Technical side of revenue recognition still vexes companies

In the continuing march to new accounting for how to recognize revenue in financial statements, some companies with complex transactions find they are still wrestling with how to apply the technical requirements.

The new five-step method for recognizing revenue that all public companies will apply beginning in 2018 requires companies to begin by identifying their contracts with customers. Then within each contract, companies must identify the individual performance obligations and allocate the purchase price to each of the distinct performance obligations. Revenue is recognized in financial statements as the company delivers on each of its distinct performance obligations.

The new model doesn’t produce much change in the pattern of recognition for companies that have relatively straightforward transactions with their customers. But in sectors like technology or life sciences, where complex contracts with multiple performance obligations are the norm, some companies find they are still parsing through how to identify individual performance obligations and allocate pricing to each of them distinctly.

The life science sector, for example, includes companies in biotechnology, like pharmaceutical companies, clinical research organizations, and medical device manufacturers. Arrangements involving licensing technology are quite common in those kinds of organizations, says Jeff Ellis, life science industry practice director at Deloitte & Touche, and companies are getting tangled up in parsing out the accounting.

Enjoy full access to Compliance Week's Digital Edition, a faithful reproduction of our monthly print magazine—conveniently online. Subscribers can browse, print, and download issues back to April 2013, add annotations, search by keyword, and more.

“You have significant intellectual property in this sector,” says Ellis, and licensing is a common means of transferring that property among entities. “Licensing transactions are very common in this industry, and the new standard has some pretty significant changes.”

“A key question is whether the license of intellectual property represents a separate performance obligation from other goods or services in a contract. “That notion of whether it is distinct is a difficult judgment to make.”

Jeff Ellis, Life Science Industry Practice Director, Deloitte & Touche

The new standard requires companies to evaluate whether a particular good or service is separately identifiable in a contract, says Ellis. That led to questions early in the implementation process that inspired the Financial Accounting Standards Board to issue further guidance to clarify. In biotech companies, bundling of goods and services with licensing arrangements is typical. “A key question is whether the license of intellectual property represents a separate performance obligation from other goods or services in a contract,” says Ellis. “That notion of whether it is distinct is a difficult judgment to make.”

Another layer of complexity emerges as companies ponder how to account for arrangements that involve variable consideration, like royalties or sales-based milestones where the numbers are not distinct or predetermined at the outset of an arrangement. FASB’s clarifying guidance has been somewhat helpful, says Dennis Howell, senior consultation partner at Deloitte, but companies are still left to exercise a great deal of judgment in deciding how to apply the requirements to their particular arrangements.

IDENTIFIED REV-REC IMPLEMENTATION ISSUES.

Below is a list of potential revenue recognition implementation issues identified by the Health Care Entities Revenue Recognition Task Force.
1. Consideration of the following regarding self-pay balances:
Application of step 1 (determine if there is a contract) and step 3 (determine the transaction price) for healthcare services provided to self-pay patients, including uninsured patient balances and self-pay patient balances arising from co-payments and deductibles.
This implementation issue will discuss evaluating whether a contract exists and what (including consideration of implicit price concessions) the transaction price is to arrangements for health care services provided to self-pay patients and balances arising from co-payments and deductibles.
Finalized to be included in a future edition of the AICPA Guide Revenue Recognition
1a.  Implicit price concessions:
This implementation issue, being submitted to the TRG, provides two views over the initial accounting for implicit price concessions for services provided to uninsured patients and two views for the subsequent accounting for these types of contracts and whether changes in the estimates of variable consideration represent changes in price concessions or impairments.
Submitted to FASB TRG
2. Application of the portfolio approach to contracts with patient:
This implementation issue will discuss how to apply the portfolio approach to revenue from self-pay patients and third party payors.
Finalized to be included in a future edition of the AICPA Guide Revenue Recognition
3. CCRC: Identifying and satisfying the performance obligation(s) and recognizing the monthly/periodic fees and non-refundable entrance fees under Type A or “life care” contracts for continuing care retirement communities:
This implementation issue will discuss the performance obligations under a typical Type A (life care) continuing care retirement community (CCRC) resident agreement and, given these performance obligations, how a Type A CCRC will estimate a transaction price and recognize nonrefundable entrance fees and monthly/periodic fees received from residents under the new model.
Re-submitted to AICPA RRWG
4. CCRC: Identifying the performance obligation(s) and recognizing the performance obligation(s) to provide future services and use of facilities:
This implementation issue will describe the changes to a continuing care retirement community’s calculation of the obligation to provide future services and use of facilities as a result of the new model.
Submitted to AICPA RRWG
5. Significant financing component - CCRC contracts, and patient and third-party payor amounts in arrears:
This implementation issue will discuss how CCRCs assess whether a significant financing component exists in determining the transaction price for its resident contracts, as well as how CCRCs and other healthcare entities will assess whether a significant financing component is applicable to patient and third-party payor amounts in arrears.
Submitted to AICPA RRWG
6. Disclosure requirements of ASU No. 2014-09:
This implementation issue will discuss judgements related to disclosure requirements under ASC 606 for health care entities.
Submitted to AICPA RRWG
7. Accounting for contract costs:
This implementation issue will discuss how health care organizations will account for certain costs of acquiring and fulfilling contracts under the new model.
Submitted to FinREC - September 2015
8. Consideration of FASB ASC 606, Revenue from Contracts with Customers, for third party settlement estimates
Source: Health Care Entities Revenue Recognition Task Force

