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Issues & Trends

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Defining Issues® November 2011, No. 11-62

Boards Release Revised Revenue Recognition Exposure Draft The FASB and IASB (the Boards) recently issued a revised joint exposure draft on revenue recognition (2011 ED).1 The Boards received nearly 1,000 comment letters on the original joint exposure draft (2010 ED) and after extensive deliberations revised various aspects of the proposed standard.2

The revisions reflected in the 2011 ED eliminate or modify some of the provisions in the 2010 ED that would have created changes in practice from current U.S. GAAP. Nonetheless, significant differences still exist. If the 2011 ED is finalized in its current form, transaction- or industry-specific accounting guidance generally would be eliminated from U.S. GAAP, which would affect the accounting for certain long-term contracts, software arrangements, telecommunications, real estate, and other industries. The proposed standard also would impact how a vendor incorporates collectibility into recognition and presentation of revenue, would require more estimates than current practice, would require more detailed disclosures in both interim and annual periods, including rollforward of certain information, and could change the accounting for certain contract acquisition and fulfillment costs.

The Boards decided to re-expose the proposed standard because revenue recognition affects virtually all business entities and they wanted to identify potential unintended consequences from applying the proposed standard. The Boards are seeking input on whether the proposed guidance is clear and can be applied in a way that effectively communicates to financial statement users the economic substance of the vendor’s contracts with customers. They have specifically requested comments on the following items in the 2011 ED:

• Recognition of revenue as a vendor transfers control of a good or service over time;

• Accounting for the effects of customer credit risk;

• Cumulative constraint on revenue when consideration is variable;

• Scope of the onerous performance obligation test;

• Disclosure requirements for interim financial statements; and

• Accounting for the transfer of nonfinancial assets that are not an output of the vendor’s ordinary activities.

Comments on the 2011 ED are due by March 13, 2012 and the Boards hope to issue a final standard in the second half of 2012.

1 FASB Proposed Accounting Standards Update, Revenue from Contracts with Customers, November 14, 2011, available at www.fasb.org, and IASB ED/2011/6, Revenue from Contracts with Customers, November 2011, available at www.ifrs.org. 2 FASB Proposed Accounting Standards Update, Revenue from Contracts with Customers, June 24, 2010, available at www.fasb.org, and IASB ED/2010/6, Revenue from Contracts with Customers, June 2010, available at www.ifrs.org.

Contents

The Model 2

Contract Modifications 10

Contract Costs 11

Onerous Performance Obligations 12

Sale of Assets That Are Not Part of a Vendor’s Ordinary Activities 13

Repurchase Arrangements 13

Principal versus Agent Considerations 14

Presentation and Disclosures 14

Effective Date and Transition 16

Potential Changes to Current U.S. Practice 17


Defining Issues® / November 2011 / No. 11-62 2

The 2011 ED would apply to all contracts with customers except for:

• Lease contracts;

• Insurance contracts;

• Contractual rights or obligations within the scope of certain financial instruments guidance;3

• Guarantees (other than product or service warranties); and

• Nonmonetary exchanges between vendors in the same line of business to facilitate sales to customers other than the parties to the exchange.4

While some clarifications were made, the scope is largely unchanged from the 2010 ED.

A contract with a customer may be partially in the scope of the 2011 ED and partially in the scope of other accounting guidance (e.g., a contract with a lease of an asset and services). If the other accounting guidance specifies how to separate and/or initially measure one or more parts of a contract, then a vendor would first apply those requirements. Otherwise, the vendor would apply the 2011 ED to separate and/or initially measure the separately identified parts of the contract.

The Model

The core principle of the revenue recognition model is that a vendor should recognize as revenue the amount that reflects the consideration to which the vendor expects to be entitled in exchange for goods or services when (or as) it transfers control to the customer. To achieve that core principle, the 2011 ED establishes a five-step model that a vendor would apply:

(1) Identify the contract with a customer;

(2) Identify the separate performance obligations in the contract;

(3) Determine the transaction price;

(4) Allocate the transaction price to the separate performance obligations; and

(5) Recognize revenue when (or as) the vendor satisfies a performance obligation.

Step 1 – Identify the Contract with a Customer. The 2011 ED defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations” and specifies that enforceability is a matter of law. An enforceable contract can be written, verbal, or implied by the vendor’s customary business practices. A customer is defined as “a party that has contracted with a vendor to obtain goods or services that are an output of the vendor’s ordinary activities.” Other parties to a contract may not be customers, but may be partners or collaborators with the vendor in developing goods or services to be sold to customers. In this situation, the guidance in the proposed standard would not apply.

3 FASB ASC Topics 310, Receivables; 320, Investments—Debt and Equity Securities; 405, Liabilities; 470, Debt; 815, Derivatives and Hedging; 825, Financial Instruments; and 860, Transfers and Servicing; all available at www.fasb.org. 4 See the Purchases and Sales of Inventory with the Same Counterparty subsections of FASB ASC Subtopic 845-10, Nonmonetary Transactions—Overall, available at www.fasb.org.



A contract with a customer would be within the scope of the proposed standard only if all of the following criteria are met:

• The contract has commercial substance, meaning the contract is expected to alter the risk, timing, or amount of the vendor’s future cash flows;

• The contract is approved by all parties and they are committed to fulfill their obligations;

• The vendor can identify each party’s rights for the goods or services to be transferred; and

• The vendor can identify the payment terms for those goods or services.

A contract would not exist under the proposed standard if each party has the unilateral right to terminate a wholly unperformed contract without compensation.

The 2011 ED proposes criteria for determining when a vendor would be required to combine two or more contracts and account for them as a single contract. Contracts entered into at or near the same time with the same customer (or related parties) would be combined if one or more of the following criteria are met:

• The contracts are negotiated as a package with a single commercial objective;

• The amount of consideration in one contract is dependent on the other contract; or

• The goods or services in the contracts are a single performance obligation (see Step 2 – Identify the Separate Performance Obligations in the Contract).

The Boards eliminated a proposal in the 2010 ED that would have required a vendor to segment a single contract and account for it as two or more contracts if certain criteria were met. Board members concluded that segmenting would be redundant to identifying separate performance obligations within a contract. However, the notion of allocating a discount within a contract to some but not all performance obligations in a contract in certain situations has been retained in Step 4 of the revised model, which usually would result in a similar outcome to segmenting the contract under the 2010 ED.

