Defining Issues. Revenue Transition Resource Group Holds First Meeting. July 2014, No Key Facts. Key Impacts

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1 Defining Issues July 2014, No Revenue Transition Resource Group Holds First Meeting The FASB and IASB s Joint Transition Resource Group for Revenue Recognition (TRG) met for the first time on July 18, 2014, and discussed four issues related to the new revenue recognition standard. 1 Contents Background of the Transition Resource Group... 2 Gross versus Net Revenue for Sale of Goods and Services in a Virtual Environment... 2 Gross versus Net Revenue Amounts Billed to Customers... 3 Key Facts The TRG discussed papers on the following issues: Gross versus net revenue for sale of goods and services in a virtual environment; Gross versus net revenue for amounts billed to customers; Application of the sales-based and usage-based royalties exception for contracts containing licenses of intellectual property and other goods or services; and Impairment testing of capitalized contract costs. Key Impacts TRG members offered a range of perspectives on the issues discussed, although they were not asked to vote or conclude on specific views or fact patterns. All seven FASB members and three IASB members attended, but they reached no decisions about whether they will undertake standard-setting activities or other efforts to resolve the issues that were discussed. However, the Boards stated that standard setting should only be expected in limited circumstances. Application of the Sales-based and Usage-based Royalties Exception for Contracts Containing Licenses of Intellectual Property and Other Goods or Services... 4 Impairment Testing of Capitalized Contract Costs... 4 Next Steps FASB Accounting Standards Update , Revenue from Contracts with Customers, available at and IFRS 15, Revenue from Contracts with Customers.

2 Instructions for submitting an issue to the TRG can be found on the FASB s Web site at Background of the Transition Resource Group The FASB and IASB formed the TRG for the primary purposes of: Soliciting, analyzing, and discussing stakeholder issues arising from implementation of the new revenue recognition standard; Informing the FASB and the IASB about those implementation issues that will help the Boards determine what, if any, action will be needed to address them; and Providing a forum for stakeholders to learn about the new guidance from others involved with implementation. The TRG advises the Boards and does not have standard-setting authority. The 19 members of the TRG include auditors, financial statement preparers, and users from various industries and geographies (both United States and International). Others who attend and participate in the meeting as observers include the FASB and IASB board members, PCAOB, SEC, AICPA, and International Organization of Securities Commissions (IOSCO) representatives. The TRG is expected to meet twice in 2014 and approximately four times annually until 2017 or Any stakeholder can submit an issue to the TRG. The issues should relate to the new revenue recognition standard, be pervasive, and should involve guidance that can be applied in different ways that potentially would result in diversity in practice. The FASB and IASB staff will decide which issues will be discussed by the TRG. For those issues, the staff will analyze the various interpretations in issue papers and post those papers to the FASB and IASB Web sites prior to the TRG meeting. The TRG members will discuss the issues in a public setting but will not issue authoritative guidance. After each meeting, the Boards will determine what the next step should be for each issue, including whether standard setting is necessary. Meeting minutes are not expected to be published. Gross versus Net Revenue for Sale of Goods and Services in a Virtual Environment The revenue recognition standard requires an entity to determine whether the nature of its performance obligation is to provide specified goods or services itself (the entity is a principal) or to arrange for another party to provide those goods or services (the entity is an agent). The standard specifies that the entity is a principal if it controls the goods or services prior to transferring them to the customer and provides indicators of when an entity is acting as an agent. Questions have arisen about whether the control principle should be applied independently of the indicators or whether the indicators are part of the control assessment. Some have questioned whether any indicators should be weighted more heavily than others, particularly when evaluating indicators that provide contradictory evidence. Some believe that principal versus agent analysis is especially difficult when an entity sells a nonphysical item (e.g., a software application developer sells its app through another party s Web site or an online game provider sells its games through another party s Web site) or a service (e.g., a service provider bundles its service with another party s service and sells both to a customer or a 2

