New Developments Summary

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1 May 10, 2016 NDS New Developments Summary FASB Transition Resource Group for Revenue Recognition meeting highlights Summary of April 18 meeting Summary The U.S. based members of the Joint Transition Resource Group for Revenue Recognition (FASB TRG) met on April 18 to discuss the following topics related to implementing the new revenue recognition standard: Scoping considerations for asset manager incentive-based capital allocations How to consider the class of customer when evaluating customer options Scoping considerations for financial institutions How control transfers over time Contract asset treatment in contract modifications This bulletin summarizes the highlights of the meeting. While the FASB TRG did not reach general agreement on the scope of incentive-based capital allocations and how to consider the class of customer when evaluating customer options, it did reach general agreement on the latter three topics listed above. The TRG does not publish authoritative guidance; rather, it provides a forum for stakeholders to learn about the new revenue standard as the TRG members discuss various implementation questions submitted by stakeholders with the FASB members and staff. In a recent public statement, 1 James Schnurr, Chief Accountant of the U.S. Securities and Exchange Commission (SEC), commented that the SEC expects registrants to monitor the TRG discussions and advised consultation with the SEC Office of the Chief Accountant when a registrant intends to select and implement an accounting policy for revenue that is inconsistent with the TRG discussions. 1 Remarks before the 12th Annual Life Sciences Accounting and Reporting Congress on March 22, 2016.

2 New Developments Summary 2 Contents A. Overview... 2 B. Topics that may require further action... 2 Scope considerations for asset manager incentive-based capital allocations... 2 How to consider the class of customer when evaluating customer options... 3 C. Topics of general agreement... 4 Scoping considerations for financial institutions... 4 How control transfers over time... 5 Contract asset treatment in contract modifications... 6 D. Staff update... 6 E. What s next... 7 A. Overview The Joint Transition Resource Group for Revenue Recognition (TRG) was formed by the FASB and the IASB to help entities implement the revenue recognition guidance in ASC 606 and IFRS 15, both titled Revenue from Contracts with Customers. In early 2016, the IASB stated that it would no longer schedule meetings with the IFRS constituents of the TRG and would instead monitor the activities of the U.S. based TRG meetings. In that regard, the IASB and staff members observed the April 18 TRG meeting. As a result, reference to the TRG throughout the rest of this document refers only to U.S. based TRG members. At its meeting on April 18, the TRG reached general agreement that entities can understand and apply the guidance as currently written in the new revenue standard regarding scoping considerations for financial institutions, how control transfers over time, and contract asset treatment in contract modifications. The TRG did not reach general agreement, however, on the scope of incentive-based capital allocations and how to consider the class of customer when evaluating whether a customer option gives rise to a material right. The FASB will consider whether to take further action on these issues. Although the TRG does not publish authoritative guidance (that is, the TRG does not establish GAAP), recent comments by James Schnurr, Chief Accountant of the U.S. Securities and Exchange Commission (SEC), indicate that the SEC expects registrants to monitor the TRG s discussions. Further, the SEC advises consultation with its Office of the Chief Accountant when a registrant intends to select and implement an accounting policy for revenue that is inconsistent with TRG discussions. B. Topics that may require further action During their discussion, TRG members expressed differing views on the two topics discussed below. As a result, further discussion or clarification may be forthcoming in these areas. Scope considerations for asset manager incentive-based capital allocations The guidance in ASC prescribes the arrangements with customers that are excluded from the scope of ASC 606. Paragraph 61 in the Basis for Conclusions (BC) helps to explain the Board s intent