Step 2 – Identify the Separate Performance Obligations in the Contract. The 2011 ED defines a performance obligation as “a promise in a contract with a customer to transfer a good or service to the customer.” In the 2011 ED, the Boards removed the word enforceable from the definition of a performance obligation and clarified that performance obligations include promises that are implied by a vendor’s customary business practices, published policies, or specific statements if those promises create a valid expectation by the customer that the vendor will transfer goods or services.

A single contract may have promises to deliver more than one good or service. A vendor would need to evaluate the promised goods or services to determine whether each good or service (or a bundle of goods or services) constitutes a separate performance obligation. The 2011 ED would require a vendor to use judgment and consider all facts and circumstances when making this evaluation. A vendor would account for a promised good or service as a separate performance obligation only if it is distinct from other goods or services in the contract. A promised good or service would be distinct if:



(a) The vendor regularly sells the good or service separately, or

(b) The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer. Readily available resources are goods or services that are sold separately by the vendor or by another vendor, or resources that the customer already has obtained from the vendor or from other transactions or events.

When evaluating criterion (b), the order of delivery of goods or services could determine whether a good or service is a separate performance obligation. For example, a company enters into an arrangement to transfer two products that are never sold separately to its customer. Product A can be used on its own but Product B cannot be used without Product A. If Product A is delivered first, the products would be separate performance obligations. However, if Product B is delivered first, it would not be considered distinct and would therefore be combined with Product A into a single performance obligation.

Additionally, goods or services in a bundle of promised goods or services are not distinct, and should be accounted for as a single performance obligation, if:

(a) The promised goods or services are highly interrelated and transferring them to the customer requires the vendor to provide a significant service of integrating the goods or services into the combined item for which the customer has contracted; and

(b) The bundle of goods or services is significantly modified or customized to fulfill the contract.

This guidance was provided to address preparers’ concerns about accounting for long-term contracts with multiple phases that may overlap or may be highly interrelated. Many tasks and activities in a long-term contract that otherwise may be distinct may be combined into a single performance obligation as a result of this guidance. That could result in the vendor accounting for all the promised goods or services in a contract as a single performance obligation.

The 2011 ED also would allow entities, as a practical expedient, to account for two or more distinct promised goods or services as a single performance obligation if those promised goods or services have the same pattern of transfer to the customer.

The 2011 ED provides specific guidance for identifying separate performance obligations in the following circumstances:

• An option for additional goods or services (such as a renewal option) would constitute a separate performance obligation only if the option gives the customer a material right that it would not receive without entering into that contract (e.g., the customer effectively pays the vendor in advance for future goods or services in the current contract). If the selling price of an option that represents a separate performance obligation is not directly observable, an estimate of standalone selling price of the option would take into account (a) the discount the customer would obtain when exercising the option, (b) any discount the customer would receive without exercising the option, and (c) the likelihood that the option will be exercised.

• A sale of a product with a right of return would not be accounted for as a separate performance obligation under the 2011 ED. Instead, a vendor would recognize revenue for the transferred goods that the vendor is reasonably



assured will not be returned, similar to current accounting. However, a refund liability for the amount of consideration expected to be refunded to the customer for returned goods and an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability also would be recognized. If the vendor concludes it is not reasonably assured of the amount to which it will be entitled for the goods that will not be returned, the vendor would not recognize revenue for transferred goods subject to the right of return until the vendor becomes reasonably assured of the amount to which it is entitled. The accounting for a sale of a product with a right of return under the 2011 ED is similar to the accounting under current U.S. GAAP except that the allowance for returns would be presented gross as a refund liability and an asset in all cases.

• Warranties are provided with the sale of a number of products and services in today’s marketplace. If a customer has the option to purchase the warranty separately, the vendor would account for the warranty as a separate performance obligation because the vendor promises to provide a service to the customer in addition to the product or service. Thus, the vendor would allocate a portion of the transaction price to the performance obligation for the warranty service.

If the customer does not have the option to purchase the warranty separately, the vendor would follow a cost-accrual model consistent with current U.S. GAAP to account for the promised warranty unless the warranty, or a part of the warranty, provides the customer with a service in addition to the assurance that the product complies with agreed upon specifications.5

The 2011 ED proposal for warranties is largely consistent with current U.S. GAAP and is a change from the 2010 ED, which would have required the deferral of revenue for all warranties. However, the model for revenue deferral would have differed depending on the nature of the warranty.

In evaluating whether a warranty provides an additional service, the 2011 ED indicates that a vendor should consider factors such as: (a) whether the warranty is required by law; (b) the length of the warranty coverage period; and (c) the nature of the tasks that the vendor promises to perform. If an additional distinct service is identified, it would be bifurcated from the warranty obligation and accounted for as a separate performance obligation.

A legal requirement to pay compensation or other damages if products cause damage would not be considered a performance obligation and would be accounted for under other U.S. GAAP.

Step 3 – Determine the Transaction Price. The transaction price is the amount of consideration to which a vendor expects to be entitled in exchange for transferring goods or services, excluding amounts collected on behalf of third parties (e.g., sales tax). The transaction price determined in Step 3 is the vendor’s expectation of the amount of consideration to which it will be entitled without constraint, which is a change from the 2010 ED. Under the 2010 ED, the transaction price would have been limited to amounts that were reasonably estimable. However, under the 2011 ED, the cumulative amount of revenue that may be recognized for a separate performance obligation in Step 5 is constrained (See within Step 5, Constraining the Cumulative Amount of Revenue Recognized). To determine the transaction price, a vendor considers the terms of the contract, its customary business practices, and

5 FASB ASC Topic 450, Contingencies, available at www.fasb.org.

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the effects of variable consideration, time value of money, noncash consideration, and consideration payable to the customer.

• Variable consideration may result from discounts, performance bonuses/penalties, contingencies, royalties, price concessions, or other items. If consideration is variable, a vendor’s measurement objective is to determine the amount that is most predictive of the consideration to which the vendor would be entitled. Depending on the facts and circumstances, this would be estimated using either:

(a) The expected value derived using a probability-weighted estimate; or

(b) The most likely amount.

A vendor would consider all information available when making its estimate and would update the estimate at each reporting date. The 2010 ED would have required a vendor to use the probability-weighted expected value approach in all circumstances; however, the Boards determined that an expected value may not always achieve the objective of the most predictive amount (e.g., when there are binary outcomes).

• Time value of money would be reflected in a vendor’s estimate of the transaction price if the contract has a financing component that is significant to the contract using the discount rate that would be reflected in a separate financing transaction between the vendor and the customer at the inception of the contract. To determine whether a financing component is significant to the contract, a vendor would be required to consider all relevant factors. In particular, the 2011 ED notes that vendors should consider:

(a) The expected length of time between when the vendor transfers the promised goods or services to the customer and when the customer pays for those goods or services;

(b) Whether the amount of customer consideration would differ substantially if the customer paid cash promptly under the typical credit terms in the industry and jurisdiction; and

(c) The interest rate in the contract and prevailing interest rates.

