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Revenue accounting reset – Consideration payable to a customer · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC's National Office.
• 0:06
  SPEAKER_02: Hello, and welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_02: I'm Heather Horn.
• 0:11
  SPEAKER_02: Today we're continuing our revenue accounting series with a discussion on payments to customers, an area that continues to raise complex accounting questions, especially when those payments come in the form of equity.
• 0:23
  SPEAKER_02: We'll cover when those payments reduce revenue, when they may instead represent consideration for distinct good or service, and we'll also highlight key changes from the FASB's recent accounting standard update on share-based payments to customers.
• 0:37
  SPEAKER_02: So obviously, an action-packed episode.
• 0:43
  SPEAKER_02: Joining me for the conversation are Angela Ferguson and Ken Stoller, both partners in PWC's national office.
• 0:49
  SPEAKER_02: With that, let's get started.
• 0:50
  SPEAKER_02: Angela, Ken, so nice to have you on together.
• 0:53
  SPEAKER_02: I think it's first time.
• 0:54
  SPEAKER_02: Yeah, thanks for having us.
• 0:56
  SPEAKER_02: Great.
• 0:56
  SPEAKER_02: So, Angela, maybe just to kick things off, I think it might be helpful to start with what ASC 606 means when it says, I'll quote, consideration payable to a customer.
• 1:06
  SPEAKER_02: What types of payments or incentives would fall into this category?
• 1:10
  SPEAKER_03: Sure.
• 1:10
  SPEAKER_03: So consideration payable to a customer is what it basically sounds like it is, which is payments to the customer, generally in cash, can also be certain kinds of credits or coupons or incentives, but really, in effect, a cash payment being made to the customer.
• 1:28
  SPEAKER_03: The other thing to keep in mind is that it could be a payment to a customer's customer.
• 1:34
  SPEAKER_03: So to give an example, if you had a consumer products company that sells their product, say laundry detergent to a retailer and then offers a rebate or coupon to the end consumer that's buying the laundry detergent from the retailer, that's also considered a payment to a customer because that end consumer is buying the company's product down the distribution chain.
• 2:00
  SPEAKER_03: The other thing that you need to keep in mind is payments to third parties that are made on behalf of a customer.
• 2:07
  SPEAKER_03: So if you take just a simple example, Heather, I could pay you$100 directly, or I could pay off your$100 utility bill for you, right?
• 2:18
  SPEAKER_03: But in both cases, I'm giving you$100.
• 2:22
  SPEAKER_03: So you can't basically avoid the guidance by paying a third party on your customer's behalf.
• 2:28
  unknown: Yeah.
• 2:28
  SPEAKER_02: And I guess, Angela, it's more straightforward when it is the direct payment.
• 2:31
  SPEAKER_02: As soon as you get into paying a customer's customer or you're paying a third party on their behalf, I would assume those are the ones that we have to be more careful to make sure that are getting identified.
• 2:42
  SPEAKER_02: Exactly.
• 2:42
  SPEAKER_02: Yeah.
• 2:42
  SPEAKER_03: And really the accounting is the same.
• 2:44
  SPEAKER_03: You think of all of those as being payments to the customer.
• 2:47
  SPEAKER_02: All right.
• 2:48
  SPEAKER_02: So then can you give an example of a case when that type of payment wouldn't reduce revenue because there actually is a distinct good or service?
• 2:56
  SPEAKER_03: Yeah.
• 2:56
  SPEAKER_03: So the general concept is that the payment to the customer reduces the transaction price for the revenue contract.
• 3:04
  SPEAKER_03: But there can be circumstances where you have both a customer relationship and a vendor relationship with the same counterparty.
• 3:14
  SPEAKER_03: So you may be actually buying a good or service from that same party.
• 3:19
  SPEAKER_03: And now you're the customer and they're the vendor.
• 3:22
  SPEAKER_03: So to figure that out, I mean, we use the same guidance about determining whether a good or service is distinct that we use in the rest of 606 for determining whether goods or services we're transferring to customers are distinct.
• 3:37
  SPEAKER_03: Here you're kind of thinking about it in reverse.
• 3:39
  SPEAKER_03: So you're thinking about whether the thing you're getting from the customer is distinct from what you're transferring to the customer.
• 3:47
  SPEAKER_03: So just to give a common example that comes up is advertising services.
• 3:53
  SPEAKER_03: So with my consumer products company example that I gave earlier, selling the laundry detergent to the retailer, they may also make a agree to pay the retailer for advertising services.
• 4:06
  SPEAKER_03: So they make a cash payment for advertising.
• 4:09
  SPEAKER_03: Well, then you need to assess is the company really receiving distinct advertising services from the retailer?
• 4:18
  SPEAKER_03: In many cases, they are not.
• 4:19
  SPEAKER_03: So a few examples.
• 4:22
  SPEAKER_03: Very common we call it like slotting fees or payments in order to put your product in a good spot in the store, right?
• 4:30
  SPEAKER_03: Or shelf placement or making a nice setup for your product in the display.
• 4:37
  SPEAKER_03: That is not considered distinct from the sale of the product.
• 4:42
  SPEAKER_03: Another example is oftentimes the payment is being put into an advertising allowance, but the retailer can essentially do whatever they want with that money.
• 4:54
  SPEAKER_03: So they're not really providing advertising services to the company.
• 4:59
  SPEAKER_03: But sometimes you can see situations where maybe you're buying advertising on the retailer's website.
• 5:07
  SPEAKER_03: That one we might think about a little bit harder.
• 5:10
  SPEAKER_03: And part of it is is that something I could buy from another company that wasn't my customer, right?
• 5:18
  SPEAKER_03: And I'm receiving something I could buy from someone else.
