In most business transactions, a company promises goods or services in exchange for cash as consideration. However, many companies exchange goods or services for noncash consideration. Equity instruments, such as stock, are the most common example of noncash consideration. Noncash consideration can also take a variety of other forms such as promised services, inventory, land, PP&E, and intangible assets.
The purpose of this article is to analyze key accounting issues from recognizing revenue with noncash consideration under Accounting Standards Codification (ASC) 606. First, the paper will discuss the accounting treatment of revenue with noncash consideration. Then it will analyze the key implementation issues from the new standard. Finally, it will highlight key differences from the previous revenue recognition standard, ASC 605, to assist with the transition to the new standard.
Determining the Transaction Price with Noncash Consideration
A company recognizing revenue that includes noncash consideration initially follows the first two steps of the five-step method just as it would with cash consideration; the company identifies the contract with the customer then identifies the performance obligations. The nature of consideration affects how a company approaches the third step – determining the transaction price.
The transaction price is consideration a company expects to receive in exchange for goods or services. For noncash consideration, the transaction price is the fair value of consideration promised. In some cases the fair value of consideration requires judgment, such as the fair value of equipment or an intangible asset. If a company cannot reasonably determine the fair value, then the standalone selling price of the goods or services promised to the customer is the transaction price.
Noncash consideration with a variable fair value is considered variable consideration, which requires the entity to estimate the amount of consideration it will receive. After estimating the amount of variable consideration to be received, these estimates must be adjusted until they no longer include amounts for which it is probable that a significant reversal will occur (the “constraint”). This area involves significant judgment and must include an assessment of both the likelihood of reversal as well as the magnitude of the reversal when compared to the total transaction price.
If noncash consideration is variable due only to the form of the consideration, then no constraint is applied. For example, if the consideration was variable solely because it was in the form of stock options or stock, an entity would not need to apply a constraint. By comparison, the entity would need to apply a constraint if the number of stock options it will receive is variable because the amount is based on a performance measure. See Issue 2 under Diversity in Thought below to read more about issues surrounding this topic. To learn more about variable consideration and the constraint, see Variable Consideration and the Constraint.
Oftentimes, a customer provides goods or services to help complete a contract. In such cases, the entity determines whether it retains control of those goods or services after the contract is completed. If the entity retains control, those goods or services are accounted for as noncash consideration. For example, a customer contributes specific supplies to a manufacturer to complete a contract. If the manufacturer uses the supplies to complete the order and receives no other benefit, then those are not noncash consideration. However, if the manufacturer has supplies from the customer left over and uses those supplies on other contracts, then the left over supplies are accounted for as noncash consideration.
Diversity in Thought Surrounding Noncash Consideration
Since the new standard has been released, several different viewpoints have been raised on how to appropriately measure the transaction price for noncash consideration. The Financial Accounting Standards Board (FASB) Transition Resource Group (TRG) will meet to discuss many of these viewpoints. The following are the viewpoints the TRG will discuss:
- What is the measurement date for noncash consideration received (or receivable) from a customer?
- How is the constraint applied to transactions in which the fair value of noncash consideration might vary due to both the form of the consideration and for reasons other than the form of the consideration?
Issue 1: Measurement Date
View A: Measured at Contract Inception
Noncash consideration is measured at contract inception when the other components of the transaction price are determined. Proponents of View A favor the following key assumptions:
- Contract inception is when the entity establishes its expectation for what it will receive in exchange for its goods or services.
- Any change in the fair value of noncash consideration between the inception date and the delivery date is not expected by the entity; therefore, the measurement of the transaction price of consideration should not be affected by those changes.
- The timing of when consideration is received or when the entity satisfies its performance obligations should have no effect on the measurement of the transaction price.
Dissenters to View A argue that not changing the measurement to reflect changes in the expectations of fair value of noncash consideration does not appropriately show the true economic flow of the transaction. Additionally, the opposition argues that this view inappropriately assumes that the most accurate measurement of what an entity expects to receive is measured at the inception date. Rather, they suggest that this expectation can change at any point, and the most accurate amount should be recorded regardless of the timing.
View B: Measured When Received
Noncash consideration is measured when noncash consideration is received. Proponents of View B favor the following key assumptions:
- The new standard was created to allow companies judgment to recognize revenue that best reflects the actual transfer of goods or services and that best reflects the actual amount an entity expects to receive.
- Measuring noncash consideration before it is received does not accurately depict the timing of the transfer or the amount of consideration when received.
