The IASB and FASB began redeliberations on the proposals within their respective exposure drafts (for the IASB ED/2010/6 Revenue from Contracts with Customers) after receiving a summary of comment letter feedback during the December 2010 joint meeting.
The staffs began the discussions by providing a flowchart diagram of their intentions for the flow of the decision making process for recognising revenue when goods or services are transferred to a customer. From the flowchart, one would first identify whether separate performance obligations exist within a contract and then determine whether the performance obligation meets the description of a service. If the performance obligation is a good then one would perform the Exposure Drafts guidance on control. If the performance obligation is a service, then one would apply the Exposure Drafts guidance on continuous transfer of goods or services. The deliberations during this meeting would focus on these components of the revenue recognition model.
Determining the transfer of goods and services
The Exposure Draft proposed that a good or service is transferred when the customer obtains control of the good or service. However, nearly all respondents felt that the proposed guidance on control was insufficient and would result in significant diversity in practice. Respondents were concerned with the removal of "risk and rewards of ownership" as a consideration for transfer of control. Respondents also overwhelmingly felt that the control guidance was insufficient for service and construction-type contracts and requested specific indicators for continuous-transfer contracts.
To address these concerns, the staffs recommended that the Boards develop separate recognition requirements for service arrangements. The staffs proposed that in order to determine if the performance of a task transfers a benefit to a customer and would meet the description of a service 1) the task would not need to be reperformed if the obligation were transferred to another entity, 2) the customer owns the work-in-process, or 3) the performance of the task would not create an asset independent of the contract and the customer cannot avoid paying for performance of the task (any of these conditions would be indicative of a task meeting the description of a service).
The Boards were supportive of supplementing the guidance in the Exposure Draft with separate recognition requirements for service arrangements. However, certain Board members expressed concerns with the proposals by introducing various example transactions ranging from commercial aircraft production to a financial statement audit engagement. One FASB member mentioned he thought many of these concerns were related more towards the method of recognising revenue under a services continuous transfer approach rather than whether the performance is a service. The staffs also clarified that the proposed continuous recognition approach for services does not automatically result in a straight-line recognition pattern, but rather the appropriate recognition method (using the output method, the input method or the passage of time method) will be based on facts and circumstances.
The Board also discussed whether reasonably measuring progress towards completion should be a requirement in order to recognise revenue for a service under the continuous transfer approach. The staffs provided the Board with three examples of services where measurement towards completion could, or could not, be reasonably measured. As part of this discussion, the Board discussed the recognition methods under the continuous transfer approach (the output method, the input method or the passage of time method). One FASB member mentioned concern over permitting a policy choice over the recognition method. An IASB member mentioned research performed during development of the SME standard. From that research it was noted that a majority of companies utilise an input approach because it is easier to apply.
The Boards tentatively agreed to provide separate recognition requirements for services and generally supported the concept of a service being based on any of the following type of criteria existing: 1) the task would not need to be reperformed if the obligation were transferred to another entity 2) the customer owns the work-in-process, or 3) the performance of the task would not create an asset independent of the contract and the customer cannot avoid paying for performance of the task.
The staffs agreed to further refine these criteria based on the feedback provided during the meeting. The Boards also tentatively agreed to the requirement that the progress towards completion be reasonably measurable in order to recognise revenue under the continuous transfer approach. The Boards requested the staffs to further develop guidance around which recognition approach (the output method, the input method or the passage of time method) would be applied under various circumstances.
The Boards also discussed the requirements in the Exposure Draft around transfer of a good under the control notion. Some comment letter respondents were concerned about the use of control and the interrelations with control concepts in other sources of GAAP (lease accounting, derecognition and consolidation). Additionally, respondents questioned the removal of "risk and rewards" from the control indicators and questioned the inclusion of the indicator related to the "design or function of the good or service is customer-specific".
The staffs recommended retaining the control notion but describing rather than defining control. Additionally, the staffs recommended that "risk and rewards" be included as an indicator of control and removing "design or function of the good or service is customer-specific" as an indicator. One IASB member questioned why control would not be defined referencing paragraph 26 from the Exposure Draft and the control discussion within that paragraph. The staffs clarified this language would be retained, and their proposal is that control would not be a defined term in the glossary of terms within the final Standard. The Board tentatively agreed with the staffs proposals.
The final topic discussed under transfers of goods or services related to contracts that involve the transfer of both goods and services. With the decision to provide separate recognition requirements for services, the Boards now need to provide guidance on which approach an entity would apply when a contract includes the bundling of goods and services. The Boards tentatively agreed that an entity would first need to assess whether the goods and services were distinct for purposes of identifying separate performance obligations. If the goods and services are distinct, the entity would account for them as separate performance obligations but if the goods and services were not distinct, then the entity would account for the bundle as a service.
