.70 Several issues exist beyond applying the five steps of the model. The revenue standard provides guidance in the following areas to assist entities in applying the model.
.71 A licence establishes a customer’s rights related to an entity’s IP and the entity’s obligations related to those rights. Licences of IP include, among others: software and technology rights; media and entertainment rights; franchises; patents; trademarks; and copyrights. Licences can vary significantly and include different features and economic characteristics, which can lead to significant differences in the rights provided.
.72 An entity should first consider the guidance for distinct performance obligations to determine if a licence is distinct from other goods or services in an arrangement. An entity will combine licences that are not distinct with other goods and services in the contract and recognise revenue when it satisfies the combined performance obligation. Examples of licences that are not distinct include a licence that is integral to the functionality of a tangible good (such as software included on a hardware device) or a licence that the customer can benefit from only in conjunction with a related service (such as access to online internet content).
.73 The nature of the rights provided in some licence arrangements is to allow access to the entity’s IP as it exists throughout the licence period. Licences that provide access are performance obligations satisfied over time and, therefore, revenue is recognised over time. The nature of the rights in other transactions is to provide a right to use the entity’s IP as it exists at the point in time the licence is granted. Licences that provide a right to use an entity’s IP are performance obligations satisfied at a point in time, with revenue recognised when control transfers to the licensee and the licence period begins.
.74 Distinct licences that meet all of the following three criteria provide access to IP (and, thus, revenue is recognised over time):
- The licensor will undertake (either contractually or based on customary business practices) activities that significantly affect the IP to which the customer has rights.
- The licensor’s activities do not otherwise transfer a good or service to the customer as they occur.
- The rights granted by the licence directly expose the customer to any effects (both positive and negative) of those activities on the IP and the customer entered into the contract with the intent of being exposed to those effects.
.75 The first criterion requires an assessment of whether a licensor might undertake activities that significantly affect the IP. These activities might result from published policies or customary practices, or they might be the result of the existence of a shared economic interest between the licensor and customer.
.76 The second criterion requires that the activities that might affect the IP are not additional performance obligations in the contract. Activities are not performance obligations if they do not directly transfer goods or services to a customer. A customer might be affected by the activities because they affect the IP; however, this effect could be either positive or negative.
.77 The third criterion requires that the effects (positive or negative) of any activities identified in the first criterion impact the customer. Activities that do not affect what the licence provides to the customer or what the customer controls do not meet this criterion.
The revenue standard includes a number of examples that illustrate how an entity should apply the criteria to different licence arrangements. Applying these criteria could be challenging and will require judgement, especially to determine what constitutes an activity rather than a separate performance obligation. Different accounting conclusions might be reached for arrangements that appear to be similar, which could make comparability across entities and industries more challenging.
.78 An entity should recognise an asset for the incremental costs to obtain a contract if management expects to recover those costs. Incremental costs of obtaining a contract are costs the entity would not have incurred if the contract had not been obtained (for example, sales commissions). Costs that the entity would have incurred if the contract had not been obtained, such as facilities costs and sales force salaries, are not capitalised. An entity can elect to expense the cost of obtaining a contract if the amortisation period would be one year or less.
.79 An entity will recognise an asset for costs to fulfil a contract if those costs:
- relate directly to a contract or anticipated contract that the entity can specifically identify;
- generate or enhance the entity’s resources that will be used to satisfy future performance obligations; and
- are expected to be recovered.
.80 Management will need to consider whether costs to fulfil a contract should be accounted for in accordance with other standards (for example, inventory, fixed assets, or intangible assets) before applying the revenue standard. Costs that relate to satisfied performance obligations are expensed as incurred.
The guidance on contract costs is expected to result in the recognition of more assets than under current practice. Entities that expense sales commissions as paid and set-up costs as incurred could now be required to capitalise and amortise these costs if they are recoverable.
.81 An asset recognised for the costs to obtain or fulfil a contract will be amortised on a systematic basis as the goods or services to which the assets relate are transferred to the customer. The asset will also be assessed for impairment each reporting period.
.82 An entity that has an obligation or right to repurchase an asset (a forward or a call option) has not transferred control of the asset to the customer because the customer is limited in its ability to direct the use of and obtain substantially all of the remaining benefit from the asset. An entity will account for the contract as a lease if the entity can or must repurchase the asset for a price that is less than the original selling price, unless the contract is part of a sale-leaseback transaction. An entity will account for a contract as a financing if it can or must repurchase the asset for a price that is equal to or greater than the original selling price of the asset. When comparing the repurchase price to the selling price an entity should consider the time value of money.
