FASB Set to Issue Final Standard on Revenue Recognition

Companies now have a complete roadmap to a new accounting standard on revenue recognition after the Financial Accounting Standards Board wrapped up its deliberations and reached agreements on a few central outstanding issues, clearing the way for implementation planning.

After more than a decade of discussion papers, proposals, comment letters, roundtables, and various other forms of outreach, FASB is in the home stretch on a new standard on how to recognize revenue in financial statements. The board made final decisions on such issues as variable consideration, licenses, and collectibility and has instructed its staff to put the finishing touches on the final language of the standard. The new rules are expected to be in print by the first quarter of 2014, FASB says.

“You could argue that this is the most important accounting standard to come down in quite some time,” says James Comito, a shareholder with audit firm Mayer Hoffman McCann. “Now people have to roll up their sleeves and actually go and do it. It's a fairly long runway, but don't be deceived. It's going to take you a while.”

Brian Marshall, a partner with McGladrey, says companies that have followed the development of the standard closely should have all the information they need at this point to prepare for implementation. “But even without a full understanding of the exact standard, there certainly are some things you could do, if you haven't already,” he says. At a minimum, companies should be looking at how they generate revenue and start categorizing various forms of revenue or contracts with customers into different categories, Marshall says. “You can start to look at those different buckets and look at how the standard is going to evaluate those contracts.”

The new standard will enable companies to accelerate the recognition of revenue in some important areas, says Diana Gilbert, a consultant with financial and accounting consulting firm RoseRyan. “In general, all the guidance on the new standard has shown a little more frontloading of revenue,” she says. “The new standard is designed to allow you to be more reasonable and reflect the business of a transaction, but with it comes judgment.” Implementation guidance will be vital to how the standard is interpreted, and therefore how judgments are exercised, she says. “People are going to want that guidance.”

Clearing the Way

As for recent decisions, FASB settled on a final plan for how companies will be required to account for revenue in some tricky situations, such as when variable consideration enters into an arrangement, when revenue arises from the licensing of intellectual property, and when concerns about collectibility from a given customer should be taken into account. To arrive at some of its conclusions, FASB turned to a familiar term in U.S. Generally Accepted Accounting Principles—probability.

The board decided to place a constraint on when companies should recognize revenue if variable consideration is a factor. Variable consideration arises when some portion of a transaction price might vary in amount or timing, such as with discounts or rebates, refunds or credits, penalties, price concessions, performance bonuses, and various other terms or incentives. FASB determined recently that companies can estimate variable consideration and include it in a transaction process as long as it is probable that there will not be a significant reversal later.

REV-REC SUMMARY

In the following excerpt from FASB's summary of the new revenue recognition standard, IASB and FASB discuss topics to be included in the final standard on revenue from contracts with customers.

Constraint on Estimates of Variable Consideration

The boards discussed the application of the constraint on estimates of variable consideration (that is, when those estimates should be included in the transaction price). Specifically, the boards discussed the objective of the constraint, reassessment, and the application of the constraint to sales- and usage-based royalties on licenses of intellectual property.

Objective of the Constraint

The boards tentatively decided to specify a confidence level in the objective of the constraint of probable. (For IASB, the confidence level will be expressed as “highly probable.” The boards acknowledge that different terms were necessary to convey the same outcome because of existing definitions in U.S. GAAP and IFRS.)

The boards also tentatively decided that if an entity expects that including some, but not all, of the estimated amount of variable consideration (that is, a minimum amount) in the transaction price would not result in a significant revenue reversal, the entity should include that amount in the estimate of the transaction price. The objective of the constraint should be stated in the final revenue standard broadly as follows:

An entity shall include an estimate of variable consideration in the transaction price to the extent it is probable that a significant revenue reversal will not occur. A significant revenue reversal will occur if there is a significant downward adjustment on the amount of cumulative revenue recognized from that contract with that customer …

Implementation Guidance: Licenses

The boards discussed improvements to the implementation guidance for licenses and to the criteria for distinguishing between two types of licenses—licenses that provide access to the entity's intellectual property (that is, a performance obligation satisfied over time) and licenses that provide a right to use the entity's intellectual property (that is, a performance obligation satisfied at a point in time). The boards suggested further drafting improvements and tentatively decided to:

1.Place greater emphasis in the implementation guidance on the importance of identifying performance obligations before applying the criteria to distinguish between the two types of licenses.