• 5:21
  SPEAKER_03: In that case, it may be distinct from the sale of the product to the customer.
• 5:26
  SPEAKER_03: You also need to consider whether you're paying fair value for the good or service.
• 5:31
  SPEAKER_03: Because if you're paying more than fair value, the excess amount is still contra revenue.
• 5:38
  SPEAKER_02: Okay.
• 5:39
  SPEAKER_02: So a lot of pieces to think about there.
• 5:41
  SPEAKER_02: I guess if we go down the path and say it's not distinct, because you gave quite a few examples of that, then what is the timing of how you record this reduction of revenue?
• 5:51
  SPEAKER_03: So the guidance uh says the timing of the reduction of revenue is the later of when the revenue is recognized for the related goods or services, or when the promise to make the payment is made.
• 6:08
  SPEAKER_03: And if it's a variable amount, you're going to apply the variable consideration guidance to estimate the amount.
• 6:15
  SPEAKER_03: That is what we talked about on last week's podcast.
• 6:17
  SPEAKER_03: So tune in if you miss that one.
• 6:20
  SPEAKER_03: But one judgment here is determining when is the promise being made to make the payment.
• 6:26
  SPEAKER_03: Sometimes that's very clear.
• 6:28
  SPEAKER_03: It's explicit in the contract, or there's an explicit communication to the customer that you're going to make the payment.
• 6:35
  SPEAKER_03: Other times it could be implied based on the company's past business practices.
• 6:41
  SPEAKER_03: So to give another example, we're going to go back to my consumer products company selling their laundry detergent.
• 6:48
  SPEAKER_03: Suppose that they sell some product to the retailer and then later on decide that they want to try to move their product off the shelves.
• 6:58
  SPEAKER_03: Maybe they're making room for a new version of their product, right?
• 7:02
  SPEAKER_03: So they want to move some inventory.
• 7:04
  SPEAKER_03: So they decide to do a one-time rebate offer to uh consumers to go try to buy a bunch of this detergent that's already been sold through.
• 7:16
  SPEAKER_03: So in that case, the revenue was recognized when they sold the product to the retailer.
• 7:21
  SPEAKER_03: So that's already occurred.
• 7:23
  SPEAKER_03: And now they're making the promise to make a payment.
• 7:28
  SPEAKER_03: So we would be later of now recording the reduction to revenue when that offer is being made.
• 7:34
  SPEAKER_03: In contrast, if the company had a history of making, you know, sending out coupons and rebate offers because they just do that all the time for their product, then you would you would need to estimate that at the time you sold the laundry detergent to the retailer because it's implied that you're going to be doing some sort of payment to the end consumer as part of that sale.
• 8:02
  SPEAKER_02: And so, Angela, the latter case definitely sounds like it involves more judgment.
• 8:06
  SPEAKER_02: And so I would guess that determining whether there is this history, that is one of the places then that the judgment would come in.
• 8:14
  SPEAKER_02: Yeah, absolutely.
• 8:15
  SPEAKER_02: Yeah.
• 8:15
  SPEAKER_02: All right.
• 8:16
  SPEAKER_02: And then what other types of judgments should you be considering when you're trying to determine uh when the payment should be recorded?
• 8:24
  SPEAKER_03: So the other big judgment here is what are what are the goods and services that the payment relates to, or what are the revenue transactions that this payment to the customer should offset?
• 8:36
  SPEAKER_03: And again, sometimes it's gonna be fairly straightforward.
• 8:39
  SPEAKER_03: So a common example is you know, a company is selling widgets to their customer and offers a rebate based on the volume of purchases.
• 8:50
  SPEAKER_03: So say they're gonna give a$10,000 rebate if the customer purchases$100,000 worth of product.
• 8:58
  SPEAKER_02: So Angela, sorry, just to confirm.
• 9:00
  SPEAKER_02: So basically they have a contract with the customer that says we're going to sell you these, but it's not for necessarily a fixed quantity.
• 9:08
  SPEAKER_03: Right.
• 9:09
  SPEAKER_03: Okay.
• 9:09
  SPEAKER_03: Right.
• 9:10
  SPEAKER_03: But here we know that they made a promise to give the rebate.
• 9:14
  SPEAKER_03: So when they recognize the revenue for the widget, they would be estimating the amount of the rebate that would offset the revenue for that widget.
• 9:26
  SPEAKER_03: But in this case, it's pretty clear that the$10,000 of rebate relates to the$100,000 of purchases.
• 9:33
  SPEAKER_03: Other cases where it may not be so clear is an example that we see quite often is where the company might make an incentive payment, say the$10,000, up front to the customer to incentivize them to enter into the contract.
• 9:51
  SPEAKER_03: Now, if the contract already has a committed amount of purchases in it, that might be, again, more straightforward because that incentive would relate to the purchases that have been committed to in that contract.
• 10:06
  SPEAKER_03: But in other cases, for example, maybe the customer has agreed to use the company as their exclusive supplier, but hasn't yet committed to any minimum amount of purchases.
• 10:20
  SPEAKER_03: Well, then you would have to estimate the purchases that are going to be made in order to figure out the timing of recognizing the incentive, because the incentive should offset the revenue from the purchases that it relates to.
• 10:36
  SPEAKER_03: So obviously that's going to require judgment.
• 10:39
  SPEAKER_03: And in some cases, a company may make an incentive payment to a customer, but it may be very uncertain what purchases that customer is going to make.
• 10:50
  SPEAKER_03: And you would so generally, if you had if you had the ability to estimate the revenue, you would set up an asset for the upfront payment, and then and then that would get recognized against the revenue as the purchases were made.
