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STAFF PAPER
January 31, 2017
Project
Transition Resource Group for Revenue Recognition
Paper topic
November 2016 Meeting – Summary of Issues Discussed and Next Steps
CONTACT(S)
Mary Mazzella
+1 203 956 3434
Dillon Jones
+1 203 956 5298
This paper has been prepared for discussion at a public meeting of the Transition Resource Group for Revenue Recognition. It does not purport to represent the views of any individual members of the board or staff. Comments on the application of U.S. GAAP do not purport to set out acceptable or unacceptable application of U.S. GAAP.
Purpose
1. The eighth meeting of the Transition Resource Group for Revenue Recognition (TRG) was held on November 7, 2016. The purpose of the meeting was for the TRG members to inform the FASB about potential issues with implementing Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, and Update No. 2016-10, Identifying Performance Obligations and Licensing (the"new revenue standard"), to help the Board determine what, if any, action may be needed to address those issues.
2. The purpose of this paper is to provide a summary of (a) the issues discussed at the November 7, 2016 meeting, (b) the views expressed at the meeting by the TRG members and FASB staff views about those issues, and (c) the planned next steps, if any, for each of those issues.
Background
3. The following topics were discussed at the November 7, 2016 meeting:
(a) Topic 1: Capitalization and Amortization of Incremental Costs of Obtaining a Contract
(b) Topic 2: Sales-Based or Usage-Based Royalty with Minimum Guarantee
The Financial Accounting Standards Board (FASB) is an independent standard-setting body of the Financial Accounting Foundation, a not-for-profit corporation. The FASB is responsible for establishing Generally Accepted Accounting Principles (GAAP), standards of financial accounting that govern the preparation of financial reports by public and private companies and not-for-profit organizations in the United States and other jurisdictions. For more information, visit www.fasb.org
(c) Topic 3: Payments to Customers
(d) Topic 4: Over Time Revenue Recognition.
4. The staff papers for each of those topics were made public to all stakeholders before the TRG meeting and are available on the FASB website. A direct link to the staff papers is also included within each topic below. This summary should be read in conjunction with those staff papers, which contain a more detailed description of the issues, stakeholder views, and staff analysis.
5. A replay of the entire meeting is available on the FASB's website. The website also contains a log of questions submitted to the TRG.
Topic 1: Capitalization and Amortization of Incremental Costs of Obtaining a Contract (TRG Agenda Ref No. 57)
6. Guidance in the new revenue standard requires an entity to recognize, as an asset, the incremental costs of obtaining a contract with a customer (for example, sales commissions) if the entity expects to recover those costs. Some stakeholders informed the staff that there are different interpretations of the guidance regarding the recognition and measurement of incremental costs of obtaining a contract as an asset and estimating the period of amortization. The TRG previously discussed questions related to incremental costs of obtaining a contract on January 26, 2015. Therefore, this summary memo should be read in conjunction with TRG Agenda Ref No. 23 and TRG Agenda Ref No. 25. At the November 2016 meeting, the TRG discussed the following two questions:
(a)  Question 1: Which costs to obtain a contract are incremental?
(b) Question 2: How should an entity determine the amortization period for an asset recognized for the incremental costs of obtaining a contract with a customer?
7. Paragraph 340-40-25-1 requires an entity to recognize, as an asset, the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. Paragraph 340-40-25-2 defines incremental costs as those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained. Stakeholders have questioned how broadly the term incremental should be interpreted when identifying the costs to capitalize.
8. On Question 1, TRG members generally agreed with the staff's view on the identification of incremental costs subject to capitalization. The staff explained that a way to think about the guidance in paragraphs 340-40-25-2 and 25-3 is to assess whether the entity would incur the cost if the customer (or the entity) decides, just as the parties are about to the sign the contract, that it will not enter into the contract. If the costs would have been incurred even though the contract is not executed, then the costs are not incremental costs of obtaining a contract. Additionally, the staff's view is that the employee's title or level in the organization is not a determining factor for assessing whether a sales commission is incremental.
9. TRG members noted that there may be a broader range of costs capitalized under the new standard as compared to current practice. Additionally, the TRG discussion highlighted that stakeholders should refer to existing guidance outside of the new revenue standard when determining whether and when to recognize a liability for the costs. The guidance in Subtopic 340-40 only addresses whether the costs are expensed or capitalized (that is, the other side of the liability entry).
10. On Question 2, TRG members agreed that the asset should be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates (consistent with the guidance in paragraph 340-40-35-1). TRG members observed that the amortization period will be an estimate and could range from the initial contract term to the average customer life, and points in between, depending on the facts and circumstances. TRG members agreed that judgment often will be necessary to identify the goods or services to which the asset relates and accordingly estimate an appropriate amortization period. These considerations are generally consistent with how an entity determines an amortization period in other areas of GAAP, such as for intangible assets or other long-lived assets.