As a practical expedient, the 2011 ED indicates that a vendor would not be required to reflect the time value of money in its estimate of the transaction price if the vendor expects at contract inception that the period between customer payment and the transfer of goods or services will be one year or less.

• Noncash consideration would be measured at fair value.6

• Consideration payable to a customer would be evaluated by the vendor to determine if the amount represents a reduction of the transaction price, a payment for distinct goods or services, or a combination of the two.

If a reasonable estimate of fair value cannot be made, the estimated selling price of the promised goods or services would be used as a reference.

The Boards eliminated the proposed requirement in the 2010 ED for a vendor to consider a customer’s credit risk (i.e., collectibility) in the measurement of the transaction price. In addition, the 2011 ED does not include collectibility as a recognition threshold that would require an assessment of the customer’s ability to pay the promised amount of consideration for revenue to be recognized. Instead, 6 FASB ASC Topic 820, Fair Value Measurement, available at www.fasb.org.



revenue would be recognized (even when collectibility is not probable or reasonably assured) and a vendor would recognize an allowance for any expected impairment loss from contracts with customers following the guidance that applies to financial instruments (accounts receivable). The corresponding impairment amounts (i.e., bad debt expense) would be presented as a separate line item adjacent to the revenue line item as contra revenue.

The Boards noted in the Basis for Conclusions that if there is significant doubt at contract inception about the collectibility of consideration from the customer, that doubt may indicate that the customer is not committed to perform its obligations under the contract and the criteria for a contract may not be met.

Step 4 – Allocate the Transaction Price to the Separate Performance Obligations. Under the 2011 ED, a vendor would allocate the transaction price to all separate performance obligations in proportion to the standalone selling price of the promised goods or services, except as noted below. The best evidence of standalone selling price would be the observable price for which the vendor sells goods or services separately. In the absence of separate observable sales, the standalone selling price would be estimated.

The 2011 ED would require a vendor to consider all information that is reasonably available and maximize observable inputs when estimating the standalone selling price. Estimation methods include, but are not limited to: (a) adjusted market assessment approach, (b) expected cost plus a margin approach, and (c) residual approach. The residual approach would be appropriate only if the standalone selling price of a good or service is highly variable or uncertain and the standalone selling prices of the other performance obligations in the contract are observable.

If the sum of the standalone selling prices exceeds the transaction price (i.e., the customer receives a discount for the bundle of goods), the discount would be allocated to all of the performance obligations unless both of the following criteria are met, in which case the entire discount would be allocated to one or some separate performance obligations:

(a) The vendor regularly sells each good or service or each bundle of goods or services in the contract on a standalone basis; and

(b) The observable selling prices from those standalone sales provide evidence of the performance obligations to which the entire discount belongs.

While this guidance on allocating a discount entirely to one or some separate performance obligations is new in the 2011 ED, it is similar to the contract segmentation guidance included in the 2010 ED.

The 2011 ED provides an additional exception to allocating the transaction price proportionately to each separate performance obligation based on relative standalone selling prices. If the transaction price includes an amount that is contingent on a future event or circumstance, the contingent amount would be allocated entirely to a distinct good or service only if both of the following criteria are met:

(a) The contingent payment terms for the distinct good or service relate specifically to the vendor’s efforts to transfer that good or service or to a specific outcome from transferring that good or service; and



(b) Allocating the contingent amount of consideration entirely to the distinct good or service, when considering all of the performance obligations and payment terms in the contract, would depict the amount of consideration to which the vendor expects to be entitled for transferring that good or service.

The treatment of contingent payments in the 2011 ED is similar in concept to the milestone method under current U.S. GAAP.7

Step 5 – Recognize Revenue When (or as) the Vendor Satisfies a Performance Obligation. A vendor would recognize revenue when (or as) the vendor satisfies a performance obligation by transferring control of a good or service (that is, an asset) to a customer. Satisfaction would occur when the customer has the ability to direct the use of, and receive the benefits from, the transferred good or service. Control also includes the customer’s ability to prevent other entities from directing the use of, and obtaining the benefit from, the good or service. A vendor would first determine whether the performance obligation is satisfied over time. If it is not, the vendor would recognize revenue at a point in time when the customer obtains control of the good or service.

After initial allocation, the transaction price would be updated over the term of the contract for changes in estimates of the variable transaction price, which would be allocated to all performance obligations on the same basis as at contract inception. Subsequent changes in the transaction price related to satisfied performance obligations would be recognized as revenue in the period when the estimate of the transaction price changes. Reallocation of the transaction price for changes in standalone selling prices would not be allowed.

• Performance Obligations Satisfied over Time. A vendor transfers control of a good or service over time if either of the following criteria is met:

(a) The vendor’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or

(b) The vendor’s performance does not create an asset with an alternative use to the vendor and at least one of the following conditions is met: (1) the customer simultaneously receives and consumes the benefits as the vendor performs each task; (2) another vendor would not need to substantially reperform work the vendor has completed to date if that other vendor were to fulfill the remaining obligation to the customer; or (3) the vendor has a right to payment for performance to date and the vendor is expected to fulfill the contract as promised.

If a performance obligation is satisfied over time, the vendor would recognize revenue only if it can reasonably measure its progress toward complete satisfaction of the performance obligation. The objective when measuring progress is to depict the transfer of control of goods or services to the customer. A vendor would measure its progress using an output method or an input method that depicts the transfer of control over the good or service and would be required to apply that method consistently to similar performance obligations and in similar circumstances. Output methods use direct measurements of the value to the customer of the goods or services transferred to date. Input methods use a vendor’s inputs (e.g., costs incurred or time lapsed) relative to the total expected inputs to the satisfaction of that performance obligation. When the vendor’s inputs are incurred evenly over time, it may be appropriate to recognize revenue on a straight-line basis.

7 FASB ASC Subtopic 605-28, Revenue Recognition—Milestone Method, available at www.fasb.org.



The 2011 ED includes an exception to the general approach for applying an input method. The exception applies when a vendor acting as a principal procures goods from another vendor and is not involved in the design or manufacture of those goods, the cost of the goods is significant relative to the total costs to satisfy the performance obligation, and control of the goods is transferred to the customer significantly in advance of delivery or services related to those goods. In this situation, the best depiction of the vendor’s performance may be for the vendor to recognize revenue in an amount equal to the cost of the goods. This is different than current U.S. GAAP, which excludes the costs of the goods from the cost-to-cost percentage-of-completion calculation until the goods are used in the project.8

• Control Transferred at a Point in Time. A vendor would use judgment in determining when control of a good or service has been transferred. The 2011 ED lists the following indicators, none of which are necessarily determinative, that control of an asset has been transferred to a customer:

(a) The vendor has a present right to payment for the asset.

