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Question 54: Can an entity that recognized revenue at a point in time under current revenue recognition guidance be required to recognize revenue over time in accordance with Topic 606?
Publication date: 31 Jan 2020
us FASB Staff Q&A Revenue 54
Reference(s): Section 606-10-25
Under Topic 606, an entity determines at contract inception whether it satisfies a performance obligation over time or at a point in time. In Step 5, an entity recognizes revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer, which is when the customer obtains control of that good or service. This means that, depending on the pattern of timing of when a customer obtains control (and hence when a performance obligation is satisfied), revenue is recognized either over time or at a point in time.
An entity should assess whether a performance obligation is satisfied over time by evaluating the criteria in paragraph 606-10-25-27 (as well as the other guidance in Topic 606 about the application of that paragraph). If the performance obligation is satisfied over time, then revenue should be recognized over time as control of the promised good or service transfers to the customer. As explained in paragraph BC124 of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), the Board developed the criteria in paragraph 606-10-25-27 to provide an entity with an objective basis for assessing when control transfers over time and, in turn, when a performance obligation is satisfied over time. Examples 13 through 17 (paragraphs 606-10-55-159 through 55-182) provide illustrations of performance obligations satisfied over time.
If an entity does not satisfy a performance obligation over time (because it does not meet any of the criteria in paragraph 606-10-25-27), then the performance obligation is satisfied at a point in time and the entity should evaluate the guidance in paragraph 606-10-25-30 to determine the point in time when the customer obtains control of the promised good or service and therefore should recognize revenue.
The Board acknowledged in paragraph BC132 of Update 2014-09 that the criteria in paragraph 606-10-25-27(a) and 606-10-25-27(b) could be challenging to apply in some circumstances. To help with an entity’s assessment of when control transfers over time, the Board developed the criterion in 606-10-25-27(c). The Board noted that this third criterion about no alternative use and enforceable right to payment may be necessary for services that are specific to a customer (for example, consulting services that ultimately result in a professional opinion for the customer) and also for the creation of tangible (or intangible) goods.
The following example illustrates a transaction that might be accounted for at a point in time today but would be accounted for over time under Topic 606.
An entity has contracted with a customer to provide a manufacturing service in which it will produce 1,000 units of a product per month for a 2-year period. The service will be performed evenly over the 2-year period with no breaks in production. The units produced under this service arrangement are substantially the same and are manufactured to the specifications of the customer. The entity does not incur significant upfront costs to develop the production process. Assume that its service of producing each unit is a distinct service in accordance with the criteria in paragraph 606-10-25-19. Additionally, the service is accounted for as a performance obligation satisfied over time in accordance with paragraph 606-10-25-27 because the units are manufactured specific to the customer (such that the entity’s performance does not create an asset with alternative use to the entity), and if the contract were to be cancelled, the entity has an enforceable right to payment (cost plus a reasonable profit margin). Therefore, the criteria in paragraph 606-10-25-15 have both been met.
In the staff’s view, 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. An entity should perform an assessment of its specific facts and circumstances on the basis of the guidance in Topic 606. An entity only recognizes revenue at a point in time if it does not meet the overtime criteria in Topic 606.
While the staff’s view is that an entity should perform an assessment of its specific facts and circumstances, the staff thinks that for most entities (but not every entity) that assessment will be straightforward and will not be time consuming.
The staff is aware from outreach activities that some entities that recognize revenue at a point in time under current GAAP have concluded that they will recognize revenue over time under Topic 606. An example of a fact pattern described to the staff from a few stakeholders is an entity (for example, a contract manufacturer, as described in the Example) that produces goods designed to a customer’s specifications. Because the goods are designed to meet the customer’s unique specifications, the entity concludes that its performance does not create an asset with an alternative use to the entity. In addition, the entity has an enforceable right to payment for performance completed to date. Consequently, the entity concludes that it meets the over-time criteria in paragraph 606-10-25-27(c) and, therefore, it will recognize revenue over time.
The staff is not implying that all entities that produce customized goods should conclude that they will recognize revenue over time under paragraph 606-10-25-27(c). An entity that recognizes revenue at a point in time under current GAAP might conclude that it should recognize revenue at a point in time under Topic 606. This would be the case, for example, if the entity does not have a right to payment. However, an entity will need to perform an assessment of its specific facts and circumstances on the basis of the guidance in Topic 606 to reach a conclusion about whether revenue should be recognized over time or at a point in time.
When an entity is evaluating whether revenue will be recognized over time or at a point in time, it might be an ideal time for the entity to also consider the relevant disclosures. Required disclosures in Topic 606 include (but are not limited to):
(a) When the entity typically satisfies performance obligations (paragraph 606-10-50-12(a))
(b) Judgments, and changes in judgments, used in determining the timing of satisfaction of performance obligations (paragraph 606-10-50-17(a))
(c) For performance obligations satisfied over time, the methods used to recognize revenue (for example, a description of the input or output methods applied) and an explanation of why the methods used provide a faithful depiction of the transfer of goods and services (paragraph 606-10-10-18)
(d) For performance obligations satisfied at a point in time, significant judgments made in evaluating when a customer obtains control of promised goods or services (paragraph 606-10-50-19).
Copyright #year# by Financial Accounting Foundation, Norwalk, Connecticut.
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