• 11:07
  SPEAKER_03: But if you can't assert or estimate that future revenue, you wouldn't be able to record an asset because you wouldn't be able to assert that it's going to be recoverable.
• 11:18
  SPEAKER_02: So, Angela, I have a few follow-up questions.
• 11:20
  SPEAKER_02: So just to make sure we're really distinguishing sort of from our first case to this second case that we've been talking about.
• 11:27
  SPEAKER_02: In the first case where you had the rebate for$100,000 of purchases, you're not giving that rebate after the purchases are made.
• 11:35
  SPEAKER_02: But you're saying that you would still be reducing, basically recording, you know, nine cents on the dollar or whatever, 90 cents on the dollar.
• 11:44
  SPEAKER_02: Exactly.
• 11:44
  SPEAKER_02: Because your expectation is that they those purchases will be made.
• 11:48
  SPEAKER_02: Exactly.
• 11:49
  SPEAKER_02: Okay.
• 11:49
  SPEAKER_02: And then in the second case, we are paying up front with sort of a hope that they're going to buy these whatever widgets that we're talking about.
• 11:58
  SPEAKER_02: No more sales or laundry deterrent than we have.
• 12:00
  SPEAKER_02: So I guess you're not going to have maybe as much laundry deterrence.
• 12:04
  SPEAKER_02: But in any case, in that second case, there could be a scenario, right, where the payment actually is exceeding the estimated revenue.
• 12:12
  SPEAKER_02: So then what happens?
• 12:14
  SPEAKER_03: Well, that's what we call a negative revenue situation.
• 12:17
  SPEAKER_03: Like an oxymoron.
• 12:19
  SPEAKER_03: And it's interesting that this comes up probably more often than you would think.
• 12:23
  SPEAKER_03: And it does require a lot of judgment to figure out what to do in that situation.
• 12:28
  SPEAKER_03: And really the first thing is understanding why is the company in this position?
• 12:33
  SPEAKER_03: Why are they willing to make a payment to the customer that exceeds the amount of revenue that they expect?
• 12:40
  SPEAKER_03: So you would, you know, need to understand the circumstances.
• 12:43
  SPEAKER_03: Maybe there's some sort of past relationship with this customer that that payment actually really relates to.
• 12:50
  SPEAKER_03: Or maybe there is something else that they're expecting for that payment.
• 12:57
  SPEAKER_03: So you want to think through all of that.
• 12:59
  SPEAKER_03: If you do that thought process and you still have this negative revenue, if you will, situation, it really becomes a policy choice at that point.
• 13:09
  SPEAKER_03: The first policy is just to record that as contra revenue and you'd be really offsetting other revenues with that amount.
• 13:17
  SPEAKER_03: Then the second policy choice is looking to some guidance that is actually superseded.
• 13:24
  SPEAKER_03: It was superseded by 606, but people still look to it.
• 13:28
  SPEAKER_03: And that guidance said that if you have a payment to a customer that exceeds revenue from the cumulative relationship with that customer.
• 13:39
  SPEAKER_03: So you have to look at your entire relationship, not just in the current period, but the cumulative revenue from that entire relationship.
• 13:48
  SPEAKER_03: And if your payment exceeds that amount, then the excess can get reclassified to an expense.
• 13:55
  SPEAKER_03: And then there's some judgment around, well, what kind of expense is that?
• 13:59
  SPEAKER_03: I mean, again, you'd be thinking about why are we willing to make this payment?
• 14:03
  SPEAKER_03: A lot of times it ends up being sales and marketing because there's usually some angle there as to why you're willing to make a payment that exceeds revenue.
• 14:11
  SPEAKER_02: And then Angela, in this case, we think people can look to superseded guidance because it was not like specifically replaced.
• 14:19
  SPEAKER_02: So even though superseded, nothing replaced.
• 14:21
  SPEAKER_03: Yeah, 606 didn't contemplate having negative revenue.
• 14:26
  SPEAKER_03: Again, it does come up more often than you might think.
• 14:29
  SPEAKER_02: Yeah.
• 14:29
  SPEAKER_02: And then just rewinding to the first case where the payment is made later, but you're reducing revenue as you go along, then what happens if they never reach that 100,000 threshold?
• 14:41
  SPEAKER_02: Or is it presumed that this would be in a case where that was like a guaranteed amount in the contract?
• 14:46
  SPEAKER_03: Well, I mean, that goes back to the variable consideration guidance, right?
• 14:50
  SPEAKER_03: Because we would be estimating what we expect, you know, the price of the widget to be.
• 14:56
  SPEAKER_03: And if we expect them to hit the volume, then the price of the widget would be lower.
• 15:02
  SPEAKER_03: If that expectation changes, then we'd be updating our estimate and updating the variable consideration on a cumulative catch-up basis, usually.
• 15:10
  SPEAKER_02: All right.
• 15:11
  SPEAKER_02: And I think we have another episode that covers that in more detail now that you gave that guidance.
• 15:15
  SPEAKER_02: So, Ken, let me bring you into the conversation because part of why we included you here is that what Angela's just been talking about is even though it was complicated, relatively more straightforward because we were talking about cash and credit types of incentives.
• 15:29
  SPEAKER_02: But we know there's also cases where the company may be offering its shares, warrants, stock options, other types of equity instruments as part of these incentives.
• 15:39
  SPEAKER_02: So, what guidance should we be applying in those cases?
• 15:42
  SPEAKER_02: And then maybe we can talk a little bit about what how it's different.
• 15:45
  SPEAKER_01: Yep.
• 15:46
  SPEAKER_01: Right.
• 15:46
  SPEAKER_01: So the basic setup is the same as what Angela's been uh talking us through, which is we're issuing some consideration to our customer.
