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Introduction
When a revenue contract involves share-based consideration, reporting entities often face challenges in navigating different topics of the FASB Accounting Standards Codification (ASC) to determine the appropriate accounting treatment. Two recent FASB proposals aim to clarify the accounting for share-based consideration – both when it is paid to a customer and when it is received from one in exchange for goods or services. The former is encompassed in its own stand-alone proposed Accounting Standards Update (ASU), “Compensation – Stock Compensation (Topic 718) and Revenue From Contracts With Customers (Topic 606): Clarifications to Share-Based Consideration Payable to a Customer.” The latter is incorporated into a broader proposal on derivatives scope refinements, “Derivatives and Hedging (Topic 815) and Revenue From Contracts With Customers (Topic 606) – Derivatives Scope Refinements and Scope Clarification for a Share-Based Payment From a Customer in a Revenue Contract.”
Share-based consideration payable to a customer
Background
Share-based consideration awarded to a customer often is offered as an incentive to drive additional purchases – for example, the award might include as a vesting condition the purchase of a specified amount of goods or services by the customer (or customer’s customer). Current guidance does not explicitly state whether such a condition should be classified as a performance condition or a service condition under Topic 718. This determination can significantly affect when an entity recognizes the impact of the award on its revenue contract.
If an award granted to a customer is subject to a performance condition, the grantor must recognize a reduction to the revenue contract’s transaction price equal to the grant date fair value of the award when it is probable that the performance condition will be met. In some cases, a grantor’s expectations of a performance condition being met might change, in which case the timing of any reduction to the transaction price would depend on when the performance condition becomes probable of being met.
If a customer award is subject to a service condition, the grantor has the following two options:
- The grantor may make an accounting policy election to estimate forfeitures expected to occur (which is an ongoing estimate, like the probability assessment for an award subject to a performance condition, as previously described).
- The grantor may elect to record actual forfeitures as they occur. That is, the grantor would immediately recognize a reduction in the revenue contract’s transaction price for the full amount of the grant. A grantor making this policy election would reverse the reduction if the grantee forfeits the award (that is, fails to satisfy the service condition).
The following example illustrates the potential differences in accounting for a customer award subject to a service condition:
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Illustrative example: Accounting for share-based payments payable to a customer
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A large beverage company (BevCorp) offers a share-based sales incentive program to attract new retail customers. Through this program, BevCorp grants 50 shares of its own stock to any first-time customer that places an advance order of at least 1,000 cases. The shares vest after one calendar year, contingent on a customer of the customer placing at least five orders of any quantity of cases throughout the calendar year.
A first-time customer places an order of 1,000 cases on Jan. 1, 20X1, and BevCorp grants the customer the requisite awards. The fair value of the shares is $30 per share on the grant date. BevCorp estimates based on historical experience that 20% of all awards granted through the incentive program will be forfeited.
Under current practice, the vesting condition (the purchases by the customer’s customer) is considered a service condition, as it is based on the achievement of a performance target that is not defined solely by reference to BevCorp’s (the grantor’s) operations or activities. Therefore, recognition of award forfeitures could differ, depending on BevCorp’s accounting policy.
Estimating forfeitures
If BevCorp follows a policy of estimating forfeitures, it records a reduction to the contract’s transaction price of $1,200, reflecting 80% of the 50 shares granted. The value of the award is based on the $30 per share fair value as of the grant date.
By Dec. 31, 20X1, none of the customer’s customers have met the five-order threshold. Thus, the customer forfeits the award. Upon the forfeiture, BevCorp recognizes $1,200 in revenue, reversing the previously recorded reduction. The subsequent reversal represents only the amount initially expected to vest.
Recording forfeitures as they occur
If BevCorp follows a policy of recording forfeitures only as they occur. BevCorp initially records $1,500 as a reduction to the contract’s transaction price, reflecting 100% of the value of the award.
By Dec. 31, 20X1, the vesting condition has not been met, and the customer forfeits the award. As a result, BevCorp recognizes revenue of $1,500 (reversing the previously recorded reduction in the transaction price).
