Retouching Revenue FASB Clarifies Guidance on Licensing and Identifying Performance Obligations. by Mark Crowley and PJ Theisen, Deloitte & Touche LLP

Transcription

1 April 15, 2016 Vlume 23, Issue 11 Heads Up In This Issue Intrductin Identifying Perfrmance Obligatins Under Step 2 f the Revenue Standard Licensing Implementatin Guidance Transitin and Effective Date Appendix Cmparisn f the FASB s and IASB s Guidance Retuching Revenue FASB Clarifies Guidance n Licensing and Identifying Perfrmance Obligatins by Mark Crwley and PJ Theisen, Delitte & Tuche LLP Intrductin On April 14, 2016, the FASB issued ASU , 1 which amends certain aspects f the Bard s new revenue standard, 2 specifically the standard s guidance n identifying perfrmance bligatins and the implementatin guidance n licensing. The amendments in the ASU reflect feedback received by the FASB-IASB jint revenue recgnitin transitin resurce grup, which was frmed t address ptential issues assciated with the implementatin f the new revenue standard, as well as cmments received frm stakehlders n the FASB s prpsed guidance. ASU amends the guidance n the fllwing: Identifying perfrmance bligatins: Immaterial prmised gds r services Entities may disregard gds r services prmised t a custmer that are immaterial in the cntext f the cntract. Shipping and handling activities Entities can elect t accunt fr shipping r handling activities ccurring after cntrl has passed t the custmer as a fulfillment cst rather than as a revenue element (i.e., a prmised service in the cntract). Identifying when prmises represent perfrmance bligatins The new guidance refines the separatin criteria fr assessing whether prmised gds and services are distinct, specifically the separately identifiable principle (the distinct within the cntext f the cntract criterin) and supprting factrs. Licensing implementatin guidance: Determining the nature f an entity s prmise in granting a license Intellectual prperty (IP) is classified as either functinal r symblic, and such classificatin shuld generally dictate whether, fr a license granted t that IP, revenue must be recgnized at a pint in time r ver time, respectively. Sales-based and usage-based ryalties The sales-based and usage-based ryalty exceptin applies whenever the ryalty is predminantly related t a license f IP. The ASU therefre indicates that an entity shuld nt split a sales-based r usage-based ryalty int a prtin subject t the recgnitin guidance n sales-based and usage-based ryalties and a prtin that is nt subject t that guidance. 1 FASB Accunting Standards Update N , Identifying Perfrmance Obligatins and Licensing. 2 FASB Accunting Standards Update N , Revenue Frm Cntracts With Custmers; issued as IFRS 15 by the IASB.

