Volume 26, Issue 4

by Bailey Walsh, Eric Knachel, and Rob Moynihan, Deloitte & Touche LLP

Introduction

Calendar-year-end public business entities (PBEs) adopted the FASB’s new revenue standard (ASC 606¹) in the first quarter of 2018.² While some companies made wholesale changes to their financial statements, the effect of the new requirements was less significant for others. However, all entities were affected by the standard’s new and modified quantitative and qualitative disclosure guidance, which significantly increased the amount of information disclosed about revenue activities and related transactions.

This Heads Up (1) provides a brief overview of the disclosure requirements for PBEs under the new revenue standard, (2) highlights some key themes regarding the application of ASC 606 (related to accounting and disclosure requirements) that we noted in our review of approximately 400 SEC staff comments issued to date, and (3) presents examples of those comments. Entities may benefit from evaluating the trends we have observed in our review as they continue to refine the information they disclose. For a comprehensive discussion of the new revenue standard, see Deloitte’s A Roadmap to Applying the New Revenue Recognition Standard (“Revenue Roadmap”). Also see Deloitte’s July 11, 2018, Heads Up for a more detailed discussion of the disclosure requirements under the new revenue standard and related disclosure trends identified. For an overview of the SEC staff’s comment letter review process, see Deloitte’s A Roadmap to SEC Comment Letter Considerations, Including Industry Insights (“SEC Comment Letter Roadmap”).

Key Takeaways Some notable themes identified through our review of SEC comments are: The disclosure of significant judgments, including the identification of performance obligations, the determination and allocation of the transaction price, and the identification of the measure of progress. The required disclosures related to performance obligations (e.g., the timing of revenue recognition and the principal-versus-agent analysis). The disclosures of the conclusions to capitalize contract costs and the related method of amortization. Such themes represented, respectively, approximately 40 percent, 20 percent, and 10 percent of the total publicly available ASC 606 comments that we reviewed. In many instances, though the written comments specifically inquired about disclosures (and requested more of them), we observed that the underlying reason for the comments was that the accounting position taken by the registrants may not have been clear to the SEC staff upon review of the disclosures provided, or it may have been considered potentially inappropriate. On the basis of our review to date, we noted that registrants in the consumer and industrial products industry (which includes consumer products; retail, wholesale, and distribution; automotive; transportation, hospitality, and services; and industrial products and construction) received approximately 45 percent of SEC staff comments, with registrants in the technology, media, and telecommunications (TMT) industry receiving approximately 35 percent. Further, registrants in the life sciences and health care industry and the financial services industry each accounted for approximately 10 percent of the comments issued, while registrants in the energy and resources industry received less than 5 percent. Within certain aspects of ASC 606, we observed that comments were concentrated in particular industries, as discussed below. Under ASC 605,3 common subjects of focus of the SEC staff within filing reviews included: (1) disclosures, (2) multiple-element arrangements, (3) principal-versus-agent considerations, and (4) revenue recognition for long-term construction-type and production-type contracts (see Deloitte’s SEC Comment Letter Roadmap). Although the terminology and guidance for these topics have changed as a result of ASC 606, the staff appears to be focusing on similar types of issues under the new revenue standard.

Significant Judgments

Disclosure Requirements

There are many significant judgments and estimates that entities must make and disclose when they adopt the new revenue standard. ASC 606-10-50-17 through 50-20 state:

50-17 An entity shall disclose the judgments, and changes in the judgments, made in applying the guidance in [ASC 606] that significantly affect the determination of the amount and timing of revenue from contracts with customers. In particular, an entity shall explain the judgments, and changes in the judgments, used in determining both of the following:
a. The timing of satisfaction of performance obligations (see paragraphs 606-10-50-18 through 50-19)
b. The transaction price and the amounts allocated to performance obligations (see paragraph 606-10-50-20).

50-18 For performance obligations that an entity satisfies over time, an entity shall disclose both of the following:
a. The methods used to recognize revenue (for example, a description of the output methods or input methods used and how those methods are applied)
b. An explanation of why the methods used provide a faithful depiction of the transfer of goods or services.

50-19 For performance obligations satisfied at a point in time, an entity shall disclose the significant judgments made in evaluating when a customer obtains control of promised goods or services.

50-20 An entity shall disclose information about the methods, inputs, and assumptions used for all of the following:
a. Determining the transaction price, which includes, but is not limited to, estimating variable consideration, adjusting the consideration for the effects of the time value of money, and measuring noncash consideration
b. Assessing whether an estimate of variable consideration is constrained
c. Allocating the transaction price, including estimating standalone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract (if applicable)
d. Measuring obligations for returns, refunds, and other similar obligations.