3 company arranges for its advertising to be placed on another party s Web site through a virtual advertising exchange). In those situations it may not be clear which party is responsible for fulfilling the contract, what constitutes inventory risk, or how to identify the customer. To further complicate the analysis, in some situations an entity determines that it is the principal but another party collects the cash from the end customer, remits a fixed portion to the entity, and the entity does not know how much the other party charged the end customer. Additionally, there may be contracts in which an entity is a principal for some goods or services and an agent for others, which raises questions about how a discount in the arrangement should be allocated to the goods or services. Many TRG members believed that it is critical to understand the nature of the entity s promise by identifying the customer and the goods or services that the entity is transferring to that customer. However, concern was expressed that the guidance in the standard could be interpreted in various ways that potentially could result in diversity in practice. There were differing views about whether a principal to a transaction should recognize as revenue only the cash received from the intermediary or the estimated amount charged by the intermediary to the end customer when this amount is not known. TRG members also acknowledged that the issues discussed at the meeting are also current practice issues in the United States. Gross versus Net Revenue Amounts Billed to Customers An entity often bills a customer for amounts in addition to the stated price of the goods or services (e.g., shipping and handling fees, reimbursable out-of-pocket expenses, and taxes or other assessments collected from customers). Unlike current U.S. GAAP, the revenue recognition standard does not provide specific guidance for the presentation of these amounts. 2 However, it defines the transaction price as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties [for example, some sales taxes) [emphasis added]. The standard also provides principal versus agent guidance as discussed above. TRG members would generally apply the principal versus agent guidance to amounts such as shipping and handling and out-of-pocket costs. Most U.S. TRG members seemed to believe this would result in gross presentation in many cases, particularly when the entity promised to deliver a good similar to current U.S. GAAP. However, some members questioned whether an entity should identify shipping as a separate performance obligation in the contract if it is determined to be the principal. Most members acknowledged that the standard requires an entity to evaluate taxes collected from customers on a case-by-case basis in each jurisdiction. 2 FASB ASC paragraphs to 45-23, and FASB ASC paragraphs to 50-4, (originally contained in EITF Issue Nos , 01-14, and 06-3), available at 3

4 Application of the Sales-based and Usagebased Royalties Exception for Contracts Containing Licenses of Intellectual Property and Other Goods or Services The core principle of the revenue recognition standard is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. However, the standard includes an exception to that core principle by specifying that an entity should recognize revenue for a sales-based or usage-based royalty promised in exchange for a license of intellectual property only when or as the later of the following events occurs: (a) the subsequent sale or usage, or (b) the performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has been satisfied or partially satisfied. Questions have been raised about when and how to apply this exception when the arrangement includes a license of intellectual property and other goods or services. Some TRG members indicated that neither sales-based or usage-based royalties nor license of intellectual property is defined in the standard and that exceptions need to be clearly scoped. Different members expressed support for three views. Some members believed that the royalty exception applies only when the royalty relates solely to a license and it is a separate (distinct) performance obligation. Some members expressed concern about applying two different accounting approaches to a single payment stream under this view. Other TRG members believed that the exception could apply when the royalty relates to a license and one or more other non-license goods or services if the license is the primary or dominant component to which the royalty relates. Some members expressed concern under this approach with the difficultly in determining when the license is the primary or dominant component. Still others believed that the exception applies whenever a contract includes a license of intellectual property. Others questioned whether that view would result in the exception being applied too broadly. Impairment Testing of Capitalized Contract Costs The revenue recognition standard provides guidance on impairment for those contract costs capitalized under its requirements. The standard specifies that an asset is impaired if the carrying amount exceeds the remaining amount of consideration that the entity expects to receive, less the costs that relate directly to providing those goods or services that have not been recognized as expenses. 4

5 When determining the amount that the entity expects to receive in its impairment analysis, an entity should apply the principles for determining the transaction price except for the constraint on estimating variable consideration. However, the revenues attributable to anticipated contracts would not be included in the transaction price, although the guidance on amortizing contract costs specifies that an entity should consider specific anticipated contracts. TRG members generally believed that cash flows from specific anticipated contracts should be included in determining the consideration expected to be received in the contract costs impairment analysis. Next Steps The FASB and IASB will consider whether any of the issues discussed require standard setting or further discussion at a future meeting. The TRG s next meeting is scheduled for October 31, Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Brian K. Allen, Michael P. Breen, Paul H. Munter and Brian J. Schilb Earlier editions are available at: Legal The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the standard or any other potential or applicable requirements of the accounting literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP. 5