2 Restrictins f time, gegraphical lcatin, and use The ASU s examples illustrate the distinctin between restrictins that represent attributes f a license and prvisins that specify that additinal licenses have been prvided. Renewals f licenses that prvide a right t use IP Revenue shuld nt be recgnized fr renewals r extensins f licenses t use IP until the renewal perid begins. This Heads Up prvides backgrund n the ASU and summarizes its key prvisins. Editr s Nte: On April 12, 2016, the IASB issued clarificatins t IFRS 15 that address (1) identifying perfrmance bligatins, (2) principal-versus-agent cnsideratins, and (3) licensing. They als prvide sme transitin relief fr mdified cntracts and cmpleted cntracts. See the appendix f this Heads Up fr a cmparisn f the IASB s and FASB s guidance. Fr mre infrmatin abut the IASB s clarificatins t IFRS 15, see the IASB s Web site. Identifying Perfrmance Obligatins Under Step 2 f the Revenue Standard Immaterial Prmised Gds r Services Under step 2 f the new revenue standard, an entity must (1) identify the gds r services it has prmised t the custmer in a cntract and (2) determine whether thse prmised gds r services are perfrmance bligatins (i.e., because they are distinct frm each ther). Because f the wrding in paragraphs BC87 thrugh BC90 f the new revenue standard s Basis fr Cnclusins, sme stakehlders questined whether the FASB and IASB intended perfrmance bligatins that are nt identified as deliverables under existing revenue guidance t be identified as perfrmance bligatins under the new standard. Unlike the SEC s guidance in SAB Tpic 13.A, the revenue standard des nt cntain guidance n incnsequential r perfunctry items. In fact, the Basis fr Cnclusins ntes that the Bards decided nt t exempt an entity frm accunting fr prmised gds r services that the entity might regard as being perfunctry r incnsequential. Instead, an entity shuld assess whether thse prmised gds r services are immaterial t its financial statements. Accrdingly, questins arse abut whether it was necessary fr an entity t identify immaterial gds r services when identifying perfrmance bligatins. Editr s Nte: Cnstituents als were cncerned that the new revenue standard culd, unlike current U.S. GAAP, result in the treatment f certain marketing incentives as perfrmance bligatins rather than as expenses. In a meeting mem, the FASB cnfirmed that marketing incentives shuld be evaluated under the guidance n identifying perfrmance bligatins. Key Prvisins f the ASU ASU states that an entity is nt required t assess whether prmised gds r services are perfrmance bligatins if they are immaterial in the cntext f the cntract with the custmer. In additin, the ASU indicates that an entity shuld cnsider materiality f items r activities nly at the cntract level (as ppsed t aggregating such items and perfrming an assessment at the financial statement level). This change shuld nt apply t an entity s assessment f ptinal gds and services ffered t a custmer, which the entity must evaluate under ASC and t determine whether they give the custmer a material right (i.e., an ptinal gd ffered fr free r at 3 Fr titles f FASB Accunting Standards Cdificatin (ASC) references, see Delitte s Titles f Tpics and Subtpics in the FASB Accunting Standards Cdificatin. 2

3 a discunt, such as that prvided thrugh lyalty pint prgrams, may nt be material fr an individual cntract but culd be material in the aggregate and accunted fr as a material right). Editr s Nte: The ASU permits entities t chse nt t evaluate whether immaterial items r activities represent perfrmance bligatins. Thus, the exclusin f such immaterial items r activities under the new revenue standard wuld nt be cnsidered a departure frm GAAP and need nt be aggregated as a misstatement. Shipping and Handling Activities Under existing revenue guidance (i.e., befre the new revenue standard s effective date), an entity generally des nt accunt fr shipping services that it prvides in cnjunctin with the sale f its prducts as an additinal deliverable. Stakehlders asked the FASB t clarify whether shipping and handling services that d nt represent the predminant activity in the cntract shuld be accunted fr as a prmised service (i.e., ptentially a separate perfrmance bligatin t which a prtin f the transactin price must be allcated) r as a fulfillment cst that shuld be accunted fr under the new fulfillment cst guidance in ASC Key Prvisins f the ASU ASU permits an entity t accunt fr shipping and handling activities that ccur after the custmer has btained cntrl f a gd as fulfillment activities (i.e., an expense) rather than as a prmised service (i.e., a revenue element). An entity may als elect t accunt fr shipping and handling as a prmised service. The ASU als explains that shipping and handling activities perfrmed befre the cntrl f a prduct is transferred d nt cnstitute a prmised service t the custmer in the cntract (i.e., they represent fulfillment csts). Editr s Nte: The electin t accunt fr shipping and handling services as a perfrmance bligatin r a fulfillment cst typically shuld nt apply t cmpanies whse principal service ffering is shipping r transprtatin. Further, we believe that such electin (1) shuld be applied cnsistently and (2) is available t entities that recgnize revenue fr the sale f gds at either a pint in time r ver time. Example An entity sells a prduct t its custmer with free-n-bard shipping-pint terms n December 31, 20X8 (and determines that cntrl is transferred t the custmer as f that date). The prduct is shipped by a third-party carrier at the entity s directin. The prduct arrives at the custmer s lcatin n January 5, 20X9. Cnsideratin paid by the custmer is $1,000. Under the ASU, the entity can elect t accunt fr the shipping activities as a prmised service in the cntract (a separate perfrmance bligatin) r as a fulfillment cst. If the entity elects t accunt fr the shipping service as a separate perfrmance bligatin, the entity wuld be required t allcate the $1,000 f cnsideratin between the prduct and the shipping services. The prtin f the cnsideratin allcated t the prduct wuld be recgnized n December 31, 20X8 (when cntrl f the prduct is transferred t the custmer), and the prtin allcated t the shipping services wuld be recgnized as thse services ccur (mst likely ver the days the prduct was in transit). If the entity elects t accunt fr the shipping activity as a fulfillment cst rather than a prmised service in the cntract, the entity wuld recgnize the entire $1,000 as revenue and accrue any csts related t the shipping activity n December 31, 20X8 (i.e., when cntrl f the prduct is transferred t the custmer). 3