• 15:55
  SPEAKER_01: The difference now is we're not issuing cash.
• 15:58
  SPEAKER_01: We are issuing some form of share-based consideration to the customer that might be our own stock, might be warrants, etc.
• 16:06
  SPEAKER_01: Once we start introducing share-based consideration into the mix, there are some additional things that we need to be concerned about.
• 16:14
  SPEAKER_01: One of those is measurement.
• 16:17
  SPEAKER_01: When and how should we be measuring whatever the equity instruments are?
• 16:22
  SPEAKER_01: And the other is classification.
• 16:24
  SPEAKER_01: Are we going to uh classify the instruments as equity or as liability on the balance sheet?
• 16:30
  SPEAKER_01: So 606 says if you're issuing equity instruments to your customer, first go look at the stock compensation guidance, which is 718 for any of the measurement considerations, any of the classification considerations, run it through that model.
• 16:50
  SPEAKER_01: Once you've gone through measurement and classification, then you bring it back into 606 for the rest of the revenue recognition stuff.
• 16:57
  SPEAKER_01: So maybe if we start with measurement, and maybe I'll riff on one of Angela's examples.
• 17:03
  SPEAKER_01: So we had a situation where we were gonna issue$10,000 to our customer if they bought$100,000 worth of widgets.
• 17:11
  SPEAKER_01: Now maybe instead of$10,000, we're gonna issue$1,000 of our shares to the customer if they buy$100,000 worth of widgets.
• 17:20
  SPEAKER_01: So we need to, because it's a thousand shares, we need to determine when are we going to measure the value of those shares.
• 17:28
  SPEAKER_01: $718 tells us to recognize or measure the value of share-based consideration at the grant date.
• 17:36
  SPEAKER_01: And there's uh a number of criteria to establish when the grant date is, but the the general gist is at what point do we have a mutual understanding between the two parties on the key terms of the arrangement?
• 17:51
  SPEAKER_01: So once we've established the grant date, maybe on the grant date, the share price is ten bucks.
• 17:56
  SPEAKER_01: Then we'll say ten dollars times our thousand shares, that equals ten thousand dollars.
• 18:02
  SPEAKER_01: That's the amount that we would reduce transaction price by or reduce revenue by.
• 18:08
  SPEAKER_01: So that's the grant date.
• 18:10
  SPEAKER_01: There are also measurement considerations if there are vesting conditions attached to the equity, which is pretty common.
• 18:17
  SPEAKER_01: So there might be things like service conditions, performance conditions, et cetera.
• 18:20
  SPEAKER_01: Maybe put a pin in that for a minute, we can come back to it, but that's another element of the measurement uh concepts in 718 that we need to address.
• 18:28
  SPEAKER_01: Once we work our way through the measurement considerations, then we move on to classification.
• 18:34
  SPEAKER_01: 718 has its own set of rules in determining whether share-based considerations should be classified as equity or classified as liability.
• 18:43
  SPEAKER_01: So we're going to run it through all those rules in 718, determine the appropriate classification.
• 18:49
  SPEAKER_01: Once we've done all that, we come back into 606 and then continue along with our revenue recognition.
• 18:55
  SPEAKER_02: So is it overly simplistic to say you go through this 718 evaluation to figure out effectively what it is that you're giving is the consideration.
• 19:05
  SPEAKER_02: And then you say, okay, well, now I know how much it's worth.
• 19:08
  SPEAKER_02: I'm going to go ahead and apply the model we just talked about.
• 19:11
  SPEAKER_02: Oh, you got it.
• 19:12
  SPEAKER_02: All right.
• 19:13
  SPEAKER_02: Good explanations there.
• 19:14
  SPEAKER_02: That's it.
• 19:15
  SPEAKER_02: And then maybe I have some follow-up questions to Ken, but the other question is we, Angela, we were talking about the fact that it can be hard sometimes to identify these arrangements.
• 19:24
  SPEAKER_02: And I'm guessing that as soon as you start to involve equity, that can make it even harder to identify that these are the accounting models that need to be applied, or is it relatively straightforward because you can see you're giving equity and it's in consideration?
• 19:39
  SPEAKER_01: Right.
• 19:40
  SPEAKER_01: I think I think generally when we're uh introducing equity into potential payments to the customer, there are usually going to be contractual terms that are specifying what type of equity are we going to issue and under what conditions are you going to earn it, et cetera.
• 19:53
  SPEAKER_01: But maybe to circle back on the service conditions and performance conditions and how that impacts the recognition.
• 20:00
  SPEAKER_01: So in some situations, we might not have any of those conditions in order for the customer to vest in the shares in our example.
• 20:09
  SPEAKER_01: And that would be similar maybe to uh one of Angela's other examples where it was just$10,000 up front to enter the contract, right?
• 20:16
  SPEAKER_01: There were no other stipulations associated with it.
• 20:19
  SPEAKER_01: So if we had in now in the equity world, we're issuing a thousand shares without any conditions attached, uh, then there wouldn't be any service or performance conditions.
• 20:28
  SPEAKER_01: We just measure the value, and that's the reduction in the transaction price.
• 20:32
  SPEAKER_01: But oftentimes there will be conditions, like in our example where they have to buy$100,000 worth of widgets from us in order to vest.
• 20:41
  SPEAKER_01: So that makes the consideration variable because the customer may or may not earn those shares.
• 20:47
  SPEAKER_01: To deal with that variability, because we're dealing with equity issued to the customer, we don't use the variable consideration guidance in 606.
• 20:56
  SPEAKER_01: We instead are pointed to 718 to assess that variability.
• 21:02
  SPEAKER_01: So we have to determine: is that vesting condition a service condition?