11. TRG Agenda Ref No. 57 highlights some factors for an entity to consider when estimating the amortization period.
(a) Identify the contract(s) to which the commission relates. The entity will need to determine whether the capitalized incremental costs (such as sales commissions) relate to goods or services that will be transferred only as a part of the initial contract or if the costs also relate to goods or services that will be transferred as a part of a specific anticipated contract(s). This will require judgement.
(b) Determine whether a commission on a renewal contract is commensurate with the commission on the initial contract. If an entity determines that the renewal commission is commensurate with the initial commission, then the asset capitalized for the incremental cost to obtain a contract would be amortized over the initial contract term. However, if an entity determines that the renewal commission is not commensurate with the initial commission, then the entity should assess the period to which the asset relates, potentially including specific anticipated contract(s).
(c) Evaluate facts and circumstances to determine an appropriate amortization period. If an entity determines that the commission on the renewal contract is not commensurate with the commission on the initial contract (or there is no commission on the renewal contract), the amortization period may extend beyond the initial contract term if there are anticipated renewals with goods or services that relate to the costs of obtaining the initial contract. If this period is greater than one year, the practical expedient in paragraph 340-40-25-4 is not applicable.
12. The staff noted that assessing whether a renewal commission is commensurate with an initial commission solely on the basis of the level of effort to obtain the contract would not be consistent with the guidance in Subtopic 340-40 and the basis for conclusions in Update 2014-09.
13. Because the discussion indicated that stakeholders can understand and apply the applicable guidance in the new revenue standard in a manner that the staff believes is consistent with the standard, the staff recommends that the Board take no further action.
Topic 2: Sales-Based or Usage-Based Royalty with Minimum Guarantee (TRG Agenda Ref No. 58)
14. Stakeholders informed the staff that minimum guarantees are used in license arrangements for intellectual property in which the consideration is in the form of a sales-based or usage-based royalty. The minimum guarantee effectively establishes a floor for the amount of consideration to be paid to the licensor.
15. Some stakeholders informed the staff that there are questions about the guidance in Update 2014-09 and Update No. 2016-10, Identifying Performance Obligations and Licensing, when determining how to account for a sales-based or usage-based royalty (variable consideration) promised in exchange for a license of intellectual property that includes a minimum guaranteed amount. Specifically, those stakeholders question whether and how the guaranteed minimum impacts the application of the recognition constraint for sales-based or usage-based royalties for licenses of intellectual property in paragraph 606-10-55-65. The TRG discussed the following two questions:
(a) Question 1: How does a minimum guarantee impact the recognition of sales-based or usage-based royalties promised in exchange for a license of symbolic intellectual property?
(b) Question 2: How does a minimum guarantee impact the recognition of sales-based or usage-based royalties promised in exchange for a license of functional intellectual property?
16. For symbolic licenses (Question 1), the TRG memo included the following views for the recognition of sales-based or usage-based royalties. Examples of the views are included in TRG Agenda Ref No. 58
(a) View A – If an entity expects total royalties will exceed the minimum guarantee, recognize revenue as the royalties (i.e. related sales) occur.
(b) View B – Estimate the transaction price for the performance obligation (including fixed and variable consideration) and recognize revenue using an appropriate measure of progress, subject to the royalties constraint (in paragraph 606-10-55-65).
(c) View C – Recognize the minimum guarantee (fixed consideration) using an appropriate measure of progress and recognize royalties only when cumulative royalties exceed the minimum guarantee.
17. TRG members generally agreed with the staff's view that the new revenue standard does not prescribe a single approach on recognizing revenue for license arrangements of symbolic intellectual property with minimum guaranteed royalties. The standard permits judgment in selecting a measure of progress, as long as the measure of progress is consistent with the guidance in paragraphs 606-10-25-31 through 25-37. TRG members generally agreed that Views A, B, and C are all reasonable applications of the new standard depending upon facts and circumstances. However, TRG members acknowledged that there could be other acceptable applications that were not included in TRG Agenda Ref No. 58. TRG members observed that the revenue recognition for a license of symbolic intellectual property must be in accordance with various aspects of the new revenue standard, including but not limited to the following provisions:
(a) Royalties recognition constraint in paragraph 606-10-55-65: For a license of intellectual property for which the consideration is based on the customer's subsequent sales or usage, an entity should not recognize revenue for the variable amounts before the sales or usage occurs.
