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Question 34: How should an entity determine if the practical expedient can be applied in scenarios in which there is a single payment stream for multiple performance obligations?
Publication date: 31 Jan 2020
us FASB Staff Q&A Revenue 34
Reference(s): Section 606-10-32
Topic 606 permits an entity to use the practical expedient referenced in paragraph 606-10-32-18 in applying the guidance on significant financing component. That practical expedient allows an entity not to adjust promised consideration for the amount of a significant financing component when the period between when the entity transfers a promised good or service to a customer and when a customer will pay for that good or service will be one year or less.
The staff has received implementation questions about scenarios in which the cash payment may not be directly tied to a particular good or service in a contract.
Consider the following example:
An entity offers a 24-month contract to customers which include the delivery of a device at contract inception and related services over 24 months. The entity concludes that the device and services are each distinct. The promised amount of consideration (combined amount for device and services) is CU2,400 payable in 24 monthly installments of CU100. Assume the transaction price is allocated to the device (CU500) and services (CU1,900 [CU79 per month]). For purposes of this example, assume that the arrangement includes a significant financing component as the question to be answered only relates to whether the practical expedient can be applied. For purposes of the analysis, this example does not include the calculation of the amount that would be attributed to interest income.
In determining the period between when the entity transfers a promised good or service and when the customer pays for that good or service, the question arises as to whether the entity should consider the full monthly consideration received as a payment of the first good or service delivered (that is, follow a first-in-first-out approach) or whether the entity should proportionately allocate the monthly consideration promised in the contract between the equipment and the services.
Assume that the entity transfers the device first and recognizes revenue for CU500. Each month the entity transfers the services and recognizes revenue for CU79. The two alternatives for determining whether the practical expedient applies are illustrated as follows:
View A
The entity allocates consideration to the first item delivered (the device). Therefore, the device will be “paid” (that is, in relation to the allocation of the transaction price) in full after 5 months (CU100/month for 5 months) and the entity concludes that the period between delivery of the device and receipt of the consideration is less than one year.
The entity notes that any given month of service will be settled in less than 12 months under this approach. For example, services delivered in month 1 will be fully paid in month 6, services delivered in month 2 will be fully paid in month 7, and so on.
The entity, therefore, applies the practical expedient not to adjust the consideration promised in the contract for the effects of a significant financing component as the entity concludes that the period between transfer of any good or service in the contract and when the customer pays for that good or service is one year or less.
View B
The entity proportionally allocates the monthly consideration to the device and the services. Each month, CU79 of the cash is allocated to service and CU21 cash is allocated to the device.
The amount related to the service receivable is fully settled at the end of each month. The entity will, however, receive the full amount outstanding on the handset only over 24 months (CU21/month for 24 months). The entity concludes that the period between delivery of the device and receipt of the consideration relating to the device to be more than one year. Therefore, the entity would be required to consider whether there is a significant financing component in the contract.
The staff notes that the fact that the practical expedient would not apply does not mean there is necessarily a significant financing component in the contract (that is, the entity would need to consider the guidance in paragraphs 606-10-32-15 through 32-17 to make that determination).
TRG members discussed the difficulty in determining when a customer has paid for a particular good or service in a contract with a customer because of the fungible nature of cash. In some circumstances, it may not be clear whether cash collected relates to a specific performance obligation in a contract. In other instances, it may be clear that a cash payment is related to a specific performance obligation based on the terms of the contract. The overall view was that judgment will need to be applied to determine whether the practical expedient may be applied based on the facts and circumstances.
Copyright #year# by Financial Accounting Foundation, Norwalk, Connecticut.
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