- The transaction price is not the fair value expected when an entity enters into the contract; rather, it is the fair value expected when consideration is received.
- The consideration measurement does not change after it is received. Support for this view is found in ASC 606-10-55-250, which gives an example of determining transaction price using the fair value of shares. The example has partially satisfied its performance obligation. It is paid weekly in shares of stock. It records the stock at fair value, and afterwards the “entity does not reflect any subsequent changes in fair value of the shares received… in revenue.”
View C: Measured at Earlier of When Received or When Performance Obligation is Satisfied
Noncash consideration is measured at the earlier of either when (1) noncash consideration is received or (2) the related performance obligation is satisfied (or as the performance obligation is satisfied, if satisfied over time). This view points to existing Generally Accepted Accounting Principles (GAAP) guidance in 505-55-30-11, which details how to measure equity when an entity promises goods or services in exchange for equity in transaction with nonemployees. The guidance states that an entity measures at either the earlier of (1) “the date at which a commitment for performance by the counterparty to earn the equity instruments is reached (a performance commitment)” or (2) “the date at which the counterparty’s performance is complete.”
In response to the guidance in ASC 606-10-55-250, which states that an “entity does not reflect any subsequent changes in fair value of the shares received… in revenue,” supporters of this view contend that the intent of the example was to show that noncash consideration is measured at fair value as the performance obligation is being satisfied. The view contends that the entity in the example had a weekly service. That service was paid for in noncash consideration at the end of the week upon its completion.
This view does acknowledge that under certain circumstances and fact patterns, an entity should measure noncash consideration on the date it is received but before the performance obligation is satisfied. In cases when noncash consideration is received upfront before the performance obligation is satisfied, the consideration should be measured when it is received even if the performance obligation is not satisfied.
Example A: Measurement of Noncash Consideration under Different Views
Consider a case where Entity A decides to take a contract to perform consulting and other services that would normally be valued at $50,000 for Company B. Entity A determines that the service is a single performance obligation. Instead of being paid in cash by Company B, Entity A agrees to be paid in 1,000 shares of common stock of Company B. Both accept the contract on Jan. 1, 2014, when shares are valued at $50 a share. On Feb. 1, 2014, Entity A completes the services, when shares are valued at $52 a share. Company B gives Entity A the shares on Mar. 1, 2014, when shares are valued at $46 a share.
View A. Entity A measures noncash consideration, the shares of Company B, at its fair value at the contract inception date of Jan. 1, 2014. The fair value of the 1,000 shares on this date is $50,000. Entity A recognizes $50,000 of revenue once all the other elements of revenue recognition have been reached.
View B. Entity A measures the shares at its fair value when it is received on Mar. 1, 2014. The fair value of the 1,000 shares on this date is $46,000.
View C. Entity A measures the shares at its fair value when it completes its services on Feb. 1, 2014. The fair value of the 1,000 shares on this date is $52,000. In this scenario, if the shares were received before the services were complete, then the reception date would be when the shares are measured.
Issue 2: Variability in the Fair Value of Noncash Consideration
View A: Constraint Applied to All Variability
The constraint applies to variability from both the form of consideration and for reasons other than the form of consideration. Proponents of View A favor the following key assumptions:
- The constraint is applied to all the changes in fair value including the variability of the form when at least one of the conditions of variability is for a reason other than form.
- ASC 606-10-32-23 states: “If the fair value of the noncash consideration promised by a customer varies for reasons other than only the form of the consideration” then the entity should estimate the variable constraint. If the emphasis is added to the word “only”, then the singular instance when variable constraint should not be applied is when noncash consideration varies due to the form alone. All other instances apply the constraint.
Under View A, revenue is likely deferred longer because the constraint is applied to more than just one factor. The entity must ensure that no significant revenue reversal occurs because of the form or the other reasons, which likely means more work goes into determining the constraint.
View B: Constraint Applied Only to Variability from the Form of Consideration
The constraint applies only to variability resulting from other than the form of consideration. This view opposes View A’s suggestion that the variability of the form should be applied. Proponents of View B favor the following key assumptions:
- The intention behind the new standard is to apply the constraint only to the variability of other reasons other than the form.
- The timing of revenue would be different for two transactions that differ in just the forms of consideration.
Opponents of this view point to the costs of the complexity of identifying each separate change in the fair value of noncash consideration for reasons other than the form. These costs make the information in financial statements less useful.