(b) Practical expedient in paragraph 606-10-55-18: The practical expedient in paragraph 606-10-55-18 is an appropriate method to measure progress if an entity has rights to consideration from a customer in an amount that corresponds directly with the value to the customer of the entity's performance completed to date.
(c) Allocation of variable consideration in paragraph 606-10-32-40 (including the series provision): The allocation of variable consideration to a distinct good or service that forms part of a single performance obligation is appropriate if both (1) the terms of a variable payment relate specifically to the entity's efforts to transfer the distinct good or service and (2) allocating the variable amount of consideration entirely to the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28.
(d) Allocation objective in paragraph 606-10-32-28: The objective when allocating the transaction price is for an entity to allocate the transaction price to each distinct good or service in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.
(e) Appropriate measure of progress in paragraph 606-10-25-31: The objective when measuring progress is to depict an entity's performance in transferring control of goods or services promised to a customer.
(f) Single measure of progress in paragraph 606-10-25-32: An entity shall apply a single method of measuring progress for each performance obligation satisfied over time, and the entity shall apply that method consistently to similar performance obligations and in similar circumstances.
18. On Question 2, TRG members generally agreed with the staff's view that a minimum guaranteed amount of royalties for functional intellectual property should be recognized as revenue at the point in time the entity transfers control of the license to the customer in accordance with paragraphs 606-10-55-58B through 55-58C, which is described as View A in TRG Agenda Ref No. 58.
19. Because the discussion indicated that stakeholders can understand and apply the applicable guidance in the new revenue standard in a manner that the staff believes is consistent with the standard, the staff recommends that the Board take no further action.
Topic 3: Payments to Customers (TRG Agenda Ref No. 59)
20. Payments to customers (or potential customers) can take the form of cash or other items (for example, a coupon, a credit, or a voucher). Scenarios also include the issuance of equity. Some stakeholders informed the staff that there is a question about the timing of recognition of the payments in the income statement, such as whether upfront payments should be immediately recognized in the income statement or recognized as assets (and subsequently"amortized"). Stakeholders have highlighted that there is diversity in practice in this area today and they question whether the guidance in Topic 606 will narrow that diversity and whether the accounting results under Topic 606 could change, compared to outcomes under current GAAP.
21. The scope of the issue discussed at the TRG meeting was about payments to customers and potential customers. The analysis does not apply to payments that are made to third parties that are not customers or potential customers (such as payments to a vendor) and does not apply to scenarios in which an entity sells goods or services to a customer at a loss with a strong expectation of profit on future orders from that customer.
22. The staff's view is that the new revenue standard is clear that when the counterparty is a customer and the payment relates entirely to a current contract with a customer, the payment should be recorded as a reduction of revenue (reduction of the transaction price), unless the payment to the customer is in exchange for a distinct good or service on the basis of the guidance in paragraph 606-10-32-25 through 32-27.
23. The TRG discussed the following circumstances in which the accounting is less straightforward than the scenario in the above paragraph:
(a) An entity makes an upfront payment to a customer (or a potential customer) and does not have a revenue contract (that is, there is not yet a contract to be accounted for under Topic 606). An entity might make an upfront payment in anticipation of future purchases from the customer.
(b) An entity makes an upfront payment to a customer and there is a revenue contract. However, the upfront payment relates to the current contract as well as anticipated future revenue contracts.
24. The TRG memo describes two views about the timing of when the reduction in revenue for an upfront payment should be recorded.
(a) View A: Payments to customers should be recognized as a reduction of revenue as the related goods or services (that is, the expected total purchases resulting from the upfront payment) are transferred to the customer. The payment might be recorded in the income statement over a period that is longer than the current legally enforceable contract. Identification of the related goods or services will require judgment on the basis of the facts and circumstances. The asset would be periodically assessed for recoverability.
(b) View B: Payments to customers should be recognized as a reduction of revenue from the existing contract (that is, existing enforceable rights and obligations). If no revenue contract exists, then the entire payment would be immediately recognized in the income statement.
25. TRG members observed that View A would be appropriate in many cases. TRG members agreed with the staff view that if an asset is recorded it should meet the definition of an asset in FASB Statement of Financial Accounting Concepts No. 6, Elements of Financial Statements, and an entity should assess whether the asset is impaired in subsequent reporting periods. However, TRG members agreed with the staff view that View B could be appropriate in some cases. TRG members agreed with the staff view that the accounting is not a policy election and agreed that an entity should understand the reasons for the payment, the rights and obligations resulting from the payment (if any), the nature of the promise(s) in the contract (if any), and other relevant facts and circumstances for each arrangement when determining the appropriate accounting. TRG members also agreed with the staff that the assessment will require significant judgment in some cases and appropriate disclosures in the financial statements might be important.
