FASB Transition Resource Group for Revenue Recognition Capitalization and Amortization of Incremental Costs of Obtaining a Contract

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1 TRG Agenda ref 57 STAFF PAPER Project Paper topic November 7, 2016 FASB Transition Resource Group for Revenue Recognition Capitalization and Amortization of Incremental Costs of Obtaining a Contract CONTACT(S) Dan Drobac ddrobac@fasb.org Aarika Friend afriend@fasb.org Kramer Holle kkholle@fasb.org This paper has been prepared for discussion at a public meeting of the Transition Resource Group for Revenue Recognition. It does not purport to represent the views of any individual members of the board or staff. Comments on the application of U.S. GAAP do not purport to set out acceptable or unacceptable application of U.S. GAAP. Stakeholders are strongly encouraged to listen to feedback about this staff paper from TRG members and Board members during the TRG meeting and to read the meeting summary, which will be prepared by the staff after the meeting. Purpose 1. Some stakeholders informed the staff that there are different interpretations of the guidance in Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606) (the new revenue standard) regarding recognition and measurement of incremental costs of obtaining a contract as an asset and estimating the period of amortization. This paper summarizes the implementation questions reported to the staff. 2. The Transition Resource Group (TRG) previously discussed questions related to incremental costs of obtaining a contract on January 26, Some stakeholders informed the staff that there are different interpretations of the discussion from that TRG meeting. See TRG Agenda Ref No. 23 Incremental Costs of Obtaining a Contract, and TRG Agenda Ref No. 25 Summary of Issues Discussed and Next Steps, for additional information on that discussion. In addition, stakeholders informed the staff of some additional implementation questions that are addressed in this paper. The Financial Accounting Standards Board (FASB) is an independent standard-setting body of the Financial Accounting Foundation, a not-for-profit corporation. The FASB is responsible for establishing Generally Accepted Accounting Principles (GAAP), standards of financial accounting that govern the preparation of financial reports by public and private companies and not-for-profit organizations in the United States and other jurisdictions. For more information visit Page 1 of 18

2 Background and Accounting Guidance 3. Entities often pay sales commissions to employees and those commissions often are incremental costs of obtaining a contract. The accounting for sales commissions is generally straightforward in contracts in which the commission is a fixed amount or a percentage of contract value and in situations in which the contract is not expected to be (or cannot be) renewed. However, when entities have complex compensation plans and anticipated contract renewals, judgment might be needed in applying the principles in the new revenue standard. This paper discusses the accounting for commissions at the contract level (refer to the discussion below about accounting for the incremental costs of obtaining a contract at the portfolio level). 4. Paragraph requires an entity to recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. The incremental costs of obtaining a contract are defined in paragraph as those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, a sales commission). 5. In accordance with paragraph , the asset recognized for incremental costs of obtaining a contract with a customer is amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. The asset may relate to goods or services to be transferred under anticipated contracts that the entity can specifically identify. 6. The staff thinks it is important for stakeholders to remember that existing guidance outside of the new revenue standard will be relevant in determining whether a liability should be recognized for the incremental costs of obtaining a contract. If an entity concludes that a liability should be recognized under other U.S. GAAP (such as Topic 405), an entity should then evaluate whether the cost should be recognized as an asset or expensed as incurred in accordance with Topic 340. Entities will need to apply judgment in this area, including in determining the amortization period. 7. The staff also thinks it is important for stakeholders to remember that the new revenue standard includes two practical expedients that might be helpful when accounting for incremental costs of obtaining a contract: Page 2 of 18

3 a. Per paragraph , an entity may recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the entity otherwise would have recognized is one year or less. b. Per paragraph , an entity might be able to take advantage of the practical expedient to account for the incremental costs of obtaining a contract at the portfolio level (for example, in determining an amortization period). An entity s specific facts and circumstances will dictate whether it can apply the guidance at a portfolio level. Implementation Questions Question 1: Which costs to obtain a contract are incremental? 8. Paragraphs through 25-3 state the following: : An entity shall recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs : The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contracts had not been obtained (for example, a sales commission) : Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained shall be recognized as an expense when incurred, unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained. [Emphasis added.] 9. Some stakeholders have questioned which costs to obtain a contract are incremental. In particular, some stakeholders have expressed concerns that the term incremental could lead to broad interpretations of the types of costs that would qualify as incremental costs to be capitalized under the new revenue standard. 10. Stakeholders have also inquired about whether an entity should consider fringe benefits in the assessment of determining incremental costs to obtain the contract. The staff refers individuals with questions regarding that topic to Issue 6 in TRG Page 3 of 18

