Revenue Recognition

Date recorded:

Wholly executory revenue contracts

The objective of the Board's discussion was to debate how the allocated customer consideration approach would be applied to wholly executory (or wholly unperformed) revenue contracts. First, the Board debated whether assets and liabilities arise in an executory contract and after confirming its earlier decision that rights and obligations do arise (and therefore assets and liabilities) consistent with its earlier decisions, the alternatives identified by the Staff were discussed. The alternatives were discussed in the context of assets and liabilities that are fungible and those that are unique.

Alternative 1 - For fungible assets, the assets and liabilities arising for each counterparty would be set-off on the basis that 'net settlement' could be achieved. For non-fungible (unique) assets and liabilities, set-off would not be permitted.

Alternative 2 was sub-divided into two components:

  • Alternative 2 - No assets or liabilities arise therefore the distinction between fungible and non-fungible is irrelevant.
  • Alternative 2 'Prime' - If the contract requires a unique performance (i.e. non-fungible) only a combined asset or liability arises. It was not clear what the treatment of fungible items would be under this alternative.

The Board expressed general agreement with the analysis performed by the Staff. Some Board members reiterated their view that for an executory contract, if a court can force the parties to perform, each party to the contract has either an asset or a liability arising from a right or an obligation to receive / deliver. The Board discussed briefly whether the right / obligation should have the same value as the item that is the subject of the contract (put differently, does the right to receive a motor vehicle have the same value as the motor vehicle itself?) but deferred that issue to a subsequent meeting when the Board discusses measurement. It was pointed out that in some jurisdictions within continental Europe (for example) the functioning of the law regarding the various rights and obligations that arise from a contract and those laws that apply to the actual performance have resulted in constituents approaching and thinking about the economics of such transactions differently.

The Board decided, consistent with its earlier decisions, that only Alternatives 1 and 2 'Prime' should be explored further.

Accounting for performance

The Board considered a paper presenting two revenue recognition methods: the extinguishment-based method (EBM) and the performance-based method (PBM). The paper went on to (a) compare and contrast those two methods and (b) evaluate each method against the conceptual criteria in FASB Concepts Statement No. 2 and the IASB Framework.

The PBM is a proportionate-performance-type method, and the EBM is a hybrid of a proportionate-performance-type and a sales-type method. Under the sales-type method, recognition is delayed until performance is complete or substantially complete. The Board indicated a preference for the performance-based method but asked the Staff to work through an example that considers the manufacture over a two year period of an item such as a yacht that separately illustrates the effect of milestone payments, a non-refundable deposit and a scenario where the contract requires no payments until delivery.

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