Heads Up

Revenue Enters the Home Stretch FASB Issues Revised Exposure Draft on Revenue Recognitionby Mark Crowley, Sean St. Germain, and Beth Young, Deloitte & Touche LLP

On November 14, 2011, the FASB and IASB (the “boards”) jointly issued their revised exposure draft (ED) Revenue From Contracts With Customers. The revised ED, released by the FASB as a proposed Accounting Standards Update (ASU), is the result of months of redeliberations of their June 2010 ED. (For a summary of the tentative decisions reached during the redeliberations, see Deloitte’s July 22, 2011, Heads Up.) The proposed ASU outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and would supersede most current revenue recognition guidance. This Heads Up summarizes the key provisions of the proposed ASU and provides insight into some potential income tax implications.

Editor’s Note: For insight into how the new proposal will affect specific industries, look for future publications in Deloitte’s Industry Spotlight series.

BackgroundThe goal of the boards’ revenue recognition project, which began in 2002, is to clarify and converge U.S. GAAP and IFRS revenue recognition principles and develop guidance that would:

• Removeweaknessesfromcurrentrevenuerecognitionrequirementsandmaketheserequirementsmoreconsistent.

• Include“amorerobustframeworkforaddressingrevenue[recognition]issues.”

• Enhancethe“comparabilityofrevenuerecognitionpracticesacrossentities,industries, jurisdictions, and capital markets.”

• Provideusersoffinancialstatementswithmoreusefulinformation“throughimproveddisclosurerequirements.”

• Decreasethenumberofstandardsthatentitiesmustreferto,therebysimplifyingthe “preparation of financial statements.”

The boards’ 2008 discussion paper Preliminary Views on Revenue Recognition in Contracts With Customers represented a significant milestone in the project. The project then picked up momentum in 2010 with the issuance of the June 2010 ED and has been one of the boards’ top priorities over the past several years. After receiving nearly 1,000 comment letters, conducting extensive outreach, and redeliberating almost every aspect of the June 2010 ED, the boards modified the proposed guidance and developed the revised ED.

November 15, 2011

Volume 18, Issue 37

In This Issue:• Background• Key Provisions of the

Proposed ASU• Applying the Provisions of the

Proposed ASU• RequiredDisclosures• Effective Date and Transition• Other Notable Provisions of

the Proposed ASU• Potential Income Tax

Implications

The proposed ASU outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and would supersede most current revenue recognition guidance.

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Comments on the proposed ASU are due by March 13, 2012. The boards are inviting commentsonallaspectsoftheproposalbutarerequestingspecificfeedbackon (1) the criteria for when a good or service transfers over time, (2) the measurement and presentation of collectibility (i.e., the customer’s credit risk), (3) the reasonably assured revenue recognition constraint, (4) the scope of the onerous performance obligations test,(5)theproposedinterimfinancialstatementdisclosurerequirements,and (6) the application of certain provisions from the proposed guidance to the transfer of a nonfinancial asset that is not within the proposal’s scope (such as the sale of property, plant,andequipment).

Editor’s Note:Question6oftherevisedED’sQuestionsforRespondentsrequestsfeedback on a proposal that would supersede the current accounting for some transfers of nonfinancial assets (e.g., under ASC 360-201). Specifically, the revised ED proposes that an entity apply the revenue recognition principles for the transfer of control (and the proposed measurement guidance) to the derecognition of (and the determination of gains or losses on) the transfer of a nonfinancial asset. Thus, an entity would need to use greater judgment in accounting for these types of transactions under the proposed ASU than it does under the current “rules-based” guidance in U.S. GAAP.

The boards plan to consider the comment-letter feedback and perform extensive outreach activities before finalizing the revenue recognition project. A final standard is not expected until later in 2012, and the effective date will be no earlier than January 1, 2015 (with a minimum of a one-year deferral for nonpublic entities).

