In their comments on the revenue recognition exposure draft, investors and other financial statement users indicated that revenue-related disclosures did not provide sufficient detail to perform worthwhile analysis. One of the goals of the new standard is to introduce disclosure requirements that improve the information communicated in financial statements (Accounting Standards Codification (ASC) 606-10-50-1).
The new standard requires additional disclosures to better communicate the nature, amount, timing, and uncertainty of an entity’s revenue and cash flows (ASC 606-10-50-1). Filers are required to provide qualitative and quantitative information about the following:
- Contracts with customers
- Significant judgments made in applying the new standard
- Assets recognized from the costs to obtain or fulfill a contract
Contracts with Customers
An entity is required to disclose revenue recognized from contracts with customers as well as impairment losses on any contract assets (for a discussion of contract assets, please see Presentation of Contract Assets and Contract Liabilities) arising from those contracts, unless these amounts are presented separately on its financial statements. The new guidance also requires information about the following categories: (1) disaggregation of revenue, (2) contract balances, and (3) performance obligations.
Disaggregation of Revenue. An entity is required to disaggregate revenue from contracts with customers into categories that help financial statement users understand the nature, amount, timing, and uncertainty of the related cash flows. The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) do not specify which characteristic(s) should be used when disaggregating revenues, but do provide the following examples:
- Type of good or service
- Geographic region
- Market or type of customer
- Type of contract
- Contract duration
- Timing of transfer of goods or services
- Sales channels
The Boards (FASB & IASB) noted in the Basis for Conclusion (BC) that “the most useful disaggregation of revenue depends on various entity-specific or industry-specific factors,” and decided each entity must determine which characteristics best meet the goal of disaggregating revenues (BC 336). Entities should consider how financial information is disaggregated when reporting to decision makers and evaluating segment performance as this information is likely useful to investors.
Entities that are neither public nor not-for-profit may choose not to disaggregate as granularly as outlined in the above guidance. These entities are still required to disaggregate revenues into categories based on timing, such as separating revenue from goods or services transferred at a point in time from those transferred over a period of time.
ASC 280 (Segment Reporting) and IFRS 8 (Operating Segments) already require disaggregation of revenue. An entity that disaggregates revenue in compliance with other guidance does not need to provide additional disaggregation as long as it accomplishes the ASC 606 disclosure objective (BC 338-340). If an entity determines that a separate revenue disclosure is needed, it must reconcile the revenue amounts displayed in both disclosures so that financial statement users can understand the relationship between the revenue and segment reporting disclosures.
Contract Balances. The goal of contract balance disclosures is to help financial statement users understand the relationship between revenue recognized and changes in contract assets and liabilities related to those revenues. Entities must disclose the following about its contract balances:
- The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed
- Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period
- Revenue recognized in the reporting period from performance obligations satisfied (or partially satisfied) in previous periods (e.g., changes in transaction price)
Entities must explain how the timing of satisfying a performance obligation relates to the typical payment schedule, and the impact they both have on contract asset and contract liability balances (ASC 606-10-50-9). For example, if an entity typically collects payment before beginning work on a performance obligation, the disclosure would discuss the fact that unearned revenue accounts are typical business practice. This helps financial statement users understand that cash inflows typically occur before the entity earns the revenue.
Filers must also quantitatively and qualitatively explain any significant changes in contract asset and contract liability balances. The guidance provides the following examples of changes that would require disclosure:
- Changes due to business combinations
- Cumulative catch-up adjustments to revenue that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price (including any changes in the assessment of whether an estimate of variable consideration is constrained), or a contract modification
- Impairment of a contract asset
- A change in the time frame for a right to consideration to become unconditional (i.e., for a contract asset to be reclassified to a receivable)
- A change in the time frame for a performance obligation to be satisfied (i.e., for the recognition of revenue arising from a contract liability)
Non-public entities are only required to disclose the beginning and ending balances of receivables and other contract-related assets and liabilities. (ASC 606-10-50-11).
Performance Obligations. An entity must describe the following about its performance obligations in contracts with customers:
- The timing of when performance obligations are usually satisfied (e.g., upon shipment, upon delivery, as services are rendered, etc.)
- Significant payment terms (i.e., whether the contract has a significant financing component, if consideration is variable, and whether the estimate of variable consideration is constrained)
- The nature of the promised goods or services and whether the entity is acting as an agent
- Obligations for returns, refunds, and other similar obligations
- Types of warranties and related obligations
In addition, the entity must disclose the amount of the transaction price allocated to performance obligations that have not been fully satisfied as of the reporting date. This disclosure must contain either a qualitative or quantitative explanation of when the entity expects to receive the related revenues (ASC 606-10-50-13). As a practical expedient, no performance obligation disclosure is required if either (1) the performance obligation is part of a contract expected to be fulfilled in less than a year, or (2) the amount of unrecognized revenue is equal to the value of the unsatisfied portion of the performance obligation.
