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Revenue recognition

Date recorded:

Identifying separate performance obligations

The Boards continued their discussion on identification of performance obligations from the January 2011 Board meetings. During that meeting, the Boards had asked the staff to further clarify the attributes for a distinct good or service and apply those attributes to example scenarios.

The staffs presented the Boards with a revised objective and criteria for identifying separate performance obligations. The objective for identifying separate performance obligations would be to faithfully depict an entity's performance by recognising revenue at an amount that reflects the profit margin that is attributable to the goods or services that have been transferred to the customer. Under the staffs' proposal, a separate performance obligation would occur when 1) the good or service is distinct and 2) the good or service is transferred to the customer at a different time from the transfer of other goods or services promised in the contract, or for contracts with multiple services are transferred continuously to the customer over the same period of time, the entity selects different methods to best depict the transfer of those services to the customer.

The staffs also clarified that a good or service is distinct if it has a distinct function or is subject to separate risks and provided additional details on each of those criteria. A distinct function would occur when a good or service is either sold separately or the customer can use the good or service either on its own or together with resources that are readily available to the customer. Separate risks would occur when the risks the entity assumes in providing the good or service are largely independent of the risks of providing the customer with the other goods or services promised in the contract. The staffs also suggested indicators for identifying separate risks including 1) the entity selling the good or service separately, 2) the entity and the customer negotiated the sale of good or service separately from the other goods or services promised in the contract, and 3) the entity manages its promise to provide the good or service to the customer independently from its promise to provide other goods or services to the customer.

The staffs also developed various examples in which the above concepts were applied to determine whether separate performance obligations existed.

Several Board members expressed concern with the incorporation of a profit margin concept in the objective for identifying separate performance obligations. One Board member mentioned the focus should be on timing of revenues than on the profit margin itself. The staff acknowledged based on the comments received by various Board members they would consider removing the mention of profit margin from the objective.

The Board was in general agreement that the criteria for identifying a separate performance obligation would be if the pattern of transfer of the good or service is different from other promised goods or services and the good or service is distinct. However, when discussing the criteria for what would constitute a distinct good or service the Boards were less supportive of the staff proposals. Members from each Board raised the issue that the indicators for separate risk contain duplicative concepts to the distinct function criteria (e.g., selling the good or service separately). They suggested the removal of the separate risks criteria and instead combine the concept under the distinct function criteria. Other Board members also expressed concern with the separate risk criteria, including the use of the term risk as they envisioned this may result in confusion during application.

One FASB Board member asked the staffs if they could consider some alternative language for distinct goods or services and the Boards could continue their discussion during Thursday's scheduled revenue recognition session.

Revenue recognition for services

Determining whether a performance obligation is satisfied continuously

The Boards also continued their discussion over revenue recognition for service arrangements from the January 2011 Board meetings. During that meeting, the staffs had proposed that a performance obligation would be satisfied continuously if 1) the customer controls the work-in-process, 2) another entity would not need to reperform the task if that other entity were required to fulfil the remaining obligation to the customer, or 3) the entity has a right to payment for the performed task and the entity's performance to date does not have an alternative use to the entity. After the January meetings, the staffs performed outreach on these criteria to see whether they could be applied and found that while preparers supported the general direction, there were various concerns with each of the three criteria.

Based on the feedback received, the staff suggested revised criteria for when a performance obligation is satisfied continuously. The proposed criteria are that 1) the entity's performance creates or enhances as asset that the customer controls or 2) the entity's performance does not create an asset with alternative use to the entity and at least one of the following is met: a) customer immediately receives a benefit from each task that the entity performs, b) another entity would not need to reperform the task performed to date if that other entity were to fulfil the remaining obligation to the customer, or c) the entity has a right to payment for performance to date even if the customer could cancel the contract for convenience.

One IASB member questioned why the first criteria needed the term 'immediately'. The staff mentioned the term was included to reinforce the concept of continuous rather than the benefit is received only upon completion. The FASB Chairman suggested language of "the customer receives a benefit as each task is performed" rather than using the term immediately to which the IASB member and staff seemed to agree would address both of their concerns.

One FASB Board member suggested revising the language on the first criteria to read "the entity's performance creates or enhances an asset that the customer controls as the asset is being created or enhanced" to also reinforce the sense of continuous service.

The Boards both tentatively agreed to the staff proposals subject to language modifications as discussed during the meeting.

Measuring progress toward complete satisfaction of a performance obligation

After the determination is made that a performance obligation is satisfied continuously, an entity would select the appropriate method for recognising revenue by measuring the progress towards completion. During the January 2011 Board meetings, the Boards asked the staffs to provide additional guidance around what circumstances would one method be preferable to another.

During this meeting, the Boards tentatively agreed that the staffs would carryforward the guidance in the Exposure Draft as well as emphasise the objective of measuring progress towards completion is to faithfully depict the entity's performance and enhance the description of the output and input methods.

Measuring progress for uninstalled materials

The Boards discussed the recognition method for those instances when materials are delivered to the customer but a significant delay occurs before the service occurs (i.e., installation). The staffs presented three possible scenarios for the Boards to consider based on current practice. The first method would have the entity measure progress based on a labour hours input method (effectively resulting in no recognition of revenue as the service has not yet occurred). The second method would have the entity measure progress based on a cost-based input method (effectively resulting in a contract wide profit margin recognised for transferring the materials). The third method would have the entity measure progress on a modified cost-based method (effectively resulting in recognising revenue for the transfer of the materials in an amount equal to the cost of the materials).

The staffs had recommended the use of the third method (modified cost-based method) as they felt the first method would result in the entity retaining inventory even though transfer has occurred. They also felt that recognition of a profit margin in the second method was not appropriate.

The Boards viewed the third approach as an exception and disagreed with the staff recommendation. The Boards preferred that for uninstalled materials they frame the issue as a clarification of how to use the input method rather which could permit entities to recognise a profit margin for uninstalled materials.

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