• 21:06
  SPEAKER_01: Is it a performance condition?
• 21:07
  SPEAKER_01: And then 718 tells us how to assess uh whether or not the customer is going to vs based on that condition.
• 21:15
  SPEAKER_01: So for example, in our thousand shares in exchange for$100,000 worth of widgets, if that is a performance condition, then 718 would say you have to assess whether it's probable that the condition will be achieved and the customer will earn the shares.
• 21:33
  SPEAKER_01: If at the outset it's probable that the shares will be earned, then we would reduce the transaction price by that$10,000 worth of shares and then we would recognize a revenue.
• 21:45
  SPEAKER_01: If at the outset management determines it's not probable that the shares are going to be earned, we're going to ignore them.
• 21:52
  SPEAKER_01: So we're not going to reduce transaction price by that amount.
• 21:55
  SPEAKER_01: But it's an ongoing assessment.
• 21:57
  SPEAKER_01: So management will continue to assess every Period, whether it's probable that the shares will be earned.
• 22:03
  SPEAKER_01: If that assessment changes at some point over the course of the contract, then we would uh adjust our transaction price accordingly.
• 22:11
  SPEAKER_01: It wasn't probable initially.
• 22:12
  SPEAKER_01: Now it is probable, and therefore we're going to reduce the transaction price by the$10,000.
• 22:17
  SPEAKER_03: Well, and the key there is that, you know, as um Ken mentioned, like if you were actually applying the variable consideration guidance in 606, it would be a slightly different way of thinking about it.
• 22:29
  SPEAKER_03: That's about to ask you.
• 22:30
  SPEAKER_03: You'd be applying the variable consideration constraint, and you'd be assessing whether it's probable you won't have a reversal of revenue in the future, which sometimes you may get to the same place, um, but it's a it's a little bit more conservative, the variable consideration constraint.
• 22:48
  SPEAKER_03: So that you had to pick one model or the other, and the FASBI picked the 718 model.
• 22:53
  SPEAKER_02: So it's just again to reiterate what Ken said earlier, then in a scenario where there are there is equity involved, you start with 718 and then apply 606.
• 23:05
  SPEAKER_02: So in the cash case, you apply the 606 model.
• 23:09
  SPEAKER_02: In the equity case, you start with 718, and then once you figure that out, you would apply it in within 606.
• 23:17
  SPEAKER_02: Right.
• 23:18
  SPEAKER_02: Okay.
• 23:18
  SPEAKER_02: They're both not you guys are both nodding.
• 23:20
  SPEAKER_02: So it's definitely a lot to think about then.
• 23:22
  SPEAKER_02: Because especially to Angela's point with these two different models for recognition, because you could come then to a different answer, it seems like from an income statement perspective, in terms of how much revenue gets recognized, right?
• 23:36
  SPEAKER_02: Yeah.
• 23:36
  SPEAKER_02: Yeah.
• 23:37
  SPEAKER_02: Okay.
• 23:37
  SPEAKER_02: Again, both nodding.
• 23:38
  SPEAKER_02: I just want to make sure I'm following.
• 23:39
  SPEAKER_02: This is a lot to think about.
• 23:41
  SPEAKER_02: All right.
• 23:41
  SPEAKER_02: So then, Ken, sticking with you, the I know in May the FASB issued a new ASU and I it touched a bit on these service and performance condition issues.
• 23:51
  SPEAKER_02: So, what can you share on that?
• 23:53
  SPEAKER_01: Yeah, so they issued this a couple of months ago.
• 23:56
  SPEAKER_01: Um the they took this on because there had been some diversity in practice in whether certain of these vesting conditions represent service conditions or performance conditions.
• 24:09
  SPEAKER_01: Like in our example where you earn the thousand shares if the per if the customer purchases the$100,000 worth of widgets.
• 24:16
  SPEAKER_01: Some may have looked at that as a service condition, others as a performance condition.
• 24:20
  SPEAKER_01: And you can actually get to a different revenue recognition pattern depending on whether you thought it was a service condition or performance condition.
• 24:28
  SPEAKER_01: Uh, FASBI decided maybe it would be better to try to reduce some of that diversity and get everybody kind of on the same page.
• 24:36
  SPEAKER_01: And that was the primary reason for this project and this ASU.
• 24:41
  SPEAKER_01: What they did is uh basically update the definition of what a performance condition is in the context of these equity issuances to customers.
• 24:53
  SPEAKER_01: So they expanded that to make it more clear what types of vesting conditions represent performance conditions.
• 25:00
  SPEAKER_01: I would say the punchline after all of it is almost all of these vesting conditions that we see if we're dealing with equity issued to a customer, almost all of them are likely to be considered performance conditions under the new ASU.
• 25:14
  SPEAKER_01: And so everybody will now be treating them basically in the same way.
• 25:17
  SPEAKER_03: Aaron Powell Which kind of makes sense because it was always awkward to think about like you're not really receiving services from a customer.
• 25:25
  SPEAKER_03: And so you know, it just made more sense for them to clarify the definition of a performance condition so that it would apply a little more broadly.
• 25:33
  SPEAKER_01: Aaron Powell Right.
• 25:33
  SPEAKER_01: I mean the 718 rules are generally based on issuing equity to your own employees to get services from them.
• 25:39
  SPEAKER_01: And so service condition is a very common thing in the vanilla situation.
• 25:44
  SPEAKER_01: Uh to Angela's point, when you're dealing with giving something to your customer, you're not receiving a service from them.
• 25:50
  SPEAKER_01: So it really is kind of hard to visualize what a service condition would be.
• 25:52
  SPEAKER_02: Aaron Powell Yeah.
