Revenue recognition (IASB-FASB)
The staff presented three papers to the board on the following interrelated topics:
Paper A: Constraint on estimates of variable consideration
Paper B: Licences
Paper C: Collectability
These are discussed in further detail below.
Paper A
In the September 2013 joint Board meeting, the Boards requested the staff to evaluate two alternatives for articulating the objective of the constraint. Those alternatives were articulated in the September 2013 Agenda Paper 7A/174A as follows:
- Significant revenue reversal—An entity should include an amount of variable consideration in the transaction price only if the entity expects that a subsequent change in the estimate of the amount of variable consideration would not result in a significant revenue reversal. (Included as Alternative 2B in the September 2013 Agenda Paper 7A/174A. This was also the objective that was included in the external review draft.)
- Predictive amount —An entity should include an amount of variable consideration in the transaction price only if that estimate is predictive of the amount of consideration to which the entity expects to ultimately be entitled. (Included as Alternative 2C in the September 2013 Agenda Paper 7A/174A.)
Additionally, the Boards also asked the staff to evaluate whether it was appropriate to specify a level of confidence in the objective of the constraint.
As a result of the past discussions, the staff have recommended the following approaches to the Board to adopt in relation to the constraint:
- The staff recommend the Boards articulate the objective of the constraint and the level of confidence as follows: Include the amount of variable consideration in the transaction price only if it is probable [IFRS: highly probable] that a subsequent change in the estimate of the amount of variable consideration would not result in a significant revenue reversal (paragraph 56.1 of Appendix A of this paper); and
- With regards to the questions on reassessment and sales-based royalties the staff recommend that the Boards adopt Alternative 1 in Appendix A. That is:
- Require an entity to update the transaction price at each reporting date (paragraph 56.4 in Alternative 1 in Appendix A).
- Include an exception that would preclude an entity from including in the transaction price an estimate of sales or usage-based royalties from licenses of intellectual property until the customer’s subsequent sales or usage occur (paragraph 56.5 in Appendix A).
Question 1: Do the Boards agree with the objective of the constraint and the level of confidence as outlined in paragraph 56.1 of Appendix A and as follows:
“Include the amount of variable consideration in the transaction price only if it is probable [IFRS: highly probable] that a subsequent change in the estimate of the amount of variable consideration would not result in a significant revenue reversal.”
Question 2: Do the Boards agree with the staff recommendation of Alternative 1 in Appendix A, that is:
(a) Require an entity to update the transaction price at each reporting date (paragraph 56.4 in Alternative 1 in Appendix A).
(b) Include an exception that would preclude an entity from including in the transaction price an estimate of sales or usage-based royalties from licenses of intellectual property until the customer’s subsequent sales or usage occur (paragraph 56.5 in Appendix A)?
One Board member requested the staff to clarify that this was for sales/usage based royalties only, and that for circumstances where revenue is recognised at a point in time, the entity would recognise the fixed portion at that point in time but spread the variable consideration. For circumstances where revenue is recognised over time, then the entity spreads both components. The staff confirmed their understanding. The Board member subsequently requested that they clarify in the Basis of Conclusion whether the treatment of the variable consideration for a point in time contract was a recognition issue, or it is an exception to the transfer of control recognition criteria (recognition principle). The Board member felt that it was a case of the latter and wanted this acknowledged. The staff agreed that they would attempt to capture this in drafting.
Several Board members generally agreed with the staff’s recommendation, while acknowledging that this issue deals with a degree of uncertainty and therefore a perfect solution would not be possible. With this in mind, they supported that keeping the amount to a minimum amount that is not going to reverse is good, as it minimises the risk of revenue reversal.
It was requested that the staff clarify in their drafting that the minimum threshold is to be applied to each type of variable consideration in a contract separately.
The Boards tentatively agreed with the staff’s recommendations in questions 1 & 2.
