at contract inception.
With a year before broadscale implementation, keep an eye out for more clarifying updates.
1 The concepts of completion of the earnings process, matching of revenues and expenses, explicit reference to risk/reward, and conveyance of title are dropped.
2 Management processes provide the ability to manage risk, such as the ability to stop delivering or cutting off/suspending service to limit that risk.
James J. Newhard, CPA, is a sole practitioner in Paoli, a CPE presenter for Loscalzo Associates, a past president of PICPA’s Greater Philadelphia Chapter, and a member of numerous PICPA committees, including the Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org or on Twitter @CatalystJimCPA.