4 Identifying When Prmises Represent Perfrmance Obligatins The new revenue standard requires entities t identify distinct gds r services as perfrmance bligatins. A gd r service is distinct if (1) the custmer can benefit frm [it] n its wn r tgether with ther resurces that are readily available t the custmer and (2) the entity s prmise t transfer the gd r service t the custmer is separately identifiable frm ther prmises in the cntract. The first criterin is similar t the cncept f stand-alne value under current U.S. GAAP. Hwever, stakehlders requested that the FASB prvide additinal guidance n the secnd criterin that clarifies when a prmise is separately identifiable. Key Prvisins f the ASU ASU clarifies the intent f the separately identifiable principle in ASC by prviding three factrs that indicate that an entity s prmises t transfer gds r services t a custmer are nt separately identifiable in a manner cnsistent with the ntin f separable risks. Accrdingly, the fcus is nw n the bundle f gds r services instead f individual gds r services. The ASU amends ASC as fllws (added text is underlined, and deleted text is struck ut): In assessing whether an entity s prmises t transfer gds r services t the custmer are separately identifiable in accrdance with paragraph (b), the bjective is t determine whether the nature f the prmise within the cntext f the cntract, is t transfer each f thse gds r services individually r, instead, t transfer a cmbined item r items t which the prmised gds r services are inputs. Factrs that indicate that an entity s tw r mre prmises prmise t transfer a gd gds r services service t a custmer isare nt separately identifiable (in accrdance with paragraph (b)) include, but are nt limited t, the fllwing: a. The entity des nt prvide prvides a significant service f integrating the gd gds r services service with ther gds r services prmised in the cntract int a bundle f gds r services that represent the cmbined utput r utputs fr which the custmer has cntracted. In ther wrds, the entity is nt using the gd gds r services service as inputs an input t prduce r deliver the cmbined utput r utputs specified by the custmer. A cmbined utput r utputs might include mre than ne phase, element, r unit. b. One r mre f the gds r services significantly mdifies r custmizes, r are significantly mdified r custmized by, ne r mre f the ther gds r services prmised in the cntract. The gd r service des nt significantly mdify r custmize anther gd r service prmised in the cntract. c. The gds r services are highly interdependent r highly interrelated. In ther wrds, each f the gds r services is significantly affected by ne r mre f the ther gds r services in the cntract. Fr example, in sme cases, tw r mre gds r services are significantly affected by each ther because the entity wuld nt be able t fulfill its prmise by transferring each f the gds r services independently. The gd r service is nt highly dependent n, r highly interrelated with, ther gds r services prmised in the cntract. Fr example, the fact that a custmer culd decide t nt purchase the gd r service withut significantly affecting the ther prmised gds r services in the cntract might indicate that the gd r service is nt highly dependent n, r highly interrelated with, thse ther prmised gds r services. T further clarify this principle and the supprting factrs, the ASU adds six new examples and amends ther examples t demnstrate the applicatin f the guidance t several different industries and fact patterns. 4