.83 An arrangement where a customer has the right to require the entity to repurchase an asset (a put option) at a repurchase price less than the original selling price will be accounted for as a lease if the arrangement provides the customer a significant economic incentive to exercise that right, unless the contract is part of a sale-leaseback transaction. The arrangement is a financing if the repurchase price of the asset is equal to or exceeds the original selling price and is more than the expected market value of the asset.
.84 An arrangement is a sale of a product with a right of return, as discussed in paragraph 91, if the customer has a repurchase right at an amount less than the original selling price (or greater than or equal to the original selling price but less than the expected market value), but does not have a significant economic incentive to exercise that right.
Principal versus agent
.85 Entities often involve third parties when providing goods and services to their customers. Management needs to assess, for each performance obligation in a contract, whether the entity is acting as the principal or as an agent in such arrangements. An entity recognises revenue on a gross basis if it is the principal in the arrangement, and on a net basis (that is, equal to the fee or commission received) if it is acting as an agent.
.86 An entity is the principal in an arrangement if it obtains control of the goods or services of another party in advance of transferring control of those goods or services to a customer. The entity is an agent if its performance obligation is to arrange for another party to provide the goods or services. An entity will need to evaluate if and when it obtains control. If an entity obtains legal title of a product only momentarily before the title is transferred to the customer, this does not necessarily indicate that the entity is acting as the principal in the arrangement.
.87 Indicators that the entity is an agent include:
- Fulfilment - The entity does not have primary responsibility for fulfilment of the contract.
- Inventory risk - The entity does not have inventory risk at any point during the transaction (that is, before the order, during shipment, or upon return).
- Pricing - The entity does not have discretion in establishing prices for the other party’s good or service.
- Credit risk - The entity does not have customer credit risk for the amount of the receivable.
- Commission - The entity’s consideration is in the form of a commission.
The indicators in the revenue standard are similar to the current guidance in IFRS and US GAAP. However, the specific requirement for the entity to obtain control differs from current guidance. The revenue standard does not weigh any of the indicators more heavily than others, unlike existing US GAAP. New and evolving business models, especially related to internet transactions, have resulted in an increased focus in this area. We expect that entities will continue to apply judgement to assess whether to recognise revenue on a gross or net basis for many of these transactions, similar to today.
Options to acquire additional goods or services
.88 Entities often grant customers the option to acquire additional goods or services free of charge or at a discount. These options might include customer award credits or other sales incentives and discounts, such as volume discounts. An option gives rise to a separate performance obligation if it provides a material right to the customer that the customer would not receive without entering into the contract. The entity will recognise revenue allocated to an option when the additional goods or services are transferred to the customer, or the option expires.
.89 An example of a material right is a discount that is incremental to the range of discounts typically given to a similar class of customers in the same market. The customer is effectively paying in advance for future goods or services and therefore revenue is recognised when those future goods or services are transferred.
.90 Management will need to determine the stand-alone selling price for the option. Often the option will not have a directly observable selling price; therefore, management will need to estimate the stand-alone selling price. This estimate is adjusted for any discount the customer would receive without exercising the option and the likelihood that the customer will exercise the option. The revenue standard includes several examples related to customer options as well as the treatment of unexercised rights.
The guidance related to options that provide the customer with a material right could have a significant effect on entities in a number of industries. For example, entities within the retail and consumer industry that provide customers with a loyalty program will need to consider whether the rewards issued by the program provide a material right. A portion of the transaction price will be allocated to the reward if it is a material right and a distinct performance obligation. This is different than current practice for entities applying an incremental cost model under US GAAP today.
Rights of return
.91 An entity will account for the sale of goods with a right of return by recognising revenue for the consideration it expects to be entitled to (considering the products expected to be returned) and a liability for the refund it expects to pay to customers, similar to current accounting under IFRS and US GAAP. Amounts are updated for changes in expected returns each reporting period. Exchanges by customers for products of the same type, quality, condition, and price are not considered returns.
.92 The entity will recognise an asset and corresponding adjustment to cost of sales for the right to recover goods from customers. The asset is initially measured at the original cost of the goods less any expected costs to recover those goods. Impairment is assessed at each reporting date. The entity should present the asset separately from the refund liability (that is, the entity should not present a net balance in the financial statements). The revenue standard includes an example that illustrates the journal entries that an entity would record to account for estimated product returns.
