As part of its Technical Corrections and Improvements agenda, the FASB issued ASU 2016-20, its last pronouncement of the 2016 calendar year, to clarify several inconsistencies that stakeholders pointed out through the Revenue Recognition Transition Resource Group (TRG) or other feedback mechanisms. The ASU addresses 13 specific issues that originated from the original issuance of ASC 606 in ASU 2014-09 or subsequently released amendments. In the interest of being as brief as possible, this post will only cover what I believe are the more significant or pervasive corrections covered in ASU 2016-20.
What’s in? What’s out?
Two of the issues that the FASB addressed deal with the scope of ASC 606. Due to some subsequent updates of the new revenue recognition standard, stakeholders were confused about whether certain accounts were covered by ASC 606 or other topics. To that end, the FASB clarified the following:
- Loan guarantee fees within the scope of ASC 460 are not in scope of ASC 606.
- All contracts in the scope of ASC 944, Financial Services—Insurance, are excluded from the scope of ASC 606. ASU 2016-20 removes the term “insurance” from the original language that stated “insurance” contracts within the scope of ASC 944 were out of scope of ASC 606. For example, investment contracts that do not subject an insurance entity to insurance risk would be excluded from the application of ASC 606 because the insurance entity would apply guidance in ASC 944 to this contract even though it is not technically an insurance contract.
Let’s talk about contract costs
ASC 606 provides updated guidance about how to account for contract costs, allowing entities to potentially capitalize them if certain conditions are met. Since assets must be tested for impairment, ASC 606 also addresses impairment consideration in ASC 340-40-35 for these capitalized costs. Under this guidance, an entity must recognize a loss if the carrying amount of the asset exceeds the expected consideration for providing goods or services less the direct costs associated with delivering those goods or services.
However, some confusion has arisen regarding what should be included in expected consideration. ASU 2016-20 provides some clarification, stating that an entity should include:
- The amount of consideration that the entity expects to receive in the future, and
- The amount of consideration that the entity has received but has not recognized as revenue.
Additionally, an entity should consider expected contract renewals and extensions when testing these assets for impairment.
The amendment also provides the order in which this impairment guidance should be applied when testing for impairment of other assets covered by ASC 350, Intangibles—Goodwill and Other, and ASC 360, Property, Plant, and Equipment:
- First, test all assets for impairment that are not within the scope of ASC 340, ASC 350, or ASC 360. These assets could include receivables or inventory, for instance.
- Second, test the assets for impairment that are within the scope of ASC 340, including capitalized costs associated with contracts with customers.
- Finally, test the assets or asset groups for impairment that are in scope of ASC 360 (PP&E) and ASC 350 (intangibles).
Hold on, there’s still guidance in ASC 605?
The Board maintained the guidance for loss contracts (i.e., committed contracts with locked in losses) under ASC 605-35 when ASC 606 was issued. The retention of these considerations is a bit unusual since pretty much all of the current revenue recognition guidance was superseded by the new standard! However, the FASB believes the requirements here that relate to construction-type or production-type contracts is still applicable in light of the new standard.
As a result of one of the previous updates to ASC 606 (ASU 2014-09), considerations for losses were generally understood to be made at the individual performance obligation-level within each contract. Stakeholders raised concerns that such a requirement would result in a change to current practice and require assessment at a more granular level. To address these concerns, the FASB clarified that companies should provide for losses at least at the contract level and gave them the ability to make an accounting policy election to assess losses at the performance obligation level, if desired.
Full disclosure required
One of the more significant changes with the transition to ASC 606 revolves around the additional disclosures that will be required. One area of particular attention is the requirement for entities to disclose information about remaining performance obligations. This includes the amount of the transaction price allocated to these remaining obligations which are unsatisfied or partially unsatisfied as of period end. However, some optional exemptions for this requirement were provided for:
- Contracts with an original duration of one year or less; or
- Performance obligations in which revenue is recognized in the amount to which the entity has a right to invoice (when using the practical expedient allowed for in ASC 606-10-55-18).
These exemptions raised questions about whether the FASB intended to require an entity to estimate variable consideration to comply with this disclosure when the entity did not otherwise need to estimate variable consideration to determine the amount to recognize as revenue. To address this concern, additional optional exemptions related to this disclosure requirement have been added for remaining performance obligations where specific situations allow an entity to avoid estimating variable consideration to recognize revenue. ASU 2016-20 also expands the required information an entity discloses when it applies one of these optional exemptions.
Another disclosure requirement that caused confusion is the requirement to disclose revenue recognized in the current reporting period from performance obligations satisfied or partially satisfied in previous periods. The Board clarified that this disclosure requirement applies to all performance obligations, not just those obligations with corresponding contract balances.
When the FASB issued the new revenue recognition standard, it superseded most of the guidance in ASC 340-20 about capitalized advertising costs. Any entities currently applying this guidance would need to consult a new subtopic, ASC 340-40, to determine whether or not to capitalize these costs when adopting ASC 606.
However, when this guidance was stricken from the Codification, the guidance for recognizing a liability related to these advertising costs was also superseded, so no guidance was going to exist at the effective date of ASC 606. The FASB realized this mistake and reinstated this subset of guidance by moving it to ASC 720, Other Expenses.
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