• 25:53
  SPEAKER_02: So then when they were discussing this leading up to issuance, was there a lot of debate?
• 25:58
  SPEAKER_02: Or it seemed once they started looking at us fairly obvious, this is the direction.
• 26:02
  SPEAKER_01: Yeah, I think they pretty quickly came to the realization that kind of thinking of these things as performance conditions is generally the right way to think about it.
• 26:09
  SPEAKER_01: And then it was just how are we going to structure the ASU to get us to that point.
• 26:13
  SPEAKER_02: All right, that's helpful.
• 26:14
  SPEAKER_02: So anything else in that ASU since we're talking about it that we should be focused on here?
• 26:19
  SPEAKER_01: Yeah, I I'll I'll touch on a couple things.
• 26:21
  SPEAKER_01: I would say the by far the main element is what we just discussed, but I think Fazby figured since we're cracking open the rules anyway, may as well uh update or clarify a couple of additional things.
• 26:33
  SPEAKER_01: So one of those is if we ever do see a service condition in one of these customer arrangements in the future, uh, there will only be one acceptable way to deal with the variability, and that is there the company will have to assess whether it's probable that the award will be earned or not, or the shares will be earned or not.
• 26:54
  SPEAKER_01: Uh that's a little bit of a change from how 718 normally works because uh service condition awards under 718, there are two acceptable approaches for recognizing the effect of vesting conditions.
• 27:07
  SPEAKER_01: You can either estimate them along the way, is it probable that they'll vest or not, or just assume everything's probable and just wait until the end and then true it up at the very end for anything that forfeits.
• 27:19
  SPEAKER_01: They just got rid of that second approach if we're dealing with a customer and say you have to estimate everything, which basically gets you back to, regardless of whether you have a service condition or a performance condition, you're basically going to have the same pro approach because you're gonna be assessing probability regardless of whether it's a performance condition or a service condition.
• 27:38
  SPEAKER_01: They clarified the treatment prior to the grant date.
• 27:44
  SPEAKER_01: You know, we talked about the grant date is when we're gonna lock in the value of the shares.
• 27:48
  SPEAKER_01: In our case, that was the$10 per share.
• 27:50
  SPEAKER_01: Sometimes the revenue contract might start before we've achieved the grant date.
• 27:56
  SPEAKER_01: The shares have to be marked to market up until we get to the grant date.
• 27:59
  SPEAKER_01: And so there was a clarification that the measurement approach and valuation approach for those marked to market adjustments will be under 718, just like all the other measurement considerations.
• 28:11
  SPEAKER_01: There was a clarification.
• 28:13
  SPEAKER_01: This is what Angela was mentioning earlier, that since this is variable consideration, 606 does not apply at all when we're thinking about the impact of this variable consideration, the constraint associated with variable consideration in 606 doesn't apply.
• 28:26
  SPEAKER_01: We're only going to be looking to 718 for the variability.
• 28:29
  SPEAKER_01: Oh, sorry to cut in.
• 28:30
  SPEAKER_02: That's the point then that Angela was making, that there are these two different models.
• 28:33
  SPEAKER_02: So you need to make sure which model you're in.
• 28:36
  SPEAKER_02: And they were just clarifying that absolutely, even though this yeah, you're getting different answers, but follow the 718.
• 28:42
  SPEAKER_01: Yeah, they just wanted to make it crystal clear that the constraint doesn't apply and we're not applying the variable.
• 28:46
  SPEAKER_02: I'm sure this is helpful in practice to know that that's yeah, there's there there could be confusion.
• 28:51
  SPEAKER_01: And do we have to apply the constraint as well as the 718 rules, or is it only one or the other?
• 28:56
  SPEAKER_01: And so that's what they were clarifying.
• 28:58
  SPEAKER_01: Um there were a couple disclosure requirements as you would expect with any new ASU.
• 29:03
  SPEAKER_01: Of course, they had some transition rules, and then the effective date for the ASU is 2027 for calendar year companies with early adoption permitted.
• 29:12
  SPEAKER_01: And then would our expectation be that we will see companies that this is applicable to early adopt or I mean this isn't terribly common in the first place because you have to have equity that you're issuing to your customer that have conditions that you've assessed as service conditions that you weren't assessing probability on.
• 29:34
  SPEAKER_01: We start getting into probably a pretty limited population.
• 29:38
  SPEAKER_01: Um, so if for for those who have been doing it that way, I wouldn't be surprised if they early adopt just because it's pretty clear what the you know, what everybody's going to be doing going forward.
• 29:48
  SPEAKER_02: All right, that's helpful.
• 29:49
  SPEAKER_02: Let's rewind though, because I think I started asking about the ASU and we never finished talking about the actual uh accounting.
• 29:56
  SPEAKER_02: So if we go all the way back, you were talking about classification considerations, and I think we focused on classification as equity.
• 30:05
  SPEAKER_02: What would happen then if we concluded that the award is actually liability classified?
• 30:10
  SPEAKER_01: Right, right.
• 30:11
  SPEAKER_01: Because if it's equity, it's more straightforward because under 718, if something's equity classified, we just measure it on the grant date, and then we don't ever think about any changes in value after that.
• 30:22
  SPEAKER_01: So that's pretty straightforward.
• 30:23
  SPEAKER_01: In our example, that's$10 on the grant date, and we're done.
• 30:26
  SPEAKER_01: If it's liability classified, then under 718, we have to mark to market that instrument all through its entire life until it's settled.
• 30:36
  SPEAKER_01: So uh for revenue recognition purposes, we're only gonna use that grant date value, the$10, uh, as the reduction in our transaction price, a reduction in revenue.
• 30:51
  SPEAKER_01: Any subsequent changes in the value of the liability because we have to market to market, those will not impact transaction price.