4 Agenda Ref No. 23. In addition, the staff thinks much of the analysis below about the notion of incremental can be applied to fringe benefits. Background 11. In the June 2010 Revenue Recognition Exposure Draft (ED), the Board proposed that an entity should expense all costs of obtaining a contract with a customer as incurred. Many stakeholders disagreed with the Board s initial view that costs of obtaining a contract should be expensed as incurred. In response to stakeholder feedback on the June 2010 Revenue Recognition ED and additional research and outreach, the Board decided that an entity should capitalize the costs to obtain a contract. The Board noted that expensing those costs when incurred would be inconsistent with other standards and would violate the Conceptual Framework s definition of an asset. The Basis for Conclusions in Update describes the reason for this change in greater detail. BC297. The Boards decided that an entity should recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. The Boards defined the incremental costs of obtaining a contract as the costs that an entity incurs in its efforts to obtain a contract that would not have been incurred if the contract had not been obtained. The Boards acknowledged that, in some cases, an entity s efforts to recognize an asset from incremental acquisition costs might exceed the financial reporting benefits. Consequently, as a practical expedient, the Boards decided to allow an entity to recognize those costs as expenses when incurred for contracts in which the amortization period for the asset that the entity otherwise would have recognized is one year or less. BC298. The Boards considered requiring an entity to recognize all of the costs of obtaining a contract as expenses when those costs are incurred. The Boards observed that, conceptually, an entity may obtain a contract asset as a result of its efforts to obtain a contract (because the measure of the remaining rights might exceed the measure of the remaining obligations). However, because the principle in Topic 606 requires an entity to recognize a contract asset and revenue only as a result of satisfying a performance obligation in the contract, the Boards observed that on the basis of that reasoning, the contract asset would be measured at zero at contract inception and any costs of obtaining a contract, therefore, would be recognized as expenses when incurred. BC299. Many respondents disagreed with recognizing all costs to obtain a contract as expenses when incurred because those costs meet the definition of an asset in some cases. In addition, they noted the following: Page 4 of 18

5 a. Other Topics require some of the costs of obtaining a contract to be included in the carrying amount of an asset on initial recognition. b. The recognition of the costs of obtaining a contract as expenses would be inconsistent with the tentative decisions in the Boards projects on leases and insurance contracts. BC300. During the redeliberations, the Boards decided that, in some cases, it might be misleading for an entity to recognize all the costs of obtaining a contract as expenses when incurred. For example, the Boards observed that recognizing the full amount of a sales commission as an expense at inception of a long-term service contract (when that sales commission is reflected in the pricing of that contract and is expected to be recovered) would fail to acknowledge the existence of an asset. BC301. Consequently, the Boards decided that an entity would recognize an asset from the costs of obtaining a contract and would present the asset separately from the contract asset or the contract liability. To limit the acquisition costs to those that clearly can be identified as relating specifically to a contract, the Boards decided that only the incremental costs of obtaining a contract should be included in the measurement of the asset if the entity expects to recover those costs. The Boards decided that determining whether other costs relate to a contract is too subjective. [Emphasis added.] 12. The Board s proposal to capitalize incremental costs to obtain a contract included in the 2011 Revenue Recognition ED was finalized in the new revenue standard. Paragraph states that incremental costs to obtain a contract are those costs that an entity would not have incurred if the contracts had not been obtained. Paragraph states that costs to obtain a contract that would have been incurred regardless of whether the contract was obtained shall be recognized as an expense when incurred. 13. In the staff s view, a way to think about the guidance in those paragraphs is: would Examples the entity incur the cost if the customer (or the entity) decided, just as the parties are about to the sign the contract, that it will not enter into the contract? If the costs would have been incurred even though the contract was not executed, then they are not incremental costs of obtaining a contract. 14. The following examples are intended to illustrate how the guidance about incremental costs to obtain a contract could be applied to various fact patterns. Some of the Page 5 of 18