Editor’s Note: One FASB member (Thomas Linsmeier) and one IASB member (Jan Engström) disagreed with the publication of the proposed ASU. Mr. Linsmeier believes that the proposal (1) provides exceptions that may permit revenue recognition that is inconsistent with the proposal’s core principle, (2) results in inconsistent accounting for economically similar circumstances (under both the proposed ASU and other ASC topics),and(3)“failstoprovideoperable[and]auditableguidance.”Mr.Engströmisconcernedabout“theextentoftheproposeddisclosurerequirements,”primarilythoserelated to interim financial statement disclosures and the resulting amendments to IAS 34.2

Key Provisions of the Proposed ASUThe proposed ASU’s core principle is that “an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”

The proposed ASU would apply to all contracts with customers except those that are within the scope of certain other Codification topics.3 It also clarifies that contracts with counterparties that are collaborators or partners, rather than customers (common in certain industries, such as pharmaceuticals and biotechnology, oil and gas, and health care), do not represent contracts with customers and are outside the scope of the proposed ASU.

The boards plan to consider the comment-letter feedback and perform extensive outreach activities before finalizing the revenue recognition project.

1 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”

2 IAS 34, Interim Financial Reporting.3 The proposed ASU would not apply to contracts within the scope of ASC 840 (leases) and ASC 944 (insurance); contractual

rights or obligations within the scope of ASC 310, 320, 405, 470, 815, 825, and 860 (primarily various types of financial instruments); contracts within the scope of ASC 460 (guarantees other than product warranties); and nonmonetary exchanges whose purpose is to facilitate a sale to another party.

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Editor’s Note: The FASB and IASB have also proposed guidance as part of their joint project on lease accounting. The proposed lease guidance provides indicators for entities to use in determining whether an asset used by a supplier in the delivery of a service is separable from the arrangement as a whole (e.g., whether the asset is sold or leased separately by the supplier and whether the customer can use the asset on its own or together with other resources available to the customer). In situations in which a supplier directs how an asset is used to perform services for a customer, the customer and supplier must assess whether the use of the asset is separable from the services providedtothecustomer(e.g.,computerandserverequipmentwithoutsourcedinformation technology services or a cargo ship with time charter services). If the asset is separable, the arrangement could contain a lease (and thus be outside the scope of the proposed revenue guidance). However, if the use of an asset is an inseparable part oftheservicesrequestedbythecustomer,theentirearrangementwouldbewithinthescope of the proposed revenue guidance. For Deloitte’s most recent summary of the status of the lease project, see the August 17, 2011, Heads Up.

In applying the provisions of the proposed ASU to contracts within its scope, an entity would:

• “Identifythecontractwithacustomer.”

• “Identifytheseparateperformanceobligationsinthecontract.”

• “Determinethetransactionprice.”

• “Allocatethetransactionpricetotheseparateperformanceobligationsinthecontract.”

• “Recognizerevenuewhen(oras)theentitysatisfiesaperformanceobligation.”

ComparedwithcurrentU.S.GAAP,theproposedASUwouldalsorequiresignificantlyexpanded disclosures about revenue recognition.

The rest of this Heads Up briefly summarizes (1) each of the steps that an entity would follow in recognizing revenue under the proposed ASU, (2) the proposed disclosure requirements,(3)theeffectivedateandtransition,(4)someoftheproposal’sothernotable provisions, and (5) some potential income tax implications of the proposal.

Applying the Provisions of the Proposed ASU

Identifying the Contract With the CustomerA contract can be written, verbal, or implied; however, the proposed ASU only applies to a contract if:

• “Thecontracthascommercialsubstance(thatis,therisk,timing,oramountofthe entity’s future cash flows is expected to change as a result of the contract).”

• “Thepartiestothecontracthaveapprovedthecontract(inwriting,orally,orin accordance with other customary business practices) and are committed to perform their respective obligations.”

• “Theentitycanidentifyeachparty’srightsregardingthegoodsorservicestobetransferred.”

• “Theentitycanidentifythepaymenttermsforthegoodsorservicestobetransferred.”

Identify the contract with the customer

Identify the separate

performance obligations

Determine and allocate the transaction

price

Recognize revenue when (or as) performance obligations are

satisfied

(Step 1) (Step 2) (Steps 3 & 4) (Step 5)

Compared with current U.S. GAAP, the proposed ASU would require significantly expanded disclosures about revenue recognition.

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The proposed ASU provides guidance on determining when an entity would combine contracts entered into at or near the same time with the same customer (or parties related to the customer).

