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Journal entry — FASB and IASB one step closer to completing redeliberations on the revenue recognition project

Published on: May 20, 2011

At their joint meetings last week, the FASB and IASB (the “boards”) reached a number of tentative decisions about the joint revenue recognition project. With these decisions, the boards are getting close to completing their redeliberations and finalizing the project. This journal entry summarizes the tentative decisions involving
(1) disclosure and presentation requirements, (2) impairment and amortization of capitalized costs, and (3) onerous contracts. (Note that all tentative decisions are subject to change before any standard becomes final.) The final items subject to the boards’ redeliberations in June include transition method, effective date, and application of the revenue model to certain industries.

Editor’s Note: The FASB staff’s summaries of the May joint meetings on revenue recognition are available on the FASB’s Web site. More detailed meeting summaries from Deloitte observers at the meetings are available on Deloitte’s IAS Plus Web site and should not be regarded as official or final.

Disclosure and Presentation Requirements

The boards determined that with the exception of minor amendments and clarifications (as detailed below), the guidance on presentation and disclosure in the exposure draft (ED) should be retained.

 

Disaggregation of Revenue

The ED proposed that revenue be disaggregated into categories that best depict how the amount, timing, and uncertainty of revenues and cash flows are affected by economic characteristics and included examples of categories that might be appropriate. At the May meeting, the boards tentatively decided that:

1.   The revenue standard should not prescribe the specific categories into which an entity should disaggregate revenue. Rather, the standard should provide a clear disaggregation principle and examples of categories that may be appropriate.

2.   An entity should disaggregate revenue either on the face of the statement of comprehensive income or in the notes to the financial statements.

3.   An entity would not be required to also disaggregate the impairment loss allowance (for customers’ credit risk that is presented adjacent to revenue).

 

Presentation of Contract Assets and Contract Liabilities

As a clarification to the definitions in the ED, the boards determined that labels other than “contract asset” and “contract liability” could be used to define such assets and liabilities in the financial statements. The boards emphasized, however, that entities should provide sufficient disclosure to differentiate between unconditional rights to consideration (i.e., contract assets) and conditional rights to consideration (i.e., accounts receivable).

 

Reconciliation of Contract Assets and Contract Liabilities

The boards clarified which line items are needed in the reconciliation of contract assets and contract liabilities. They tentatively decided that “an entity does not need to include specified line items in the reconciliation if those reconciling items would not be useful for explaining a material change in that contract asset or contract liability balance.” Further, the boards tentatively decided that additional line items should be included in the reconciliation if users would need them to understand the change in the balance.

 

Disclosure of Remaining Performance Obligations

The ED required entities to disclose, for contracts with an expected duration of more than one year, “the amount of the transaction price allocated to the performance obligations remaining at the end of the reporting period that are expected to be satisfied” over certain periods. At the May meeting, the boards tentatively decided that:

1.   An entity should disclose the amount of the transaction price allocated to remaining performance obligations for contracts that have both of the following attributes:

a.   An original expected contract duration of more than one year; and

b.   Terms and conditions that result in the entity, in practice, being required to apply each step of the revenue model (specifically, to determine the transaction price and allocate that transaction price to the separate performance obligations) in order to recognize revenue.  An entity would not be required to provide this disclosure if, in practice, the entity would not need to specifically apply those steps of the revenue model to recognize revenue (for example, some “time and materials” contracts).

2.   An entity should explain when it expects those amounts to be recognized as revenue, either on a quantitative basis in time bands that would be most appropriate for the duration of the contract or by using a mixture of quantitative and qualitative information.

 

Disclosures About Assets From Contract Acquisition or Fulfillment Costs

The boards tentatively decided that entities should disclose “a reconciliation of the carrying amount of an asset arising from the costs to acquire or fulfill a contract with a customer, by major classification (for example, acquisition costs, precontract costs, and setup costs).” In addition, the boards tentatively decided that qualitative disclosures should be provided, including “a description of the method used to determine the amortization for the period.”

Impairment and Amortization of Capitalized Costs

As a practical expedient, the boards tentatively decided that for contracts with an expected duration of one year or less, certain acquisition and fulfillment costs incurred may be expensed instead of capitalized. The boards also made tentative decisions regarding the impairment and amortization of capitalized costs, as discussed in the following paragraphs:

 

Impairment

A previous tentative decision stipulated that certain precontract fulfillment costs may be capitalized if certain criteria are met. The FASB and IASB staffs observed that if an asset is recognized before the existence of a contract, an immediate impairment charge may be required because there is no transaction price to offset the direct costs related to fulfilling the contract. The boards therefore decided to clarify that an entity should use the following cash flows for the impairment test: “(1) the amount of consideration to which the entity expects to be entitled in exchange for the goods or services to which the asset relates less (2) the remaining costs that relate directly to providing those goods or services.” The amount of consideration that the entity expects to be entitled to should be consistent with the principles for determining the transaction price. Regarding future reversals of previously recognized impairment charges, the IASB decided to require entities to reverse the charges; however, the FASB decided not to allow for such reversals. The differences in these tentative decisions are consistent with the guidance in current U.S. GAAP and IFRSs on reversals of previous impairment for certain other assets.

 

Amortization

The boards agreed that the amortization period for these capitalized costs may extend beyond the period in which the goods or services of an initial contract will be transferred to a customer (e.g., contract renewals, related subsequent sales). An entity will be permitted to look forward beyond the initial contract period only if it can demonstrate that there is sufficient historical evidence indicating that the asset will contribute to future cash flows from the same customer.

Onerous Contracts

The boards tentatively decided that the onerous test only needs to be performed for performance obligations that are continuously satisfied over a “long” period of time. (At a future meeting, the boards plan to clarify what constitutes a “long” period of time.) When a contract includes multiple distinct performance obligations, an entity would be required to separate the performance obligations that are satisfied (1) at a point in time or continuously over a short period and (2) continuously over a long period. The entity would then only need to perform the onerous test for the separate performance obligations satisfied continuously over a long period. In addition, the boards decided that the costs to be used in this test should be the lower of the direct costs to satisfy the remaining performance obligations or the amount that the entity would have to pay to cancel the contract.

Finally, the FASB unanimously decided that not-for-profit entities would not be required to perform the onerous test when they enter into a contract for a social benefit or charitable purpose. (The IASB chose not to address this issue.)

Editor’s Note: The tentative decisions made by the boards about the onerous test address many of the scenarios identified by constituents in the comment letter process and staffs’ outreach activities. In these scenarios, the test did not generate meaningful results by creating an onerous loss contract upon inception. Examples of these scenarios include (1) the first seat booked on an airline or cruise ship or at a performing arts event and (2) products or services sold at a loss in an anticipation of profits from future contracts.

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