(b) The customer has legal title to the asset.

(c) The vendor has transferred physical possession of the asset.

(d) The customer has the significant risks and rewards of ownership of the asset.

(e) The customer has accepted the asset.

The indicators of transfer of control in the 2011 ED are different than the indicators in the 2010 ED. The 2011 ED removed “the design or function of the good or service is customer specific” and added (d) and (e). The 2011 ED provides interpretive guidance on applying these indicators to bill-and-hold and consignment arrangements that is largely consistent with the 2010 ED. When a vendor enters into a bill-and-hold arrangement, it would determine whether it has satisfied its performance obligation by transferring control of that good to the customer based on meeting all of the following specific additional criteria: (1) the reason for the bill-and-hold arrangement must be substantive; (2) the product must be identified separately as belonging to the customer; (3) the product currently must be ready for physical transfer to the customer; and (4) the entity cannot have the ability to use the product or to direct it to another customer. These criteria differ in two key respects from existing SEC guidance.9

Licensing and Rights to Use Intellectual Property. Licensing refers to granting a customer the right to use, but not own, intellectual property, which may include software and technology, motion pictures, music and other forms of

The bill-and-hold arrangement is not required to be at the customer’s explicit request and the vendor would not need a specified delivery schedule to meet the bill-and-hold criteria in the 2011 ED. If control of the goods has been transferred, the vendor also would consider whether the custodial service is a separate performance obligation and, therefore, part of the transaction price should be allocated to this service. To identify consignment arrangements, a vendor would evaluate whether it maintains control over a good even though the customer has physical possession similar to current accounting.

8 FASB ASC Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, available at www.fasb.org. 9 SEC Staff Accounting Bulletin Topic 13, Revenue Recognition, available at www.sec.gov.



media and entertainment, franchises, patents, trademarks, copyrights, and other intangible assets. Promises to deliver those rights create a performance obligation that the vendor satisfies when the customer obtains control of the rights. If the license is a separate performance obligation, revenue allocated to the license would be recognized when the customer obtains control of the license, subject to limitations on sales-based royalties.

However, if the license is combined with a service that is delivered over time (e.g., because the license is not distinct or the license is combined with services that involve significant customization), the vendor would recognize license and service revenue over time as the combined performance obligation is satisfied.

This guidance on licensing was changed from the 2010 ED. Most notably, the 2010 ED would have required a vendor that grants an exclusive license to recognize revenue over the term of the exclusive license rather than at the point in time the customer obtains control of the right to use the intellectual property.

• Constraining the Cumulative Amount of Revenue Recognized. The cumulative amount of revenue that a vendor may recognize for a separate performance obligation would be limited to amounts to which the vendor is reasonably assured to be entitled. A vendor is reasonably assured to be entitled to an amount only if:

(a) The vendor has experience with similar types of performance obligations (or has other evidence such as access to the experience of other entities); and

(b) The vendor’s experience (or other evidence) is predictive of the outcome of the performance obligation.

Notwithstanding a vendor’s experience with licensing intellectual property, the Boards concluded that a vendor would not be reasonably assured to be entitled to sales-based royalties until the customer’s sales occur. This is a significant change from the 2010 ED, which would have allowed royalties, as well as all other variable fees, to be included in the transaction price if they were reasonably estimable without being subject to any further constraint.

• Customers’ Unexercised Rights (Breakage). The 2011 ED provides specific guidance on accounting for breakage (e.g., for gift cards). This was not addressed in the 2010 ED. If a vendor is reasonably assured of the amount of expected breakage, it would recognize the effects of the expected breakage as revenue in proportion to the pattern of rights exercised by the customer. Otherwise the vendor would recognize the effects of the expected breakage when the likelihood of the customer exercising its remaining rights becomes remote. The guidance in the 2011 ED is largely consistent with current practice under U.S. GAAP.10

Contract Modifications

A contract modification occurs when the parties to a contract approve a change in the scope or price of a contract (or both). A contract modification that impacts only the price of a contract would be treated as a change in the transaction price. If the parties have approved a change in scope, but have not yet determined the corresponding change in price (e.g., an unpriced change order), the proposed guidance would be applied to the modified contract at the point that the vendor has an expectation that the price will be approved, which may be at a later time than under current practice. 10 SEC Staff Speech, by Pamela R. Schlosser, December 5, 2005, available at www.sec.gov.



A contract modification would be treated as a separate contract if the modification results in (a) a promise to deliver additional goods or services that are distinct; and (b) the vendor has a right to receive consideration that reflects the vendor’s standalone selling price of those goods or services adjusted to reflect the circumstances of the contract.

If those criteria are not met, the modification would be accounted for on a combined basis with the original contract. If the remaining goods and services under the original contract and the modification are distinct from those transferred on or before the date of the contract modification, then the unrecognized consideration is allocated to the remaining performance obligations; revenue is recognized when (or as) the remaining performance obligations are satisfied. Using this approach would effectively account for the modification prospectively. However, if the remaining goods and services are not distinct from those transferred on or before the date of the contract modification and are part of a single performance obligation that is partially satisfied at the date of the modification, the measure of progress toward satisfaction of the performance obligation would be updated, and the vendor would recognize the cumulative effect of the contract modifications in the period when they occur. In this circumstance, the modification would effectively be accounted for using a cumulative catch-up model.

The 2010 ED would have required a vendor to account for a contract modification as a separate contract if the contract modification and original contract are priced independently. If not, the modification would have been recorded as a cumulative catch-up adjustment.

Contract Costs

Incremental Costs of Obtaining a Contract. Incremental costs that a vendor incurs only as a result of obtaining a contract (e.g., sales commissions) would be capitalized if the vendor expects to recover these costs. Under the 2011 ED, costs that would be incurred regardless of whether the contract was obtained would be expensed as incurred unless they meet the criteria to be capitalized as fulfillment costs. As a practical expedient, a vendor would not be required to capitalize the incremental costs of obtaining a contract if the amortization period of those costs would be one year or less. This approach represents a change from the 2010 ED, which would have required all costs of obtaining a contract to be expensed as incurred.

