In response to implementation questions about the new revenue guidance in ASC 606, Revenue from Contracts with Customers, FASB issued a proposed Accounting Standard Update (ASU) in May. The proposed amendments relate to identifying performance obligations and licensing intellectual property, and represent FASB’s first proposed changes to the revenue standard. The board plans to propose more changes soon.
FASB has requested comments on the proposed ASU by June 30.
Identifying performance obligations
The board discussed several topics related to Step 2 of the revenue model, which requires an entity to identify its performance obligations in a contract with a customer.
Under the guidance in ASC 606, before an entity identifies its performance obligations, it must pinpoint the promised goods or services in a contract so that it can assess if each promise meets the definition of a performance obligation. To reduce the cost and complexity of applying the guidance, the board has proposed not requiring entities to identify promised goods or services that are immaterial in the context of the contract.
The board proposed allowing entities to account for shipping and handling as a fulfillment cost (an expense) rather than as a promised good or service within the contract, when shipping and handling are performed after control of the good has been transferred to the customer.
The proposed changes would clarify the “separately identifiable” principle. An entity would determine whether the nature of its promise is to transfer each of the goods or services or to transfer a combined item (meaning the promised goods or services are simply inputs to the combined item).
The proposal includes a question to constituents asking whether the “series provision” in ASC 606 should be optional. The series provision requires good or services to be accounted for as a single performance obligation when two criteria are met, despite the underlying goods and services being distinct. The FASB/IASB Joint Transition Resource Group for Revenue Recognition (TRG), which evaluated the implementation questions, noted that requiring the series provision may make compliance more complex for some entities, when the board’s intent was to make it easier.
Implementation guidance on intellectual property licenses
The board discussed ways to make the implementation guidance on intellectual property (IP) licenses more operable and easier to understand. The proposed guidance would deal with an entity’s promise to grant a customer a license and distinguish between “functional IP” and “symbolic IP.” The distinction focuses on the IP’s ability to provide benefits or value.
Functional IP has significant stand-alone functionality and includes software, biological compounds or drug formulas, and completed media content. An entity would satisfy its obligation at the point in time the customer could use and benefit from the license, because functional IP derives a substantial part of its usefulness from its significant stand-alone functionality. However, the entity would account for revenue over time if both of the following applied:
- The functionality of the IP to which the customer has rights is expected to substantively change during the license period because of the entity’s activities that don’t transfer a good or service to the customer.
- The customer is contractually or practically required to use the updated IP.
In contrast, symbolic IP doesn’t have significant stand-alone functionality, and its usefulness stems from the entity’s past and ongoing activities. So an entity satisfies its promise to provide a license to symbolic IP over time. This type of IP includes brands, team or trade names, logos and franchise rights.
The proposed changes clarify that when a single performance obligation includes a license and other promised goods or services, an entity must consider the nature of its promise in granting the license in order to apply other guidance in ASC 606. This particularly applies to guidance to determine if an entity satisfies a performance obligation over time or at a specific time, and how to best measure progress toward the complete satisfaction of a performance obligation that’s satisfied over time.
ASC 606 provides an exception from applying the variable consideration and related constraint guidance for sales- and usage-based royalties promised in exchange for a license of IP. The proposed changes would clarify that when a royalty relates to two or more performance obligations, an entity shouldn’t split a single royalty into a portion subject to the exception and one that’s not subject to that guidance. The proposed changes would also clarify that the exception applies whenever the predominant item to which the royalty relates is a license of IP.
ASC 606 states that contractual restrictions define the attributes of the promised license, but doesn’t indicate whether the entity satisfies its performance obligation at a specific time or over time. The proposed changes would clarify that contractual restrictions on the customer’s rights under the license don’t affect the entity’s identification of the promised goods or services in the contract.
The proposed ASU would become effective at the same time as ASC 606.
Proposed deferral of compliance
FASB recently issued a proposed ASU, Revenue from Contracts with Customers: Deferral of the Effective Date, seeking public comment on a one-year deferral of the effective date of the new revenue guidance. This would make the guidance effective for public entities in annual reporting periods beginning after Dec. 15, 2017, and for nonpublic entities in annual reporting periods beginning after Dec. 15, 2018.
Early application would be permitted for both public and nonpublic entities at the dates permitted in ASU 2014-09.