Under this view, it is more likely that revenue will be recognized earlier. This is because an entity has one less variability to consider when estimating the probability of a significant revenue reversal.
Example B: Constraint on the Variability of Noncash Consideration
Consider the case previously where Entity A negotiates a contract with Company B to perform services that would normally be valued at $50,000. Entity A determines that the services constitute a single performance obligation. Instead of being paid in cash, Entity A agrees to be paid in 1,000 stock options for shares of common stock of Company B, whose stock price has recently varied from $30 to $100. Entity A’s best estimate for the stock price is $80 when they finish the project, but they believe it is probable that the stock could fall to $40 a week after they finish the project.
The contract stipulates that Entity A will not receive any shares of stock if the consulting services are not completed. If Entity A performs the services within one month, the exercise price of the options will be $10. If Entity A performs the services within two months, the exercise price of the options will be $20. If Entity A performs the services within three or more months, the exercise price of the options will be $30. Finally, Company B reserves the right to raise the exercise price by $10 a week after the completion of the project if the company is unsatisfied. Entity A estimates that it will finish the project within two months, and it estimates that it is less than probable that Company B will be unsatisfied with the project.
View A. Under this view, the constraint will be applied. Entity A estimates that the exercise price will be $20 and the share price when it exercises the options will be $80. This produces an estimated transaction price of $60 for 1,000 shares, or $60,000. However, because it is probable that the share price will decrease from $80 to $40 within a short period after the completion of the project, a constraint is applied. The transaction price for noncash consideration will not be recognized until Entity A believes it is no longer probable that the share price will change so dramatically after the completion of the project.
View B. Under this view, no constraint will be applied. Entity A would recognize the estimated $60,000 transaction price for this project. If in this example Entity A believes that it would be probable that Company B will not be satisfied and subsequently raise the exercise price, then it would apply the constraint and would not be able to recognize the transaction price until it believed it was no longer probable that that event would occur.
Comparison to Noncash Consideration in ASC 605
In current guidance, an entity sets the noncash consideration transaction price equal to the fair value of the goods or services being sold. If the fair value of the goods or services cannot be reasonably determined, then the entity measures noncash consideration at its fair value. This can result in the entity and the customer recognizing different amounts for noncash consideration for the same transaction. Under ASC 606, an entity first looks at the fair value of noncash consideration for the transaction price. If the fair value is not determinable, then noncash consideration is the selling price of the goods or services exchanged.
Additionally portions of ASC 845 are superseded by ASC 606 so that there are no longer exceptions to measure noncash consideration at its carrying amount. Also, current guidance contains a section on how to account for advertising barter transactions while ASC 606 does not. Consequently, more judgment will need to be exercised when accounting for advertising barter transactions under ASC 606.
Under the new five-step model for recognizing revenue from contracts, entities will need to exercise judgment when determining the transaction price for revenue involving a noncash consideration. Noncash consideration is measured at fair value, unless fair value is not determinable, in which case the standalone selling price of the goods or services being sold by the entity should be used.
There are three differing perspectives on when to measure noncash consideration. The first group believes consideration should be measured at contract inception because the other portions of transaction price are measured at that date. The second believe that consideration should be measured when it is received by the entity because of their belief that an example in the codification supports their view. Finally, the third group believes consideration should be measured at the earlier of either the date consideration was received or when the performance obligation was received because this most closely follows current GAAP practices.
Two differing perspectives exist on how to appropriately apply constraint to a noncash consideration that varies in both form and for other reasons. The first group believes that the constraint is applied to both the form and for other reasons because the codification states that the only situation when constraint is not applied is when a consideration varies only due to variability of form. The second group believes that the constraint is applied only to the other reasons and not to the form because it believes the intention of the codification was to prohibit applying constraint to variability of form.
The major changes from 605 to 606 is the way noncash consideration is measured. ASC 605 measures consideration by the fair value of the goods or services being sold and contains many exceptions that allowed consideration to be measured at its carrying amount. ASC 606 measures consideration by the fair value of noncash consideration and contains no exceptions that allow measurement at the carrying amount.
- ASC 606-10-32-21 to 32-24, 55-248 to 55-250
- ASC 845
- EY, Financial Reporting Developments: “Revenue from Contracts with Customers.” October 2018. Section 5.4.
- FASB TRG Memo 15: “Noncash Consideration.” 26 January 2014.
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” May 2016. Section 5.3.3.
- PWC, “Revenue from contracts with customers.” August 2016. Section 4.5.