To help investors better understand an entity’s revenues, filers are required to disclose any significant judgments and changes in those judgments that are used in determining (1) the timing of the performance obligations being satisfied, and (2) the transaction price and amounts allocated to performance obligations (ASC 606-10-50-17).
Timing of the performance obligations being satisfied. For performance obligations satisfied at a specific point in time, an entity must provide the significant judgments in determining when a customer obtains control of the goods or services. For performance obligations satisfied over time, an entity must explain the method used to recognize revenue (e.g., input or output method), and why that method best describes the transfer of the promised goods or services.
Transaction price and amounts allocated to performance obligations. An entity must explain all methods, inputs, and assumptions used to do the following:
- Determine the transaction price
- Assess if variable consideration is constrained
- Allocate the transaction price
- Measure returns, refunds, and similar obligations
Non-public entities may elect to exclude certain disclosures, as defined in ASC 606-10-50-21. If any practical expedients are used, a company must disclose that it is applying those practical expedients.
Assets Recognized from Costs to Obtain or Fulfill a Contract
Revenue recognition is now subject to disclosure guidance in Topic 340 (Other Assets and Deferred Costs), because the FASB believes that Topic 340 helps accomplish the new disclosure goals. Public entities must include the following disclosures:
- The judgments made in determining the amount of the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph 340-40-25-1 or 340-40-25-5)
- The method it uses to determine the amortization for each reporting period
- The closing balances of assets recognized from the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph 340-40-25-1 or 340-40-25-5) by main category of asset (e.g., costs to obtain contracts with customers, pre-contract costs, and setup costs)
- The amount of amortization and any impairment losses recognized in the reporting period
(ASC 340-40-50-2 & 50-3)
Filers must provide the disaggregated revenue information described above in interim reports (e.g. quarterly and semiannual). ASC 606 requires the disclosure of the following, if material:
- Opening and closing balances of contract assets and liabilities, if they are not separately presented on the financial statements
- The amount of revenue recognized in the current period that was included in the opening contract liability balance
- The amount of revenue recognized in the current period from performance obligations that were satisfied (or partially satisfied) in previous periods
- Information about the entity’s remaining performance obligations (described above)
(KPMG Issues In-Depth Revenue from Contracts with Customers – Section 12.2)
Filers are allowed to choose one of two adoption methods, “full retrospective” or “modified retrospective” adoption. The Boards have expressed preference for the full retrospective method. A filer must disclose which, if any, practical expedients were used, and their impact on the financial statements.
If an entity chooses the modified retrospective method, it must disclose the amount by which each revenue-related financial statement line item is different from what it would be under the full retrospective method. This makes the modified retrospective method particularly cumbersome. For this reason, we recommend using the full retrospective method because an entity will have to calculate account balances under the new guidance regardless of the transition method used.
Comparison to 605
Under ASC 605, revenue disclosures are limited to descriptions of accounting policies of only a few areas, including rights of return, principal vs. agent classification, and customer payments and incentives (Accounting Standards Update (ASU) 2014-09, p. 8). There are industry- and transaction-specific guidance that require more disclosures, but investors commented that these disclosures provide insufficient information to perform meaningful analysis.
The new standard expands the meaning of “public entity” to include (1) not-for-profit entities that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market and (2) employee benefit plans that file or furnish financial statements to the Securities and Exchange Commission (SEC). Although these entities are not considered public under ASC 605, they will be subject to the new disclosure guidance.
The new standard greatly increases the number of required disclosures. The work needed to meet disclosure requirements will be especially time-consuming for filers that have many product lines and divisions or operate in many geographic areas because of the new disaggregation requirements. Entities need to evaluate their current resources (e.g., staff training, information systems, procedures, etc.) and make any changes needed to track the information for disclosures.
ASC 606 brings big changes to revenue disclosure requirements. The goal of the new standard is to provide information that better meets the needs of financial statement users. Public entities are required to disclose the following:
- Contracts with customers—including disaggregation of revenue, contract balances, and outstanding performance obligations
- Significant judgments made in applying the new standard
- Assets recognized from the costs to obtain or fulfill a contract
These requirements apply to both interim and year-end financial reports. Because the new requirements are much more extensive, entities need to evaluate their current operating environment and update as necessary.
- ASC 340-40-50-2 to 50-3
- ASU 2014-09: “Basis for Conclusions.” BC 336, BC 338-340.
- EY, Financial reporting developments: “Revenue from contracts with customers.” Revised August 2016. Section 9, “Presentation and Disclosure.”
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” May 2016. Section 12 “Disclosure.”