The Boards discussed allocating the transaction price to separate performance obligations, accounting for contract acquisition costs, applying the proposed model to bundled arrangements and constraining the cumulative amount of revenue recognised on licences.
Allocation of the transaction price
In its 2011 revised exposure draft (2011 ED), the Board proposed that an entity should allocate to each separate performance obligation the amount of consideration the entity expects to be entitled in exchange for satisfying that performance obligation. An entity would allocate the transaction price on a relative standalone selling price basis. In circumstances where there is a variable performance obligation (e.g., software licence arrangements), the use of the residual method would be appropriate. However, other methods of estimation may be suitable for estimating the standalone selling price of a good or service.
At this meeting, the Boards discussed possible refinements and clarifications to these proposed requirements – namely regarding use of a residual approach in allocating to each separate performance obligation the amount of consideration the entity expects to be entitled in exchange for satisfying that performance obligation.
The staff outlined feedback received from constituents regarding use of a residual approach. Many respondents requested clarification about how to apply the residual approach for estimating the standalone selling price in arrangements that contain more than one performance obligation for which the goods or services underlying those performance obligations have standalone selling prices that are highly variable or uncertain. The 2011 ED, as drafted, contemplated the residual approach applying when the price of one good or service is highly variable or uncertain, but it did not specifically address situations in which more than one good or service has a highly variable or uncertain price.
The staff, analysing the proposals in the 2011 ED, believed the rationale for using the residual approach to estimate a standalone selling price is the same regardless of how many goods or services to a contract have a highly variable or uncertain selling price. Therefore, the staff proposed that the Boards retain the proposals in the 2011 ED relating to the use of a residual approach to estimate the standalone selling price of a performance obligation where a variable performance obligation exists. However, the staff proposed that the Boards clarify that a residual approach could also be used when two or more performance obligations in a contract have standalone selling prices that are highly variable or uncertain. When two or more performance obligations have standalone selling prices that are highly variable or uncertain, the entity could estimate the standalone selling prices by first applying the residual approach to estimate an aggregate amount for the group of promised goods or services, and then using another method to estimate the standalone selling prices of the goods or services underlying each separate performance obligation.
The Boards generally supported the staff proposals, but a few concerns were expressed.
Specifically, one Board member, reviewing illustrative examples of application of the proposals provided in the staff paper, requested that the proposals specify that use of other methods to estimate the standalone selling prices of the goods or services underlying each performance obligation be subject to the objective for allocating the transaction price to separate performance obligations specified in paragraph 70 of the 2011 ED – that being, that use of other estimation methods should depict the amount of consideration to which the entity expects to be entitled in exchange for satisfying each separate performance obligation. Most Board members agreed with this proposal.
Another Board member questioned whether the use of ‘other’ measurement options, such as an adjusted market assessment approach, expected cost plus a margin approach or a residual approach, as outlined in the 2011 ED, is subject to any consistency requirement. The staff noted that the 2011 ED specifies that judgements and estimation methods should be applied consistently, with disclosure of the methods, inputs and assumptions used to determine the transaction price and the amounts allocated to performance obligations.
With little additional debate, the Boards tentatively agreed with the staff proposals, subject to specifying that use of ‘other’ estimation methods should depict the amount of consideration to which the entity expects to be entitled in exchange for satisfying each separate performance obligation.
The Boards then discussed possible clarifications on the application of the proposals in paragraphs 75-76 of the 2011 ED related to allocating a discount and allocating contingent consideration.
Some respondents disagreed with the proposals in paragraph 75 of the 2011 ED for allocating the discount in a contract specifically to one (or some) performance obligations. Those respondents commented that the proposals are too restrictive and would not yield an outcome that reflects the economics of their transactions. A few of those respondents suggested the entity should be allowed to allocate the discount specifically to a performance obligation if it is able to demonstrate where the discount belongs.