6 questions are more basic than the ones being asked in practice, but the staff thinks they can be instructive in answering more complex questions. Fixed Employee Salaries 15. Consider the following example: Example 1: An entity pays an employee an annual salary of $100,000. The employee s salary is based upon the employee s prior-year signed contracts and the employee s projected signed contracts for the current year. The employee s salary will not change based on the current year s actual signed contracts; however, salary in future years likely will be impacted by the current year s actual signed contracts. What amount, if any, should the entity record as an asset for incremental costs to obtain a contract during the year? View A: Determine what portion of the employee s salary is related to sales projections and allocate that portion of the salary as an incremental cost to obtain a contract. View B: Do not capitalize any portion of the employee s salary as an incremental cost to obtain a contract. The costs are not incremental costs to any contract because the costs would have been incurred regardless of the employee s signed contracts in the current year. 16. In the staff s view, View B is the appropriate application of the new revenue standard. The staff thinks that none of the employee s salary should be capitalized as an incremental cost to obtain a contract. This is because the costs associated with the employee s salary are not incremental costs that result from obtaining a specific revenue contract. Whether the employee sells 100 contracts, 10 contracts, or no contracts, the employee is still only entitled to a fixed salary. 17. The staff thinks it is important to note that the objective of the requirements in paragraph is not to allocate costs that are associated in some manner with an entity s marketing and sales activity. The objective is to identify the incremental costs that an entity would not have incurred if the contract had not been obtained. Some Costs Are Incremental and Some Costs are Not Incremental 18. Consider the following example: Page 6 of 18

7 Example 2: An entity pays a 5% sales commission to its employees when they obtain a contract with a customer. An employee begins negotiating a contract with a prospective customer and the entity incurs $5,000 of legal and travel costs in the process of trying to obtain the contract. The customer ultimately enters into a $500,000 contract and, as a result, the employee receives a $25,000 sales commission. What amount should the entity capitalize as an incremental cost to obtain the contract? View A: The entity should capitalize only $25,000 for the sales commission. Those costs are the only costs that are incremental costs to obtain the contract because the entity would not have incurred the costs if the contract had not been obtained. View B: The entity should capitalize $30,000, which includes the sales commission, legal expenses, and travel expenses. The entity would not have been able to obtain the contract without incurring those expenses. 19. In the staff s view, View A is the appropriate application of the new revenue standard. Incremental costs to obtain a contract are costs that are incurred only as a result of obtaining a contract. The staff thinks that the sales commission is the only cost that the entity would not have incurred if the contract had not been obtained. While the entity incurs other costs that are necessary to facilitate a sale (such as legal, travel and many others), those costs would have been incurred even if the customer decided at the last moment not to execute the contract. 20. Consider a nearly identical situation in which an employee incurs the same type of legal and travel expenses to negotiate a contract, but the customer decides not to enter into the contract right before the contract was to be signed by both parties. In that situation, the travel and legal expenses would still have been incurred even though the contract was not obtained. However, the commission would not have been incurred. Timing of Commission Payments 21. Consider the following example: Example 3: An entity pays an employee a 4% sales commission on all of the employee s signed contracts with customers. For cash flow management, the entity pays the employee half of the commission (2% of Page 7 of 18