Feedback From the SEC

To date, approximately 40 percent of the publicly available ASC 606 SEC staff comments relate to disclosures of significant judgments. These comments can be broken into the following four broad categories, which are discussed in the sections below: (1) identification of performance obligations, (2) determination of the transaction price, (3) allocation of the transaction price, and (4) identification of a measure of progress.

Identification of Performance Obligations

The SEC staff recently stated⁴ that it believes it is important for companies to have clear and transparent disclosures regarding the identification of performance obligations and that the SEC is likely to issue a comment if the disclosure is unclear or it appears to conflict with the guidance. In a manner consistent with this statement, many of the staff’s comments on significant judgments relate to the identification of performance obligations. These comments include requests for additional disclosure of the significant judgments made in the identification of performance obligations and often question the appropriateness of the identified performance obligations. For example, in at least one case, the staff questioned whether maintenance, support, and warranty services represented a single performance obligation. In addition, we observed that the staff has focused on contracts with promises to provide multiple goods and services to a customer and has questioned the conclusion of whether such goods and services are distinct performance obligations in accordance with ASC 606-10-25-19 through 25-22. We also observed that the staff has requested additional information to understand whether an option for additional goods or services was considered a material right. On the basis of our review to date, we observed that registrants in the TMT industry received more than half of the SEC comments related to identification of performance obligations. Examples of such comments are excerpted below.

Determination of the Transaction Price

Another topic of significant judgment under the new revenue standard is the determination of the transaction price, and as a result, the SEC staff has focused its attention on disclosures about how such a determination is made, particularly those related to variable consideration. The staff has questioned registrants on multiple types of variable consideration and requested additional information about how, and to what extent, such consideration has been included in the transaction price. Further, the staff has questioned whether variable consideration was constrained and, if so, the significant judgments that went into the determination of the constraint and when the constraint will be removed. Examples of such comments are excerpted below.

Further, ASC 606-10-55-65 and 55-65A provide an exception to the inclusion of certain sales- or usage-based royalties in the determination of the transaction price, stating that revenue from a sales- or usage-based royalty related to a license of intellectual property (IP) should be recognized at the later of when (1) the “subsequent sale or usage occurs” or (2) the “performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has been satisfied (or partially satisfied),” provided that the license of IP is “the predominant item to which the royalty relates.” We observed that the SEC staff has questioned the application of ASC 606-10-55-65 to certain sales- or usage-based royalty arrangements in which the license of IP is combined with other goods and services and whether, in such arrangements, the license of IP is “the predominant item to which the royalty relates.” The following is an example of such a comment:

Allocation of the Transaction Price

Another focus of the SEC staff’s comments on significant judgments relates to the allocation of the transaction price. The staff has asked registrants to expand their disclosures about the significant judgments, including the “methods, inputs, and assumptions” inherent in the allocation process. For example, the staff has requested that registrants enhance their disclosures to clarify that a performance obligation represents a series and the method used to allocate consideration to each distinct good or service in the series. In addition, the staff has questioned how registrants determined the stand-alone selling price of a good or service, including the application of the residual approach as well as how the registrants considered a range of transactions in determining the stand-alone selling price. Further, registrants in the TMT industry received approximately 65 percent of the SEC comments related to allocation of the transaction price. Examples of such comments are excerpted below.

Identification of a Measure of Progress

For performance obligations satisfied over time, the SEC staff has reminded registrants to satisfy the requirements in ASC 606-10-50-18 to disclose: (1) “[t]he methods used to recognize revenue” and (2) “[a]n explanation of why the methods used provide a faithful depiction of the transfer of goods or services.” The following are examples of such comments:

Performance Obligations

Disclosure Requirements

The new revenue standard introduces various quantitative and qualitative requirements related to performance obligations. Under ASC 606-10-50-12, an entity must disclose the following:

a. When the entity typically satisfies its performance obligations (for example, upon shipment, upon delivery, as services are rendered, or upon completion of service) including when performance obligations are satisfied in a bill-and-hold arrangement.
b. The significant payment terms (for example, when payment typically is due, whether the contract has a significant financing component, whether the consideration amount is variable, and whether the estimate of variable consideration is typically constrained in accordance with paragraphs 606-10-32-11 through 32-13).
c. The nature of the goods or services that the entity has promised to transfer, highlighting any performance obligations to arrange for another party to transfer goods or services (that is, if the entity is acting as an agent).
d. Obligations for returns, refunds, and other similar obligations.
e. Types of warranties and related obligations.

