Revenue recognition (IASB and FASB)
The Boards were asked to consider questions raised in response to the 2011 revised exposure draft (2011 ED) related to:
- Accounting for repurchase agreements
- Application of the proposals to the asset management industry
- Consequential amendments associated with the transfer of non-financial assets
- Disclosure and transition requirements
Paragraphs 9 and 10 of the 2011 ED specify that the proposals apply to all contracts with customers. A few respondents, considering this scope, questioned if a transaction with a collaborator or partner could ever be within scope of the model (i.e., are collaborator and customer arrangements mutually exclusive), while others questioned if the Boards intended to narrow the population of collaborative arrangements to only those that develop a marketable product. Others requested additional guidance to distinguish between a customer and a collaborator or a partner.
In analysing this topic, the staff believed, consistent with paragraph BC37 of the 2011 ED, that transactions with partners or participants in a collaborative arrangement can be within scope of the model if the counterparty meets the definition of a customer. However, the staff did not believe additional guidance should be provided about when a counterparty could be a customer in different types of transactions due to differing terms and conditions of specific arrangements across industries. The staff also believed that it was not the Boards’ intent to limit the definition of collaborative arrangements to those that result in a marketable product, thereby excluding certain not-for-profit grants or other activities. On the basis of their analysis, the staff recommended that the Boards affirm the definition of a customer included in the 2011 ED, while also clarifying that a collaborative arrangement is not limited to the development and commercialisation of a product and a collaborator or a partner can be within the scope of the model if the collaborator or partner is a customer in a transaction.
One Board member believed the issue could be made more clear by moving paragraph BC37 of the 2011 ED into the main body of the Standard. Many Board members supported this proposal.
Another Board member expressed concern with the general interaction between the revenue proposals and the joint arrangement standard. He believed cross-referencing was required between the revenue proposals and the joint arrangement standard to specify disclosure requirements, etc. However, others were not convinced cross-referencing was necessary given that the revenue proposals were merely scoping out collaboration arrangements in which a customer relationship is not established. The staff did note, however, that they would consider the interaction of the revenue proposals with the joint arrangement standard offline.
Ultimately, both Boards tentatively supported the staff recommendations, subject to moving paragraph BC37 of the 2011 ED into the main body of the Standard.
Application to financial service contracts
The Boards then discussed the application of the revenue proposals to hybrid financial services contracts – contracts that include one or more transactions within the scope of the financial instruments guidance as well as goods or services that qualify for accounting under the proposed revenue model. The staff have received feedback requesting clarification and/or application guidance on how the transaction price would be determined for hybrid financial services contracts and then allocated between the financial instrument component and the services component. The staff noted that the 2011 ED (paragraph 11) proposes that if contractual rights and obligations are accounted for under other, specified standards, then the related revenue would continue to be accounted for under those other standards (thus, financial instrument guidance would be looked to first for determining the premise on which parts of a financial services contract are separated), while the components within the scope of the revenue model would be ascribed any residual amount. The reason for this proposal was to avoid undermining the initial recognition decisions made in the financial instruments project. To emphasise this point, the staff recommended providing implementation guidance or examples to assist entities in performing the required scoping and subsequent separation and measurement requirements. With little debate, the Boards tentatively supported the staff recommendation.
The Board considered possible clarifications to the proposed accounting for repurchase agreements in paragraphs IG38—IG48/B38—B48 of the 2011 ED.
Put options included in sale-leaseback transactions
In September 2012, the Boards tentatively confirmed that if there is a call option (with a strike price less than the original sales price) included in the transaction that also includes terms evaluated for a potential sale and subsequent leaseback, then the sale and leaseback should be accounted for as a financing. At that meeting, one Board member requested that the staff also consider the guidance on put options and how it may be affected by a sale-leaseback transaction. The staff believed that, consistent with the Board’s tentative decisions related to a call option, when there is a put option (with a repurchase price less than the original sales price) in a sale-leaseback transaction, and the customer (lessor) has a significant economic incentive to exercise the put, then the contract should be accounted for as a financing.
One Board member, while not objecting to the proposal, questioned the placement of this tentative decision in the 2011 ED (and final standard). Specifically, he noted that the decision on call/put options is included in the implementation guidance of the 2011 ED, and thus, people are required to work their way through the model before seeing this scoping point. He believed the information should be referenced in the scope. The staff noted that the current placement in the implementation guidance served to demonstrate how to apply the control principle. However, hearing his concern, the staff noted they would consider providing a reference to this possible scope exception in the scoping paragraphs of the proposals.
