ASU 20014-09 Daily Digest for 20140618: What are the Main Provisions? (Part 2)

What Are the Main Provisions?

The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

To achieve that core principle, an entity should apply the following steps:

Step 1: Identify the contract(s) with a customer.

Step 2: Identify the performance obligations in the contract.

Step 3: Determine the transaction price.

Step 4: Allocate the transaction price to the performance obligations in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

Yesterday we covered Steps 1 & 2.  Today we will cover Step 3:

Step 3:   Determine the Transaction Price

The transaction price is the amount of consideration (for example, payment) to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. To determine the transaction price, an entity should consider the effects of:

1.       Variable consideration—If the amount of consideration in a contract is variable, an entity should determine the amount to include in the transaction price by estimating either the expected value (that is, probability-weighted amount) or the most likely amount, depending on which method the entity expects to better predict the amount of consideration to which the entity will be entitled.

2.       Constraining estimates of variable consideration—An entity should include in the transaction price some or all of an estimate of variable consideration only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

3.       The existence of a significant financing component—An entity should adjust the promised amount of consideration for the effects of the time value of money if the timing of the payments agreed upon by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing for the transfer of goods or services to the customer.  In assessing whether a financing component exists and is significant to a contract, an entity should consider various factors.  As a practical expedient, an entity need not assess whether a contract has a significant financing component if the entity expects at contract inception that the period between payment by the customer and the transfer of the promised goods or services to the customer will be one year or less.

4.       Noncash consideration—If a customer promises consideration in a form other than cash, an entity should measure the noncash consideration (or promise of noncash consideration) at fair value.  If an entity cannot reasonably estimate the fair value of the noncash consideration, it should measure the consideration indirectly by reference to the standalone selling price of the goods or services promised in exchange for the consideration.  If the noncash consideration is variable, an entity should consider the guidance on constraining estimates of variable consideration.

5.       Consideration payable to the customer—If an entity pays, or expects to pay, consideration to a customer (or to other parties that purchase the entity’s goods or services from the customer) in the form of cash or items (for example, credit, a coupon, or a voucher) that the customer can apply against amounts owed to the entity (or to other parties that purchase the entity’s goods or services from the customer),  the entity should account for the payment (or expectation of payment) as a reduction of the transaction price or as a payment for a distinct good or service (or both).  If the consideration payable to a customer is a variable amount and accounted for as a reduction in the transaction price, an entity should consider the guidance on constraining estimates of variable consideration. 

ASU 20014-09 Daily Digest for 20140617: What are the Main Provisions?

What Are the Main Provisions?

The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

To achieve that core principle, an entity should apply the following steps:

Step 1: Identify the contract(s) with a customer.

Step 2: Identify the performance obligations in the contract.

Step 3: Determine the transaction price.

Step 4: Allocate the transaction price to the performance obligations in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

Step 1:  Identify the Contract with a Customer

A contract is an agreement between two or more parties that creates enforceable rights and obligations. An entity should apply the requirements to each contract that meets the following criteria:

1. Approval and commitment of the parties

2. Identification of the rights of the parties

3. Identification of the payment terms

4. The contract has commercial substance

5. It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.

In some cases, an entity should combine contracts and account for them as one contract. In addition, there is guidance on the accounting for contract modifications.

Step 2: Identify the Performance Obligations in the Contract

A performance obligation is a promise in a contract with a customer to transfer a good or service to the customer. If an entity promises in a contract to transfer more than one good or service to the customer, the entity should account for each promised good or service as a performance obligation only if it is:

(1) distinct or

(2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer.

A good or service is distinct if both of the following criteria are met:

1. Capable of being distinct—The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.

2. Distinct within the context of the contract—The promise to transfer the good or service is separately identifiable from other promises in the contract.

A good or service that is not distinct should be combined with other promised goods or services until the entity identifies a bundle of goods or services that is distinct.

We’ll cover Steps 3,4,5 in tomorrow’s Daily Digest.

ASU 20014-09 Daily Digest: Why Is the FASB Issuing This Accounting Standards Update (Update)? (ASU 2014-09) (ASC 606)

As I begin to make my way through this ASU, I plan to share some sections or portions with you, on a daily basis, thereby implementing the “divide and conquer” principle when it comes to digesting this new pronouncement which is over 800 pages in length.  We have about two years to process it, which means if we process about 1-2 pages per day we can get through it in two years or less…

Here is an excerpt from the beginning of ASU 2014-09, Section 1, Page 1, which explains, in fairly accessible terms, why FASB is, in effect, re-engineering the revenue recognition codification (replacing ASC 605 with ASC 606):

“Revenue is an important number to users of financial statements in assessing an entity’s financial performance and position. However, previous revenue recognition requirements in U.S. generally accepted accounting principles (GAAP) differ from those in International Financial Reporting Standards (IFRS), and both sets of requirements were in need of improvement. Previous revenue recognition guidance in U.S. GAAP comprised broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes resulted in different accounting for economically similar transactions. In contrast, IFRS provided limited guidance and, consequently, the two main revenue recognition standards, IAS* 18, Revenue, and IAS* 11, Construction Contracts, could be difficult to apply to complex transactions. Additionally, IAS* 18 provides limited guidance on important revenue topics such as accounting for multiple-element arrangements.

“Accordingly, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS that would:

1. Remove inconsistencies and weaknesses in revenue requirements.

2. Provide a more robust framework for addressing revenue issues.

3. Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.

4. Provide more useful information to users of financial statements through improved disclosure requirements.

5. Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.

“To meet those objectives, the FASB is amending the FASB Accounting Standards Codification® and creating a new Topic 606, Revenue from Contracts with Customers, and the IASB is issuing IFRS 15, Revenue from Contracts with Customers. The issuance of these documents completes the joint effort by the FASB and the IASB to meet those objectives and improve financial reporting by creating common revenue recognition guidance for U.S. GAAP and IFRS.”

End notes:

* International Accounting Standard