In addition, under ASC 606-10-50-12A, an entity must disclose “revenue recognized in the reporting period from performance obligations satisfied (or partially satisfied) in previous periods (for example, changes in transaction price).”

Feedback From the SEC

In addition to comments related to the significant judgments inherent in the identification of performance obligations as discussed above, the SEC staff has also issued comments related to certain disclosure requirements (under ASC 606-10-50-12) for the identified performance obligations. These comments can be categorized into four primary topics: (1) timing of revenue recognition, (2) significant payment terms, (3) significant financing components, and (4) the nature of goods or services, including principal-versus-agent considerations. These topics are discussed below.

Timing of Revenue Recognition

One of the key considerations related to the timing of revenue recognition under the new revenue standard is whether a performance obligation is satisfied at a point in time or over time. For instance, in a scenario in which a registrant is constructing an asset for a customer by using the customer’s specifications, the SEC staff has questioned how the registrant considered the criteria in ASC 606-10-25-27 through 25-29 in determining whether revenue should be recognized at a point in time or over time. Further, the staff has issued comments related to the identification of the appropriate point in time at which to recognize revenue. On the basis of our review to date, we observed that registrants in the TMT industry received more than half of the SEC comments related to timing of revenue recognition. The following are examples of such comments:

Significant Payment Terms

The SEC staff has requested that registrants disclose significant payment terms (e.g., when payment typically is due, whether the consideration amount is variable, and whether the variable consideration is typically constrained). Examples of such requests are reproduced below.

Significant Financing Components

The SEC staff has also issued comments requesting that registrants clarify how they reached the conclusion that their contracts did not include a significant financing component, as well as requesting future disclosure if a registrant elected the practical expedient in ASC 606-10-32-18 that permits an entity not to recognize a significant financing component if the time between the transfer of a good or service and payment is one year or less. Examples of such comments are excerpted below.

Nature of Goods or Services, Including Principal-Versus-Agent Considerations

For each identified performance obligation, registrants are required by ASC 606-10-50-12(c) to disclose “[t]he nature of the goods or services that the entity has promised to transfer, highlighting any performance obligations to arrange for another party to transfer goods or services (that is, if the entity is acting as an agent).” The SEC staff has often referenced ASC 606-10-50-12 when commenting that the registrant should provide greater detail of the nature of the goods or services that the registrant has promised to transfer. Further, the staff has requested that registrants clarify whether they are presenting revenue on a gross or net basis and to explain how the conclusion to report revenue on a gross or net basis was reached. There are many significant judgments registrants have to make in reaching a conclusion about whether they are principals or agents. As a result, the staff has stated that registrants should be mindful of the requirement in ASC 606-10-50-17 to “disclose the judgments, and changes in the judgments, made in applying the guidance in [ASC 606] that significantly affect the determination of the amount and timing of revenue from contracts with customers.” Examples of comments related to principal-versus-agent considerations are excerpted below.

Contract Costs

Disclosure Requirements

Under the new revenue standard and in accordance with ASC 340-40,⁵ entities capitalize certain costs associated with obtaining⁶ and fulfilling a revenue contract. These costs are subsequently amortized. Accordingly, entities are required to disclose:

• The judgments used to determine the amount of costs incurred to obtain and fulfill a contract.
• The method used to determine amortization for each reporting period.
• The closing balances of assets recognized from the costs incurred to obtain or fulfill a contract, by asset category.
• The amortization and impairment loss recognized in the reporting period.

Feedback From the SEC

Nearly 10 percent of the SEC staff’s publicly available comments on ASC 606 relate to the accounting or disclosure requirements for contract costs. Though we noted instances in which the staff requested that registrants provide additional information in their disclosures about the costs they are capitalizing in accordance with ASC 340-40, the majority of the staff’s comments related to the incremental costs to obtain a contract represented requests for additional disclosure about (1) the method being used to amortize the capitalized costs and (2) how the selected amortization period correlates to the period of benefit. We also observed that when additional commissions are paid upon renewal, the staff has questioned (1) whether such commissions are commensurate with the initial commissions and (2) how such renewals are considered in the amortization period. Examples of comments on the amortization of costs to obtain a contract are excerpted below.