Paper B
At the November 2012 joint Board meeting, the Boards tentatively decided that for some licenses, the nature of the promise in transferring a license is to provide access to the entity’s intellectual property, while for other licenses, the nature of the promise is to provide a right to use the entity’s intellectual property. The Boards reconfirmed this view in September 2013. This is because the Boards observed that licenses can vary significantly and include a wide array of different features and economic characteristics, which lead to significant differences in the rights provided by a license.
To distinguish between the two types of licenses the Boards tentatively decided to specify criteria rather than only relying on the control guidance. This is because the nature of the promised goods or services in a license needs to be defined before an entity can assess when control of those promised goods or services has transferred. Throughout their discussion on licenses, the Boards considered but ultimately rejected other factors to distinguish between the two types of licenses.
As a result, the staff have developed three criteria to determine when the intellectual property subject to a licence is dynamic:
- Criterion A: The contract requires or the customer reasonably expects that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights (that is, the intellectual property to which the customer has rights is dynamic). Factors that may indicate that a customer could reasonably expect an entity will undertake activities that [significantly] affect the intellectual property include the entity’s customary business practices, published policies, specific statements or the existence of a shared economic interest (eg a sales-based royalty) between the entity and the customer (or potential customer) related to the intellectual property licensed to the customer.
- Criterion B: Those activities do not transfer a good or a service to the customer as those activities occur (that is, the activities are not accounted for as performance obligations).
- Criterion C: The rights granted by the license directly expose the customer to any positive or negative effects of the entity’s activities that affect the intellectual property as and when the entity undertakes those activities and the entity expects that the customer entered into the contract with the intention of being exposed to those effects.
When not all the criteria are met, the license provides the customer with a right to use (rather than a right to access) the entity’s intellectual property as that intellectual property exists (in that form and with that functionality) at the point in time when the license transfers to the customer.
Question for the Boards:
Do the Boards agree with the direction explained in this paper for differentiating between the two types of licenses (those that provide access and those that provide a right to use)?
One Board member wanted to clarify the language being used to direct the preparer to focus on those activities that have the most relevant bearing on the ability to use and obtain the benefits from the IP. They preferred the wording be drafted to be more obvious and refer to the kinds of activities that bear on their function and ability to use and control the IP. The staff agreed that they will bear this in mind for further drafting for the IG.
The Board noted that given the decision made on paper 7A, then wording in criterion A in reference to sales-based royalties should be removed as they are dealt with in paper 7A. This was challenged in situations where you have a fixed payment upfront and sales based royalties subsequently. It was clarified that there is a need to make a judgment about what to do with the sales based component. An entity would be required to distinguish point in time from over time before it thinks about how to account for the sales based piece.
There was general agreement with the staff’s criteria with drafting improvements around what is dynamic and what is static, and that the intent of what the Boards are trying to achieve needs to be more clearly explained to readers. The Board also recommended that clarification be provided in drafting that what makes a licence dynamic is not the performance obligation itself.
The Boards tentatively agreed with the staff’s recommendations.
Paper C
This paper considers how assessments of a customer’s credit risk should be reflected in accounting for contracts with customers.
As a result of past discussions, the staff have proposed the following drafting changes:
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Suggested changes to current drafting |
Reasoning |
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12(e). The parties are committed to perform their respective obligations and they intend to enforce their respective contractual rights (see paragraph 14). An indication that a customer may not be committed to the contract is when there is significant doubt at contract inception about the entity collecting the consideration to which the entity expects to be entitled (in accordance with paragraph 50) in exchange for the goods or services promised to the customer. 14. [Paragraph to be deleted]
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Several comments indicated there was confusion about the draft requirement for an entity to enforce its contractual rights (as per paragraph 12(e)) and the acknowledgement in paragraph 14 that an entity may choose not to enforce its rights under the contract because they intend to offer a price concession. Based on that feedback, the staff think that the clarification provided by this expanded drafting has been ineffective. Consequently, the staff replaced that clarification with an indication of when the customer may not be committed to the contract. This indication was previously mentioned in paragraph BC34(b) of the 2011 ED.