Although these provisions would most likely be applied to a single contract, in certain circumstances an entity may need to combine a group of contracts. The proposed ASU provides guidance on determining when an entity would combine contracts entered into at or near the same time with the same customer (or parties related to the customer). Further, a contract modification would be accounted for as a separate contract only if the modification results in (1) a separate performance obligation and (2) additional consideration that reflects the entity’s stand-alone selling price of that separate performance obligation (when appropriate adjustments for the contract’s particular circumstances are taken into account). Otherwise, an entity would evaluate the modified contract and allocate the remaining transaction price to the remaining performance obligations (on a prospective basis) and update its measure of progress toward completion for performance obligations that are satisfied over time (which could result in a cumulative catch-up). However, if the modification to the contract is only a change in the transaction price, the modified transaction price would be reallocated to all performance obligations in the contract (see Allocating the Transaction Price section below).

Editor’s Note: Under the proposed ASU, a collectibility threshold is not explicitly requiredforrevenuerecognition(whichsomehavenotedasachangefromcurrentU.S. GAAP). However, in the proposed ASU’s Basis for Conclusions, the boards clarified that they decided not to include a separate recognition threshold for collectibility because (1) a reasonable expectation of collectibility is implicit in the definition of a contract (i.e., for a contract to have commercial substance, an entity would have a reasonableexpectationofcollectibility)and(2)thenewrequirementtopresentlossesfor collectibility as a separate line item next to gross revenue (i.e., as contra revenue) helps users compare those losses with revenue recognized.

Identifying the Separate Performance ObligationsAlthough the proposed ASU does not define goods or services, it provides a few examples, including goods produced (purchased) for sale (resale), granting a license, and performing contractual acts (to name a few). The following diagram illustrates the process in the proposed ASU for identifying the separate performance obligations in a contract.

Principle

“An entity shall evaluate the goods or services promised in a contract and shall identify which goods or services (or which bundles of goods or

services) are distinct and, hence, that the entity shall account

for as a separate performance obligation.”

Yes

Are there multiple goods or

services promised in the contract?

Treat as a single performance obligation.

No

Do the promised goods or services transfer at

the same time?

Is the good or service distinct?

Account for a distinct good or service as a separate performance obligation.

Combine goods or services until two or more are distinct and account for as a

separate perfornace obligation.

Yes

No

No

Abundleofdistinctgoodsorservicesisrequiredtobetreatedasasingleperformanceobligation when certain criteria are met.

Yes

Principle

“An entity shall apply[the]proposed

guidance to each contract identified in accordance with” the

standard.

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The boards tentatively decided that adjustments for collectibility would be presented in the income statement as a separate line item next to gross revenue (i.e., as contra revenue).

A good or service is “distinct” if the entity regularly sells it separately or the customer can benefit from the good or service on its own or together with resources that are readily available. Further, the boards decided that an entity would account for a bundle of goods or services as a single performance obligation if the goods or services are (1) highly interrelated and the entity provides a significant service of integrating them into a combined item or items and (2) significantly modified or customized to fulfill the contract.

Editor’s Note: Under the proposed guidance, an entity may need to use significant judgment when determining whether the goods or services are “highly interrelated” and “significantly modified or customized.” The proposed ASU includes examples to illustrate this guidance; however, further clarification may be needed to ensure consistent application.

Determining the Transaction PriceTheproposedASUrequiresanentitytodeterminetheamount of consideration (the transaction price) it expects to be entitled to in exchange for the promised goods or services in the contract. The transaction price can be a fixed amount or can vary because of discounts, rebates, refunds, credits, incentives, performance bonuses/penalties, contingencies, price concessions, or other similar items. Under the proposed guidance, an entity would estimate the transaction price by considering the effect of variable consideration, the time value of money (if significant), noncash consideration, and consideration payable to the customer. A transaction price that is subject to variability would be estimated by using a probability-weighted approach (expected value) or an approach based on the single most likely amount (whichever is more predictive).

Under the proposed ASU, an entity would continue applying the measurement and recognition guidance in ASC 310 to consideration the entity deems uncollectible. However, the boards tentatively decided that adjustments for collectibility would be presented in the income statement as a separate line item next to gross revenue (i.e., as contra revenue).

Editor’s Note: The adjustment to revenue for collectibility, as proposed in the ASU, refers to a customer’s credit risk — that is, the “risk that an entity will be unable to collect from the customer the amount of consideration to which the entity is entitled in accordance with the contract.” Entities may need to evaluate the type of adjustments currently being recorded within the allowance for doubtful accounts as bad-debt expense (or similar accounts) to ensure that the adjustments recorded for collectibility upon adoption of the proposed guidance are consistent with this principle.