The staff believed that any proposal to expand the criteria in paragraph 75 of the 2011 ED created a risk of unintended consequences and raised a question of how that expanded criteria can be appropriately limited so as to not diminish the rigor of the allocation process. Therefore, the staff recommend no change to the criteria in paragraph 75 of the 2011 ED. However, the staff believed the Boards should clarify that paragraph 75 of the 2011 ED should be applied before using the residual approach to estimate the standalone selling price for promised goods or services with a highly variable and uncertain selling price. The staff believed that the resulting allocation from making this clarification would be more consistent with the core allocation principle described in paragraph 71 of the 2011 ED.
Further, some respondents requested clarification of the proposal in paragraph 76 of the 2011 ED for allocating contingent consideration. Those respondents interpreted paragraph 76 to mean that the contingent amount could be allocated either to one distinct good or service or allocated proportionately to all of the distinct goods or services promised in the contract, but not to any combination in between.
The staff believed that those respondents interpreted the wording of paragraph 76 of the 2011 ED too narrowly because the proposal was intended to apply to, among other things, repetitive services contracts in which each increment of service would have been distinct.
As a result, the staff proposed to retain the proposals in paragraphs 75-76 of the 2011 ED, while also clarifying that discounts and contingent consideration should be initially allocated on the basis of paragraphs 75 and 76 of the 2011 ED before applying a residual approach to estimate the standalone selling price of any other performance obligations. Likewise, an entity can allocate contingent consideration to more than one distinct good or service in the contract.
Board members tentatively supported the staff recommendation.
Contract acquisition costs
The Boards then discussed possible modifications and clarifications to the proposed requirements in paragraphs 91-103 of the 2011 ED relating to the accounting for contract acquisition costs. The 2011 ED proposed that incremental costs expected to be recovered should be capitalised, however, a practical expedient would permit the recognition of contract acquisition costs as a period cost (as opposed to capitalised costs) for contracts with an expected duration of one year or less.
Respondents to the 2011 ED expressed concern with these proposals relating to reduced comparability between sales from the direct channel and from the indirect channel given application of the 2011 ED proposals, while others expressed practical or cost-related challenges associated with continuous assessment of contract acquisition costs.
The Boards considered different alternatives to responding to these concerns, including amending the proposals to expense all contract acquisition costs, allowing a policy choice to expense or recognise contract acquisition costs as an asset or retaining the proposals in the 2011 ED but expanding the practical expedient. While some expressed support for expensing all contract acquisition costs consistent with the proposals in the Boards’ 2010 exposure draft on revenue – based primarily on a belief that contract acquisition costs do not meet the definition of an asset – most Board members supported retention of the 2011 ED proposals based primarily on consistency of such an approach with decisions reached taken to date on the leasing, insurance and financial instruments projects.
Therefore, the Boards tentatively decided to retain the proposals in the 2011 ED which require capitalisation of contract acquisition costs if they are incremental and the entity expects to recover the costs. Likewise, the practical expedient would be retained permitting the recognition of contract acquisition costs as a period cost (as opposed to capitalised costs) for contracts with an amortisation period of one year or less.
The Boards then discussed the application of the proposed revenue recognition model to bundled arrangements when an entity promises to transfer services to the customer together with a distinct good that relates to the provision of those services. The proposals in the 2011 ED require an entity to allocate the transaction price to the separate performance obligations on a relative standalone selling price basis and to capitalise costs to obtain a contract subject to a one-year practical expedient.
Feedback to the proposals in the 2011 ED have primarily come from the telecommunications and cable or satellite television industries. Concerns have been raised relating to the effect of the allocation proposals on the usefulness of the information that would result from applying the proposals to bundled sales arrangements in the telecommunications industry; the resulting disparate accounting for sales through the direct and indirect channels; and the cost of applying the proposals. Many respondents have suggested modifying the proposals for allocating the transaction price to introduce a contingent cap (as discussed in BC193-BC197 of the 2011 ED), or expanding the use of the residual approach for estimating the standalone selling price of a good or service (paragraph 73(c) of the 2011 ED) or allowing an entity greater freedom to allocate a discount entirely to one performance obligation if they have evidence about where it belongs (paragraph 75 of the 2011 ED).