2.Include additional rationale in the implementation guidance that explains the intent of the criteria.

3.Provide further examples to clarify the objective and application of the criteria.

Collectibility

The boards discussed assessments of customer credit risk (that is, collectibility) in the revenue model. The boards affirmed previous tentative decisions to measure the transaction price, and therefore revenue, at the amount of consideration to which the entity is entitled (that is, an amount that is not adjusted for customer credit risk). The boards also tentatively decided to clarify the requirements relating to estimates of variable consideration, specifically as they relate to assessing whether an entity has provided a price concession.

The boards also tentatively decided to clarify the criteria that must be met before an entity can apply the revenue model to a contract with a customer by including an explicit collectibility threshold. To meet that threshold and apply the revenue model, an entity must conclude that it is probable that it will collect the consideration to which it will be ultimately entitled in exchange for the goods or services that will be transferred to the customer. In making that assessment, the boards noted that an entity would only consider customer credit risk and not other uncertainties, such as those related to performance or measurement, which would be accounted for in the timing of recognition and measurement of revenue. In setting the threshold, the boards also acknowledged that the term probable has different meanings in U.S. GAAP and IFRS; however, the boards tentatively decided to set the threshold at a level that is consistent with current practice and existing standards for revenue recognition in US GAAP and IFRS.

Source: FASB.

“That is going to be a big change,” says Mark Crowley, a director with Deloitte & Touche. “Today, under U.S. GAAP, if you have contingent or variable revenue, the amount of revenue you can recognize is limited to the amount that is not contingent.” Companies can't recognize any contingent amounts until the amount is known, he says. Still, the “probable” constraint chosen by FASB is one known to those who work in GAAP and is recognized as a fairly high threshold, he says. “You have to be pretty certain of the amount,” he says.

FASB also determined that companies should include revenue arising from licensing of intellectual property, especially in the form of sales-based or usage-based royalties, in a transaction price when uncertainty over the amount is resolved. The board also says it will provide more guidance on distinguishing between types of licenses where a company's performance obligation may differ. In some cases, a company's obligation is met at a single point in time when it transfers a right to use intellectual property, while in other cases a performance obligation may be met over an extended period of time. As such, the revenue recognition would differ. FASB plans to provide more rationale and examples to help companies navigate this complex area of revenue recognition.

FASB is essentially applying the same “probable” constraint to revenue arising from licensing, says Doug Reynolds, a partner with Grant Thornton. “So if you're not certain about revenue because your revenue is based on someone else selling something, you should not record any revenue until that uncertainty is resolved,” he says. “That's going to be a very high threshold. But it's certainly clearer than it was a few months ago.” Companies likely will be happy with that guidance because it's clear, and therefore straightforward to implement, and it's similar to how companies recognize such revenue currently, he says.

As for collectibility, FASB has been struggling with where to draw the line on the extent to which a company would consider the credit risk of a given customer in deciding whether to recognize revenue at all at the front end of a transaction. Relying again on the “probable” constraint, FASB determined a company would only recognize revenue at the front end of a contract if it determined it will probably be able to collect. “So now collectibility is a gate,” says Reynolds. “You have to get through this gate before you can even apply the revenue model.” That approach is similar to the rules under current GAAP, he says, so companies shouldn't have difficulty applying it.

Dee Mirando-Gould, a director with consulting firm MorganFranklin, says the judgments called for in the new standard are likely going to increase documentation needs. Given the planned effective date of January 2017, companies supplying three years of financial data in their financial statements will want to be ready to begin applying the guidance to their contracts in 2015 so they can build up their repository of retrospective data to be reported in 2017, she says. “You will still have to account for revenue under existing standards, but you also have to be thinking about comparative periods,” she says. “If this goes out in the first quarter of 2014, you don't have as much time as you thought.”