As a result of feedback received to the Boards’ revised exposure draft Revenue from Contracts with Customers (2011 ED), the staffs brought the following topics to the Boards for consideration:
- Possible improvements to the constraint on the cumulative amount of revenue that can be recognised if the amount of consideration which an entity expects to be entitled is variable; and
- The impact of collectibility on recognition, measurement and presentation.
Constraining the cumulative amount of revenue recognised
The Boards discussed possible improvements to the revenue recognition proposals in response to feedback obtained on the proposed revenue recognition constraint.
The staffs noted that the concept of a constraint was included in the 2011 ED to address concerns about recognising revenue when significant uncertainties exist about the amount of consideration to which the entity expects to be entitled. While most respondents agreed in principle with the need for a constraint in the revenue model, and many broadly agreed with the principles proposed to apply the constraint, many requested further clarity on when and how the constraint should be applied. Some of the areas where additional further clarity was requested included:
- The scope of the constraint; in particular, when the transaction price is considered to be variable;
- Use of the term ‘reasonably assured’ in constraining the amount of revenue recognised; and
- The application of the constraint and how an entity would practically apply the indicators in paragraph 82 of the 2011 ED to determine whether the entity’s experience would be considered to be predictive.
Scope of the constraint
Paragraph 81 of the 2011 ED states that the constraint applies to variable consideration. The 2011 ED does not define variable consideration but paragraph 53 in the 2011 ED includes a list of what may result in variability (e.g., discounts, rebates, refunds, performance bonuses, contingencies, etc.).
Some respondents to the 2011 ED raised questions about what type of amounts the Boards would consider to be ‘variable’ (specifically questioning use of the term ‘contingencies’ in paragraph 53).
Therefore, the staffs proposed that the Boards clarify the meaning of ‘variable consideration’ in paragraph 53 of the 2011 ED, specifically explaining that the term ‘contingencies’ can apply to uncertain price adjustments (e.g., variable consideration) as well as uncertain events (i.e., fixed consideration but uncertainty as to whether an entity will be entitled to the consideration).
As a result of its analysis, the staffs recommended:
- There should be an explicit reference from paragraph 81 of the 2011 ED to paragraph 53 to clarify the scope of the constraint for ‘variable consideration’.
- The word ‘contingencies’ in paragraph 53 of the 2011 ED should be replaced with ‘uncertain events’ to eliminate confusion as to whether it is intended to be consistent with contingencies in other areas of IFRS and US GAAP.
- An additional paragraph immediately following Paragraph 53 of the 2011 ED should be added to clarify that uncertain events can either relate to:
- uncertainties affecting the price: uncertainties where an entity has the right to obtain consideration and the amount to which the entity will be entitled varies depending on subsequent events or other variables. However, the right to obtain consideration is not contingent; and
- uncertainties related to events: uncertainties where the entity’s right to obtain consideration is contingent on the occurrence or non-occurrence of uncertain future events. The outcome of the events could be within the entity’s control, the customer’s control, or neither.
Board members expressed general agreement with the principle of these recommendations. However, multiple concerns were expressed. Specifically:
- Multiple Board members noted circularity in the (c)(ii) definition above (i.e., the term ‘uncertain events’ is used to define ‘uncertain events’). The staffs noted that they would work to clarify the definition of uncertain events in final drafting.
- Multiple Board members failed to see the distinction between uncertainties affecting the price and uncertainties related to events since both are contingent on future events. Board members asked that the staffs clarify these two unique uncertainties in final drafting.
- One Board member requested that the final standard explicitly state that default of the counterparty (i.e., customer credit risk) is excluded from the scope of the constraint for ‘variable consideration’.
Other Board members questioned whether the list of items in paragraph 53 of the 2011 ED were indeed within the scope of the variable consideration constraint. These Board members did not see bonuses, penalties and refunds as within the scope of the variable consideration constraint. However, the staffs asked that this point be considered at a later time.
When put to a vote, the Boards tentatively agreed with the principles of the staffs’ recommendations, subject to drafting edits as outlined above.
‘Reasonably assured’ term and understanding when an entity’s experience is predictive
The staffs noted that many respondents to the 2011 ED expressed confusion regarding the use of the term ‘reasonably assured’ in constraining the amount of revenue recognised. Specifically, respondents noted that the term is used elsewhere in IFRSs, US GAAP and auditing requirements, and further noted that the meaning is often different than the qualitative assessment the Boards intended in the 2011 ED.
The staffs noted that the term ‘reasonably assured’ is defined (paragraph 81 of the 2011 ED) by reference to whether an entity has predictive experience, and therefore, the use of the term could be deleted and replaced with a definition/indicators of predictive experience. Board members tentatively agreed with the removal of the term ‘reasonably assured’ given the confusion it created, but expressed concerns regarding how the final standard would define whether an entity’s experience (or other evidence) is predictive of the amount of consideration to which the entity will be entitled.
The staffs outlined three options for addressing the issue of understanding when an entity’s experience is predictive:
- Option 1 — retain the qualitative assessment in the 2011 ED by reinforcing the principle in paragraph 81 and retaining the indicators in paragraph 82;
- Option 2 — amending the guidance in paragraph 82 of the 2011 ED to provide an objective and determinative methodology to ensure that revenue is not recognised when there are a broad range of possible consideration amounts; and
- Option 3 — retaining the 2011 ED indicators in paragraph 82 and introducing a threshold for the level of confidence an entity must have when assessing whether or not an entity’s experience is predictive.
