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Journal entry — Revenue — Boards continue redeliberating exposure draft

Published on: Dec 19, 2012

At their joint meeting this week, the FASB and IASB continued redeliberating their November 2011 exposure draft (ED) Revenue From Contracts With Customers. They discussed the following topics: (1) allocating the transaction price, (2) contract costs, (3) the effect of the revenue recognition model on certain bundled arrangements, and (4) constraining the cumulative amount of revenue recognized in license arrangements.

Allocating the Transaction Price

The boards tentatively agreed to retain the ED’s residual approach to estimating the stand-alone selling price of a good or service if that stand-alone selling price is highly variable or uncertain. They further clarified that this approach could be used when two or more performance obligations in the contract have stand-alone selling prices that are highly variable or uncertain. In such situations, entities could use a combination of techniques, including the residual method, to estimate stand-alone selling prices to determine an aggregate amount for the performance obligations. They could then use another estimation method to allocate this amount to the individual performance obligations.

The boards also clarified that an entity should apply the guidance in paragraph 75 of the ED (on allocating the discount entirely to one (or some) performance obligations in the contract) before using the residual method to estimate the stand-alone selling price.

Contract Costs

The boards tentatively decided to retain the ED’s proposals related to costs of obtaining a contract, including the one-year practical expedient. This guidance would continue to be applied to contracts in all industries.

Effect of Revenue Recognition Model on Certain Bundled Arrangements

In their comments on the ED, constituents from the telecommunications industry expressed significant concerns that the proposed revenue recognition model could alter many of the key metrics relied upon by users of their financial statements. In particular, the proposed guidance requires an entity to allocate the transaction price to the separate performance obligations (e.g., bundled arrangements such as a handset and subsequent wireless service) on a relative stand-alone selling price basis and to capitalize costs to obtain a contract (subject to a one-year practical expedient). This could result in the recognition of more revenue up front and affect an entity’s margins, depending on the structure of arrangements (i.e., sales through direct versus indirect channels). Despite the feedback received, the boards tentatively decided not to amend the proposed guidance on allocating the transaction price. In addition, the boards reaffirmed their tentative agreement that the proposed guidance on costs to obtain a contract would apply to all types of contracts, including those executed in the telecommunications industry. Lastly, the boards acknowledged that when applying the proposed revenue recognition model, entities may use a portfolio technique to aggregate contracts with customers that exhibit similar characteristics. The boards therefore tentatively agreed to add clarifying language to the ED to emphasize that it is acceptable for all industries, including the telecommunications industry, to use a portfolio technique as long as it yields results that are similar to those the entity would have obtained if it had applied the revenue model to an individual contract.

Constraining the Cumulative Amount of Revenue Recognized in License Arrangements

The boards tentatively agreed to remove the constraint guidance in paragraph 85 of the ED that would have required an entity to limit the cumulative amount of revenue recognized in licenses of intellectual property when such revenue varies on the basis of the customer’s subsequent sales (e.g., a sales-based royalty). Rather, the general constraint guidance, as amended at the boards’ November 2012 meeting, would be applied to all arrangements with variable consideration. During that meeting, the boards tentatively decided that revenue would only be included in the transaction price when an entity has a “high level of certainty” that the amount of revenue recognized would not be subject to future reversals. To mitigate concerns related to eliminating the constraint guidance on license arrangements, the boards tentatively agreed that an entity should evaluate whether a customer’s or an end user’s actions may affect the amount of variable consideration to which an entity expects to be entitled and that the estimated transaction price might be zero in some circumstances.

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