Costs to Fulfill a Contract. If the costs incurred in fulfilling a contract are not within the scope of other guidance (e.g., inventory; property, plant and equipment; or capitalized software), a vendor would recognize an asset only if the fulfillment costs:11

• Relate directly to an existing contract (or a specific anticipated contract);

• Generate or enhance resources of the vendor that would be used to satisfy performance obligations (i.e., the costs relate to future performance obligations under the contract); and

• Are expected to be recovered.

11 FASB ASC Topics 330, Inventory; and 360 Property, Plant, and Equipment; and FASB ASC Subtopics 985-20, Software—Costs of Software to Be Sold, Leased, or Marketed; and 350-40, Intangibles—Goodwill and Other – Internal-Use Software; all available at www.fasb.org.



The 2011 ED identifies the following examples of fulfillment costs that would be eligible for capitalization if the criteria above are met:

• Direct labor (e.g., employee wages);

• Direct materials (e.g., supplies);

• Allocation of costs that relate directly to the contract (e.g., depreciation);

• Costs that are explicitly chargeable to the customer under the contract; and

• Other costs that were incurred only because the vendor entered into the contract (e.g., subcontractor costs).

Under the 2011 ED, the following costs would be expensed as incurred:

• Costs relating to satisfied performance obligations;

• Abnormal amounts of wasted materials, labor, or other fulfillment costs that were not reflected in the price of the contract; and

• General and administrative costs that are not explicitly recoverable from the customer under the contract.

If a vendor cannot distinguish the fulfillment costs that relate to future performance obligations from the costs that relate to past performance obligations, the vendor would expense these costs as incurred. This proposed guidance is largely consistent with the 2010 ED.

Amortization and Impairment. Under the 2011 ED, costs to fulfill a contract and incremental costs of obtaining a contract recognized as assets would be amortized on a systematic basis consistent with the pattern of transfer of goods or services to which the asset relates. In some cases, the asset may be amortized over more than one contract when the asset relates to goods or services that will be provided under an anticipated contract that the vendor can identify specifically (e.g., renewal options).

A vendor would recognize an impairment loss to the extent that the carrying amount of the asset exceeds its recoverable amount. The recoverable amount would be defined as the:

• Remaining amount of consideration the vendor expects to be entitled in exchange for the goods or services to which the asset relates, less

• Costs that relate directly to providing those goods or services.

When assessing an asset for impairment, the amount of consideration included in the impairment test would not be adjusted for customer credit risk (i.e., collectibility) because that impairment loss would be recorded separately. Reversals of impairment of the capitalized fulfillment or acquisition asset would not be permitted under U.S. GAAP.

Onerous Performance Obligations

The 2011 ED would require a vendor to evaluate each performance obligation that it expects at contract inception to satisfy over time and over a period of one year or more to determine whether the performance obligation is onerous. The scope of this onerous performance obligation evaluation was modified from the 2010 ED, which would have required a vendor to consider whether each separate performance



obligation was onerous rather than only those expected to be satisfied over time and over a period of one year or more. Under the 2011 ED, a performance obligation would be onerous if the lowest cost of settling the performance obligation is in excess of the transaction price allocated to the performance obligation. The lowest cost is the lower of the costs that relate directly to satisfying the obligation or the amount the vendor would have to pay under the contract to cancel the performance obligation. This model, referred to by the Boards as the least-cost model, is different from the proposed requirement in the 2010 ED. Under the previous proposal, a performance obligation would have been considered onerous if the present value of the probability-weighted costs that relate directly to satisfying that performance obligation exceeds the amount of the transaction price allocated to that performance obligation.

A vendor would be required to recognize a loss for each onerous performance obligation first by recognizing an impairment loss on the related assets and then by recognizing any additional amount as a liability separate from the contract liability. The liability would be remeasured with an adjustment to expense at each subsequent financial statement date until the performance obligation is satisfied.

Sale of Assets That Are Not Part of a Vendor’s Ordinary Activities

Certain aspects of the 2011 ED also would be applied to sales of intangible assets and property, plant, and equipment, including real estate, that are not an output of the vendor’s ordinary activities. A vendor would derecognize the asset when the counterparty obtains control of the asset. The resulting gain or loss would be based on the difference between the transaction price and the carrying amount of the asset but limited to amounts to which the seller is reasonably assured to be entitled.

Repurchase Arrangements

If a vendor sells an asset to a customer and promises to repurchase the asset, the accounting for that promise depends on the form of the promise (i.e., forward, call option, or put option). If a customer has a significant economic incentive to exercise an unconditional right to require the vendor to repurchase the asset (put option), the customer would be considered to effectively pay the vendor for the right to use the asset for a period of time. Consequently, the vendor would account for the agreement as a lease.12

If the vendor has an unconditional obligation (a forward) or an unconditional right (a call option) to repurchase the asset, the customer would not have control of the asset. The vendor would account for the entire agreement as a lease if it expects to

To determine whether the customer has a significant economic incentive to exercise its right, a vendor would consider factors including the relationship of the repurchase price to the expected market value of the asset at the date of repurchase and the amount of time until the right expires. The 2011 ED specifies that if the repurchase price is expected to exceed the market value of the asset, the customer would have a significant economic incentive to exercise the put option. If the customer does not have a significant economic incentive to exercise its right, the vendor would account for the agreement similar to a sale of a product with a right of return. Under the 2010 ED, a vendor would have accounted for the sale of an asset subject to a put option in all circumstances as a sale with a right of return.

12 FASB ASC Topic 840, Leases, and the summary of the joint project of the FASB and IASB - Leases, both available at www.fasb.org.




repurchase the asset for less than the original sales price of the asset.13

Principal versus Agent Considerations

If the vendor expects to repurchase the asset for an amount that is greater than or equal to the original sales price, it would account for the transaction as a financing arrangement.

When other parties also are involved in providing goods or services to a vendor’s customer, the vendor should make a determination about whether its performance obligation is to provide the specified goods or services itself or to arrange for another party to provide them (i.e., whether it is acting as a principal or an agent). If a vendor obtains control of goods or services from another party before transferring them to the customer, the vendor’s performance obligation is to provide the goods or services. In that situation, the vendor is acting as a principal and would recognize revenue at the gross amount collected from the customer. If a vendor does not obtain control of the goods or services from another party before transferring them to the customer, the vendor is acting as an agent for the other party and should recognize revenue at the net amount. If the vendor obtains legal title of a good only momentarily before legal title is transferred to the customer, the vendor may not be acting as a principal. The 2011 ED includes the following indicators that a vendor is acting as an agent and should recognize revenue on a net basis:

• The other party is primarily responsible for fulfilling the contract.

• The vendor does not have inventory risk.