Even further complicating the accounting, biotech companies commonly enter into various kinds of collaboration arrangements with other entities, like joint ventures, which leads to even more questions about how to account for revenue, says Howell. In doing the analysis of how to recognize revenue under the new guidance, companies could feasibly come to a conclusion that they are neither the vendor nor the customer to a partner in such a collaborative arrangement, he says.

FASB recently added a project to its technical agenda to try to help sort out when transactions between parties to a collaborative arrangement are within the scope of the new revenue guidance. It’s not clear when FASB might reach some conclusions that companies could apply in meeting the new revenue requirement in 2018, leading Howell to wonder if some companies might have to take their individual facts and circumstances to the Securities and Exchange Commission to ask for the staff’s pre-clearance of their own accounting determinations.

A close cousin to life sciences, companies in the healthcare sector are wrestling with how to apply the new revenue recognition method to their contracts as well. The complexity of the payor system for hospitals working with various types of insurance programs, not to mention uninsured patients, creates some uncertainty, says Philip Santarelli, a partner at audit firm Baker Tilly Virchow Krause.

Collectibility is a big issue in the healthcare sector, says Santarelli, where hospitals may have trouble identifying whether patients will be able to pay their bills or even their co-pays. The standard requires entities to consider collectibility as part of the determination of when and in what amounts to recognize revenue, but providers may have no way of knowing at the time they deliver a service whether a particular patient will pay.

“Some companies are discussing a portfolio approach to managing those types of contracts,” says Santarelli, but for some entities the path forward is not crystal clear. “They’re going to have to put models in place to address collectibility as they identify contracts,” he says.

Joelle Pulver, a partner at audit firm Moss Adams, says healthcare entities will have to sort out the difference between explicit price concessions and those that are more implicit, as the accounting may be different. The healthcare task force at the American Institute of Certified Public Accountants identified questions in implicit price concessions that it has referred to FASB’s Transition Resource Group for some guidance.

Long-term care facilities, says Pulver, are wrestling with how to recognize revenue on arrangements where a care provider accepts large upfront payments in exchange for caring for an individual for life, whatever kind of care that might entail and for however long that might last. Entities will have to develop some means of determining how to apply that upfront payment over such an uncertain range of care and timeline, she says.

Santarelli says companies in the biotech area in particular are becoming concerned they may suffer some incomparability with peers in the early periods of reporting because of how much judgment and uncertainty is involved. “Reasonable people looking at the same situation could come to different judgments on how to account for a particular contract,” he says.

Like many accounting experts, Santarelli is advising companies to roll up their shirt sleeves and dig into such technical accounting complexity sooner rather than lateras 2017 progresses.