8 the total contract value) upon completion of the sale, and the remaining half of the commission (2% of the total contract value) in six months. The employee is entitled to the unpaid commission, even if the employee is no longer employed by the entity when payment is due. An employee makes a sale of $50,000 at the beginning of year one. What amount should the entity capitalize as an incremental cost to obtain the contract? View A: Capitalize half of the commission ($1,000) and expense the other half of the commission ($1,000). View B: Capitalize the entire commission ($2,000). 22. In the staff s view, View B is the appropriate application of the new revenue standard. The commission is an incremental cost that relates specifically to the signed contract and the employee is entitled to the unpaid commission. The staff thinks that the timing of payment does not impact whether the costs would have been incurred if the contract had not been obtained. 23. In this fact pattern, only the passage of time needs to occur for the entity to pay the second half of the commission. However, the staff cautions that there could be other fact patterns in which additional factors might impact the payment of a commission to an employee. For example, an entity could require that an employee sell additional services to the customer to receive the second half of the commission. Or an entity could make the second payment contingent upon the customer completing a favorable satisfaction survey about its first six months of working with the entity. An entity will need to assess its specific compensation plans to determine the appropriate accounting for incremental costs of obtaining a contract. Commissions Paid to Different Levels of Employees 24. Consider the following example: Example 4: An entity s salesperson receives a 10% sales commission on each contract that he or she obtains. In addition, the following employees of the entity receive sales commissions on each signed contract negotiated by the salesperson: 5% to the manager and 3% to the regional manager. Which commissions are incremental costs of obtaining a contract? Page 8 of 18

9 View A: Only the commission paid to the salesperson is considered incremental because the salesperson obtained the contract. View B: Only the commissions paid to the salesperson and the manager are considered incremental because the other employee likely would have had no direct contact with the customer. View C: All of the commissions are incremental because the commissions would not have been incurred if the contract had not been obtained. 25. In the staff s view, View C is the appropriate application of the new revenue standard. The new revenue standard defines incremental costs as those that an entity incurs in its efforts to obtain a contract and those that would not have been incurred if the contract had not been obtained. The new revenue standard does not make a differentiation based on the function or title of the employee that receives the commission. It is the entity that decides which employee(s) are entitled to a commission directly as a result of entering into a contract. 26. Some stakeholders have raised concerns that View C could result in an entity capitalizing several commissions payments for the same contract. In the staff s view, it is possible that several commissions payments are incremental costs of obtaining the same contract. However, the staff encourages those stakeholders to ensure that each of the commissions are incremental costs of obtaining a contract with a customer, rather than variable compensation (for example, a bonus) based on a number of factors (one of which is related to sales). In other words, stakeholders should focus on whether the entity has an obligation to make a payment to the employee as a result of obtaining the contract. Consider a compensation arrangement in which an employee receives a discretionary annual bonus based on the entity (or a business unit within the entity) achieving sales growth targets, minimum profitability levels, and progress toward various strategic goals. Although one of the factors involves sales, the bonus is not an incremental cost of obtaining a contract because there are other factors involved in determining the annual bonus. Therefore, the staff does not think the annual bonus described above would be capitalized as a cost to obtain a contract. Page 9 of 18

10 Commission Payments Subject to a Threshold 27. Consider the following example: Example 5: An entity has a commission program that increases the amount of commission a salesperson receives based on how many contracts the salesperson has obtained during an annual period. The breakdown is as follows: 0-9 contracts... 0% commission contracts. 2% of value of contracts contracts % of value of contracts Which commissions are incremental costs of obtaining a contract? View A: No amounts should be capitalized because the commission is not directly attributable to a specific contract. View B: The costs are incremental costs of obtaining a contract with a customer and, therefore, the costs should be capitalized. 28. In the staff s view, View B is the appropriate application of the new revenue standard. The entity would apply other GAAP to determine whether a liability for the commission payments should be recognized. When a liability is recognized, the entity would recognize a corresponding asset for the commissions. This is because the commissions are incremental costs of obtaining a contract with a customer. The entity has an obligation to pay commissions as a direct result of entering into contracts with customers. The fact that the entity s program is based on a pool of contracts (versus a program in which the entity pays 3% for all contracts) does not change the fact that the commissions would not have been incurred if the entity did not obtain the contracts with those customers. Question 2: How should an entity determine the amortization period for an asset recognized for the incremental costs of obtaining a contract with a customer? 29. In accordance with paragraph , an asset recognized for incremental costs of obtaining a contract with a customer should be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which Page 10 of 18

