Distinct or bundled? FASB and IASB discuss revenue proposal

By February 29, 2012

Ken Tysiac

Distinguishing whether goods and services should be reported as distinct or bundled is one of the most frequently discussed areas of FASB’s joint proposal with the International Accounting Standards Board (IASB) for recognizing revenue from contracts with customers, officials said Wednesday during an educational webcast.

The notion of a distinct good or service is important as the proposed guidance is effectively accounting for or identifying separate performance obligations on the basis of whether they are performance obligations to provide a customer with a good or service that is distinct.

FASB Practice Fellow and Project Leader Kristin Bauer said the boards have received many questions related to paragraph 28 of the exposure draft, which identifies goods and services that are capable of being distinct, and paragraph 29 of the ED, which discusses whether goods or services in a bundle are not distinct and must be accounted for as a single performance obligation.

IASB Senior Technical Manager Glenn Brady explained the theory behind paragraph 28: “A good or service is going to be distinct if the customer can benefit from that good or service on its own, or together with other resources that the customer has readily available to them,” he said. “... If the entity regularly sells the good or service separately, that provides a clear indication that that is a good or service that is distinct. Because, why would an entity sell a good or service separately if that would not be a good or service that a customer could use on its own or together with other resources that a customer could readily obtain?”

Brady said board members had construction contracts in mind when they wrote the proposed guidance in paragraph 29 of the ED. For example, a construction company building a house delivers bricks, timber, tiles and labor, which all might at, first glance, be considered distinct.

“Each of those goods or services might be capable of being individually distinct. But the fact is, in that contract, the customer hasn’t contracted with the entity to supply them with bricks, timber, tiles and labor,” Brady said. “What they’ve actually contracted the entity to do is bring together each of those goods or services and effectively construct the house or construct the building that the customer has contracted with them for.”

Therefore, in that example, the bricks, timber, tiles and labor would not be reported as individual goods or services under the proposed standard.

FASB calls the proposal Revenue Recognition (Topic 605): Revenue From Contracts With Customers. The IASB calls the proposal Revenue From Contracts With Customers. The comment period for the entire project ends March 13.

The core principle of the proposed standard is that an entity would recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

A five-step process is proposed to identify that amount:

Step 1: Identify the contract with a customer.
Step 2: Identify the separate performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the separate performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

The current timetable calls for a final revenue standard to be released in late 2012 or early 2013. The earliest the standard could take effect would be the reporting period beginning Jan. 1, 2015.

The concept in paragraph 35 of the ED is generating a lot of feedback from stakeholders, Bauer said. That section discusses distinguishing between performance obligations that are satisfied over time and those satisfied at a point in time. Brady said users have questioned whether the boards are removing completion percentage accounting from the standard.

“No, we’re not,” Brady said. “So if your contract, which might be a construction contract or some other service contract, can meet the requirements of paragraph 35(a) or paragraph 35(b), then you will be able to recognize revenue over time, and you will then select the appropriate measure of progress in order to measure the entity’s satisfaction of that performance obligation over time.”

Other questions addressed during the webcast included:

Q: How does the standard apply when contracts with customers include items within the scope of other standards?

Brady: “There will be some circumstances where there is a contract with a customer that includes components, some of which are within the scope of another standard and the remainder of which may be within the scope of the revenue standard. … The boards proposed that, when you do have a contract, which includes elements within the scope of another standard, you should apply that [other] standard first. And in effect, the revenue standard becomes the default or the residual standard that applies to the goods or services within the contract.”

For example, Brady said, a contract with a customer might include a service as well as financial instruments. The entity would first identify the financial instruments within the contract and account for them within the financial instruments standards. The entity would subtract the fair value of the financial instruments from the transaction price. The remaining amount would be allocated to the service, which would be accounted for in the revenue model. Examples include contracts containing lease components, financial instruments and insurance coverage.

Q: Will the standard be applicable to banks?

Bauer: “Yes. If you have a contract with a customer, that would be in the scope of the standard. You would look through the scoping paragraphs, and, obviously, financial instruments would get scoped out. But anything that remains would be within the scope. So, yes, banks and other financial institutions are within the scope of the standard to the extent they have contracts with customers.”

Q: Do all contracts have to be in writing?

IASB Technical Manager Allison McManus: “The very short answer is no. Not all contracts have to be in writing. But stepping back a bit, the proposals provide principles that must apply across many jurisdictions, where the form of the contract or the legal environment might vary. So, often, the contract may be written, in particular for large items, but it can also be oral, or it can be implied by the customary business practices. Sometimes something as simple as a verbal order at a fast food establishment may actually create a contract. I think the key is that the contract really creates legally enforceable rights and obligations that will be accounted for under these proposals.”

Q: By requiring presentation of customer credit risk adjacent to revenue, did the boards intend it to be reported as a contra revenue amount or to be included in a net revenue line?

Brady: “The boards do not intend that impairment loss line, which they have proposed, should be presented adjacent to the revenue, to effectively be part of revenue. So in that sense, it’s not intended to be reported as a contra revenue amount or … to be some sort of net revenue line. … Currently, if there’s an impairment loss, it will show up in other expenses. It may or may not be separately identified as a separate line item in the income statement currently. … What the board is working to do is to ensure that the revenue, which is now shown unadjusted for customer credit risk, is presented next to the expected customer credit risk impairment loss.”

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.