Another Board member questioned why the scope of the staff recommendation was limited to put option with a repurchase price less than the original sales price. He preferred to consider put options more generally regardless of relative repurchase price. However, others did not support this view.
When put to a vote, the Boards tentatively supported the staff recommendation.
The Boards was then asked to consider two issues related to repurchase agreements in the 2011 ED. The staff proposed to:
- delete unconditional from the repurchase agreements implementation guidance (as it was being viewed by some as an intention to exclude repurchase agreements that may include conditions which was not believed by the staff to be the intention of the Boards), and
- clarify that processing costs should be excluded from the repurchase price when an entity sells a product to a contract manufacturer and repurchases the product as part of a larger component for a higher price (as some respondents questioned whether processing costs should be included in the determination of the repurchase price).
One FASB member expressed concern that the Boards were over-specifying accounting on the processing costs’ issue. He believed the accounting could vary depending on the nature of costs – a consideration which is outlined in current US GAAP requirements. Therefore, he suggested that the tentative decision should confirm that it is not the FASB’s intention to change the current accounting for processing costs – to which other FASB members agreed.
With little additional feedback, the Boards tentatively agreed with the staff recommendation (subject to the comments related to the FASB’s intention as outlined above).
Some respondents raised questions regarding the application of the implementation guidance to some common fact patterns including: a contract that includes a guaranteed minimum resale value, and equipment that is sold and subsequently repurchased subject to an operating lease.
On the topic of contracts with guaranteed minimum resale values, some respondents to the 2011 ED expressed concern that the proposals may result in two economically similar transactions being accounted for in a different manner and/or provide structuring opportunities that may lead to different accounting for economically similar transactions. Specifically, respondents interpret that the 2011 ED would require that the agreement to repurchase the car be accounted for as a lease (if the customer has significant economic incentive to exercise its right, as per paragraph IG43/B43), whereas the agreement to guarantee the residual value would be accounted for as a sale because the guaranteed residual value does not appear to affect the customer’s ability to direct the use of and obtain substantially all of the benefits from the asset. The staff observed that the agreement to repurchase the car would represent a put option for which the customer has a significant economic incentive to exercise. In accordance with the 2011 ED, this put option should be accounted for as a lease (with a purchase option) in accordance with paragraph BC323 of the 2011 ED. However, in other cases, when an entity guarantees the residual value, the customer is not encumbered in its ability to utilise the asset or enjoy substantially all the remaining benefits from the asset. In the staff’s view, this was quite different to the economics of the repurchase agreement and thus the accounting should follow.
The staff believed the 2011 ED provided sufficient guidance to enable an entity to assess when control transfers. Therefore, the staff did not recommend any changes to the 2011 ED.
One Board member noted that these questions are arising as a result of the tension created between the risk and rewards model as opposed to the control model. He saw the guaranteed minimum resale value as a pseudo put option – there is no change in economics as the buyer is incentivised to do the exact same thing in both cases. However others saw repurchase agreements and guaranteed minimum resale values as economically different since one gives you the option to control the car (the repurchase agreement), while the minimum guarantee does not necessarily provide residual access to the car and thus control.
After a lengthy debate, the FASB Chair asked who agreed that the guarantee of the minimum residual value should be accounted for differently (as a sale with a guarantee) when, after evaluating all facts and circumstances, there is no contractual or other indication that the seller is obligated to take the car back. The implication of this being that if there is an explicit or implicit obligation for the seller to take the car back, you would account for contract as a put. Both Boards tentatively agreed with this assessment.
On the topic of equipment that is sold and subsequently repurchased subject to an operating lease (the manufacturer (via its finance affiliate) is required to repurchase the product for lease to the dealer’s customer), some respondents questioned whether these transactions represent a put option, and whether they would be required to apply the guidance on repurchase agreements. The staff noted that this transaction does not meet the definition of a repurchase agreement in paragraph IG38/B38 because the sale and subsequent agreement to repurchase the product represents two separate transactions with different customers.
The staff believed the 2011 ED provided sufficient guidance to enable an entity to assess when control transfers and the accounting outcome from applying the 2011 ED and the implementation guidance for repurchase agreements to these arrangements is appropriate. Therefore, the staff did not recommend any changes to the 2011 ED.