11 the asset relates. The asset may relate to goods or services to be transferred under a specific anticipated (that is, future) contract. The basis for conclusions in Update explains that amortizing the asset over a longer period than the initial contract would not be appropriate in situations in which an entity pays a commission on a renewal contract that is commensurate with the commission paid on the initial contract. In that case, the acquisition costs from the initial contract do not relate to the subsequent contract. 30. In the staff s view, the amortization guidance in Subtopic is conceptually consistent with the notion of amortizing an asset over its estimated useful life in other Topics. For example, under Topic 350, Intangibles Goodwill and Other, an intangible asset should be amortized over its useful life, as follows: A recognized intangible asset shall be amortized over its useful life to the reporting entity unless that life is determined to be indefinite. If an intangible asset has a finite useful life, but the precise length of that life is not known, that intangible asset shall be amortized over the best estimate of its useful life. The method of amortization shall reflect the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. If that pattern cannot be reliably determined, a straight-line amortization method shall be used. 31. In the staff s view, the use of judgment in estimating the amortization period for an asset representing the incremental costs of obtaining a contract is similar to estimating the amortization or the depreciation period for intangible assets (for example, a customer relationship acquired in a business combination or internal-use software) and tangible assets (for example, a manufacturing plant). The period is inherently subjective and, therefore, it requires judgment. Today, entities are able to estimate useful lives for those other assets and some of those assets are material to the entities financial statements. Entities disclose the estimated useful lives and the amortization and depreciation expense for the period. The staff is not aware of issues associated with current practice on amortization or depreciation from financial statement users, preparers, or auditors. 32. In the staff s view, the following are some items to consider when estimating the amortization period of an asset arising from incremental costs of obtaining a contract: Page 11 of 18

12 a. Identify the contract(s) to which the commission relates In accordance with paragraph , an entity must determine whether the capitalized incremental costs (such as sales commissions) relate to goods or services that will be transferred only as a part of the initial contract or if the costs also relate to goods or services that will be transferred as a part of a specific anticipated contract(s). See Question 2a for further analysis. b. Determine whether a commission on a renewal contract is commensurate with the commission on the initial contract If an entity pays a commission on a renewal contract, then the entity must determine whether the commission on the renewal contract is commensurate with the commission on the initial contract. See Question 2b for further analysis about determining whether a commission is commensurate. If an entity determines that the renewal commission is commensurate with the initial commission, then the asset would be amortized over the initial contract term. That is because the commission from the initial contract does not relate to the renewal contract. However, if an entity determines that the renewal commission is not commensurate with the initial commission, then the entity should assess the period to which the asset relates, potentially including specific anticipated contract(s). c. Evaluate facts and circumstances to determine an appropriate amortization period If an entity determines that the commission on the renewal contract is not commensurate with the commission on the initial contract (or there is no commission on the renewal contract), the staff thinks the new revenue standard requires that the amortization period extend beyond the initial contract term if there are anticipated renewals with goods or services that relate to the costs of obtaining the initial contract. An entity will need to evaluate its specific facts and circumstances to determine an appropriate amortization period. The staff does not think the new revenue standard requires an entity to amortize the asset over the average customer term (or life), but rather that an entity should use judgment in its determination of the goods or services to which that asset relates, which might include not only the goods or services to be transferred during the Page 12 of 18

13 initial contract term, but also the term of specific anticipated renewal contracts. Some entities might conclude that its best estimate of the amortization period is the average customer term because the costs to obtain a contract relate to goods or services to be provided throughout the average customer term. The staff thinks using an amortization period equal to the average customer term is a reasonable application of the new revenue standard provided that the facts and circumstances do not clearly indicate that the average customer term is inconsistent with the amortization guidance in paragraph The staff cautions that the average customer term might not always be the same as the average amount of time that a third party has been a customer. For example, assume that an entity has been in business for decades and enjoys long-term relationships with many of its customers with an average customer life of twenty years. In most industries, the goods and services that an entity was providing two decades ago are very different from the goods and services the entity currently provides to its customers. Under paragraph , an asset recognized for incremental costs of obtaining a contract with a customer should be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. The staff thinks it is unlikely that a commission paid twenty years ago has any relationship to the goods or services provided today. d. Disclosure Subtopic includes disclosure requirements about costs to obtain a contract. The staff thinks that an ideal time for an entity to consider those disclosure requirements is when it is making judgments and estimates about what costs are incremental and the amortization period for those incremental costs. The following are the disclosure requirements: Consistent with the overall disclosure objective in paragraph and the guidance in paragraphs through 50-3, an entity shall provide the following disclosures of assets recognized from the costs to obtain or fulfill a contract with a customer in accordance with paragraphs or An entity shall describe both of the following: Page 13 of 18