3 New Developments Summary 3 regarding the scope exceptions that is, if specific guidance in other areas of the Codification deals with a particular transaction, entities should apply the more detailed guidance rather than the general revenue guidance in ASC 606. However, stakeholders, including asset managers, continued to raise questions related to the scope of ASC 606. Asset managers of private equity or real estate fund limited partnerships are commonly compensated, at least in part, through incentive-based fees, which are paid either in cash or through an allocation of capital, commonly referred to as carried interests, from the fund s limited partners. The existing guidance in ASC S99-1 includes two acceptable methods of accounting for incentivebased performance fees, including carried interests. In Method 1, the entity recognizes the incentive fees when it performs the services and all contingencies are resolved, whereas in Method 2, the entity recognizes incentive fees throughout the contract, measured on the basis of the amount that would be due from the customer as though the contract were terminated at the reporting date. Stakeholders asked if incentive-based capital allocations, such as carried interests, are within the scope of ASC 606 or within the scope of other Codification Topics because they are ownership interests. Some TRG members expressed the view that asset management fees from incentive-based capital allocation agreements are within the scope of ASC 606 because the arrangements are designed to compensate the asset manager for the services it performs in managing the investment fund, and that these fees should therefore be accounted for like any other incentive-based performance arrangements. Other TRG members and an SEC observer suggested that it may also be acceptable to account for the allocations in accordance with other Codification Topics, including ASC 323, Investments Equity Method and Joint Ventures, on the basis that the arrangements represent ownership interests. The scope question is significant because if included within the scope of ASC 606, the incentive-based capital allocations would be subject to the variable consideration and constraint guidance, which would likely result in accounting similar to Method 1 under ASC 605. However, if included in the scope of other guidance such as ASC 323, additional considerations related to investment accounting may arise, including a full consolidation analysis. The FASB will decide whether to take further action on this issue, such as making a technical correction to clarify the scope of ASC 606. How to consider the class of customer when evaluating customer options Customer options to acquire additional goods or services for free or at a discount may come in many forms, including sales incentives, customer award credits or points, contract renewal options, and other discounts on future goods or services. The new revenue guidance requires an entity to account for an option as a separate performance obligation if that option provides a material right to the customer that the customer would not receive without entering into the contract. The guidance in ASC provides the following example of a material right: a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market [emphasis added]. The evaluation of whether an option constitutes a material right is significant because when a right is deemed to be material, the entity should identify that right as a separate performance obligation, allocate

4 New Developments Summary 4 a portion of the transaction price to that performance obligation, and recognize revenue either as it transfers those goods or services or when the option expires. Stakeholders asked how the class of customer should be considered when evaluating whether a customer option gives rise to a material right. At its October 31, 2014 meeting, TRG members generally agreed that entities should consider relevant transactions with the customer as well as both qualitative and quantitative factors, including whether the right accumulates, when evaluating whether a customer option provides a material right. At its April 18 meeting, the TRG reaffirmed the prior general agreement, but it did not reach general agreement on how to assess the class of customer when evaluating whether a right accumulates. For example, TRG members expressed different views on how entities should consider situations where airline status is earned by some customers through prior purchases, yet is available for purchase or sometimes even awarded irrespective of prior purchases to other customers. TRG members also expressed differing views on which situations would require the identification of a class of customers, how to assess whether similar discounts are offered to the same class of customer, and which customers would make up the class of customers. As a result, the FASB staff will meet with stakeholders in the industries most impacted, including the travel industry, to discuss the issue further. C. Topics of general agreement The TRG reached general agreement on the three topics discussed below. As a result, further standardsetting for these issues is not expected as it appears that entities can understand and apply the guidance in ASC 606. Scoping considerations for financial institutions The scope of ASC 606 excludes, in part, financial instruments and other contractual rights or obligations within the scope of ASC 860, Transfers and Servicing; ASC 460, Guarantees; ASC 815, Derivatives and Hedging; and ASC 405, Liabilities. As discussed above in Section B, BC paragraph 61 explains that if specific guidance in other Codification Topics deals with a transaction, the more detailed guidance from those Topics should be applied rather than the guidance in ASC 606. Stakeholders in the depository institutions industry asked whether the following fees are within the scope of ASC 606: Servicing and sub-servicing fees: These fees arise as compensation for an entity s services, such as collecting interest, principal, and escrow in the capacity of a loan servicer. A servicer may also engage another entity (a sub-servicer) to perform certain servicing duties. Deposit-related fees: These fees arise from depository relationships and include automated teller, wire transfer, foreign exchange, stop payment order, and account maintenance fees.