Allocating the Transaction PriceUnder the proposed ASU, when a contract contains more than one separate performance obligation,anentitywouldgenerallyberequiredto allocate contract consideration to each separate performance obligation on a relative stand-alone selling price basis. The best evidence of stand-alone selling price is the price at which the good or service is sold separately by the entity. If the good or service is not sold separately, an entity is requiredtoestimateitbyusinganapproachthatmaximizes the use of observable inputs. Acceptable estimation methods may include, but are not limited to, expected cost plus a margin, adjusted market assessment, or residual (when the selling price is highly variable or uncertain). If certain conditions are met, there would belimitedexceptionstothisgeneralallocationrequirement.

Principle

“The transaction price is the amount of consideration

to which an entity expects to be entitled in exchange for transferring promised

goods or services to a customer.”

Principle

“For a contract that has more than one separate performance

obligation, an entity shall allocate the transaction price to each

separate performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange

for satisfying each separate performance obligation.”

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When a performance obligation is deemed to be satisfied over time, an entity recognizes revenue by measuring the obligation’s progress toward completion in a manner that best depicts the transfer of goods or services to the customer.

Except for contract modifications discussed in the Identifying the Contract With the Customer section above, changes in the transaction price after contract inception would be allocated to all performance obligations in the contract (unless an entity meets certain criteria that allow for specific allocation to one or more performance obligations).

Editor’s Note: The proposed ASU allows entities to use a residual approach in allocating contract consideration but only when the stand-alone selling price of a good or service is “highly variable or uncertain.” An entity would need to use judgment in determining whether the stand-alone selling price of a particular good or service meets this criterion. Entities may need to develop policies and work closely with their accounting advisers to ensure that they have applied the guidance, and exercised judgment, consistently in similar situations. For example, some may conclude that the useoftheresidualmethodwouldbeappropriatewheneveranentityisrequiredtoestimate a selling price because such a price would be deemed “uncertain.” However, others may conclude that the use of the residual method was intended to be limited and would only be used when there are difficulties in estimating a selling price.

Recognizing Revenue When (or as) Performance Obligations Are SatisfiedThe boards defined “control” in the context of this principle as “the ability to direct the use of and obtain substantially all the remaining benefits from the asset” underlying the good or service. Under the proposed ASU, an entity first demonstrates whether control of a good or service is transferred over time.

When the control of a good or service (and therefore satisfaction of the related performance obligation) is transferred over time, an entity would berequiredtorecognizerevenueovertimeasthegoods or services are transferred to the customer. Under the proposed ASU, a performance obligation is considered to be transferred over time when at least one of the following criteria is met:

(a) The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced. . . .

(b) The entity’s performance does not create an asset with an alternative use to the entity . . . and at least one of the following criteria is met:

(i) The customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs.

(ii) Another entity would not need to substantially reperform the work the entity has completed to date if that other entity were to fulfill the remaining obligation to the customer. . . .

(iii) The entity has a right to payment for performance completed to date, and it expects to fulfill the contract as promised.

When a performance obligation is deemed to be satisfied over time, an entity recognizes revenue by measuring the obligation’s progress toward completion in a manner that best depicts the transfer of goods or services to the customer. The proposed ASU provides specific guidance on the use and application of an output method and an input method for measuring progress toward completion.

The boards added that revenue may only be recognized over time when an entity can reasonably measure the progress toward completion. When an entity is not able to reasonably determine the amount of profit but it is reasonably assured that a loss will not be incurred, revenue should be recognized to the extent that costs are incurred (i.e., a contract with a zero profit margin).

Principle

“An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good

or service (that is, an asset) to a customer . . . when (or as) the

customer obtains control of that asset...[in]theamounttowhichthe entity is reasonably assured to

be entitled.”

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The boards tentatively decided to limit the cumulative amount of revenue recognized for a satisfied performance obligation to the amount to which the entity was reasonably assured to be entitled.

If a performance obligation does not meet the criteria to be satisfied over time, it is satisfied at a point in time. The proposed ASU states that indicators that control of an asset has been transferred to a customer at a point in time include, but are not limited to, the following:

• “Theentityhasapresentrighttopaymentfortheasset.”