5 Editr s Nte: Despite the ASU s clarificatin f the separately identifiable principle, an entity must use judgment in identifying when prmises represent perfrmance bligatins. Fr instance, Case A in the ASU s Example 11 cncludes that an installatin service that is rutinely perfrmed by ther entities is distinct. Hwever, services d nt need t be prvided by ther parties fr an entity t reach a cnclusin under the revenue standard that they are distinct. Entities must therefre carefully assess situatins in which ther entities d nt prvide the same gd r service. Licensing Implementatin Guidance Determining the Nature f an Entity s Prmise in Granting a License The new revenue standard cntains implementatin guidance n an entity s prmise t grant a license f its IP 4 and requires entities t determine whether the license grants custmers a right t use the underlying IP (which shuld result in pint-in-time revenue recgnitin) r a right t access the IP (which shuld result in revenue recgnitin ver time). This determinatin hinges n whether the licensr s nging activities are expected t significantly affect the underlying IP. Stakehlders questins fcused mainly n (1) the nature f the licensr s activities that affect the IP and (2) hw entities shuld evaluate the impact f such activities n the IP (e.g., the effect n the IP s frm and functinality, value, r bth). Key Prvisins f the ASU The ASU revises the guidance in ASC 606 t distinguish between tw types f licenses: (1) functinal IP and (2) symblic IP, which are classified accrding t whether the underlying IP has significant standalne functinality (e.g., the ability t prcess a transactin, perfrm a functin r task, r be played r aired). Functinal IP represents a right t use the IP and shuld be recgnized at a pint in time, whereas symblic IP represents a right t access and shuld be recgnized ver time. Examples f functinal IP include sftware, bilgical cmpunds r drug frmulas, and cmpleted media cntent (fr example, films, televisin shws, r music). Examples f symblic IP include brands, team r trade names, lgs, and franchise rights. 4 ASC thrugh 55-64; paragraphs B52 thrugh B62 f IFRS 15. 5

6 The flwchart belw, which is reprduced frm the ASU, depicts the decisin prcess an entity shuld use in determining whether a license t IP represents a right t access r a right t use the IP. Start Des the intellectual prperty t which the custmer has rights have significant standalne functinality? (paragraph ) N The intellectual prperty t which the custmer has rights is symblic. The nature f the entity s prmise is t prvide the custmer with a right t access the entity s intellectual prperty. (paragraph ) Yes The intellectual prperty t which the custmer has rights is functinal. Is the functinality f the intellectual prperty expected t substantively change during the license perid as a result f activities f the entity that d nt transfer a gd r service t the custmer? (paragraph (a)) N The nature f the entity s prmise is t prvide the custmer with a right t use the entity s intellectual prperty. (paragraph ) Yes Is the custmer cntractually r practically required t use the updated intellectual prperty? (paragraph (b)) N Yes The nature f the entity s prmise is t prvide the custmer with a right t use the entity s intellectual prperty. (paragraph ) The nature f the entity s prmise is t prvide the custmer with a right t access the entity s intellectual prperty. (paragraph ) Sales-Based and Usage-Based Ryalties The new revenue standard cntains specific guidance n sales- r usage-based ryalties prmised in exchange fr licenses f IP, ften referred t as the ryalty cnstraint exceptin. 5 In such arrangements, entities must recrd revenue at the later f when (1) the subsequent sale r usage ccurs r (2) the related perfrmance bligatin has been fully r partially satisfied. Otherwise, entities wuld need t apply the general cnstraint guidance t estimate the amunt f variable cnsideratin t include in the transactin price (i.e., the amunt f variable cnsideratin that wuld nt be subject t significant revenue reversal) and reassess it. 6 5 ASC ; paragraph B63 f IFRS ASC thrugh 32-14; paragraphs 56 thrugh 59 f IFRS 15. 6

