In the final step of the Accounting Standards Codification (ASC) 606 five-step revenue standard, an entity recognizes revenue when control of a promised asset or service is transferred to the customer. The entity can transfer control either at a point in time (as with point-of-sale transactions) or over a period of time (as with many service contracts). Entities must determine whether each performance obligations are satisfied over time or at a point in time, and then recognize revenue in a way that best represents the transfer of control to the customer.
This article addresses the guidance for revenue that is recognized at a point in time and briefly summarizes topics related to transfer of control that are discussed in depth in other articles. Issues related to performance obligations satisfied over time are discussed in Input vs. Output methods and Revenue Recognition over Time.
Once an entity has determined that a performance obligation is satisfied at a point in time, it must determine when the customer obtains substantially all of the benefits from the asset, and is able to control the asset’s use. Control of an asset includes being able to prevent other entities from obtaining benefits (defined broadly as potential cash flows) from the asset. To determine when control of the asset is transferred, an entity must consider factors that indicate when control has transferred. ASC 606-10-25-30 provides the following list of five indicators of control, although this list is not meant to be exhaustive:
- The entity has a present right to payment. When the entity has a right to payment, this frequently indicates that control has passed to the customer.
- The customer has legal title to the asset.
- The entity has transferred physical possession of the asset. This factor should be evaluated in light of other arrangements or contractual stipulations, e.g., consignment goods.
- The customer has the significant risks and rewards of ownership of the asset. This is an area that requires judgment. For example, if an entity has sold goods but retains responsibility for delivery to the customer, then the entity likely retains control. However, entities should determine if some risks of ownership of the asset could be separate performance obligations, such as an additional obligation to provide maintenance services for products that have been delivered. Such risks should be accounted for separately, and would not impact the determination of transfer of control.
- The customer has accepted the asset.
Most indicators beyond these five would be related to at least one of the five in some way. For example, imagine that Entity A enters into a contract with customer B for goods that are currently in the entity’s warehouse. If Entity A retains the ability to sell the promised goods to a different customer and satisfies the contract with Customer B using substitute goods, then Customer B likely has not taken control. On the other hand, if Customer B has the right to prevent the entity from selling those goods to another customer– implicitly preventing competitors from obtaining those goods–that right would indicate that the customer has already taken control of the goods. Such evidence would be even stronger in the presence of other indicators.
Additionally, other indicators could arise from the business practices of the entity. Consider a scenario in which a contract states that a customer has responsibility for damage that occurs during transportation (FOB shipping point), but the entity has a historical practice of accepting the losses for such damage. The indicator that legal right has been passed to the customer might be overcome by the historical practice indicating that the entity still implicitly bears the risks of ownership.
Occasionally, the presence of only one of these factors may be sufficient to support revenue recognition. However, the best evidence for revenue recognition is a combination of the above factors, with few or no indicators that the transfer of control has not occurred. Often, several indicators will signal that control has transferred to a customer at a certain point in time; typically this will be the point at which revenue should be recognized. For example, when a customer purchases clothes from a retail store, the first three indicators on the above list signal that control has transferred at the point of sale. This provides very strong evidence that revenue should be recognized at the point of sale.
Effect of Shipping Terms
Shipping terms can be a strong indicator in determining when control is transferred to a customer. Many standard shipping terms specify the point at which the title passes to the customer. Typically, arrangements with terms of FOB destination would transfer control at the time of delivery, whereas transactions with FOB shipping point would transfer control when the goods are shipped. Even when shipping terms are standardized, an entity should consider its historical practices to assess whether the presumption created by the shipping terms is correct. If an entity has a practice of accepting the risk of loss beyond its contractual agreement, that history could overturn the presumption created by the shipping terms.
When shipping terms in a contract are not standardized, or are unspecified, judgment may be required to determine the point at which control has been transferred. When shipping terms do not clearly indicate the timing of the transfer of control, entities should consider their historical business practices, industry norms, and any other relevant indicators to determine when goods have passed into the customer’s control.