Separating a contract
The Exposure Draft proposed that a contract would be separated under a two-step process. First, a contract would be separated if the prices of some goods or services are independent of other goods or services in the contract in order to "ring fence" allocations of the transaction price. Then, an entity would identify any separate performance obligations within a contract.
Comment letter responses felt the two-step process was confusing and unnecessary. Respondents felt that the principle for segmenting a contract overlaps the criteria used to identify separate performance obligations and that segmenting a contract would be unnecessary if the Boards clarified how an entity should allocate discounts and changes in the transaction price.
The staffs clarified that the discussion on allocating discounts and changes in the transaction price was not part of the current discussion and would be discussed separately during a future Board meeting. The Boards tentatively agreed to require separation of a contract in a one-step process rather than segmenting a contract for price allocation purposes as well as identifying separate performance obligations.
Identifying separate performance obligations
The Exposure Draft proposes that an entity should identify the performance obligations to be accounted for separately based on the good or service being distinct. The Exposure Draft included guidance on what constitutes distinct, specifically that 1) the entity, or another party, sells an identical or similar good or service separately, or 2) the entity could sell the good or service separately because it has a distinct function and distinct profit margin.
The comment letter respondents generally agreed with the principle of "distinct goods or services" for identifying separate performance obligations. However, they also did not interpret the proposed criteria in the manner intended by the Boards.
The Boards tentatively agreed to retain the principle of "distinct goods or services" for identifying separate performance obligations but to emphasise the objective for identifying separate performance obligations in order to address the confusion of constituents. The staffs mentioned that the Basis for Conclusions of the Exposure Draft included the following:
"the boards objective was to develop requirements that would result in an entity recognising revenue and profit margins in a manner that faithfully depicts the transfer of goods or services to the customer and that would be practical."
The Boards tentatively agreed to move this language into the body of the final Standard to help emphasise the objective of identifying separate performance obligations.
Comment letter respondents also had concerns over the proposal on a good or service being distinct if another entity sells an identical or similar good or service separately, or the entity could sell the good or service separately because it has a distinct function and distinct profit margin. In particular, they felt these criteria would result in the requirement to account for performance obligations at a level that does not accurately characterise the economics of a contract.
In considering these comments, the staffs reconsidered the distinct criteria in the Exposure Draft of having a distinct function and distinct profit margin and thought that criteria of a distinct function, distinct risks and distinct timing of transfer may be more appropriate. Additionally, the staffs provided the Boards with indicators that may assist constituents in applying judgement as to whether a good or service is distinct, rather than the Exposure Drafts proposals that had specific criteria in making the determination. Those indicators included:
- The goods or services are clearly specified in the contract or there is other evidence available that suggests that the customer considers the good or service to be a distinct component of the contract.
- The promised good or service was negotiated separately and the customer could have chosen to purchase, or not purchase, that good or service without materially affecting the scope and pricing of the remainder of the contract.
- The entity sells identical or virtually identical goods or services separately.
- Another entity sells the good or service separately.
- A reasonable basis exists for estimating the standalone selling price for the good or service.
The Boards had various concerns with both the distinct criteria (distinct function, distinct risks and distinct timing of transfer) and the indicators provided. One FASB member mentioned that the guidance needs to emphasise that the assessment would be a top-down approach considering all the criteria rather than a criterion-by-criterion assessment. He also had concerns with including the indicator of goods or services provided by another entity as they would not necessarily be subject to the same risks as the entity performing the revenue recognition assessment (using the example of a home builder, he questioned the fact that hardware stores sell lumber and nails separately, therefore would the home builder need to look at the hardware store business model in making the distinct assessment).
Other Board members raised additional examples of a security business that manufactures, installs and monitors security systems and telecom companies that sell smartphone devices and cellular service contracts. The staff emphasised that the analysis would depend on whether those items outside of the continuous service arrangements are distinct. One IASB member mentioned that perhaps rather than distinct risks they should focus on rewards (benefits) being provided to the customer. Other IASB Board members also had concerns with the distinct risk criterion and how it would be applied.
The staff concluded the discussion by stating they would take the feedback from this meeting and further refine the proposals. In particular, there seemed to be broad agreement over the distinct function criterion, and then they would look at overlaying the distinct risk and perhaps the distinct timing criteria on to the distinct function component. They will bring back the revised proposals at a future meeting along with the analysis applied to different examples.