New Developments Summary - Update On Proposed Revenue Recognition Guidance

Author:Ms Grant Thornton's Audit Practice Group
Profession:Grant Thornton LLP


It's been about a year since the FASB and the IASB issued their revised exposure document, Revenue from Contracts with Customers, which reflects revisions made to their original proposal to develop a single comprehensive, converged revenue recognition model. Since the revised guidance was issued in 2011, the Boards have redeliberated several aspects of the proposed revenue model based on a significant amount of feedback generated from outreach efforts and comment letters. As a result, the Boards have tentatively decided to revise some of the proposed revenue guidance, and may make further revisions as they continue their redeliberations.

This bulletin summarizes the current status of the proposed revenue recognition model reflecting tentative decisions made by the Boards through the November 2012 joint meeting.

If all goes well, the Boards plan to issue a final standard in the first half of 2013, which would be effective no sooner than for annual reporting periods beginning on or after January 1, 2015.

  1. Introduction

    More than five years ago, the FASB and IASB embarked on a joint project to develop a single model for recognizing revenue and to streamline substantially all revenue recognition guidance. That project began taking shape in 2008 with the issuance of the joint Discussion Paper, Preliminary Views on Revenue Recognition in Contracts with Customers. Then, in June 2010, the Boards issued a joint exposure document (ED), Revenue from Contracts with Customers, for public comment. After performing extensive outreach with constituents and reviewing nearly 1,000 comment letters on the 2010 ED, the Boards decided to revise their original proposal and to re-expose it for public comment in November 2011.

    Over the past year, the Boards have performed extensive outreach on various aspects of the revised revenue recognition proposals and gathered feedback in response to specific questions raised in the 2011 ED. As a result of that process, the Boards identified a number of topics for redeliberation, such as performance obligations satisfied over time, identification of separate performance obligations, constraint on the cumulative amount of revenue recognized, customer credit risk, and disclosures. The Boards have tentatively decided to revise some of the proposed revenue guidance and may make further revisions as they continue their redeliberations.

    This bulletin updates the proposals included in the 2011 ED to reflect the tentative decisions reached by the Boards in redeliberations through the November 2012 joint meeting.

    Barring any unforeseen problems, the Boards plan to issue a final standard with converged guidance on revenue recognition in the first half of 2013. When finalized, the proposed guidance would replace most of the guidance in FASB Accounting Standards Codification® (ASC or Codification) 605, Revenue Recognition.

  2. Proposed revenue recognition model

    The proposed revenue model is based on the core principle that requires an entity to recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. A "customer" is defined as "a party that has contracted with an entity to obtain goods or services that are an output of the entity's ordinary activities."

    To apply this principle, an entity would perform the following five steps:

    1. Identify the contract with a customer.

    2. Identify separate performance obligations.

    3. Determine the transaction price.

    4. Allocate the transaction price to separate performance obligations.

    5. Recognize revenue when or as an entity satisfies performance obligations.

      The proposed guidance would apply to most contracts with customers to provide goods or services. It would not apply to certain contracts that are within the scope of other U.S. GAAP, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantees other than product warranties, and nonmonetary exchanges between entities in the same line of business to facilitate sales to third-party customers.

      Step 1: Identify the contract with a customer

      The first step in the proposed model is to identify the "contract," which the proposed guidance defines as "an agreement between two or more parties that creates enforceable rights and obligations." A contract can be written, oral, or implied by an entity's customary business practices. According to the proposed guidance, a contract with a customer must satisfy all of the following criteria:

      The contract has commercial substance. The parties have approved the contract and are committed to perform. The entity can identify each party's rights and the payment terms for the goods and services to be transferred. For purposes of applying the proposed guidance, a contract would not exist if each party has a unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party.

      In response to concerns about recognizing revenue for transactions that contain nonrecourse seller-based financing, the Boards tentatively agreed in September 2012 to provide additional guidance to determine whether a contract with a customer exists based on the customer's commitment to perform under the contract.

      Combining contracts

      An entity would combine two or more contracts and account for them as a single contract if they are entered into at or near the same time and meet one of the following criteria:

      The contracts were negotiated as a package with one commercial objective. The amount paid under one contract is dependent on the price or performance under another contract. The goods or services to be transferred under the contracts constitute a single performance obligation. Contract modifications

      A contract modification results when the parties to a contract agree on a change in the scope and/or the price of a contract. If the parties approve a change in scope but the corresponding price has not yet been determined, the entity would apply the proposed revenue guidance to the modified contract when the entity has an expectation that the price of the modification has been approved.

      In October 2012, the Boards tentatively decided that contract modifications, including contract claims where changes in scope and price are either unapproved or in dispute as described in ASC 605-35, Revenue Recognition – Construction-Type and Production-Type Contracts, would be considered approved when the modification creates or changes the enforceable rights and obligations of the parties to the contract. Approval could be made orally or in writing or could be implied by customary business practice.

      An entity would account for a modification as a separate contract, which would affect future revenues only, if the modification results in both of the following:

      Promised goods or services that are "distinct," as defined The right to receive consideration reflecting the goods' or services' stand-alone selling prices under the circumstances of the modified contract If a contract modification is not a separate contract, the entity would evaluate the remaining goods and services to be delivered under the modified contract to determine how to account for the modification, as follows:

      If the remaining goods or services are distinct from those delivered before the contract was modified, the entity would treat the modification as a termination of the original contract and the creation of a new contract. As such, the transaction price available for allocation to the remaining separate performance obligations would equal the amount of consideration received from the customer but not yet recognized as revenue, plus the amount of any remaining consideration the customer has promised to pay that has not been recognized as revenue (tentatively clarified in October 2012). If the remaining goods or services are not distinct and are part of a single performance obligation that is partially satisfied as of the modification date, the entity would treat the modification as part of the original contract by adjusting both the transaction price and the measure of progress toward completion of the performance obligation. The revenue recognized to date would be adjusted for the contract modification on a cumulative catch-up basis. If the modification represents a combination of the two preceding scenarios, the entity would allocate the consideration received but not yet recognized to revenue, and any remaining consideration the customer has promised to pay to the remaining performance obligations, including those partially satisfied. The entity would also update the transaction price and remeasure the progress toward completion for any performance obligation that is satisfied over time. The entity would neither reallocate consideration to, nor adjust the amount of revenue recognized for, separate performance obligations satisfied on or before the contract modification date. If the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification and there is a subsequent change in the estimated transaction price, an entity would account for the modification prospectively, unless the change in transaction price relates to satisfied performance obligations. Amounts allocated to a satisfied performance obligation would be recognized either as revenue or as a reduction of revenue in the period the transaction price changes (tentative decision in October 2012). Step 2: Identify separate performance obligations

      Once an entity has identified a contract, it would identify separate performance obligations within that contract. The proposed guidance defines a "performance obligation" as a promise to transfer goods or services to the customer. This includes promises explicitly identified in the contract, as well as promises "implied" by an...

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