14 a. The judgments made in determining the amount of the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph or ) b. The method it uses to determine the amortization for each reporting period An entity shall disclose all of the following: a. The closing balances of assets recognized from the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph or ), by main category of asset (for example, costs to obtain contracts with customers, precontract costs, and setup costs) b. The amount of amortization and any impairment losses recognized in the reporting period. Question 2a: How should an entity determine whether a sales commission relates to goods or services to be transferred under a specific anticipated contract? 33. Paragraph provides guidance that an entity should amortize the asset from incremental costs of obtaining a contract on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. During the development of the new revenue standard, the Board discussed whether the asset should be amortized solely based on goods or services transferred under the initial contract, or whether the asset could relate to goods or services under potential future contracts. The Board decided that the asset could relate to goods or services under a specific anticipated contract. 34. The staff thinks that judgment should be applied to an entity s specific facts and circumstances when determining to which contract(s) a commission relates. If an entity pays a commission based only on the initial contract without an expectation that the contract will be renewed (based on its past experience or other relevant information), the staff thinks amortizing the asset over the initial contract term would be an appropriate application of the new revenue standard. However, if the entity s past experience indicates that a contract renewal is likely, then the amortization period could be longer than the initial contract term if the asset relates to goods or services to be provided during the contract renewal term. Page 14 of 18

15 35. Example 2 in paragraphs through 55-9 illustrates a circumstance in which an entity pays a commission associated with an information technology outsourcing arrangement. The initial contract term is five years and the contract is renewable for subsequent one-year periods. The entity s average customer term is 7 years. In this example, the entity amortizes the asset over seven years because it concludes that the asset relates to the services transferred to the customer during the contract term of five years and the entity anticipates that the contract will be renewed for two subsequent one-year periods. 36. The conclusion in Example 2 that the asset relates to future contracts will not always be an appropriate conclusion in every fact pattern. For example, an entity might have no history of renewals. Therefore, an entity will need to evaluate its facts and circumstances to make a judgment about the amortization period. Question 2b: If a sales commission is paid for an initial contract and also paid for contract renewals, how should an entity evaluate whether the sales commission paid on the contract renewal is commensurate with the sales commission paid on the initial contract? 37. In BC309 of Update , the Board stated that amortizing an asset over a longer period than the initial contract would not be appropriate in situations in which an entity pays a commission on a contract renewal that is commensurate with the commission paid on the initial contract, as follows: BC309. The Boards decided that an entity should amortize the asset recognized from the costs of obtaining and fulfilling a contract in accordance with the pattern of transfer of goods or services to which the asset relates. Respondents broadly agreed; however, some asked the Boards to clarify whether those goods or services could relate to future contracts. Consequently, the Boards clarified that in amortizing the asset in accordance with the transfer of goods or services to which the asset relates, those goods or services could be provided under a specifically anticipated (that is, future) contract. That conclusion is consistent with the notion of amortizing an asset over its useful life and with other standards. However, amortizing the asset over a longer period than the initial contract would not be appropriate in situations in which an entity pays a commission on a contract renewal that is commensurate with the commission paid on the initial contract. In that case, the acquisition costs from the initial contract do not relate to the subsequent contract. Page 15 of 18