• “Thecustomerhaslegaltitletotheasset.”

• “Theentityhastransferredphysicalpossessionoftheasset.”

• “Thecustomerhasthesignificantrisksandrewardsofownershipoftheasset.”

• “Thecustomerhasacceptedtheasset.”

Finally, in response to concerns about recognizing contingent revenue without constraints, the boards tentatively decided to limit the cumulative amount of revenue recognized for a satisfied performance obligation to the amount to which the entity was reasonably assured to be entitled. That is, if the transaction price is variable, revenue would only be recognized to the extent that the entity is reasonably assured to be entitled to the amount allocated to the satisfied performance obligation. The proposed ASU provides specific criteria that must be met for an entity to conclude that it is reasonably assured to be entitled to an amount.

Editor’s Note: Under current U.S. GAAP, the amount of revenue recognized is generally limited to the amount that is not contingent on a future event. Under the proposed guidance, the amount of revenue recognized would be limited to the amount to which the entity is “reasonably assured” to be entitled. An entity must use considerable judgment in determining whether it is reasonably assured to be entitled to an amount; however, such a constraint should be less restrictive than that under current U.S. GAAP, which may allow for earlier recognition of revenue in certain circumstances.

Required DisclosuresTheproposedASUrequiresentitiestodisclosebothquantitativeandqualitativeinformation about (1) the amount, timing, and uncertainty of revenue (and related cash flows) from contracts with customers; (2) the judgment, and changes in judgment, exercised in applying the proposal’s provisions; and (3) assets recognized from costs toobtainorfulfillacontractwithacustomer.Therequireddisclosures,whicharesignificantly expanded compared with those in existing revenue standards, include:

• Adisaggregationofrevenueintothe“primarycategoriesthatdepicthowthenature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors.”

• Areconciliationofthebeginningandendingbalanceofcontractassetsandliabilities.

• Certaininformationaboutperformanceobligations(e.g.,typesofgoodsorservices, significant payment terms, typical timing of satisfying obligations, and other provisions).

• Informationaboutonerousperformanceobligations(natureandamountofsuchperformance obligations, the reasons they became onerous, the expected timing to satisfy the liability, and reconciliation of onerous balances).

• Adescriptionofthesignificantjudgments,andchangesinthosejudgments,thataffect the amount and timing of revenue recognition.

• Informationaboutthemethods,inputs,andassumptionsusedtodeterminethetransaction price and allocate amounts to performance obligations.

• Informationaboutassetsrecognizedfromcoststoobtainorfulfillacontract,including a reconciliation of the beginning and ending assets (by main category of asset).

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The final standard’s effective date will not be earlier than annual reporting periods beginning on or after January 1, 2015, for public entities, with a minimum of a one-year deferral for nonpublic entities.

Therearecertainexceptionstothedisclosurerequirementsfornonpublicentities.Asnoted in the Backgroundsectionabove,theboardshaverequestedfeedbackontheirtentativedecisiontorequireentitiestoprovidecertainoftheproposedASU’sdisclosuresin their interim financial statements.

Effective Date and Transition The proposed ASU would be applied retrospectively in accordance with ASC 250, with certain optional practical expedients that can be employed during the retrospective application. The final standard’s effective date will not be earlier than annual reporting periods beginning on or after January 1, 2015, for public entities, with a minimum of a one-year deferral for nonpublic entities. Early application would not be permitted for the FASB’s proposed ASU; however, the IASB’s proposal would permit early application.

Editor’s Note: The proposed ASU does not provide nonpublic entities with any relief fromtheproposedtransitionrequirements.However,theboardsnotedthatnonpublicentitiesarenotspecificallyrequiredbyU.S.GAAPtopresentmultiyearfinancialstatements. This may allow certain entities to avoid some of the complexity of applying the transition guidance to multiple periods.

Other Notable Provisions of the Proposed ASUIn addition to the core principles discussed above, the proposed ASU provides guidance on several other important topics, including the accounting for certain revenue-related costs. Some of the more significant provisions are highlighted below.

Onerous Performance Obligations Entities that satisfy separate performance obligations in a contract over a period greater thanoneyeararerequiredtodeterminewhetherthelowestcoststosatisfy(orsettle)those obligations are greater than the transaction price allocated to them. If so, entities wouldberequiredtorecognizealiabilityandcorrespondingexpensefortheexpectedloss. This loss would be updated as of each reporting date and would be reflected in the income statement.