5 New Developments Summary 5 Financial guarantee fees: These fees arise when a financial institution guarantees a loan for a borrower. TRG members generally agreed that servicing and sub-servicing fees are excluded from the scope of ASC 606. An entity should instead look to ASC 860 for guidance on how to account for servicing revenue. The guidance in ASC 860 addresses servicing cash flows via subsequent measurement of the mortgage servicing right asset or liability and collection of servicing fees, which gives rise to recording the servicing revenue. Said differently, the servicing fee is inseparable from the mortgage servicing right, and since the guidance in ASC 860 addresses the accounting for the mortgage servicing right, it implicitly addresses the accounting for the servicing and sub-servicing revenue. Likewise, TRG members generally agreed that fees from financial guarantees are not within the scope of ASC 606 because these types of guarantees are generally within the scope of the guidance in ASC 460 and 815, which provide the appropriate accounting guidance for the related fees. Finally, TRG members generally agreed that deposit-related fees are within the scope of ASC 606. While the deposit-related liability is within the scope of ASC 405 and is excluded from the scope of ASC 606, ASC 405 lacks accounting guidance for deposit-related fees. Therefore, the guidance in ASC 606 is the only guidance to apply to deposit-related fees. How control transfers over time An entity must determine at contract inception whether it satisfies a performance obligation over time or at a point in time. The revenue guidance includes three criteria to determine whether the entity transfers control over time and therefore satisfies its performance obligation, in which case, it should recognize revenue over time. An entity recognizes revenue for a performance obligation that it satisfies over time by measuring the progress toward complete satisfaction of its performance obligation. The guidance in ASC 606 provides various methods that may be used to measure the entity s progress, including input and output methods. The guidance does not prescribe the use of a particular measure, but requires that an entity apply the selected method consistently to similar performance obligations in similar circumstances. The new revenue guidance provides examples of several output methods, including milestones reached. When an entity concludes that it satisfies its performance obligation over time and therefore recognizes revenue over time, stakeholders asked if control can be transferred at discrete points of time. In particular, they wanted to know if it would be appropriate to measure progress based on the achievement of specific milestones. The TRG members agreed that control does not transfer at discrete points in time if the entity meets any of the criteria to recognize revenue over time. The TRG members also agreed that an appropriate measure of progress should not cause an entity to recognize a material asset as a result of its performance, such as work in process, because control transfers as the entity performs.

6 New Developments Summary 6 Some members observed that it may be helpful to consider whether the entity may recognize assets as inventory when the assets have not yet been customized as part of a specified project and may still be redirected to another project. Contract asset treatment in contract modifications The new revenue guidance provides accounting guidance in the event of a contract modification. Under the new revenue standard, a contract modification is a change in the scope or price (or both) of a contract that is approved by the parties to the contract. When the scope of the contract increases because the parties agree to add a promised good or service that is considered distinct, as defined in the new revenue guidance, and the price of the contract also increases to reflect the entity s stand-alone selling price of the added good or service, the entity should account for the contract modification as a separate contract. When the contract modification is not accounted for as a separate contract, the entity should account for the modification as though it were a termination of the existing contract and the creation of a new contract if the remaining goods and services are distinct from the goods or services the entity transferred prior to the contract modification. The entity should allocate to the remaining performance obligations any consideration promised by the customer, including amounts already received, that have not yet been recognized as revenue, as well as any additional consideration promised as part of the contract modification. Stakeholders asked how an entity should account for a contract asset when a contract is modified and the modification is accounted for as if it were a termination of the existing contract and the creation of a new contract. The TRG members agreed that the modification should be accounted for on a prospective basis consistent with the discussion in BC paragraph 78. As a result, a contract asset that exists at the time of modification should be carried forward to the new contract because the asset relates to a right to consideration for goods and services that the entity has already transferred and is deemed to be distinct from those goods and services that will be transferred in the future. Accordingly, it would not be appropriate to reverse revenue already recognized for the goods and services transferred before the modification; rather, the amount of the contract asset should be realized as amounts become due. It was noted that entities will need to consider all facts and circumstances and may need to exercise considerable judgment in accounting for contract modifications, given the various forms modifications can take. D. Staff update The FASB staff reported that they received a question on Example 38, Case B, in ASC related to the presentation of a contract asset versus a receivable. While the staff thinks the new guidance is clear on when to present a receivable and when to present a contract asset, they agree with the submission that the language in the example could be clarified and will recommend a technical correction to that effect to the Board.

7 New Developments Summary 7 ASC 606 requires an entity to present a contract asset when the right to consideration in exchange for goods or services transferred to the customer is conditioned on something other than the passage of time, for instance, future performance. An entity presents a receivable when its right to consideration is unconditional, meaning that only the passage of time is required before payment of the consideration is due. E. What s next The FASB has scheduled additional meetings for the U.S. based members of the TRG on July 25 and November 7. Approximately one week in advance of the July meeting, the FASB staff is expected to post the following information to its website: A summary of the April 18 TRG meeting A submissions log of issues compiled by the staff, including the current status of each The staff papers for the July 25 meeting To submit an issue, and to access all meeting dates, materials, and archived webcasts of previous meetings, visit the TRG homepage on the FASB website Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP bulletin provides information and comments on current accounting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in the bulletin. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this bulletin. For additional information on topics covered in this bulletin, contact your Grant Thornton LLP professional.