16 38. Stakeholders have raised questions about how an entity should interpret the term commensurate when determining the appropriate amortization period (for example, when a commission is paid for renewal contracts, but at a rate less than the initial commission). TRG Agenda Ref No. 23 included discussion about this specific stakeholder concern. The following is an excerpt from that paper. 22. The Oxford English Dictionary defines commensurate as: corresponding in size or degree, in proportion giving the examples salary will be commensurate with age and experience and such heavy responsibility will receive commensurate reward. 23. The staff think that, in general, it would be reasonable for an entity to conclude that a renewal commission is commensurate with an initial commission if the two commissions are reasonably proportional to the respective contract value (for example, 5% of the contract value is paid for both the initial and the renewal contract). Similarly, the staff think it would be reasonable for an entity to conclude that a renewal commission is not commensurate with an initial commission if it is disproportionate to the initial commission (for example, 2% renewal commission as compared to a 6% initial contract commission). The staff do not think entities should have to undertake complex analyses to demonstrate a proportional renewal commission is commensurate with an initial commission or to demonstrate that a disproportionate renewal commission is not commensurate with an initial contract submission. 24. However, in practice, it is not unusual for it to be no more difficult to obtain a renewal than it is to secure the initial contract, or it might be less difficult as the incumbent of a contract to secure a renewal (for example, if there are barriers to the customer changing supplier or it is costly or difficult to establish new customer relationships). Accordingly, in some circumstances, if the renewal commission is less than the initial commission, it might still be commensurate with the initial commission. This will depend on the specific facts and circumstances and, therefore, judgment might be required. 39. The discussion at the January 2015 TRG meeting indicated that stakeholders can understand and apply the applicable guidance in the new revenue standard in a manner that the staff believes is consistent with the standard and, therefore, the staff did not recommend that the Board take any further action at that time. 40. However, subsequent to the January 2015 TRG meeting, some stakeholders informed the staff that they interpret paragraph 24 from TRG Agenda Ref No. 23 to mean that any entity can consider whether (a) the initial commission is commensurate with the Page 16 of 18

17 level of effort to obtain the initial contract and (b) the renewal commission is commensurate with the level of effort to obtain the renewal contract. For example, assume the initial commission rate is 7% and the renewal commission rate is 2%. The entity concludes that the commission paid for the initial contract and the commission paid for the renewal contract are commensurate with the level of effort of obtaining each of those contracts. The rates are different because the sales group that obtains a new contract spends substantially more time winning new business than a different sales group spends obtaining customer renewals. Under this interpretation of some stakeholders, the anticipated contract renewal would not be included in the amortization period of the asset for the initial commission. 41. The interpretation by some stakeholders of paragraph 24 in TRG Agenda Ref No. 23 that an assessment of commensurate can be based on level of effort is not consistent with the staff s intention in writing that paper. The staff does not think that interpretation is consistent with Subtopic In the staff s view, the key question is not whether a commission is commensurate with the level of effort to obtain the contract. The level of effort is about the past and it is not about the period over which the entity will transfer goods or services to which the asset relates. The staff expects that most entities pay their employees a commission that is commensurate with the level of effort required to obtain the business, whether it be to obtain an initial contract or a renewal contract. In the staff s view, the key question is about the transfer to the customer of goods or services to which the asset relates considering the initial contract and specific anticipated contracts. 42. In the staff s view, the example provided in paragraph 23 of TRG Agenda Ref 23 is a straightforward way to determine whether the renewal commission is commensurate with the initial commission. The staff thinks this approach is consistent with the new revenue standard and is a practical approach to assessing whether the commissions paid for the initial and renewal contracts are commensurate. 43. During the staff s outreach on this implementation question, some stakeholders raised concerns with the staff s view. First, some note that the staff view might impact an entity s ability to apply the practical expedient in paragraph (if the amortization period is a year or less, costs can be expensed as incurred). Second, some note that recognizing the asset in the year of adoption could involve significant Page 17 of 18

18 costs to gather sufficient data to measure the asset for incremental costs of obtaining a contract. The further back an entity must go to determine the asset upon initial application (that is, the longer the amortization period), the higher the costs. The staff has reported those concerns to the Board. Question for the TRG Members 1. Do the TRG members agree with the staff s analysis in this paper? Page 18 of 18