Steven Treglia | April 2, 2019
On May 28, 2014 the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their final standard on revenue from contracts with customers. The standard, issued as ASU 2014-09 by the FASB and as IFRS 15 by the IASB, outlines guidance for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance.
The updated guidance established a five-step process for recognizing revenue from contracts with customers as follows:
- Identify the customer contract(s)
- Identify the performance obligation(s) in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligation(s) in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
Recognizing Revenue at a Point in Time or Over a Period of Time
The last step of the process addresses at what time revenue from contracts with customers should be recognized. One of the principal considerations used in this determination is whether the performance obligation is satisfied at a point in time (when) or over a period of time (as). This determination should be made for each performance obligation at the inception of a contract and is determined based on the method the entity transfers control of the promised goods or services to a customer. The guidance assumes the performance obligation is satisfied at a point in time, unless any one of the following criteria are met:
- The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
- The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
- The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.
Whereas the first condition is primarily focused on delivery of services, the next two are focused on the creation or enhancement of goods, although the criteria could be applied to either in certain circumstances.
To clarify, customers simultaneously receive and consume benefits generally if the asset is transferred in intervals where the delivery of individual service is distinct and identifiable. The specific example in the guidance is a cleaning service. The second condition relates primarily to work-in-process assets and if/when the rights to the asset is controlled by the customer throughout the process. In this case the asset would have value to the customer at some point during the creation or enhancement process. An example might be software development where the customer may have control of the related asset even though the development process is not complete. The final condition could be determined either by the product itself or the contract terms. For example, the contract terms could specifically exclude the vendor from using the asset elsewhere, as in a trademark. Alternatively, the product itself could simply have no alternative use, such as a custom-built machine.
Period of Time
If any one of the above criteria are met, the performance obligation is considered to be satisfied over a period of time. For performance obligations satisfied over a period of time, ASU 2014-09 states that revenue should recognized “by measuring the progress toward complete satisfaction of that performance obligation.” Further, the guidance describes two methods for measuring such progress, the “input method” and the “output method.” The entity should only measure satisfaction of the performance obligation over a period of time if the entity has reliable information from which to reasonably measure its progress toward completing the performance obligation under one of these methods.
Output Method
Under this method, the entity would measure completion of the total performance obligation either in relation to the total obligation that has been satisfied or in relation to what remains to be satisfied. Examples provided include surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed, and units produced or units delivered.
Input Method
As indicated by the title, this method measures the level of effort the entity has put into satisfying the performance obligation in relation to the total. Examples include resources consumed, labor hours expended, costs incurred, time elapsed, or machine hours used. Costs included in this method should be tailored to exclude those costs that are not incurred directly in satisfaction of the performance obligation.
The entity should elect the measurement method that most accurately reflects its progress toward satisfaction of the performance obligation. Once elected, the entity should apply that method in measuring the satisfaction of similar performance obligations in similar circumstances.
Point in Time
Once the determination has been made that the performance obligation has been satisfied at a point in time, the next step is to determine at what point in time the obligation is satisfied. The guidance does not provide a distinct set of criteria for when the performance obligation is satisfied but does provide the following factors to be considered in this determination.
- The entity has a present right to payment for the asset
- The customer has legal title to the asset
- The entity has transferred physical possession of the asset
- The customer has the significant risks and rewards of ownership of the asset
- The customer has accepted the asset
These factors are points of consideration in determining when control of the related asset passes to the customer. Transfer of control could result from a combination of factors depending on the facts and circumstances of the contract. Alternatively, a number of these factors could be present but if the customer still did not have control of the asset, the performance obligation may not be satisfied. For example, in consignment arrangements the customer may have accepted and taken physical possession of the goods but control is not deemed to have been transferred until the goods are sold by the consignor.
In determining when control has been transferred, the entity should consider the assets at which point in time the customer has the ability to direct the use of—and obtain substantially all the benefits of—that asset.
Disclosure Requirements
ASU 2014-09 requires the entity to disclose certain qualitative information about the methods and assumptions used to satisfy performance obligations. Specifically, the entity is required to disclose:
- For performance obligations satisfied over a period of time:
- a description of the input or output method used
- a description of why that method best represents the complete satisfaction of the performance obligation
- For performance obligations satisfied at a point in time:
- a description of the assumptions used in determining how control of goods or services are transferred to the customer
However, non-public companies are only required to disclose the description of the input or output method used. They do not have to disclose any of the other requirements noted above.