Disaggregation of Revenue

Disclosure Requirements

Under the new revenue standard, an entity is required by ASC 606-10-50-5 and 50-6 to disaggregate revenue for disclosure purposes into categories as follows:

• The categories must depict how “revenue and cash flows are affected by economic factors.”
• The disclosures must contain sufficient information to convey the relationship between disaggregated revenue and each disclosed segment’s revenue information.

As discussed in paragraph BC336 of ASU 2014-09,⁷ “because the most useful disaggregation of revenue depends on various entity-specific or industry-specific factors, the Boards decided that Topic 606 should not prescribe any specific factor to be used as the basis for disaggregating revenue from contracts with customers.” Instead, ASC 606-10-55-91 provides examples of categories that may be appropriate for an entity’s disclosures in the financial statements, such as type of good or service, geographical region, market or type of customer, type of contract, contract duration, timing of transfer of the good or service, and sales channels.

When selecting the types of categories for disaggregated revenue, an entity should consider how and where it has communicated information about revenue for various purposes, including (1) disclosures outside the financial statements, (2) information regularly reviewed by the chief operating decision maker for evaluating the financial performance of operating segments, and (3) other information that is similar to the types of information identified in (1) and (2) and that is used by the entity or users of its financial statements for evaluating its financial performance or making decisions about resource allocation.

Feedback From the SEC

The SEC staff has issued comments asking registrants to clarify how they determined that the categories in which they present disaggregated revenue information were sufficient. The staff has reminded registrants that they should consider information disclosed outside the financial statements. Further, the staff has questioned whether the selected categories are appropriate given the registrants’ business model and whether the categories depict how revenue and cash flows are affected by economic factors. Registrants in the consumer and industrial products industry received approximately 70 percent of the SEC comments related to disaggregated revenue. Although comments on disaggregation constituted approximately 5 percent of the total publicly available ASC 606 comments, the staff recently stated⁸ that it anticipates that disaggregated revenue disclosures will continue to be a focus in the coming year. The following are examples of such comments:

Contract Balances

Disclosure Requirements

Under the new revenue standard, in accordance with ASC 606-10-50-8 through 50-10, registrants must disclose the following information about contract balances:

• “The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed.”
• The amount of revenue recognized in the reporting period from the beginning contract liability balance.
• An “explanation of the significant changes in the contract . . . balances during the reporting period” (by using quantitative and qualitative information).
• An explanation of “how the timing of satisfaction of [the entity’s] performance obligations . . . relates to the typical timing of payment . . . and the effect that those factors have on the contract asset and the contract liability balances.”

Feedback From the SEC

The SEC staff has issued comments to registrants asking them to include additional information in their disclosures about how contract balances are derived. Examples of these comments are reproduced below.

Remaining Performance Obligations

Disclosure Requirements

ASC 606-10-50-13 requires an entity to disclose the following about its remaining performance obligations:

• “The aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the reporting period.”

• “An explanation of when the entity expects to recognize as revenue the amount disclosed in accordance with [the requirement above], which the entity shall disclose in either of the following ways:

  1. On a quantitative basis using the time bands that would be most appropriate for the duration of the remaining performance obligations

  2. By using qualitative information.”

Several practical expedients are available for the disclosure of remaining performance obligations (see Deloitte’s Revenue Roadmap for details). Under ASC 606-10-50-15, if a PBE elects to apply the practical expedients related to the disclosure of remaining performance obligations, it is required to disclose which of the practical expedients it is applying as well as certain other qualitative information.

Feedback From the SEC

We observed instances in which the SEC staff questioned how registrants have complied with the disclosure requirements of ASC 606-10-50-13 through 50-15 regarding information about remaining performance obligations. For instance, the staff has questioned how registrants have complied with the requirement of ASC 606-10-50-13(b) to disclose when the registrant expects to recognize amounts recorded as deferred revenue. Examples of such comments are excerpted below.

Thinking Ahead

The adoption of the new revenue standard has led to a noticeable increase in the amount and type of information entities have disclosed about revenue activities and related transactions. Although we observed some consistency in their disclosures, companies’ interpretations of the requirements and the amount of information to disclose have varied. We encourage registrants to continue to refine their accounting for revenue and the information they disclose as accounting standard setters clarify guidance and regulators issue more comments. We believe that registrants should take this opportunity to revisit their disclosures in advance of quarterly filings in 2019 while keeping in mind that certain disclosures are not required for interim filings in year 2 of adoption (see Section 14.6 of Deloitte’s Revenue Roadmap for details). In addition, looking ahead to future filing cycles, companies will benefit from moving toward a repeatable and sustainable process of assessing and preparing the new revenue standard disclosures.

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