Six areas where new revenue recognition standard will require judgment

BY KEN TYSIAC
August 9, 2013

The new, converged revenue recognition standard will include substantially less industry-specific, “bright-line” guidance than many U.S. companies are accustomed to.

The standard that FASB and the International Accounting Standards Board are expected to issue this year will create the need for new judgments to be reached by financial statement preparers in a large number of circumstances.

The core principle of the model will be that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount the entity expects to be entitled to.

Five steps in the model will call for preparers to:

  • Step 1: Identify the contract with a customer.
  • Step 2: Identify 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.


Applying the five steps may be simple in some cases, McGladrey LLP partner Brian Marshall said during a recent AICPA webcast.

“But there are a lot of times where that’s not going to be the case,” said Marshall, a partner in the firm’s National Accounting Standards Group. “…There’s going to be a lot of judgment involved in the revenue model.”

Here are six areas where Marshall expects preparers will have to exercise judgment in applying the model.

1. Who is considered a customer (in Step 1)? In some situations—in pharmaceutical industry research and development arrangements, for example—an entity has partners and collaborators and delivers goods or services to them.

A customer will be defined in the new model as a party that has contracted with the entity to obtain goods or services that are an output of an entity’s ordinary activities. The boards have decided that revenue could be recognized from transactions with partners or collaborators to the extent they are determined to be customers in a transaction.

“That’s going to depend on the particular facts and circumstances, and you’re going to need to evaluate what is required to be delivered to that partner or collaborator, and whether it is an output of an entity’s ordinary activities,” Marshall said. “That’s judgment area No. 1.”

2. Significant collectibility concerns (in Step 1). The model will state that for a contract to exist for revenue recognition purposes, all parties must be committed to perform. Do significant collectibility concerns eliminate the existence of a commitment to perform by the customer?

Unlike current GAAP, which says collectibility has to be reasonably assured for revenue to be recognized, Marshall said, the new revenue model will not have a collectibility threshold. According to Marshall, if the collectibility concern is significant enough that an entity concludes that the customer is not expected to perform, a contract will not exist for purposes of the revenue model. The assessment of a commitment to perform should be made from a qualitative rather than a quantitative standpoint.

But the boards also said that if the customer is expected to partially perform, that would not preclude the parties from determining that they have a contract for the purposes of revenue recognition, he said.

“It’s not a situation where you say, ‘Well, the customer may not perform on part of their payments, so then I don’t have a contract.’ You still could have a contract,” Marshall said. “It’s very judgmental.”

If it is determined that a contract exists in these scenarios, collectibility concerns would still need to be considered in determining whether the transaction price in Step 3 includes variable consideration due to the potential for price concessions.

3. Highly independent vs. highly interrelated (in Step 2). On some occasions, multiple goods or services will be treated as separate performance obligations. Other times, they will be bundled together as a single performance obligation.

Determining whether the criteria are met to account for goods or services separately will create some challenges. Take the sale of a good along with installation or implementation services, for example. Should those services be accounted for separately from the associated good? Marshall said some of the items a preparer will have to look at include how dependent the goods are on the services, and whether the services significantly modify the goods.

One of the key judgments, Marshall said, relates to significant modification. But he said there is no definition of “significant” at this point.

“Right now, not having seen what the implementation guidance will be, it’s unclear as to how you would make that evaluation,” Marshall said.

4. Significant revenue reversal (in Step 3). The model will say that preparers should not include amounts in the transaction price that are subject to a risk of significant revenue reversal. For example, if $30 of an initial $100 variable price estimate is determined to be subject to significant revenue reversal, just $70 should be included in the transaction price, Marshall said.

Determining the amounts that are subject to a risk of significant revenue reversal could be a challenge, though.

“The boards are going to include some factors for consideration that you’d look to for evaluating this variable consideration, such as, do you have experience with that particular contingency,” he said. “Is that experience predictive? Again, that’s going to be one of the bigger areas of contention and judgment involved in the new model.”

5. Time value of money (in Step 3). If an entity will be paid within a year before or after delivering the promised goods or services, the time value of money will not need to be considered.

But entities that do not meet that practical expedient will be required to consider the time value of money for situations that have a significant financing component. The judgments involved here in determining whether there is a significant financing component could be complex.

“If you think about situations where you have multiple different goods or services or performance obligations that will be delivered over an extended period, evaluating the payment terms in comparison to when you’re delivering can get confusing and will involve a lot of tracking that you otherwise may not be considering in terms of time of delivery versus timing of payment,” Marshall said.

6. Recognizing over time or at a point in time (in Step 5). Revenue will be recognized under the new model when control of the goods or services is transferred.

Deciding whether to recognize revenue over time—or at a point in time—will require significant judgment, Marshall said. Recognition of revenue over time would be required if:

  • The performance creates or enhances an asset that the customer controls;
  • The customer receives and consumes the benefits as performance takes place, and the work completed would not need to be substantially reperformed by a new vendor if the contract was terminated; or
  • The asset created does not have an alternative use, the contract specifies a right to payment for performance completed to date, and the contract is expected to be fulfilled as promised.


If revenue cannot be recognized over time, it will be recognized at a point in time under the new model. Judgment may be required from preparers as they evaluate many of these items—and other factors throughout the standard—in the absence of industry-specific guidance.

“It’s a very lofty goal because what they’re looking to do is have a single revenue recognition standard for all industries and entities,” Marshall said. “Today in U.S. GAAP there is a lot of industry-specific guidance. It’s quite a feat to move from that to a single revenue recognition model.”

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

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