7 Stakehlders expressed uncertainty abut hw t apply the ryalty cnstraint when a license is bundled with ther gds r services in a cntract (e.g., franchise licenses with training services). Sme suggested that under the new revenue standard, entities wuld need t split a single ryalty and accunt fr a prtin f it under the ryalty cnstraint exceptin and the remainder under the general variable cnsideratin cnstraint guidance. Key Prvisins f the ASU The ASU indicates that the ryalty cnstraint guidance shuld be applied either (1) when the ryalty nly pertains t a license f IP r (2) when a license f IP is the predminant item t which the ryalty relates (fr example, the license f intellectual prperty may be the predminant item t which the ryalty relates when the entity has a reasnable expectatin that the custmer wuld ascribe significantly mre value t the license than t the ther gds r services t which the ryalty relates). The ASU rejects the ntin f splitting ryalties, indicating that ding s wuld be cmplex and may nt yield useful infrmatin. Nte that this guidance applies nly t licenses f IP and nt sales f IP. Editr s Nte: Entities need t use judgment t determine whether a license f IP when bundled with ther gds r services (i.e., the license is nt a distinct perfrmance bligatin) is the predminant item t which the ryalty is related. The change permits brader applicatin f the ryalty cnstraint and eliminates the ptential need t apply variable cnsideratin and ryalty cnstraint guidance t different prtins f a single ryalty. Restrictins f Time, Gegraphical Lcatin, r Use After the issuance f the new revenue standard, stakehlders sught guidance n the effect f cntractual restrictins n the accunting fr licenses f IP under ASC 606. Their views differed abut whether cntractual restrictins culd affect the number f licenses granted t the custmer r whether such restrictins simply represented attributes f the license. Key Prvisins f the ASU Examples in the ASU clarify that restrictins f time, gegraphical regin, r use affect the scpe f the custmer s right t use r right t access the entity s IP (i.e., they are attributes f a license) and d nt define the nature f the license (i.e., functinal versus symblic). Hwever, restrictins shuld be distinguished frm cntractual prvisins that, explicitly r implicitly, require the entity t transfer additinal gds r services (including additinal licenses) t the custmer (e.g., an entity that prmises a license t a sng that can be used in ne specific cuntry during the first year f the license but, during the secnd year f the license, can be used thrughut the entire wrld effectively prmises t prvide ne license at the start f the first year and anther license at the start f the secnd year). Renewals f Licenses That Prvide a Right t Use IP During the FASB s utreach n the prpsed ASU, questins arse n the timing f recgnizing revenue related t an extensin r renewal f a license that prvides a right t use an entity s IP (revenue recgnized at a pint in time). Since the IP is already available t the custmer at the time the custmer decides t renew, it was unclear whether revenue related t the renewal perid shuld be recgnized at the time the custmer agreed t renew r at the beginning f the renewal perid. 7

8 Key Prvisins f the ASU Under the prpsed guidance, it wuld have been apprpriate t recgnize revenue fr an extensin f an riginal license in which the IP had already been delivered at the time the extensin was agreed upn. Hwever, the Bard ultimately decided t require entities t recgnize revenue related t a renewal when the renewal perid begins. The Bard nted that a renewal license is subject t the same revenue recgnitin requirements as any ther license that grants additinal rights t the custmer. Editr s Nte: The ASU s guidance n renewals r extensins f licenses will be a change fr certain entities that apply ASC thrugh n renewals f sftware licenses. That guidance permits entities t recgnize revenue fr a right t use a license that is being extended r renewed fr a preexisting, currently active license fr the same prduct when the extensin is agreed upn. Transitin and Effective Date The ASU s effective date and transitin prvisins are aligned with the requirements in the new revenue standard, which is nt yet effective. 8

9 Appendix Cmparisn f the FASB s and IASB s Guidance The fllwing table cmpares the FASB s guidance n identifying perfrmance bligatins and its licensing implementatin guidance under ASU with the IASB s guidance as a result f its recently issued clarificatins t IFRS 15: Tpic FASB s Guidance IASB s Guidance Cmparisn Identifying Perfrmance Obligatins Immaterial prmised gds r services An entity is permitted t evaluate the materiality f prmises at the cntract level; if the prmises are immaterial, the entity des nt need t evaluate such prmises further. N changes t IFRS 15. The ASU clarifies but des nt change the revenue standard s guidance; therefre, divergence is nt expected. Shipping and handling activities Identifying when prmises represent perfrmance bligatins Licensing Implementatin Guidance Determining the nature f an entity s prmise in granting a license Sales-based and usage-based ryalties Restrictins f time, gegraphical lcatin, and use Renewals f licenses that prvide a right t use IP Clarifies that shipping and handling activities that ccur befre cntrl is transferred t the custmer are fulfillment csts. Allws entities t elect a plicy t treat shipping and handling activities as fulfillment csts if they ccur after cntrl is transferred. Reframes the separatin criteria t fcus n a bundle f gds r services. Adds illustrative examples. Requires an entity t characterize the nature f a license as either functinal r symblic. Clarifies that rather than splitting a ryalty (and applying bth the ryalty and general cnstraints t it), an entity wuld apply the ryalty cnstraint if the license is the predminant feature t which the ryalty is related. Distinguishes cntractual prvisins that require an entity t transfer additinal licenses t a custmer frm thse that define the attributes f a prmised license. Adds guidance and an example t clarify that a renewal r extensin f a license is subject t the use and benefit guidance, which will result in revenue recgnitin at the beginning f the renewal perid. N similar plicy chice is available fr shipping and handling activities after cntrl is transferred. Same as FASB s guidance. Clarifies the guidance n when an entity is expected t undertake activities that will significantly affect intellectual prperty and, if s, t characterize a license as a right t use. Same as FASB s guidance. N changes t IFRS 15. N changes t IFRS 15. The decisin t nt allw a plicy electin will result in divergence. Entities that adpt IFRSs will need t determine whether shipping and handling after cntrl has transferred is a perfrmance bligatin. Cntinued cnvergence is expected. The decisins are different and will result in divergence. Althugh the accunting fr many licenses will be similar under bth U.S. GAAP and IFRSs, sme licenses may be accunted fr differently. The decisins are the same; cntinued cnvergence is expected. The ASU clarifies but des nt change the revenue standard s guidance; therefre, divergence is nt expected. The decisins are different and will result in divergence. Therefre, depending n facts and circumstances, revenue fr license renewals may be recgnized sner fr entities that reprt under IFRSs. 9