• 30:58
  SPEAKER_01: Those should not affect revenue.
• 31:00
  SPEAKER_01: So we still have to market to market, but any of the gains or losses associated with uh adjusting the liability will be elsewhere in the income statement, probably some other income or expense account, but definitely not part of revenue.
• 31:13
  SPEAKER_02: All right.
• 31:14
  SPEAKER_02: And then Angela, how about from a recognition standpoint then?
• 31:17
  SPEAKER_02: So now that we've determined how it's measured, how it's classified for these share awards, what then what would companies be thinking about from a revenue recognition timing perspective?
• 31:26
  SPEAKER_03: Right.
• 31:26
  SPEAKER_03: So this is where we have the handoff.
• 31:28
  SPEAKER_03: Yeah.
• 31:28
  SPEAKER_03: So 606.
• 31:30
  SPEAKER_03: Um, so at this point, once you've determined the grant date fair value, so let's say it's the$10,000, we've been using that number a lot.
• 31:39
  SPEAKER_03: Then you you treat that the same as if you were giving$10,000 of cash to the customer.
• 31:46
  SPEAKER_03: So everything I talked about before is going to apply where you think of it as if you paid cash to the customer.
• 31:55
  SPEAKER_03: So sometimes this is pretty intuitive.
• 31:58
  SPEAKER_03: You know, we had the example of the, you know, the 10, the$10,000 worth of shares being paid if the company, if the customer purchases a certain volume of widgets.
• 32:10
  SPEAKER_03: So it's the same concept as if you gave cash, you'd be offsetting the transaction price for each of those widgets that they buy.
• 32:18
  SPEAKER_03: Sometimes it's not quite as intuitive.
• 32:20
  SPEAKER_03: Um, for example, if you had a warrant you were issuing to a customer who had that had vesting provisions and say it it vested just based on time over a two-year period.
• 32:35
  SPEAKER_03: But the warrants were an incentive for the customer to purchase, say, equipment and then maintenance services.
• 32:43
  SPEAKER_03: I think sometimes the instinct is, well, there's a two-year vesting period, so I should recognize the value of the shares over two years.
• 32:52
  SPEAKER_03: But we're remember, we're not receiving services from the customer.
• 32:56
  SPEAKER_03: That's not what we're trying to reflect.
• 32:58
  SPEAKER_03: We're we're offsetting the transaction price for the goods and services we're transferring to the customer.
• 33:06
  SPEAKER_03: So you would take the value of those warrants, reduce the transaction price for the equipment and maintenance services.
• 33:14
  SPEAKER_03: And now that that reduced transaction price we're going to allocate to the equipment and the services like we would in any other revenue contract, and then recognize the revenue as we transfer the equipment and the services.
• 33:28
  SPEAKER_03: So I I mean the difference is it's not necessarily going to align with that two-year time-based vesting period that was in the terms of the warrant.
• 33:38
  SPEAKER_02: Yeah.
• 33:39
  SPEAKER_02: So I guess if I take a step back, it really is this handoff.
• 33:43
  SPEAKER_02: So once you've made these determinations that Ken talked about, you just apply 606.
• 33:49
  SPEAKER_02: You don't start to try to commingle the two models.
• 33:52
  SPEAKER_02: Exactly.
• 33:53
  SPEAKER_02: Yeah.
• 33:53
  SPEAKER_01: But I could see it being somewhat of a sleeper issue for companies because there would be a natural tendency if the stuff is earned over two years, then it's like, shouldn't I be recognizing whatever the effect of that is over that two-year period?
• 34:04
  SPEAKER_01: And Angela's telling us no, it's a little bit more than that.
• 34:07
  SPEAKER_02: Yeah.
• 34:08
  SPEAKER_02: And then Angela, we just talked, Ken was just talking about these liability classified awards where we're remeasuring the fair value each period.
• 34:16
  SPEAKER_02: How is there any specific interaction with that that we should be thinking about?
• 34:20
  SPEAKER_03: No, we we ignore that part for our revenue recognition.
• 34:24
  unknown: Okay.
• 34:25
  SPEAKER_03: Okay.
• 34:26
  SPEAKER_03: It's just that initial uh grant aid fair value that we're then now viewing similar to cash as a discount essentially on the revenue transaction.
• 34:36
  SPEAKER_03: I mean, the only kind of pass back would be if you're changing your estimate of the probability of the awards vesting, uh, right, which you would continue to do that under 718.
• 34:47
  SPEAKER_02: And then if you concluded, for example, originally that they it was probable and then later you could determine it wasn't, that then would interact with your 606.
• 34:56
  SPEAKER_02: Right.
• 34:57
  SPEAKER_03: You'd be doing a cumulative catch-up adjustment for that change in estimate.
• 35:00
  SPEAKER_02: All right.
• 35:00
  SPEAKER_02: So that's helpful.
• 35:02
  SPEAKER_02: And then just to complicate things a little bit more, we know that sometimes the terms could change partway into it.
• 35:09
  SPEAKER_02: And so, you know, so basically, particularly if this happens after the good has already been delivered and then there's some changes made to the share-based award.
• 35:19
  SPEAKER_02: How should companies think about that situation?
• 35:22
  SPEAKER_01: Yeah, so if we if we've got adjustments made related to the equity that we're issuing to the customer, then this is another one of these measurement considerations where we're looking to 718 for our guidance.
• 35:34
  SPEAKER_01: So that would be a modification to the share-based consideration.
• 35:38
  SPEAKER_01: Uh, I think Heather, you and I have done a previous podcast on modification accounting, and that was an entire podcast, so we won't go into the depths of modification accounting, but we would run it through that model.