One FASB member discussed the relevance of the principal-agent relationship to this environment. Specifically, he referenced Subtopic 605-15 Revenue Recognition – Products (formerly EITF 95-4), which requires, in situations in which auto manufacturers sell automobiles to dealerships and subsequently, the dealer’s customer chooses to lease the automobile through the manufacturer’s captive finance affiliate, these transactions to be accounted for as a sale by the auto manufacturers when specific criteria are met (i.e., the dealer is independent, control of the automobile transfers to the dealer, a lease obligation does not exist at the time of the sale, and the customer has other financing alternatives). He believed principal-agent analysis would be required in assessing whether the manufacturer’s sale transaction would be deemed a sale with a right of return. Other FASB members agreed. With little additional debate, the Boards supported the staff recommendation (with the FASB requesting that the staff elaborate on the relevance of the principal-agent determination in reaching a conclusion).
Call options – significant economic incentive not to exercise
Some respondents questioned why the existence of a call option – regardless of how likely the holder is to exercise – would always preclude the transfer of control (paragraph IG40/B40), whereas a put option requires an analysis of whether the customer has a significant economic incentive to exercise (paragraph IG43/B43).
After analysing the issue, the staff believed that the presence of a call option that will likely not be exercised should not preclude an entity from recognising revenue at the time its performance obligation is satisfied. Thus, the staff recommended the Boards amend the implementation guidance for repurchase agreements, such that when there is a call option, an entity would be required to assess whether it has a significant economic incentive not to exercise the option.
Many Board members expressed reservations with the proposals. Specifically, they noted the reason for precluding sale accounting when the arrangement includes a call option is that exercise is outside of the customer’s control (per BC318 of the 2011 ED). However, Board members did not believe non-substantive options should affect the entity’s assessment of the transfer of control to a customer (i.e., non-substantive terms should generally be ignored). Ultimately, the Boards tentatively decided to retain the proposals included in the 2011 ED, but not that non-substantive options should not affect the entity’s assessment of the transfer of control to a customer.
The Boards discussed possible refinements to the 2011 ED to address concerns raised by some respondents about how the proposals would apply to the asset management industry. Specifically, the Board considered how (a) the constraint on revenue recognised and (b) contract cost proposals in the 2011 ED would affect the asset management industry. These questions were raised in the context of the performance-based incentive fees (in which the fee varies based on the extent by which the fund’s investment performance exceeds a benchmark index) received by an asset manager. Some preparers in the alternative asset management industry expressed concern that the since the amount of the performance fees would be affected by volatility in the market, paragraph 82 of the 2011 ED would typically preclude an asset manager from recognising revenue from these fees until the volatility is resolved – and they did not believe this result faithfully reflected the economics of their transactions. The staff identified two alternatives to account for an asset manager’s performance-based incentive fees:
- View A — Retain the proposals in the 2011 ED (as amended in the November 2012 joint Board meeting.
- View B — Amend the constrain on revenue recognition.
Under View A, asset managers would apply the constraint on revenue recognition to their performance fees. This means that revenue would be recognised only when market volatility will not cause a significant revenue reversal. Under View B, if the contract contains a termination provision that gives an entity contractual rights to consideration before the end of the measurement period specified in the arrangement and this consideration is indexed to a market, then the amount of revenue recognised would be equal to the liquidation value of the contract as if the contract was terminated at that date. The staff recommended View A. They noted that the rationale of View B is arguably not consistent with the basis of the constraint. That is because the objective of the constraint is to recognise revenue at an amount that should not be subject to significant revenue reversals.
Many Board members expressed support for the staff recommendation primarily because this alternative is consistent with the accounting for other contracts with incentive fees for which the Boards decided that revenue should be recognised only when the amount is not subject to a significant revenue reversal. However, two FASB members were supportive of View B. They believed that under this alternative, an asset manager’s financial statements would better reflect the changes in a fund’s fair value from period to period and, therefore, better reflect the asset manager’s performance. When put to a vote, the Boards tentatively supported the staff recommendation.
The Boards then discussed the accounting for upfront commission costs in the asset management industry. A number of respondents raised questions regarding costs incurred in an arrangement between an asset manager and a fund, where the asset manager agrees to provide various services to the fund. The questions raised by respondents centred around how to account for the upfront commission costs incurred by an asset manager in the distribution service contract. Current US GAAP allows asset managers to capitalise and amortise the upfront commissions paid to third-party brokers. However, existing guidance is not proposed to be retained in the revenue recognition proposals.
The 2011 ED makes a distinction between contract acquisition costs and fulfilment costs. Since there is a wide spectrum of asset management arrangements, the terms and conditions of these arrangements could result in the upfront commission costs paid by an asset manager in a back-end load fund being interpreted as either fulfilment costs or contract acquisition costs. The staff analysed this issue and believed that all of the facts and circumstances in each asset management arrangement should be assessed when determining whether these costs are contract acquisition costs or fulfilment costs. As a result, the staff did not recommend that the Boards make any changes to the contract cost proposals in the 2011 ED. The FASB staff did, however, recommend that the FASB retain its current cost guidance as it believed constituents would reach the same accounting under either current US GAAP or the 2011 ED.