Other Transfer of Control Considerations
Repurchase Agreements: The party with discretion to exercise the option generally maintains control. If the entity has a forward or call option then the asset will (or may) be required to be returned to the entity, and the customer cannot direct the use of the asset to obtain all of its benefits. In contrast, put options enable the customer to elect whether or not the option is exercised. Therefore, a customer put option allows the customer to obtain all of the benefits of the asset, and control has transferred.
Customer Acceptance Provisions: If an entity cannot objectively determine that delivered goods meet specified acceptance criteria, or if it is the customer’s prerogative to accept the goods once received, then control has not yet transferred and revenue recognition should be deferred. Once a customer has accepted the goods or the right to reject the goods has expired then revenue is recognized. However, if an entity can objectively demonstrate that specifications have been met then control has passed to the customer and the entity should recognize revenue. General rights of return should be treated as variable consideration and do not affect the transfer of control.
Bill-and-Hold: If certain criteria are met, and substantially all of the benefits of ownership are transferred, then a vendor can recognize revenue before delivering the product. ASC 606-10-55-83 dictates that for a customer to obtain control in a bill-and-hold arrangement the following criteria must be met:
- The reason for the bill-and-hold arrangement must be substantive.
- The product must be identified separately as belonging to the customer.
- The product currently must be ready for physical transfer to the customer.
- The entity cannot have the ability to use the product or to direct it to another customer.
Consignments: Vendors ship on a consignment basis to improve the marketability of products and transfer them closer to the consumer. Consignees often have no obligation to pay for the product until subsequent resale. ASC 606-10-55-80 provides three indicators that a consignment arrangement exists. This list (provided below) is not all-inclusive, and should be considered along with the other indicators of the transfer of control.
- The product is controlled by the entity until a specified event occurs or a specified period expires.
- The entity is able to require the return of the product or transfer the product to a third party.
- The dealer does not have an unconditional obligation to pay for the product.
Comparison to 605
Under ASC 605, revenue had to be earned and realized (or realizable) before revenue could be recognized. Staff Accounting Bulletin (SAB) Topic 13 further required that in order to meet the requirements of ASC 605, revenue had to meet four criteria:
- Persuasive evidence of an arrangement exists
- Delivery has occurred or services have been rendered
- The seller’s price to the buyer is fixed or determinable
- Collectability is reasonably assured
The SEC has not yet decided how it will apply SAB Topic 13 to the new revenue standard. Under ASC 606, transfer of control replaces the concept of delivery under SAB Topic 13. Because transferring control can be interpreted more broadly than delivery, ASC 606 will likely lead to revenue being recognized sooner for some entities. However, the requirement that delivery occur before revenue can be recognized was also much less principles-based, meaning that ASC 606 will require more judgment to determine if control is transferred before delivery occurs.
To recognize revenue under Step five of ASC 606, entities must determine whether performance obligations are satisfied over time or at a point in time. For performance obligations satisfied at a point in time, entities recognize revenue when control of the asset is transferred to the customer. The new standard provides five examples of indicators of the transfer of control that entities should consider. These indicators replace the requirement from SAB Topic 13 that delivery must occur before revenue is recognized. The change will often lead to revenue being recognized sooner, but determining exactly how much sooner may require significant additional judgment for some entities.
- ASC 605-10-S99-SAB 13.A.2-Q2; ASC 606-10-25-30 to 25-35; ASC 606-10-55-22 to 55-29,55-66 to 55-88.
- ASU 2014-09: “Basis for Conclusions.” BC 363-367.
- Deloitte, Revenue From Contracts With Customers: “A Roadmap To Applying ASU 2014-09.” Section 7.1.2, “Sale With a Right of Return.”
- EY, Financial reporting developments: “Revenue from contracts with customers.” Revised August 2016. Section 4.5 “Consignment arrangements,” Section 7.3 “Repurchase agreements,” and Section 7.4 “Bill-and-hold arrangements.”
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” May 2016. Sections 5.2.2 “Implied promises and adminstrative tasks,” 5.5.5 “Repurchase agreements,” and 5.5.7 “Bill-and-hold arrangements.”
- PWC, “Revenue from contracts with customers.” August 2016. Section 8.2 “Rights of return,” Section 8.5 “Bill-and-hold arrangements,” Section 8.6 “Consignment arrangements,” and Section 8.7 “Repurchase rights.”