Editor’s Note: Many respondents to the June 2010 ED were concerned about the onerousperformanceobligationstest,sinceentitieswererequiredtoperformthetestat the level of each separate performance obligation. These respondents noted that thisrequirementcouldhaveresultedinaccountingthatwasinconsistentwiththeeconomics of the contract (e.g., recognition of an onerous loss at the performance obligation level when the overall contract is profitable). During redeliberations, the boards tentatively decided that the unit of account for the onerous test would be at the contract level (i.e., the remaining performance obligations in the contract). However, because of the decision to limit the scope of the test to performance obligations satisfied over a period greater than one year, the revised ED proposes that the unit of account be returned to the level of each separate performance obligation.

Contract Costs The proposed model contains specific criteria for capitalizing certain costs associated with obtainingandfulfillingacontract.Asapracticalexpedient,qualifyingcoststoobtaina contract can be expensed as incurred when the expected amortization period is one year or less. Amortization of capitalized costs would occur in a manner consistent with the pattern of transfer of the goods or services to which the asset relates and, in certain circumstances, may extend beyond the original contract term with the customer (e.g., future anticipated contracts, expected renewal periods).

Editor’s Note: The proposed ASU may make the accounting for costs to obtain and fulfill a contract more consistent throughout U.S. GAAP. However, depending on how an entity currently accounts for revenue-related costs, the proposed guidance may also result in significant changes in practice. Entities may want to closely evaluate the impact of such guidance on their current accounting policies and provide feedback on the proposed ASU if they have concerns with the proposed guidance.

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The proposed ASU includes numerous examples illustrating application of many of its provisions.

Right of Return During deliberations, the boards considered whether a right of return should represent a separate performance obligation (a stand-ready obligation to accept a return during a specified period) and ultimately decided that such rights should not be accounted for as a separate performance obligation. However, the proposed guidance indicates that revenue should not be recognized for goods or services that are expected to be returned (or refunded).

Warranties The proposed ASU allows entities to continue to use a cost accrual model to account for warranty obligations (in accordance with ASC 460), but only for warranties that assure that the good or service complies with agreed-upon specifications. To the extent that a warranty provides a service beyond assuring that the good or service complies with agreed-upon specifications, it would be accounted for as a separate performance obligation. Further, if the customer has the option to purchase the warranty separately, it would also be accounted for as a separate performance obligation.

Product liabilities, such as compensation paid by an entity for harm or damage caused by its product, would not represent a separate performance obligation in the contract and would continue to be accounted for in accordance with the existing literature on loss contingencies in ASC 450.

Customer Options for Additional Goods or Services Undertheproposedguidance,anoptionprovidedtoacustomertoacquireadditionalgoods or services would represent a separate performance obligation if it provides a material right to the customer that it otherwise would not have received without entering into the contract. If an option is deemed to be a separate performance obligation, an entity would allocate a portion of the transaction price to the option and recognize revenue when control of the goods or services underlying the option is transferred to the customer or when the option expires.

Customers’ Unexercised Rights Customer contracts may include a nonrefundable prepayment for the right to receive goods or services in the future (e.g., prepaid gift cards). In certain instances, a customer may not exercise all of its rights (which results in “breakage” on the contract liability). The proposed guidance allows for the recognition of the expected breakage amount in proportion to the pattern of rights exercised by the customer but only when an entity is reasonably assured of such an amount. Otherwise, the breakage amount would not be recognized until it is “remote” that the rights will not be exercised by the customer.

Other TopicsOther topics addressed in the proposed ASU that are not covered in this section include presentation of contract assets and liabilities, principal-versus-agent considerations, licensing and rights to use, nonrefundable up-front fees, repurchase agreements, consignment arrangements, bill-and-hold arrangements, and customer acceptance. The proposed ASU also includes numerous examples illustrating application of many of its provisions.

Editor’s Note: The boards decided to eliminate the original ED’s guidance on licenses and rights to use an entity’s intellectual property (which was a lease-type model). Accordingly, sales of licenses and rights to use intellectual property will be subject to the project’s overall revenue recognition model.

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The proposed guidance may change the amount and timing of revenue recognition for entities that maintain their books and records under U.S. GAAP or IFRSs; these changes may, in turn, affect taxable income.

