When the Financial Accounting Standards Board (FASB) released Accounting Standards Codification 606, Revenue from Contracts with Customers (ASC 606), on May 28, 2014, several industries were provided additional resources for implementation. Among them was telecommunications (telecom), for which the Revenue Recognition Transition Resource Group and AICPA’s Telecommunications Entities Revenue Recognition Task Force have tackled some of the most challenging issues faced while implementing ASC 606.
The public company effective date of Dec. 15, 2017, is behind us, and there have been two issues that have had the largest impact on telecom financial statements resulting from the adoption of the five-step model outlined in ASC 606:
- Elimination of the contingent revenue cap (step 4)
- Material right considerations for nonrefundable up-front activation or installation fees (step 2)
Telecoms often provide services through bundled offerings and generate revenues through subscription fees or usage charges for access to networks that provide data, internet, voice, and television services. Some also sell or lease equipment such as mobile phones, modems, cable boxes, and a variety of accessories.
Prior to ASC 606 adoption, when a wireless device was sold, revenue recognized by a telecom was restricted to the amount received that was not contingent on the provision of future services, which was typically the cash received at the time of sale. This restriction is often referred to as the “contingent revenue cap.”
Upon implementation of ASC 606, the sale of a phone and ongoing wireless services may be considered two performance obligations (step 2). When a contract includes two or more performance obligations, the entity would generally allocate the transaction price on a relative stand-alone selling price (SSP) basis. ASC 606 cites the best evidence of an SSP as the price for which the entity sells a good or service under similar circumstances to similar customers. Therefore, under ASC 606 more revenue typically will be allocated to the equipment sale than the amount historically recognized because of the elimination of the revenue cap. Additionally, a contract asset is recorded at the time of sale equal to the revenue recognized on the equipment in excess of amounts billed. Entities that provide wireless devices at subsidized prices in connection with fixed-term service plans will be most affected by this change.
Identifying performance obligations within a contract (step 2) involves dissecting the entity’s promise to the customer and determining if the goods or services are distinct. To be distinct, the promise to transfer the good or service must be separately identifiable from other promises within the contract, and the customer must be able to benefit from the good or service (either on its own or together with readily available resources).
Telecom providers often charge activation or up-front nonrefundable fees. Typically, up-front fees are nominal, charged regardless of the contract term (i.e., one month vs. two year), and permit customers to renew the service contract without paying an additional fee. When up-front, nonrefundable fees are charged in connection with a bundled service offering, the performance obligation is often the delivery of the actual services (such as television, internet, and voice). Activation would not typically be considered a performance obligation, as no transfer of good or service has occurred. Under prior guidance (ASC 605), these were typically recognized over the life of the customer.
As illustrated in ASC 606, the accounting treatment for an up-front fee depends on whether the customer’s ability to forgo paying the fee upon subsequent renewals represents a material right for which the customer would not have obtained without entering into that contract. If an option is granted to a customer to acquire additional goods (i.e., mobile phones) or services (i.e., discounted minutes), that option gives rise to a performance obligation only if it represents a material right the customer would not have obtained without entering into that contract. The Transition Resource Group emphasizes consideration of both qualitative and quantitative factors in the assessment of whether the entity provides a material right to an existing customer. If deemed a performance obligation, a portion of the transaction price is allocated to that option and the related revenue is recognized when control of the goods or services underlying the option is transferred or when the option expires. The determination of an appropriate period for recognition is subject to judgment.
Although ASC 606 was effective for publicly held companies for reporting periods beginning after Dec. 15, 2017, it will soon be effective for private companies. Recently filed Form 10-Q reports of publicly held companies describe the impact of this revenue recognition on telecoms. Several wireless entities report reductions in service revenue with increases to equipment sales revenue due to the elimination of the revenue cap. While there is some relief for private companies for note disclosures, these issues will need to be thoroughly analyzed to determine the potential impact.
Vanessa A. Zang, CPA, is a director with Kreischer Miller in Horsham. She can be reached at email@example.com.