10 Subscriptins If yu wish t subscribe t Heads Up and ther Delitte accunting publicatins, please register at subscriptins. Dbriefs fr Financial Executives We invite yu t participate in Dbriefs, Delitte s webcast series that delivers practical strategies yu need t stay n tp f imprtant issues. Gain access t valuable ideas and critical infrmatin frm webcasts in the Financial Executives series n the fllwing tpics: Business strategy and tax. Financial reprting fr taxes. Transactins and business events. Driving enterprise value. Gvernance, risk, and cmpliance. Financial reprting. Technlgy. Dbriefs als prvides a cnvenient and flexible way t earn CPE credit right at yur desk. Subscribe t Dbriefs t receive ntificatins abut future webcasts at Technical Library and US GAAP Plus Delitte makes available, n a subscriptin basis, access t its nline library f accunting and financial disclsure literature. Called Technical Library: The Delitte Accunting Research Tl, the library includes material frm the FASB, EITF, AICPA, PCAOB, IASB, and SEC, in additin t Delitte s wn accunting and SEC manuals and ther interpretive accunting and SEC guidance. Updated every business day, Technical Library has an intuitive design and navigatin system that, tgether with its pwerful search features, enable users t quickly lcate infrmatin anytime, frm any cmputer. Technical Library subscribers als receive Technically Speaking, the weekly publicatin that highlights recent additins t the library. Fr mre infrmatin, including subscriptin details and an nline demnstratin, visit In additin, be sure t visit US GAAP Plus, ur free Web site that features accunting news, infrmatin, and publicatins with a U.S. GAAP fcus. It cntains articles n FASB activities and updates t the FASB Accunting Standards Cdificatin as well as develpments f ther U.S. and internatinal standard setters and regulatrs, such as the PCAOB, AICPA, SEC, IASB, and IFRS Interpretatins Cmmittee. Check it ut tday! Heads Up is prepared by members f Delitte s Natinal Office as develpments warrant. This publicatin cntains general infrmatin nly and Delitte is nt, by means f this publicatin, rendering accunting, business, financial, investment, legal, tax, r ther prfessinal advice r services. This publicatin is nt a substitute fr such prfessinal advice r services, nr shuld it be used as a basis fr any decisin r actin that may affect yur business. Befre making any decisin r taking any actin that may affect yur business, yu shuld cnsult a qualified prfessinal advisr. Delitte shall nt be respnsible fr any lss sustained by any persn wh relies n this publicatin. As used in this dcument, Delitte means Delitte & Tuche LLP, a subsidiary f Delitte LLP. Please see fr a detailed descriptin f the legal structure f Delitte LLP and its subsidiaries. Certain services may nt be available t attest clients under the rules and regulatins f public accunting. Cpyright 2016 Delitte Develpment LLC. All rights reserved. Member f Delitte Tuche Thmatsu Limited.