• The vendor does not have latitude in establishing prices for the other party’s goods or services.

• The vendor’s consideration is a commission.

• The vendor does not have customer credit risk for the amount receivable in exchange for the other party’s goods or services.

Presentation and Disclosures

Under the 2011 ED, a vendor would present a contract asset or contract liability (i.e. the net asset or liability arising from the remaining rights and obligations in a contract) in its statement of financial position when either party to the contract has performed. The vendor performs by transferring goods or services and the customer performs by paying consideration to the vendor. An unconditional right to consideration would be presented as a receivable and not as a contract asset. A right to consideration is unconditional if nothing, other than the passage of time, is required before the consideration is due. Capitalized fulfillment costs, costs to obtain a contract, and liabilities for onerous contracts also would be presented separately from the net contract asset or liability.

Disclosure Requirements for Annual Periods. The 2011 ED would require disclosures that help financial statement users understand the nature, amount, and timing of revenue and cash flows arising from contracts with customers. The

13 For more information about the Boards’ joint project on accounting for leases, see KPMG’s Defining Issues No. 11-54 FASB and IASB Propose to Retain Operating Lease Accounting for Some Leases of Lessors, and Issues In-Depth 10-5, Potential Implications of the FASB, IASB Joint Exposure Draft on Lease Accounting, both available at www.kpmginstitutes.com/financial-reporting-network.



proposed quantitative and qualitative disclosure requirements fall into the following categories:

• Contracts with customers:

• Disaggregation of revenue;

• Reconciliation of contract balances; and

• Performance obligations, including onerous performance obligations;

• Significant judgments, and changes in judgments, in the application of the proposed requirements:

• The timing of satisfaction of performance obligations; and

• The transaction price and allocating it to performance obligations; and

• Assets recognized from the costs to obtain or fulfill a contract with a customer.

Significant changes from the 2010 ED related to presentation and disclosure include:

• The 2010 ED listed specific categories for which a vendor would be required to disaggregate revenue. The 2011 ED does not prescribe the specific categories into which a vendor would be required to disaggregate revenue. Instead, a disaggregation principle is given with examples of categories that may be appropriate. The disaggregated revenue may be presented in the statement of comprehensive income or in the notes to the financial statements. The impairment loss allowance (for customer credit risk that is presented as a contra-revenue account) would not be required to be disaggregated.

• The 2011 ED indicates that the specified reconciling line items would not need to be included if they are not applicable; this was not specifically stated in the 2010 ED.

• For performance obligations satisfied at a point in time, the 2011 ED added a disclosure requirement about the significant judgments in evaluating when the customer obtains control of the promised goods or services.

• For contracts with an original expected duration of more than one year, a vendor would be required to disclose the amount of the transaction price allocated to remaining performance obligations and an explanation of when it expects those amounts to be recognized as revenue. A vendor may achieve the objective of this requirement in the 2011 ED either by making the disclosures on a quantitative basis in time bands that would be most appropriate for the duration of the remaining performance obligations, or by using qualitative information. The 2010 ED would have required quantitative disclosures based on specified time bands.

• Specific disclosures about capitalized costs associated with contracts that were not included in the 2010 ED were added to the 2011 ED including:

• A reconciliation of the carrying amount;

• Disclosure by major category (e.g., acquisition costs, pre-contract costs, setup costs, and other fulfillment costs); and

• A description of the method used to determine amortization.



Nonpublic Entity Disclosures (or Exemptions from Disclosure Requirements) for Annual Periods. The FASB decided to permit nonpublic entities to disaggregate revenue between performance obligations satisfied at a point in time versus those satisfied over time and disclose qualitative information about how economic factors (such as the type of customer, geographical location of customers, and type of contract) affect the amount, timing, and uncertainty of revenue and cash flows. The FASB also decided to exempt nonpublic entities from disclosing the reconciliations of contract assets and contract liabilities, onerous performance obligation liabilities, and capitalized costs to obtain or fulfill a contract. Other disclosure exemptions for nonpublic entities would include the amount of the transaction price allocated to remaining performance obligations and the expected timing of their satisfaction; the required disclosures of significant judgments and the changes in determining the timing of the satisfaction of performance obligations; and the determination of the transaction price and allocating it to performance obligations.

Interim Period Disclosures. The Boards also decided that the following disclosures would be required for interim financial reporting of public entities, if material:

• Disaggregation of revenue;

• Reconciliation of changes in contract balances;

• Timing of satisfaction of performance obligations;

• Information about onerous performance obligations and reconciliation of the changes in onerous liability; and

• Reconciliation of changes in assets recognized from costs to obtain or fulfill a contract with a customer.

Nonpublic entities that apply U.S. GAAP would not be required to make these interim disclosures because much of this information is not required to be disclosed by nonpublic entities in their annual financial statements.

Effective Date and Transition

A vendor would be required to retrospectively adopt the proposed standard for annual reporting periods beginning on or after the effective date. The Boards have not determined the effective date but have concluded that for public entities it would not be earlier than for years beginning on or after January 1, 2015. The effective date for nonpublic entities would be a minimum of one year after the effective date for public entities under U.S. GAAP. The 2011 ED provides for the following optional practical expedients from full retrospective application:

• Contracts completed before the date of initial application that begin and end in the same annual reporting period would not need to be adjusted retrospectively;

• A vendor would be permitted to use the transaction price at the date the contract was completed for contracts with variable consideration that are completed before the date of initial application;

• A vendor would be permitted to evaluate whether a performance obligation is onerous only at the date of initial application without applying the test to comparative periods, unless an onerous contract liability was previously recognized for the contract; and



• For all periods before the date of initial application, a vendor would not be required to disclose the amount of transaction price allocated to the remaining performance obligations and an explanation of when the vendor expects to recognize the amount as revenue.

A vendor electing to use one or more of the practical expedients would be required to apply them consistently to all reporting periods presented and to disclose which ones have been used along with a qualitative description of the effect of applying them.

Early adoption of the proposed standard would be prohibited under U.S. GAAP.

Potential Changes to Current U.S. Practice

The 2011 ED, if adopted in its current form, could result in changes in accounting for many entities applying U.S. GAAP. The discussion below highlights some of the potential changes to current U.S. GAAP based on our initial impressions and current understanding of the 2011 ED. It is not intended to be an exhaustive list of all potential changes.

