The draft Revenue Recognition standard: Step 5 

Welcome to this, the fourth in our series of videos on the new exposure draft “revenue from contracts with customers”. 

In our previous videos we introduced the 5 steps in the proposed revenue recognition model.  Let’s just look at a reminder of the 5 step approach

In this forth video we will take a more detailed look at the last step – step 5 on the right hand side and also other application issues for technology companies. 

Let’s take a look at Step 5, how to recognised revenue as each performance obligation is satisfied...[slide 2]

A company would recognise revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service). 

A performance obligation may be satisfied at a point in time (typically for promises to transfer goods to a customer) or over time (typically for promises to transfer services to a customer).

There are specific criteria upon which an entity is required to assess, at contract inception, in order to recognise revenue over time.

For revenue to be recognised over time EITHER the performance creates or enhances an asset that the customer controls, for example onsite improvements to customers IT systems OR performance does not create an asset with alternative use to the entity and at least one of the following:

a) The customer receives & consumes benefit as entity performs – so perhaps maintenance or support

b) The task would not need to be re-performed.

c) The entity has right to payment for performance to date and expects to fulfill contract – for example a technology company develops customised software, expects to complete it and is entitled to payment for progress to date.

For performance obligations satisfied over time, a company would select an appropriate measure of progress to determine how much revenue should be recognised as the performance obligation is satisfied.  The proposals would limit the cumulative amount of revenue a company recognises to date to the amount to which the company is reasonably assured to be entitled.

Now lets consider some specific application issues

How to account for licences?  A licence provided by a technology company to a customer would give rise to a performance obligation that the technology company satisfies at a point in time when the customer obtains control of the licence.   For US GAAP reporters, there is a significant change for time based licenses, which under current guidance may be recognised over the life of the license.

How to account for royalty-based fees?  If the licence fee is variable, then the cumulative amount of revenue recognised to date would be limited to the amount to which the company is reasonably assured to be entitled.  Additionally, the 2011 ED states that if a company licenses intellectual property and receives a sales-based royalty, then the company would not be reasonably assured to be entitled to the additional amount of consideration until the uncertainty is resolved, e.g. when the customer's subsequent sales occur.

How to account for costs to fulfil a contract?  Under the 2011 ED, a company would first consider whether the costs of fulfilling a contract are in the scope of another IFRS; if this is the case, then the company would apply the guidance in that other IFRS. The 2011 ED also proposes amending IAS 2 Inventories to scope out the costs of a service provider. If the costs of fulfilling a contract are not within the scope of other IFRSs, then a company would capitalise the costs if they:

• relate directly to a contract (or a specific anticipated contract);

• generate or enhance resources of the company that are used to fulfil the performance obligation; and

• are expected to be recovered.

Otherwise, the company would expense the costs as incurred.

How to account for incremental costs of obtaining a contract?

The 2011 ED proposes that companies capitalise the incremental costs of obtaining a contract if they are expected to be recovered, unless the contract duration is one year or less. Incremental costs are those that would not have been incurred if the contract had not been obtained.

The qualifying costs of obtaining a contract would be recognised as an asset, amortised over the expected period of benefit and tested for impairment.

At present, there is diversity in the technology sector in relation to the accounting for costs of acquiring a customer or contract. Some companies capitalise such costs and some expense them as incurred. Those technology companies that currently expense all subscriber acquisition costs may meet the criteria to capitalise and amortise the incremental costs of obtaining a contract with a duration of more than one year.

How to determine whether a performance obligation is onerous?

The 2011 ED retained the proposal to apply the 'onerous test' at a performance obligation level rather than at a contract level. However, recent deliberations indicate that the boards have tentatively agreed to retain the existing guidance on accounting for onerous contracts.

That’s the end of this video looking at the new exposure draft “revenue from contracts with customers”.

Thank you for watching this video.