At least once every three years, the Securities and Exchange Commission (SEC) staff reviews a company’s financial statements and other filings to make sure they are in accordance with the applicable laws. If the SEC questions anything about the filings, a member of the staff writes a letter to the company, asking for clarification. Once the issue is resolved, the comment letters are made available to the public at sec.gov.
SEC comment letters are useful to the public because the comments provide additional detail about the company’s filings and often point to issues in the financial statements that require significant judgment. Companies care about these letters because the letters provide insight into how the SEC interprets the standard. This knowledge helps financial statement preparers make better judgments in the future. The comment letters also show the topics that the SEC is currently most concerned about, and the trends can be very informative. The graph below shows the comment letter topics related to Accounting Standards Codification (ASC) 606 through December 2019. The remainder of this article presents the top ten topics, summarizes the main take-aways from the comment letters, and provides helpful examples of actual comment letter discussions.
Top 10 Topics Through 2019
1. Disclosures (ASC 606-10-50)
196 threads, 45.5 percent
Of the 431 comment threads (a thread is composed of a comment from the SEC and a response from the company), the subtopic with the most comments—by far—was disclosures. Nearly half of all comment letters mentioned disclosures, demonstrating the importance the SEC places on the information companies share in their filings. Because disclosures receive so much attention from the SEC, we analyze those comment letters in a separate article: SEC Commentary on Revenue Recognition Disclosures.
2. Distinct Goods or Services (ASC 606-10-25-19 through 25-22)
75 threads, 17.4 percent
Another frequently mentioned topic in comment letters was identifying distinct goods or services in a contract. Identifying which goods or services are distinct allows a company to correctly identify each performance obligation. The rationale for these judgments requires a deep understanding of the nature of the business and the promises the company makes to its customers.
3. When to Recognize Revenue from Performance Obligations (ASC 606-10-25-27 through 30)
43 threads, 10.0 percent
Perhaps the most visible aspect of revenue recognition is whether revenue is recognized over time or at a point in time. Just like the decision about distinct goods and services, the judgment of when to recognize revenue requires a detailed knowledge of the business and the contract. As such, most of the comments relate to areas where the SEC could not determine the rationale behind revenue recognition based on the current disclosure.
4. Variable Consideration (ASC 606-10-32-5 through 32-9)
35 threads, 8.1 percent
Estimating variable consideration requires significant judgment, and the SEC asked about this judgment in 8.1 percent of its ASC 606 comment letters. Specifically, the SEC asked companies how certain items (such as advertising or commission revenue, outcome-based pay, contract guarantees, fuel surcharges, or volume discounts) were treated with respect to the variable consideration guidance. It also asked why the most likely or expected value method was appropriate for the situation and how the decision to constrain or not constrain revenue was appropriate.
5. Principal vs. Agent Considerations (ASC 606-10-55-36 through 55-40)
35 threads, 8.1 percent
The principal vs. agent determination does not affect net income, because the only difference in the accounting is whether revenues are reported gross or net. However, this difference in presentation is important because top-line revenues are used in many ratios and analyses. The SEC pushed back on many companies about how they determined themselves to be principals or agents in their revenue arrangements.
6. Sales-Based or Usage-Based Royalties (ASC 606-10-55-65 through 55-65B)
29 threads, 6.7 percent
The sales-based or usage-based royalties exception is discussed only in three short paragraphs in the implementation section of ASC 606. However, almost 7 percent of the comments through 2019 related to these paragraphs, indicating the importance of this exception. Because a potentially significant portion of the transaction price relating to the sales-based or usage-based royalty is deferred until actual sales or usage occurs, the SEC asked companies to justify using or not using the exception.
7. Promises in Contracts with Customers (ASC 606-10-25-16 through 25-18B)
26 threads, 6.0 percent
Determining whether a provision in the contract is material was another major area of comment. Companies must consider both explicit and implicit promises to transfer goods or services in their contracts, unless such promises are immaterial. The promises are then evaluated to see whether they are distinct performance obligations, as discussed in number two above. This distinction is significant because, if a promise is a material right, the right would be considered another performance obligation and part of the transaction price would need to be allocated to it, potentially changing the amount of revenue recognized in a given period.
The comments were split between non-marketing promises (e.g., rights transferred with a license) and marketing promises (e.g., loyalty programs). Many non-marketing promises contained an in-depth analysis of the promise (see Corbus below). Alternatively, many companies who were questioned about marketing promises were able to respond that the provisions in question were merely marketing incentives, not material rights, and were accounted for as such (see Delta below).
8. Allocation Based on Standalone Selling Prices (ASC 606-10-32-31 through 32-35)
21 threads, 4.9 percent
When allocating revenue to different performance obligations, a company must exercise significant judgment to determine the standalone selling price of its performance obligations. ASC 606 lists three methods of determining the standalone selling price but explicitly states that other methods may be used. Most of the SEC comments about this topic request justification for the method the company used to determine the standalone selling price, particularly if they used the residual method.
9. Identifying the Contract (ASC 606-10-25-1 through 25-8)
20 threads, 4.6 percent
The first step in revenue recognition is determining if the arrangement in question represents a valid contract with a customer. If an arrangement does not qualify as a contract, much of the other guidance in ASC 606 does not apply. However, if a company receives consideration before a valid contract exists, the company must recognize that consideration as a liability and can only recognize revenue after certain events have occurred. Identifying the contract also includes determining the duration of the contract, which is particularly difficult when termination provisions exist. The SEC commented on companies’ policies for when a contract is established and asked how they treated contract termination provisions, among other things.
10. Licensing (ASC 606-10-55-54 through 55-64A)
17 threads, 3.9 percent
Like sales- and usage-based royalties and principal vs. agent considerations, licensing is another topic that is only discussed in the implementation guidance subtopic yet received a lot of comments. The SEC commonly brought up the following issues:
- How companies determined that licenses were or were not distinct performance obligations
- Whether the licenses were accounted for as symbolic or functional licenses
- Whether the licenses were material performance obligations
These summaries and comment letters provide examples of the issues recently highlighted in SEC comments to registrants. These areas of ASC 606 require significant judgment on the part of the companies who are interpreting the standard, so the many questions from the SEC are not surprising. For additional guidance on the appropriate accounting for any of these topics, consider referencing the related articles linked throughout this article.