As discussed in ASC 470-10-25-1
, a sale of future revenue typically involves a reporting entity receiving cash from an investor and agreeing to pay to the investor, for a defined period, a specified percentage or amount of the revenue or of a measure of income (e.g., gross margin, operating income, pretax income) of a particular product line, business segment, trademark, patent, or contractual right. Typically, immediate income recognition is not appropriate.
The cash flows to be provided to the investor in a sale of future revenue will vary based on the reporting entity’s future revenues or other measure of income. Generally, these features do not require bifurcation because a separate contract with the same terms would be excluded from the scope of ASC 815
based on the exception in ASC 815-10-15-59(d)
. This scope exception applies when the underlying on which settlement is based involves a specified volume of sales or service revenues of one of the parties to the contract.
provides a number of factors to be considered in determining whether the proceeds received from the investor should be classified as debt or deferred income.
While the classification of the proceeds from the investor as debt or deferred income depends on the specific facts and circumstances of the transaction, the presence of any one of the following factors independently creates a rebuttable presumption that classification of the proceeds as debt is appropriate:
a. The transaction does not purport to be a sale (that is, the form of the transaction is debt).
b. The entity has significant continuing involvement in the generation of the cash flows due the investor (for example, active involvement in the generation of the operating revenues of a product line, subsidiary, or business segment).
c. The transaction is cancelable by either the entity or the investor through payment of a lump sum or other transfer of assets by the entity.
d. The investor's rate of return is implicitly or explicitly limited by the terms of the transaction.
e. Variations in the entity's revenue or income underlying the transaction have only a trifling impact on the investor's rate of return.
f. The investor has any recourse to the entity relating to the payments due the investor.
In many cases, the reporting entity has significant continuing involvement in the generation of the cash flows due to the investor. The presence of this factor creates a rebuttable presumption that the proceeds should be classified as debt.
As described in ASC 470-10-35-3
, in situations when debt classification is appropriate, the reporting entity must determine an effective interest rate and amortize the debt under the interest method. The effective interest rate should be determined based on the proceeds received and projections of the amounts and timing of the future cash outflows.
A reporting entity should revisit its estimate of future cash outflows each reporting period. When the amount and timing of the estimated future cash flows change, one of the following three methods should be applied:
• Prospective approach: A new effective interest rate is computed based on the current carrying value of the debt and the revised estimated remaining cash flows. Changes in cash flows from previous estimates are included in future interest expense on a prospective basis.
• Catch-up approach: The carrying value of the debt is adjusted to the present value of the revised estimated cash flows discounted at the original effective interest rate. Using this approach, the impact of the change in cash flows is recorded in the current period.
• Retrospective approach: A new effective interest rate is computed based on the original proceeds received, actual cash flows to date, and the revised estimate of remaining cash flows. The new effective interest rate is then used to adjust the carrying value of the debt to the present value of the revised estimated cash flows, discounted at the new effective interest rate. Using this approach, the impact of the change in cash flows is recorded in the current and future periods.
While a current period adjustment is recorded under both the catch-up and retrospective approaches, the key distinction relates to the effective interest rate. In a catch-up approach, cash flows are updated to reflect current estimates, but the rate used to discount those cash flows remains the original effective interest rate. Under the retrospective approach, the effective interest rate is changed to reflect the actual cash flows paid to date and the revised estimate of future cash flows.