Revenue Recognition

Date recorded:

The Board considered how the fair value of a reporting entity's performance obligations to its customers is determined. In particular the Board considered whether it should be:

  • the amount that would have to be paid to a third party to legally assume responsibility for performing all of the reporting entity's remaining obligations, or
  • the amount of consideration paid or to be paid to the reporting entity by the customer, or
  • the amount of the reporting entity's costs to perform the activities.

The staff recommended using the amount that would be paid to a third party to assume the obligations and noted that tha FASB had recently affirmed that this measurement requirement be adopted and that it be measured as a business-to-business transaction.

The Board noted that the measurements should include any performance guarantees.

The following example was considered:

Retailer A is a consumer electronics company that sells television sets for $300 that it buys from the manufacturer for $250. Like other consumer electronics retailers, Retailer A also sells for $100 warranty contracts that extend 2 years beyond the manufacturer's 1-year product warranty. Those extended warranties are offered only on products that are sold in the same transaction, and the high profit margins on the warranties allow the products to be offered at highly competitive prices. The fees charged for those extended warranties are not refundable.

Like other consumer product sellers, Retailer A can either service the warranties itself or pay reliable third-party administrators to legally assume the warranty servicing obligations. History indicates that one in 10 sets will experience a failure during the extended warranty period, and that the average incremental cost to repair or replace a defective unit is approximately $140.

Reliable third-party administrators are willing to legally assume the warranty obligations for a price of $30 per contract.

Retailer A sells 10 television sets with extended warranties and collects the selling price in full. However, it has not yet decided whether to engage a third-party administrator to legally assume the liabilities for servicing the warranties or to service the warranties itself (Retailer A has a year between the date of sale and the beginning of the extended warranty period in which to decide).

In this case, Retailer A's performance obligations are unconditional obligations to stand ready to repair or replace any defective television sets that fail during the warranty period. The issue is whether the fair value of the performance obligations should be measured at $1,000 (10 warranties @ $100 customer consideration amount per warranty) or $300 (10 warranties @ $30 legal layoff amount per warranty).

Certain Board members expressed concern as to whether the amount a third party would pay to assume performance obligations can be reliably measured and verified.

The Board asked whether in a sale of goods the staff recommendation resulted in recognising the full gross profit on date of order as the obligation to fulfil the order would be measured at the amount charged by the manufacturer. The staff agreed that this was a correct application of the principle but noted that the longer the time between order and delivery, the greater the risk and this would have an impact on the measurement of the performance obligation.

The Board expressed considerable concerns particularly as to the practical application of the approach but expressed support for the concept and agreed to continue pursuing the approach.

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