Real Estate Sales. The 2011 ED would apply to the derecognition of real estate whether or not that is a part of the vendor’s ordinary activities. Current U.S. GAAP contains prescriptive criteria that must be met to recognize the full amount of a gain on sale of real estate.14

Long-Term Contracts. Although the 2011 ED is not expected to have as significant an impact as the 2010 ED could have had on accounting for long-term contracts, there could still be changes including:

Under the proposed standard, a gain or loss may be recognized for a transaction that does not meet the current requirements for full profit recognition. Instead, the 2011 ED would require a seller to derecognize the asset when the counterparty obtains control of the asset. However, certain provisions of real estate sale transactions, such as repurchase arrangements, may impact the determination about whether the counterparty obtains control of the asset. The elimination of the provisions of the existing U.S. GAAP that limit the amount of gain that can be recognized generally would reduce the number of instances where gains, or part of the gains, on sales of real estate are required to be deferred. If selling real estate represents an ordinary activity of the seller, it would record revenue and expense based on the transaction price and the carrying amount of the asset, respectively. Conversely, if selling real estate is not an ordinary activity, the seller would record a gain or loss based on the difference between the transaction price and the carrying amount of the asset but limited to amounts to which the seller is reasonably assured to be entitled.

• Vendors would no longer have one consistent profit margin over the life of a contract unless they use the cost-to-cost method for measuring progress. Under the 2011 ED, the recognition of revenues and costs would be decoupled from one another. Aside from capitalized contract acquisition and fulfillment costs, costs would be recognized either as incurred or as control over goods (inventory) transfers to the customer. If a vendor uses an output method to measure progress, margins could vary significantly over the course of the contract.

14 FASB ASC Subtopic 360-20, Property, Plant, and Equipment – Real Estate Sales, available at www.fasb.org.




• Change orders and other contract modifications may need approval by the vendor and the customer (i.e., legally enforceable) before they are considered to be contracts subject to the proposed standard.

• As discussed in the section Performance Obligations Satisfied over Time, there may be a change to the percentage-of-completion calculation when a vendor transfers uninstalled materials if the customer controls the materials, the costs are significant, and the vendor is not involved in the design or manufacture the materials.

• The constraint on cumulative revenue recognized to amounts that the entity is reasonably assured to be entitled to may preclude the recognition of certain consideration, such as performance bonuses, incentives, and other pricing mechanisms that may be permitted under current U.S. GAAP.

• Payment terms and each performance obligation should be considered when determining whether the time value of money is factored into the transaction price. It is unclear how retention payments may affect the time value of money consideration.

Vendors will need to make an assessment of each performance obligation when a contract has multiple performance obligations to determine whether it is onerous at contract inception and at each reporting date. If a contract has multiple performance obligations, it could have one or more onerous performance obligations even though the contract may be expected to be profitable overall.

Software Revenue Recognition. The 2011 ED could significantly alter revenue-recognition practices for transactions within the scope of the software revenue recognition guidance.15

The proposed model could result in revenue being recognized earlier for many multiple-element software arrangements. Most significantly, a vendor would no longer be required to have vendor-specific objective evidence of fair value (VSOE) for the undelivered items in a software arrangement to account for those items separately. Rather, each distinct good or service would be accounted for separately, and a vendor would need to estimate standalone selling prices for all distinct goods or services for which VSOE does not exist. For example, in an arrangement that provides a customer with specified software and the right to unspecified products in the future on a when-and-if-available basis, a vendor would be required to allocate a portion of the transaction price to the right to receive unspecified additional software products if that right is distinct from the specified software license. The amounts allocated to the specified products would be recognized as revenue when the customer obtains control. This would be a change from current U.S. GAAP that requires vendors to follow a subscription accounting model in these circumstances and recognize revenue ratably over the term of the arrangement. Additionally, under current guidance a vendor that does not have VSOE for undelivered PCS in a bundled arrangement recognizes revenue from the entire arrangement ratably. Under the 2011 ED, the vendor would estimate the standalone selling price of PCS and the

Software vendors would need to consider whether the software license is distinct from post-contract customer support (PCS) and other professional services and whether any other services are significant integration services that would require the services to be combined into one performance obligation with the software license.

15 FASB ASC Subtopic 985-605, Software – Revenue Recognition, available at www.fasb.org.




license and allocate the transaction price using the relative standalone selling price method, which would result in an acceleration of revenue recognition.

The residual method, which is now used to allocate arrangement consideration in software arrangements when VSOE is available for the undelivered items but not for the delivered items, would no longer be permitted under the 2011 ED. However, a residual approach to estimating a standalone selling price would be permitted when the estimated standalone selling price of one item is highly variable or uncertain. It is expected that many software vendors will be permitted to continue using a residual technique to allocate revenue to software licenses because the selling price of the software license typically is highly variable. Otherwise, the 2011 ED would require the use of the relative selling price method in allocating the transaction price to the performance obligations (unless an exception is met for allocating discounts or contingent amounts), which could lead a vendor to allocate a greater proportion of the transaction price to the delivered elements.

Franchisors. Under current practice, an upfront franchise fee payment from an individual franchise sale generally is recognized as revenue when all material services or conditions relating to the sale have been substantially performed or satisfied by the franchisor.16

Other Licensing and Rights to Use Intellectual Property. Current U.S. GAAP contains other industry-specific guidance for licenses such as films and music.

The proposed standard may not change current practice because the franchisor generally would satisfy the performance obligation when the franchisee obtains control of the rights (i.e., begins operations). However, other performance obligations such as equipment and training and other ongoing services would be satisfied when the goods and services are transferred if they are determined to be distinct performance obligations. Royalties would not be recognized until the franchisee’s sales occur, which would result in treatment that is consistent with current U.S. GAAP.

17

Nonrefundable Upfront Fees. Under current guidance, unless a nonrefundable upfront fee is paid in exchange for products or services performed that represent the culmination of a separate earnings process, the upfront fee should be deferred and recognized over the expected period of performance. This period extends beyond the initial contract period if the relationship with the customer is expected to extend beyond the initial term and the customer continues to benefit from the payment of the upfront fee. Under the proposed standard, a nonrefundable upfront fee would be recognized over a period that extends beyond the initial contract period if the vendor

For many of these arrangements, the conclusion that a vendor satisfies a performance obligation when the customer obtains control over the license would not change current practice. For other licenses, such as patents, trademarks, copyrights, and other intangible assets, there is no specific U.S. GAAP guidance about whether license revenue should be recognized over the license term or at the inception of the license period. Current SEC staff guidance indicates that revenue for licenses of intellectual property should be recognized “in a manner consistent with the nature of the transaction and the earnings process.” The 2011 ED would change practice for vendors who have an accounting policy of recognizing revenue for term licenses over time (i.e., straight-line over the license term).