The Boards considered multiple alternatives including retaining the proposals in the 2011 ED, modifying the proposals for populations of contracts that meet specified criteria (for example, a large portfolio of contracts with multiple deliverables) and expanding the use of the residual approach. However, most Board members struggled to conceptually support alternatives other than what was proposed in the 2011 ED given concern that such alternatives were inconsistent with the objectives of the overall revenue recognition model. Thus, the Boards tentatively decided to retain the proposals in the 2011 ED for allocating the transaction price to distinct performance obligations to all types of contracts.
The Boards discussed the introduction of an illustrative example regarding how an entity would apply the proposals to a bundled arrangement. However, many Board members were uncomfortable with the example presented by the staff, either as a result of concerns that the example would appear to dictate prescriptive application or concerns with the fact pattern included in the staff example. Instead, multiple Board members preferred that any application guidance specify that the above proposals could be applied to a portfolio of contracts rather than only individual contracts. Both Boards tentatively supported this view when a portfolio of contracts or performance obligations with similar characteristics is not expected to yield materially different outcomes from that which would result from applying the proposals to an individual contract or performance obligation.
Constraint on recognising variable consideration on licences
Finally, the Boards discussed whether to retain paragraph 85 of the 2011 ED, and if retained, whether to revise the scope of that paragraph. Paragraph 85 in the 2011 ED constrains the amount of revenue that can be recognised from licenses of intellectual property that are subject to sales-based royalties, until the uncertainty related to those sales-based royalties is resolved, and follows from paragraphs 81-84 of the 2011 ED which sets out the proposed requirements that an entity would follow to determine whether an amount of variable consideration can be recognised as revenue prior to the uncertainty associated with that variable consideration being resolved.
Notwithstanding the general requirements in paragraphs 81-84 of the 2011 ED, the Boards previously decided to include paragraph 85 in the 2011 ED to provide specific guidance related to revenue recognition for licenses given concerns that paragraphs 81-84 of the 2011 ED might not always result in an appropriate application of the constraint for licenses of intellectual property where the consideration is based on a sales-based royalty.
Respondents to the 2011 ED expressed different views on paragraph 85, including a view that it was an unnecessary exception that should be deleted (given paragraphs 81-84), as well as a view that the scope of paragraph 85 of the 2011 ED should be expanded to become a general principle that would always apply when the consideration is dependent on the customer’s future actions.
A few Board expressed support for the retention of paragraph 85. These Board members believed paragraphs 81-84 were more difficult to apply for licences that transfer a right (as compared to the transfer of other goods or services at a point in time with cost bases that could help in the determination and estimation of the transaction price).
However, most Board members were supportive of eliminating the specific exception in the 2011 ED which would have constrained revenue from licences of intellectual property where payments vary based on the customer’s subsequent sales. These Board members requested that clarifications be made to the indicators that an entity’s experience (or other evidence) is not predictive of the amount of consideration to which the entity will be entitled for purposes of applying the constraint to contracts where consideration is uncertain (i.e., paragraph 82 of the 2011 ED). Specifically, they believed that when consideration is highly susceptible to factors outside the entity's influence (including judgements and actions of third parties including customers), the entity's experience for determining the transaction price might not be predictive. They also preferred that the proposals explain that when an entity applies the general principles of the constraint on revenue recognised in paragraphs 81–84 of the 2011 ED (as revised by the Boards’ tentative decisions in November 2012) and is required to recognise a minimum amount of revenue based on its estimate of the amount of consideration to which it expects to entitled, that minimum amount may, in some cases, be nil. The Boards directed the staff clarify these points in the final standard.