26. Because he discussion indicated that stakeholders can understand and apply the applicable guidance in the new revenue standard in a manner that the staff believes is consistent with the standard, the staff recommends that the Board take no further action.
Topic 4: Over Time Revenue Recognition (TRG Agenda Ref No. 56)
27. Step 5 of the new revenue standard is to recognize revenue when (or as) the entity satisfies a performance obligation. This determination is made for each performance obligation identified in the contract. The new revenue standard includes criteria to determine whether an entity transfers control over time and, therefore, satisfies a performance obligation and recognizes revenue over time. If the over time criteria are not met, then an entity recognizes revenue at a point in time.
28. The TRG discussed the following three questions:
(a) Question 1: Can an entity that recognizes revenue at a point in time under current revenue recognition guidance be required to recognize revenue over time in accordance with the new revenue standard?
(b) Question 2: In assessing whether an entity's performance creates an asset with no alternative use in accordance with paragraph 606-10-25-27(c), should an entity consider the completed asset or the in-production asset?
(c) Question 3: How and when should an entity determine whether it has an enforceable right to payment in accordance with paragraph 606-10-25-27(c)?
29. On Question 1, TRG members agreed with the staff's view that an entity that currently recognizes revenue at a point in time should not presume it will recognize revenue at a point in time under Topic 606. Instead, an entity should perform an assessment of the specific facts and circumstances of each contract on the basis of the guidance in the new revenue standard.
30. On Question 2, TRG members agreed with the staff view that (1) the entity shall evaluate the criteria for over time revenue recognition at the inception of the contract, (2) those criteria shall not be reassessed unless there is a contract modification, and (3) when assessing whether the entity’s performance does not create an asset with alternative use to the entity, the entity should consider the characteristics of the ultimate asset to be transferred to the customer, except as follows. If the entity is contractually restricted or has a practical limitation on its ability to direct the asset for another use, then the asset would not have alternative use, regardless of the characteristics of the ultimate asset.
31. On Question 3, TRG members agreed with the staff's view that an entity has an enforceable right to payment if, on termination for reasons other than the entity's failure to perform as promised, the termination payment compensates the entity for its performance completed to date, including a reasonable profit margin (see paragraph 606-10-25-29). An entity should consider the terms of the contract, as well as any legislation or legal precedent that could supplement or override those contractual terms, when assessing the existence and enforceability of a right to payment for performance completed to date.
32. When assessing whether the overtime criteria in paragraph 606-10-25-27(c) have been met, some TRG members discussed the linkage among right of payment, measure of progress, and the timing of the customization of a good. Example B in TRG Agenda Ref No. 56 describes a scenario in which the customization of the asset begins when the manufacturing process is 75% complete. That example does not include any facts regarding right to payment. However, TRG members raised questions about the impact on the over time assessment in scenarios in which an entity does not have a right to payment prior to the start of the product customization (for example, prior to the customization the product may be considered inventory). The staff explained that the right to payment is for performance completed to date on the contract and that performance should coincide with how an entity defines the nature of its performance obligation and its performance when measuring progress towards satisfaction of that performance obligation.
33. Because the discussion indicated that stakeholders can understand and apply the applicable guidance in the new revenue standard in a manner that the staff believes is consistent with the standard, the staff recommends that the Board take no further action.
Project Update
34. At the TRG meeting, the staff provided an update on issues raised at previous TRG meetings. The majority of the implementation questions discussed at the first seven TRG meetings have been resolved at those meetings without any further action needed. However, standard setting has been required on a few of the issues. The staff provided the following update on the status of those issues.
(a) After the April 2016 TRG meeting, the FASB issued two proposed Updates that related to technical corrections and improvements to Update 2014-09. [On December 21, 2016, the FASB issued Update No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.]
(b) In the proposed Accounting Standards Update, Technical Corrections and Improvements to Update 2014-09, Revenue from Contracts with Customers (Topic 606), the Board proposed to supersede the guidance on preproduction costs related to long-term supply arrangements in Subtopic 340-10. Due to stakeholder concerns about superseding guidance in Subtopic 340-10 that were received immediately before the conclusion of redeliberations, the Board decided to remove the amendments related to this issue from the technical corrections and improvements project (that is, not supersede Subtopic 340-10). The Board did not want to delay all of the other amendments to address this one issue. The staff plans to separately perform additional research and outreach on this topic.
The Financial Accounting Standards Board (FASB) is an independent standard-setting body of the Financial Accounting Foundation, a not-for-profit corporation. The FASB is responsible for establishing Generally Accepted Accounting Principles (GAAP), standards of financial accounting that govern the preparation of financial reports by public and private companies and not-for-profit organizations in the United States and other jurisdictions. For more information, visit www.fasb.org
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