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Proposed changes
Definition of a performance condition
The proposed ASU would broaden the definition of a performance condition within Topic 718 by explicitly including conditions related to achieving performance targets that are based on purchases of the grantor’s goods or services by the grantee (the customer) or by parties that purchase the grantor’s goods or services from the grantee (the customer’s customer).
Accounting for forfeitures
Furthermore, for awards that are subject to service conditions even under the amended definition of a performance condition, the proposed ASU would eliminate the policy election option to record forfeitures as they occur for awards granted to customers. Therefore, under the proposed changes, an entity would be required to estimate expected forfeitures for all customer awards with a service condition.
Variable consideration constraint
The proposed ASU also would clarify that entities should refer to Topic 718 when evaluating conditions that could affect the vesting and fair value of customer awards. The proposal explicitly states that entities would not apply the guidance on variable consideration in Topic 606.
Transition
Entities would be required to adopt the amendments on a modified retrospective basis, with a retrospective option permitted. After the comment period, the FASB will determine if early adoption would be permitted.
Share-based consideration received from a customer
Background
Current guidance does not specifically indicate how an entity should account for share-based payments (such as shares, options, warrants, and forward contracts on shares) received as consideration in a contract with a customer. Because of this, it can be challenging for entities to determine when to recognize the share-based payment received – at contract inception (under Topic 321, “Investments – Equity Securities,” or Topic 815, “Derivatives and Hedging”) or upon fulfillment of the associated performance obligation (under Topic 606).
Proposed changes
The proposed ASU would clarify the appropriate accounting for share-based payments received as consideration from a customer. The changes would direct an entity to first recognize the share-based payment under Topic 606, applying the guidance on noncash consideration, prior to referring to any other topics, such as Topic 815 or Topic 321.
Aligning the recognition of share-based payments with that of noncash consideration under Topic 606 means that an entity must satisfy the associated performance obligation prior to recognizing the share-based payment. One effect of the proposed amendment would be a difference in initial recognition for transactions involving share-based payments received that are determined to be:
- Within the scope of Topic 606 (involves a revenue contract): Share-based payments would not be recognized by the grantee until the grantee fulfills the performance obligation. Topics 815 or 321 could apply thereafter.
- Not within the scope of Topic 606 (does not involve a revenue contract): In accordance with Topics 815 or 321, share-based payments would be recognized at contract inception.
Under the proposal, an entity would recognize the share-based payment received as an asset only upon the receipt or retention of the payment no longer being contingent on the fulfillment of the performance obligation. An entity would measure the asset based on estimated fair value at the time of contract inception.
The following example, which illustrates how an entity would account for share-based payments received as consideration from a customer, is taken from the FASB’s proposal:
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Illustrative example from proposed updates to FASB Accounting Standards Codification: Entitlement to noncash consideration
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606-10-55-248. An entity enters into a contract with a customer to provide a weekly service for one year. The contract is signed on January 1, 20X1, and work begins immediately. In exchange for the service, the customer promises 100 shares of its common stock per week of service (a total of 5,200 shares for the contract). The terms in the contract require that the shares must be paid upon the successful completion of each week of service.
606-10-55-249. In accordance with paragraph 606-10-15-3A, the entity applies the guidance in this Topic to a contract with a share-based payment from a customer that is consideration for the transfer of a service (the shares). The entity concludes that its right to receive 100 shares from the customer is no longer contingent on its performance once it completes each week of service. As a result, the 100 shares are recognized as assets under this Topic as each week of service is complete. In this Example, the timing of the recognition of the shares coincides with the timing of the payment of the shares. The guidance in other Topics does not apply to the shares until the shares are recognized as assets under this Topic. The entity concludes that the service is a single performance obligation in accordance with paragraph 606-10-25-14(b). This is because the entity is providing a series of distinct services that are substantially the same and have the same pattern of transfer (the services transfer to the customer over time and use the same method to measure progress – that is, a time-based measure of progress).
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For a full overview of the proposed ASU on derivatives scope refinements, including the amendments on accounting for share-based consideration received from a customer, refer to the Crowe article “FASB Proposes Derivatives Scope Refinements.”
Transition
Entities would be required to adopt the amendments related to accounting for the receipt of share-based consideration in a revenue contract using a modified retrospective approach. Early adoption would be permitted.