One IASB member expressed concerns that the US GAAP and IFRS proposals may be applied differently in practice. Specifically, US GAAP would provide definitive accounting requirements while IFRSs would say that an entity should exercise judgement in assessing commission costs as either fulfilment costs or contract acquisition costs. For the sake of convergence, she preferred that the guidance be aligned. Another Board member believed IFRS constituents would analogise to the US GAAP explicit requirements given that both US GAAP and IFRS were applying the same underlying principle. With little additional feedback, the Boards tentatively agreed with the staff recommendation (the retention of current US GAAP guidance being a FASB only decision).
The Boards considered possible changes to the consequential amendments related to the transfer of non-financial assets that were proposed in the 2011 ED. Those amendments propose that an entity should apply the proposed requirements on control and measurement in the 2011 ED to transfers of non-financial assets that are not an output of an entity’s ordinary activities to determine when to derecognise the asset the amount of the gain or loss on derecognition. The staff reported that some respondents have raised concerns that the proposed requirements in the revenue standard should not or could not be applied to transfers of non-financial assets. Questions/concerns expressed by constituents included:
- Whether the accounting for transfers of non-financial assets should be addressed as part of its own separate project (because the proposed consequential amendments may have a more than insignificant effect on some transactions).
- Whether the requirements for determining contract existence (i.e., paragraphs 13 – 15 in the 2011 ED) in the revenue proposals should be applied (as those criteria would be relevant for all transfers of non-financial assets).
- Potential negative consequences of applying the measurement requirements to transfers of non-financial assets (e.g., recognising a loss on the transfer as a result of applying the constraint on revenue recognised to the consideration and different measurement for economically similar contracts).
On the topic of addressing the accounting for transfers of non-financial assets as a separate project, the staff recommended that the Boards confirm the proposed consequential amendments that would require an entity to apply the control and measurement proposals from the 2011 ED to sales of non-financial assets. They noted that this decision would create consistency for the accounting for the transfers of non-financial assets between US GAAP and IFRSs generally; sales of real estate that are not an output of an entity’s ordinary activities and similar sales arising from a contract with a customer under US GAAP; and transfers of nonfinancial assets and contracts with customers under IFRS. They also noted moving forward would eliminate any possible complexities that may result from retaining separate recognition criteria for transfers of non-financial assets as compared to contracts with customers.
In considering whether the requirements for determining contract existence in the revenue proposals should be applied to transfers of non-financial assets that are not an output of an entity’s ordinary activities, the staff believed they should; the reason being, because the contract existence criteria would be equally relevant for transfers of non-financial assets since they are often economically similar.
Finally, on the last issue considering potential negative consequences of applying the measurement requirements to transfers of non-financial assets, the staff considered possibly specifying that an entity should measure the consideration in a transfer of a non-financial asset at fair value instead of by applying the measurement requirements in the 2011 ED (to respond to the two risks noted above). However, the staff acknowledge that there is diversity in practice today in applying fair value as the measurement basis for transfers of non-financial assets given subjectivity in recognition and measurement. As a result of these challenges, the staff recommended that the Boards confirm their consequential amendments proposed as a result of the 2011 ED that would require an entity to apply the measurement principles from the 2011 ED to transfers of non-financial assets.
The Boards were generally supportive of all of the staff recommendations. However, a few IASB members were concerned with the last proposal regarding affirmation of the proposed consequential amendments. Specifically, a few Board members noted that applying the measurement principles in the 2011 ED to transfers of non-financial assets may result in different measurement principles from other economically similar transactions (e.g., transfers of a business and a transfer of financial assets, or more generically, transfers in the ordinary course of business versus non-ordinary activities). They therefore preferred fair value as the measurement basis in cases in which control is transferred. But with little additional discussion, the Boards tentatively supported all of the staff recommendations.
The staff provided a summary of the feedback received on the proposed disclosure and transition requirements included in the 2011 ED. The summary included feedback received through comment letters and outreach activities undertaken both during the comment period and the redeliberations period, including the feedback provided in the disclosure and transition workshops held in 2012. The staff noted that it intends to bring a paper on potential changes to the disclosure and transition requirements included in the 2011 ED to the February 2013 meeting.
No specific concerns or questions were raised and no tentative decisions were taken. The Boards will consider this topic again at its February 2013 meeting.