• 35:49
  SPEAKER_01: I would say the general gist of that model is we're thinking about what was the value of the instrument immediately before we made the change, and then what's the value afterward?
• 36:00
  SPEAKER_01: And if the value of the new thing is more, then in this context, it's we have given additional consideration to our customer.
• 36:09
  SPEAKER_01: So we would measure all of that under 718, and then we would bring that additional consideration back into 606 to figure out what to do with it.
• 36:17
  SPEAKER_01: Maybe, as you said, if if uh all of the goods and services have already been uh uh provided, then that might be an immediate uh reduction to revenue.
• 36:28
  SPEAKER_01: If we're still uh in the midst of the revenue contract, then we would just say here's additional consideration uh as part of the overall transaction.
• 36:37
  SPEAKER_01: And then what would 606 tell us to do uh with respect to recognition?
• 36:42
  SPEAKER_02: All right.
• 36:42
  SPEAKER_02: So definitely a lot of pieces to think about, but I'm sure there's others we haven't talked about here.
• 36:46
  SPEAKER_02: So, Angela, any other ones that you would highlight that companies should keep in mind?
• 36:51
  SPEAKER_03: Well, since we're talking about payments to customers, um, one topic that seems to be coming up uh more lately is payments to customers as part of settling litigation claims or other disputes.
• 37:05
  SPEAKER_03: And this can happen, for example, if there's some sort of dispute over pricing in a contract or the performance of the vendor in the contract, and then the company ends up making a payment to the customer.
• 37:20
  SPEAKER_03: I guess the important thing to remember is that even though we're in the context of maybe some litigation or a dispute, you would still look at that through the payments to customers guidance.
• 37:32
  SPEAKER_03: So oftentimes that is going to end up being a reduction of revenue.
• 37:37
  SPEAKER_03: It's essentially giving a refund or a partial refund back to the customer because something went wrong, right?
• 37:45
  SPEAKER_03: Um you typically are not receiving a distinct good or service from the customer in that situation.
• 37:52
  SPEAKER_03: So this is maybe not intuitive.
• 37:54
  SPEAKER_03: Companies may think because it relates to litigation, it should be an expense.
• 37:58
  SPEAKER_03: And there are potentially some limited circumstances where that may be appropriate, especially if the claims relate to something sort of beyond just performance under the contract, but really something something else is going on.
• 38:13
  SPEAKER_03: But something to be aware of that you can't forget that this is still a payment to a customer at the end of the day.
• 38:20
  SPEAKER_02: All right.
• 38:20
  SPEAKER_02: So a lot to think about here.
• 38:22
  SPEAKER_02: And I think from a I will say, as someone who's not an expert in these topics, is these are two relatively complex models, and then you know, obviously some interaction between them.
• 38:32
  SPEAKER_02: So just as you're working with teams and clients that have these types of questions, any particular advice that you would give, maybe Angela, I can start with you.
• 38:43
  SPEAKER_03: Well, again, I I think it comes back to making sure you've really thought through and you understand the reasons for making the payment to the customer because that's going to ultimately drive the accounting.
• 38:55
  SPEAKER_03: And yeah, so you need to understand the motivations.
• 38:58
  SPEAKER_03: What does it relate to?
• 38:59
  SPEAKER_03: What are you trying to achieve in order to get the accounting right?
• 39:03
  SPEAKER_02: Yeah, I think that's almost always good advice when you're dealing with accounting.
• 39:07
  SPEAKER_02: How about kind of from your perspective?
• 39:09
  SPEAKER_01: Yeah, maybe if I put myself in the shoes of uh at folks at companies who are dealing with the accounting, sometimes there are different people who are kind of the more of the experts on revenue accounting, and then there are others who are the experts on some of the compensation accounting.
• 39:20
  SPEAKER_01: And so the, you know, the folks who are dealing with this are primarily going to be the revenue folks, because you're part of revenue contracts, making sure that you're kind of communicating with the right stock compensation experts, because it is very different models that you're dealing with under 718, make sure we've got the good communication.
• 39:37
  SPEAKER_02: Yeah, and actually it's funny you give that advice, Ken, because while the two of you were talking, I was thinking about the fact I didn't realize the two of you worked together so much on this type of thing.
• 39:46
  SPEAKER_02: So I think it is definitely good advice there.
• 39:48
  SPEAKER_02: And then um maybe a final question.
• 39:50
  SPEAKER_02: I'm sure for our listeners that have these issues, they'd love to go read some more about this.
• 39:55
  SPEAKER_02: So where would you recommend they go for more advice?
• 39:58
  SPEAKER_03: Well, you have to hit a couple spots.
• 40:00
  SPEAKER_03: So we got chapter four of our revenue recognition guide, uh, where we talk about payments to customers, and then you pop on over to chapter seven of the stock compensation guide where we talk about um equity payments to customers.
• 40:16
  SPEAKER_03: Um and I we also issued a publication on the new ASU.
• 40:22
  SPEAKER_01: Yeah, there was a we we put a brief publication out just describing that new ASU that I was mentioning.
• 40:26
  SPEAKER_02: All right, so definitely some good resources out there.
• 40:29
  SPEAKER_02: And as always, such a pleasure to talk to two of you.
• 40:32
  SPEAKER_02: You did a uh, I think it's a great issue to talk about and to highlight.
• 40:36
  SPEAKER_02: So really appreciate that.
• 40:37
  SPEAKER_02: So thanks so much for joining me today.
• 40:40
  SPEAKER_02: That's our show for today.
• 40:43
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• 40:48
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• 40:53
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• 41:03
  SPEAKER_02: From Thought Leadership at PwC, I'm Heather Horn.
• 41:07
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• 41:14
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