.93 An entity accounts for a warranty as a separate performance obligation if the customer has the option to purchase the warranty separately. An entity accounts for a warranty as a cost accrual if it is not sold separately, unless the warranty is to provide the customer with a service in addition to assurance that the product complies with agreed-upon specifications.
.94 An entity should consider factors such as whether the warranty is required by law, the length of the warranty period, and the nature of the tasks the entity has promised to perform as part of the warranty to determine whether the warranty provides the customer with an additional service. Judgement will be required in this assessment. The portion of a warranty that provides a service in addition to assurance that the product complies with specifications is accounted for as a separate performance obligation. An entity that cannot reasonably separate the obligation to provide an additional service from the rest of the warranty should account for both together as a single performance obligation providing a service.
The guidance on accounting for warranties is generally consistent with current guidance in IFRS and US GAAP. However, it might be challenging to separate a single warranty that provides both a standard warranty and an additional service in some arrangements. Management will have to develop processes to estimate stand-alone selling prices and allocate the transaction price between the performance obligations in the arrangement when such services are not sold separately.
Non-refundable upfront fees
.95 Some entities charge a customer a non-refundable fee at the beginning of an arrangement. Examples include set-up fees, activation fees, and joining fees. Management needs to determine whether a non-refundable upfront fee relates to the transfer of a promised good or service to a customer.
.96 A non-refundable upfront fee might relate to an activity undertaken at or near contract inception. Similar to current accounting under IFRS and US GAAP, the activity does not result in the transfer of a promised good or service to the customer unless the entity has satisfied a separate performance obligation. The upfront fee is recognised as revenue when goods or services are provided to the customer in the future. Depending on the nature of the fee, the period of revenue recognition could extend beyond the initial contractual period if the entity grants the customer the option to renew the contract and that option provides the customer with a material right.
.97 In a bill-and-hold arrangement, an entity bills a customer for a product but retains physical possession of the product until a later date. Revenue is recognised upon transfer of control of the goods to the customer (that is, the customer has the ability to direct the use of and obtain substantially all of the remaining benefits from the asset). In addition to applying the control guidance in the standard, all of the following requirements must be met to recognise revenue in a bill-and-hold arrangement:
- The reason for the customer requesting the bill-and-hold arrangement is substantive.
- The product is ready for physical transfer to the customer and separately identified as the customer’s product.
- The entity cannot use the product or direct the product to another customer.
.98 An entity will need to consider whether it is providing custodial services to the customer that might be a separate performance obligation if the bill-and-hold criteria are met. Custodial services that are a separate performance obligation will result in a portion of the transaction price being allocated to that service.
The list of indicators for bill-and-hold transactions is generally consistent with the current guidance under IFRS. There might be situations where revenue is recognised earlier compared to current US GAAP for bill-and-hold arrangements because there is no longer a requirement for the vendor to have a fixed delivery schedule from the customer in order to recognise revenue.
Transfers of assets that are not an output of an entity’s ordinary activities
.99 The revenue standard also amends existing requirements for gain or loss recognition on the transfer of certain non-financial assets that are not the output of an entity’s ordinary activities. Specifically, ASC 360, Property, Plant and Equipment, ASC 350, Intangibles—Goodwill and Other, IAS 16, Property, Plant and Equipment, IAS 38, Intangible Assets, and IAS 40, Investment Property, were modified. US GAAP reporters will apply the concepts related to the existence of a contract, recognition, and measurement (including the constraint on revenue) to these arrangements. IFRS reporters will apply the concepts related to control and measurement to these arrangements. The revenue standard will be applied to determine when the asset should be derecognised and determine the consideration to be included in the net gain or loss recognised on transfer of these assets.
.100 It is common in certain industries for entities to transfer goods to dealers or distributors on a consignment basis. The transferor typically owns the inventory until a specified event occurs, such as the sale of the product to an end customer. Revenue should not be recognised in a consignment arrangement until the transferor no longer controls the asset.
.101 Management should consider the following common characteristics to determine if an arrangement is a consignment arrangement:
- The entity holding the goods does not have an unconditional obligation to pay for the goods.
- The entity can require return of the product or transfer to another distributor (which indicates that control has not transferred to the distributor).
- The goods are controlled by the entity until a specified event occurs.