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53.2 The variability relating to the consideration promised by the customer may be specified in the contract. In addition to the terms and conditions specified in the contract, the promised consideration is variable if either of the following circumstances exist: (a) [no change, see Appendix A] (b) Other facts and circumstances indicate that the entity’s intention, when entering into the contract with the customer, is to offer a price concession to the customer. For example, those facts and circumstances indicate that there is [significant doubt][significant uncertainty] about the ability of the customer to pay all of the promised consideration (that is, the customer is a significant credit risk) an entity may transfer goods or services to the customer even though the entity has [significant] doubts about the customer’s ability or intention to pay the promised consideration and the customer has not offered the entity [adequate] collateral in the event that the customer does not pay. 53.3 [Paragraph to be deleted] 53.4 [Paragraph to be deleted]
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The additional guidance in paragraph 53.3 was confusing to many reviewers and, hence, has been deleted. Paragraph 53.2 has been retained because it explains how an entity might offer price concessions that are not explicitly stated in the contract. Paragraph 53.2(b) has been revised to provide some guidance on a circumstance in which customer credit risk might indicate that the entity is intending to offer a price concession, even if the entity does not have a past practice of doing so.
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53.5. If an assessment of the facts and circumstances in paragraph 53.3 does not indicate that the entity intends to offer a price concession to a customer who is a significant credit risk Once an entity has determined the amount of consideration to which it is entitled (and if that entitled amount is not expected to be subject to a subsequent variation from a further price concession), the an entity shall subsequently consider any subsequent changes in the customer’s credit risk when assessing the carrying amount of a contract asset (or a receivable) for impairment in accordance with Topic 310 on receivables [IFRS 9 Financial Instruments].
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This revised guidance is added to indicate that an entity should consider whether a further price concession is likely to be granted to the customer. In the event that the granting of another price concession is not expected, an entity should account for any subsequent changes in the assessment of a customer’s credit risk as a matter for impairment of the receivable (or contract asset) in accordance with the financial instruments standards. |
The staff also recommend including a collectibility threshold in the model. While the drafting improvements are necessary to address the feedback, they alone will not resolve the inherent risk that a contract may pass into the revenue model despite doubts about the commercial substance of the contract and the commitment of the parties to the contract. Therefore, for the avoidance of doubt and more as a prevention tool (admittedly only to address a significant minority of contracts), the staff think the simplest and most effective way to address the concerns raised is to incorporate a threshold into the revenue model.
Question 1: Do the Boards agree with the drafting with improvements suggested herein (paragraph 17)? (Drafting changes)
Question 2: Do the Boards agree with the staff recommendation to also include a collectibility threshold (in addition to the drafting improvements) in the final revenue standard (Alternative B)?
Board members were generally supportive of the staff’s recommendations.
One Board member disagreed with the recommendations for the following reasons:
- The concept of having a threshold for recognition is inconsistent with the work that has been done on the Conceptual Framework.
- The Board member does not support a ‘last minute’ change to previous discussions ie not to have a collectibility threshold, particularly as the staff have presented robust arguments against having a collectibility threshold in the past.
- The staff clarified an example discussed previously where when applying the threshold to a portfolio of contracts where you expect to collect 98% of contracted revenue, when you apply the threshold to the individual contract (unit of account), the 2% should not be prevented for recognition by the threshold. The Board member noted that the collectibility threshold is intended to be a gate to recognition, but in the example it isn’t effective.
One Board member noted that they supported having no threshold as then for revenue presentation, one would present the amount they are entitled to (gross) and then any subsequent impairments as bad debt expense below, and the Board member believed that this was the most useful information for users of the financial statements.
The Boards noted that the use of the term ‘probable’ has different interpretations between the Boards and this would be a divergence.
The Boards tentatively decided to agree with the staff’s recommendations.