The staffs noted that subsequent to publishing the agenda paper, constituent feedback was received related to the second and third options outlined in the staffs’ paper. The feedback expressed a perception that Options 2 and 3 would artificially constrain revenue on long-term service and construction contracts as compared to current practice. The staffs noted they were still evaluating the feedback raised, and thus, requested more time to complete the related research. However, the staffs requested a directional steer from the Boards regarding the options raised.
While no vote was taken, many Board members believed that the final standard would require more definitive guidance (compared to the 2011 ED) as to whether an entity’s experience is predictive of the amount of consideration to which the entity will be entitled. Some Board members saw merit in Option 2 given that the proposals set forth by the staffs would be generally understood in an IFRS and US GAAP context. Other Board members preferred that staff proposals explicitly focus on the Boards’ primary objective in developing the constraint. That being, limiting true-ups to revenue in subsequent accounting periods.
However, Board members agreed that the staffs should complete their research before any tentative decision is taken. The staffs will bring back this issue to a future meeting.
The Boards were asked to consider possible refinements to the revenue model to clarify the proposals on the presentation of the impairment loss line item.
Collectibility recognition threshold and determination of when there is a contract with a customer
The Boards were first asked to consider whether they wished to include a collectibility threshold (i.e., collectibility must meet or exceed a specified confidence threshold for revenue to be recognised) in the final revenue standard. This question was raised in response to concerns raised by some constituents that the proposals may result in the recognition of revenue for transactions in which risks have not adequately transferred to the customer. It also addresses questions raised by constituents regarding whether it was the Boards’ intention (as explained in paragraph BC34 of the 2011 ED) to include an implicit collectibility threshold with the requirement in paragraph 14(b) (that is, in order for a contract to exist, the customer must be committed to perform under the contract).
The staffs recommended that there should be no collectibility threshold because the 2011 ED already required an arrangement to be legitimate and enforceable in order for recognise revenue. However, the staffs acknowledged that the guidance regarding the legitimacy and enforceability of contracts could be clarified to ensure consistency in application. Therefore, the staffs recommended that in conjunction with the recommendation not to include a collectibility threshold, amendments should be made to the proposals to clarify how to determine whether a customer is committed to perform.
Paragraph 14(b) of the 2011 ED stated that the proposal would apply only if the parties to the contract are committed to perform their respective obligations, yet the 2011 ED was perceived by some to provide little guidance on how an entity can demonstrate a commitment to perform.
To help clarify the importance of the attributes of a contract in paragraphs 14(a) (commercial substance) and 14(b) (commitment to perform obligations), the staffs recommended including indicators of ‘commitment to perform their respective obligations’ in implementation guidance. The staffs noted that relevant indicators may include, but are not limited to, the following:
- payment terms that reflect uncertainty about the customer’s interest and intent on following through with its obligations. Such terms may include (i) a small down payment relative to the overall contracted price, (ii) nonrecourse, seller financing, (iii) collateral or guarantees that is (are) not highly liquid, (iv) continuing payments that extend over a relatively long period of time, and/or (v) guarantees which are provided by non-highly rated companies.
- the reason for the parties entering into the transaction, in light of the parties’ business models, raises a question as to the customer’s intent on following through with its obligations. For example, if a customer is entering into a transaction for speculative purposes, which is not part of their ordinary business activity, the customer may not be committed to fulfil its obligations.
- experience that the entity has with the customer for the same or similar transactions (experience may be that of the entity or another entity). For example, if the entity has limited experience with the customer, and does not have access to the experience that others have had with the customer, then the entity may not have a solid basis on which to conclude that the customer will fulfil its obligations.
With little debate, Board members tentatively agreed with the staffs’ recommendations. However, they requested that this guidance be included in the body of the standard (supplementing paragraph 14 of the 2011 ED) as opposed to inclusion in implementation guidance. They also requested that the staffs look to some of the more risky transactions which would call into question ‘commitment’ (such as sales in exchange for the buyer’s nonrecourse debt, particularly when the sale involves real estate; cash sales when the seller guarantees or otherwise backstops debt financing the buyer’s purchase; and seller financed purchases to entities with unusually weak credit), and further develop the above indicators in contemplation of these transactions.
The Boards then began a general discussion on collectibility. They discussed presentation of customer credit risk, whether the impairment loss line item should reflect credit risk impairments for both initial and subsequent periods and whether the presentation of impairment on receivables should differ depending on whether a significant financing component exits.
Many opinions were expressed. Specifically, some Board members preferred the impairment loss line be reflected adjacent to revenue, while others preferred its presentation as an expense. Others preferred that a distinction be made in presentation based on whether the product is financed by the seller.
Some Board members believed a distinction should be made between initial and subsequent credit risk impairments. However, many accepted the operational challenges with distinguishing these amounts (e.g., Many contracts are assessed on a portfolio basis for impairment. Hence, when contracts in a portfolio are not entered into at the same time, identifying what portion of an estimated impairment loss represents initial impairment becomes impractical). Additionally, some Board members thought both initial and subsequent impairments should be reflected collectively, as they saw subsequent period impairments as the correction of the initially recorded impairment charge.
With little progress being made, the FASB Chair asked that the staffs consider the feedback expressed during the meeting and put together illustrative examples of proposed alternatives for further discussion on Thursday of this week.