Potential Income Tax ImplicationsFederal income tax law contains specific rules on certain types of revenue recognition, such as income from long-term contracts and advance payments for goods and services. However, those rules often overlap with a taxpayer’s financial reporting records; in those circumstances, the taxpayer simply follows the tax revenue recognition method it uses in maintaining its books and records (e.g., cash basis, U.S. GAAP, IFRSs). The Internal RevenueCodedoesnotrequirethatataxpayermaintainitsaccountingrecordsonaspecific method of accounting, such as U.S. GAAP, to determine its taxable income.

The proposed guidance may change the amount and timing of revenue recognition for entities that maintain their books and records under U.S. GAAP or IFRSs; these changes may, in turn, affect taxable income. For example, under federal tax principles, the general rule is that income is recognized no later than when received. There are a few limited exceptions that allow a taxpayer to defer revenue recognition (one or two years or longer) for advance payments. One exception allows a taxpayer to defer the recognition of revenue for advance payments for one year to the extent that the revenue is deferred under the taxpayer’s applicable books and records.

The proposed ASU may affect the timing and measurement of revenue for contracts with advance payments and thus may accelerate revenue recognition for contracts with multiple performance obligations, which could have an impact on current taxable income.

In addition, a few of the concepts in the proposed ASU may give rise to or affect the measurement of certain temporary differences. These concepts may include:

• Revenuerecognitionuponthetransferofcontrolthatresultsinchangesinbookrevenue recognition (and contract assets and contract liabilities).

• Potentialchangesinthetimingofrevenueincontractsthatincludevariableorcontingent consideration or a significant financing component.

• Capitalizationofcertaincostsincurredtoobtainorfulfillacontract,someofwhich currently may be deductible for tax purposes.

• Timingoflossdeductionsrelatedtoonerousperformanceobligations.

The tax implications associated with implementing the proposed ASU will be based on an entity’s specific facts and circumstances. Thus, it will be important for tax professionals to understand the detailed financial reporting implications of the proposed ASU so that they can analyze the tax ramifications and facilitate the selection of any alternative tax accounting methods that may be available. Before a taxpayer can select a new tax accounting method, however, the taxpayer must obtain consent from the commissioner. In addition to selecting alternative tax accounting methods, if a taxpayer is following its book method and the book method changes, the taxpayer may have to secure the commissioner’s consent to continue to follow the book method. A taxpayer that does not secure consent to change its tax accounting method may have to maintain its current tax accountingmethod,whichcouldrequireadditionalrecordkeeping.Therearegenerallytwo procedures a taxpayer performs to gain consent from the commissioner to change its taxaccountingmethod.CertaintaxaccountingmethodchangesrequiretheIRStoreviewan application before granting consent. Other tax accounting method changes provide automatic consent if the taxpayer complies with certain terms and conditions.

Thefollowingareafewquestionsforentitiestoconsiderinplanningforthetransition:

• WillpotentialchangestothetimingormeasurementofU.S.GAAPorIFRSrevenue or expenses affect the timing of revenue or expense recognition for income tax purposes?

• Ifthefinancialstatementmodificationsinrevenuerecognitionmethodsunderthe proposed ASU are favorable and permissible for tax purposes, is there a change in method of tax accounting that the taxing authorities might need to approve?

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• Ifthefinancialstatementmodificationsareunfavorableorimpermissible,willthe entity need to maintain certain legacy U.S. GAAP or IFRS accounting records (i.e., records in accordance with the revenue recognition guidance that will be superseded by the proposed ASU)?

• Whentheamountofrevenueinacontractwithmultipleperformanceobligations is allocated to the separate performance obligations under the proposed ASU, are there specific contractual terms that may result in a difference between the allocation for tax and book accounting purposes?

• Totheextentthattaxaccountingmethodsdifferfrombookaccountingmethods,arethereanynewdataorsystemrequirementsthatneedtobetakeninto consideration?

• Arethereanycashtaximplicationsinforeigncontrolledentitiesthat,forexample, maintain statutory accounting records under IFRSs?

Heads Up is prepared by the National Office Accounting Standards and Communications Group of Deloitte as developments warrant. This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any actionthatmayaffectyourbusiness,youshouldconsultaqualifiedprofessionaladvisor.

Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

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