Scott Levy – Head of Accounting Advisory Group
The Financial Accounting Standards Board (FASB) recently conducted a post-implementation review of Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The rules were issued in 2014 but took effect in 2018 for public companies and in 2019 for private companies.
The revenue recognition standard replaced hundreds of industry-specific rules with a principle-based five-step model for reporting revenues earned. Public feedback on Topic 606 has generally been positive. However, eight topics surfaced as challenging for public companies as they navigated the implementation process.
1. Principal vs. Agent Determination
Many companies expressed concerns over the rules for determining if an entity is a principal or agent in a revenue arrangement. These provisions require the entity to assess whether it controls the good or service before it’s transferred. This assessment requires significant judgment, and it can have a consequential effect on the income statement.
Specifically, challenges surfaced in the context of emerging business models, or technology platform companies in which an entity uses an app to connect end consumers with a supplier. A related issue is consideration payable to a customer, which was also raised in the context of technology platform companies.
2. Licensing Distinction
The FASB discovered that some companies found it challenging to determine when a license is distinct from other services in the contract, such as software with updates. Companies also struggled with how to allocate the total transaction price when the contract includes a sales-based or usage-based royalty.
3. Estimates of Variable Consideration
For variable consideration, companies found it challenging to determine when and how estimated amounts should be constrained. Estimating variable consideration for contracts with sales or usage-based royalties that aren’t licenses of intellectual property can be difficult.
4. Short-Cycle Contract Manufacturing
Manufacturing companies have found it challenging to ascertain whether short-cycle contract revenue should be recognized over time or at a point in time. Differing interpretations of the rules can result in different revenue recognition timing for similar transactions depending on customization of goods.
The four other issues that the FASB flagged during its post-implementation review include:
1. Improving disclosures by providing more specificity around disaggregated revenue and remaining performance obligation disclosures,
2. Estimating standalone selling prices, especially when a new performance obligation has never been sold on a standalone basis or has little or no cost basis (or an undeterminable cost basis),
3. Identifying performance obligations, including assessing the nature of a promise and whether or not goods or services are distinct, and
4. Determining which incremental costs of obtaining a contract should be capitalized and the period over which those costs should be amortized.
Some effects of adopting the updated revenue recognition rules may take several years to fully manifest. In addition, private companies may encounter different challenges during the implementation process than public ones. The FASB plans to conduct more research on these topics and provide additional clarity. In 2022, FASB staff will expand its review to monitoring the benefits and costs for private companies. Contact DLA for the latest developments on these challenging aspects of recognizing contract revenue.