Allocating the transaction price
The staff discussed that the underlying principle of the ED is that an entity should allocate to each separate performance obligation the amount of consideration the entity expects to receive in exchange for satisfying that performance obligation. The staff recommended that to apply this core principle, an entity should allocate the transaction price on a relative standalone selling price basis (using estimated selling prices if necessary) except in the following circumstances in which an entity should be permitted to use an alternative allocation method:
- If an entity transfers a significant good or service to the customer at the beginning of a contract and the price for that good or service is highly variable (e.g. software license), the entity should be permitted to allocate the transaction price to the remaining performance obligations in a contract at an amount equal to the standalone selling prices of the goods or services underlying those remaining performance obligations (i.e. residual method)
- If a relative selling price allocation results in a loss on one or more performance obligation, an entity should be permitted to allocate the transaction price to the performance obligations in a contract using either a residual method or by allocating the discount in the contract in proportion to the individual profit margin on each separate performance obligation (i.e. a profit margin method).
The staffs' recommendations with respect to the alternative methods generated significant discussion by the Boards and there were many concerns raised and views shared by the Boards. Some of the concerns centred on whether (a) was specifically tailored to the software industry and whether there was a difference between residual method and residual technique. Concerns around (b) centred on the ability to choose between two methods and that there was a lack of clarity around what costs were involved in determining the profit margin and situations where loss leaders would be able to use alternative methods to allocate revenue.
- The Boards tentatively agreed to change the wording on (a) to note that the residual method would be appropriate technique where there is a variable performance obligation. This is not a choice but a technique to meet the core principle of the ED.
- The staff clarified that exception (b) related to situations where there are normally profitable components on a contract which as a result of the allocation of a discount based on the relative selling price now has some loss making components which is not representative of the economics of the product/service. Several Board members noted that the exception (b) was not sufficiently clear or narrow enough. The Boards were spilt on agreeing to exception (b) and neither of the Boards agreed to a more narrow interpretation of exception (b). Consequently, the Boards tentatively agreed in principle to drop exception (b) and revert to an allocation based on relative selling price.
Allocating subsequent changes in the transaction price
The staff recommended that an entity should allocate changes in the transaction price on a relative standalone selling price basis to all performance obligations in the contract, except when a change in the transaction price relates entirely to one performance obligation. That would be the case if both of the following conditions are met:
- The contingent payment terms of the contract relate specifically to the entity's efforts to satisfy that performance obligation or a specific outcome from satisfying that separate performance obligation; and
- The amount allocated (including the change in the transaction price) to that particular performance obligation is reasonable relative to all of the performance obligations and payment terms (including other potential contingent payments) in the contract).
The Boards tentatively agreed with the staff's recommendation.
Licences and rights to use intangible assets
The Boards re-deliberated whether the revenue standard should distinguish between different types of licenses following feedback from respondents who mainly disagreed that entity should distinguish between an exclusive and a non-exclusive license as the majority of the respondents felt that exclusivity does not affect the nature of an entity's performance obligation, and therefore is counterintuitive to have different patterns of revenue recognition depending on whether a license is exclusive. The Boards tentatively agreed with the staff's recommendation that the revenue standard should not distinguish between the types of licenses. The Boards also clarified that licenses and rights to use intangible assets had been scoped out of the lease standard (in particular, from a vendor perspective).
The Boards considered two alternatives to accounting for a contract in which the entity grants a license to a customer. Under Alternative A, an entity would apply the overall revenue model when accounting for a contract in which the entity grants the customer rights to use the entity's intellectual property. As such, an entity satisfies its performance obligation (and therefore, recognises revenue), when the customer is able to use and benefit from the promised rights (i.e. when the customer obtains control). Under Alternative B, an entity satisfies its performance obligation and recognises revenue over the period in which the customer has the right to use to underlying assets. This alternative could significantly change current practice for accounting for various transactions. The Boards tentatively agreed with the staff's recommendation that in a contract in which an entity grants a license to a customer, the promised asset is the license and the promise to grant that license represents a single performance obligation that the entity satisfies when the customer is able to use and benefit from the license (i.e. Alternative A).
The Boards had previously discussed the issues relating to the costs of obtaining a contract at the February 2011 meeting and tentatively decided that an entity should recognise an asset for the incremental costs of obtaining a contract that the entity expects to recover. Incremental costs of obtaining a contract are costs that the entity would not have incurred if the contract had not been obtained.
This meeting considered improvements to the proposed guidance in the ED on accounting for the costs incurred to fulfil a contract with a customer. Certain Board members expressed reservation that costs were addressed in the ED. However, some Board members noted that this guidance would provide more clarification, consistency, and improve convergence that it was not possible to develop a comprehensive revenue standard without addressing some cost guidance as was requested by respondents. The Boards tentatively agreed with the majority staff view and recommendation to retain the existing scope in the ED for the fulfilment cost guidance rather than addressing costs comprehensively.
The Boards tentatively affirmed the proposal in the ED that an entity should first apply the requirements of other standards (e.g. on inventory, PP&E, and intangibles) to account for the costs of fulfilling a contract. The Boards discussed and tentatively concurred that the definition of "standards" referred to official literature.
If an entity incurs costs to fulfil a contract and those costs are not in the scope of another standard, the entity should recognise an asset arising from fulfilment costs if all of the following conditions are met: a) the costs relate directly to a contract; b) the costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future, and c) the costs are expected to be recovered. Certain Board members felt that this definition was vague and the staff agreed to draft wording to make the criteria/definition of an asset clearer. The Boards tentatively agreed in principle to the staff's proposal. There was some discussion that this could lead to unintended consequences where some costs that were previously expensed would be capitalised.
The Boards tentatively concurred with the staff's clarification that "costs relating directly to a contract" include pre-contract fulfilment costs that relate directly to a specific anticipated contract. Specifically, the staff clarified that pre-contract costs are fulfilment costs that an entity incurs prior to obtaining a contract, such as the costs of mobilization, engineering and design, architectural or other fulfilment costs incurred on the basis of commitments or other indications of interest in negotiating a contract.
The Boards considered the staff's proposal to clarify what was meant by "abnormal costs". The Boards tentatively agreed to use the language in the ED asked the staff to add some clarity but not to over engineer the wording.
The Boards tentatively agreed to the staff's proposal to provide a few more examples of allocations of costs that relate directly to a contract but that these should be limited.
Some respondents had questioned how to apply the proposed revenue model to account for the effects of learning costs in a contract with a customer. The Board tentatively agreed and asked the staff to draft an illustrative example.