16 FASB ASC Topic 952, Franchisors, available at www.fasb.org. 17 FASB ASC Topics 926, Entertainment—Films, and 928, Entertainment—Music, both available at www.fasb.org.



grants the customer an option to renew the contract that represents a material right. If a customer may renew a contract each year without paying an additional upfront fee, that may indicate that a vendor has provided the customer a material right. This may result in the same treatment as under current guidance. However, other industry-specific guidance would change. For example, initial hookup fees in the cable television industry are currently recognized as revenue up to the amount of direct selling costs incurred.18

Consideration of Collectibility. The SEC guidance on revenue recognition requires that collectibility be reasonably assured for revenue to be recognized. Under the 2011 ED, collectibility is not considered in measuring the transaction price nor is it a recognition criterion. If a vendor determines that all or a portion of a receivable or a contract asset is uncollectible, then an allowance is established and any subsequent adjustments should be recorded as a separate line item adjacent to the revenue line item (as contra revenue). As a result of the 2011 ED, the installment method and cost-recovery method would no longer be allowed.

Under the proposed standard, these fees would be deferred unless they relate to distinct goods or services that are transferred to the customer at the inception of the arrangement. Some of the direct selling costs may be eligible for capitalization under the proposed standard’s guidance for incremental costs of obtaining a contract. If set-up activities do not satisfy a performance obligation, the vendor would disregard those activities and related costs when measuring progress towards satisfaction of a performance obligation.

19

Use of Estimates. In determining the transaction price (e.g., estimating variable consideration) and allocating the transaction price on the basis of standalone selling price, a vendor could be required to use estimates more extensively than under current standards. For example, for arrangements involving variable consideration, a vendor would use previous experience that is relevant to the performance obligation to determine the transaction price. (However, the amount of revenue recognized would be limited to the cumulative constraint.) Under current U.S. GAAP and SEC staff guidance that applies to arrangements other than long-term construction-type or production-type contracts, a vendor is not permitted to include variable consideration until amounts become fixed or determinable.

Multiple-Element Arrangements. In the absence of VSOE, a vendor would no longer be required to look first to third-party evidence before considering other evidence of standalone selling price, although it may be considered when using the adjustment market assessment approach. The residual approach would be allowed when the standalone selling price of a good or service is highly variable or uncertain. This effectively would reverse a recent decision to eliminate the residual method for non-software arrangements, although only in those situations where the selling price is highly variable or uncertain.20

18 FASB ASC Subtopic 922-605, Entertainment—Cable Television – Revenue Recognition, available at www.fasb.org.

For contracts that contain contingent revenue provisions, current U.S. GAAP limits the amount of revenue recognized on delivered items to the amount that is not contingent on delivery of the undelivered items. The 2011 ED does not contain such a restriction and therefore vendors that are reasonably assured of being entitled to the amount of contingent consideration would recognize more revenue sooner. This may have a significant impact on

19 FASB ASC paragraphs 605-10-25-3 through 25-5, available at www.fasb.org. 20 FASB Accounting Standards Update 2009-13, Multiple Deliverable Revenue Arrangements, available at www.fasb.org.




vendors in certain industries, such as telecommunications. For example, a vendor may provide a free or discounted handset with a two-year service contract. Currently, revenue recognized on sale of the handset is limited to the amount that is not contingent on the delivery of future services (i.e., the cash received at the inception of the arrangement). In these circumstances, the 2011 ED would require recognizing revenue when control of the handset transfers to the customer based on its relative standalone selling price.

Customer Loyalty Programs. There currently is no explicit U.S. GAAP guidance about accounting for point and loyalty programs. Many vendors accrue the direct and incremental costs of providing the goods or services underlying the program. Under the 2011 ED, benefits received by customers under loyalty programs would be considered a separate performance obligation because the points provide a material right to the customer that would not be received without entering into a purchase transaction that earns the points. Revenue would be allocated to this performance obligation on a relative standalone selling price basis and would be deferred until the obligations are satisfied.

Recognition of Losses. A vendor would be required to recognize losses for onerous performance obligations if the performance obligation is satisfied over time and over a period of one year or more. Under current guidance, excluding a few specific situations (e.g., long-term construction-type contracts, software-revenue arrangements, and separately priced extended warranty and product maintenance contracts), contract losses are not accrued in advance of performance.

Contract Costs. Under the 2011 ED, fulfillment costs would be required to be capitalized if they relate directly to an existing contract (or a specific contract under negotiation), generate or enhance resources of the vendor that would be used to satisfy performance obligations, and are expected to be recovered. Although there is no specific authoritative guidance under current U.S. GAAP that applies to arrangements other than long-term construction-type contracts, the SEC staff has generally required that fulfillment costs be expensed as incurred unless the costs relate to activities that do not qualify for revenue recognition (e.g., set up activities) and the vendor elects a policy to defer these costs. In addition, incremental costs that a vendor incurs only as a result of obtaining a contract (i.e., contract acquisition costs) would be capitalized if the vendor expects to recover these costs. This also would be a change from current practice under U.S. GAAP. Current SEC guidance permits a vendor to either capitalize or expense as incurred these costs as an accounting policy election. The proposed guidance in the 2011 ED would require capitalization unless the expected amortization period for the asset is less than one year.

Criteria to Determine whether the Vendor Is Acting as a Principal or an Agent. Certain criteria for assessing whether a party is a principal or an agent in current U.S. GAAP are not included in the 2011 ED (e.g., determining the primary obligor or product or service specifications). It is unclear what effect, if any, these changes may have on recognizing revenue gross as a principal or net as an agent. Additionally, the 2011 ED does not contain explicit principal-agent guidance for shipping costs and cost reimbursement that exists under current U.S. GAAP. However, a vendor would

The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the proposed 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. ©2001-2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity.

Contact us: This is a publication of KPMG’s Department of Professional Practice 212-909-5600

Contributing authors: Hershell W. Cavin Prasadh Cadambi David B. Elsbree, Jr. Alan F. Lewis Tamara Mathis Paul H. Munter Jorge Garcia Martell Darren W. Robb Brian J. Schilb

Earlier editions are available at: http://www.kpmginstitutes.com/financial-reporting-network

no longer have a policy election to present sales taxes on a gross basis (i.e., in both revenues and costs.)21

Disclosures. A vendor would be required to disclose more information about its contracts with customers than currently required, including more disaggregated information about recognized revenue and more information about its performance obligations remaining at the end of the reporting period.

These would be presented on a net basis under the 2011 ED.

21 FASB ASC paragraphs 605-45-50-3 through 50-4, available at www.fasb.org.

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