FASB Issues Accounting Standards Update 2016-08—Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)

In March 2016 the FASB issued Accounting Standard Update 2016-08 to address issues related to guidance on principal versus agent arising from the discussion of Transition Resource Group meetings. While the amendments in this Update do not change the core principle of the guidance (i.e. the 5 step revenue recognition model), the amendments clarify the implementation guidance on principal versus agent considerations.

When another party is involved in providing goods or services to a customer, an entity should evaluate whether the nature of its promise is to provide the specified good or service itself (that is, the entity is a principal) or to arrange for that good or service to be provided by the other party (that is, the entity is an agent). When an entity is a principal, the entity recognizes revenue in the gross amount of consideration to which it is entitled in exchange for the specified good or service.Conversely as an agent, the entity recognizes revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging for the specified good or service to be provided by the other party.

The amendments in this Update are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations by clarifying the following:

  1. An entity determines whether it is a principal or an agent for each specified good or service promised to the customer. A specified good or service is a distinct good or service (or a distinct bundle of goods or services) to be provided to the customer. If a contract with a customer includes more than one specified good or service, an entity could be a principal for some specified goods or services and an agent for others.
  1. An entity determines the nature of each specified good or service (for example, whether it is a good, a service, or a right to a good or service).
  1. When another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of (a) a good or another asset from the other party that it then transfers to the customer;(b) a right to a service that will be performed by another party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf; or (c) a good or service from the other party that it combines with other goods or services to provide the specified good or service to the customer.
  1. The purpose of the indicators in paragraph 606-10-55-39 is to support or assist in the assessment of control. The amendments in paragraph 606-10-55-39 A clarify that the indicators may be more or less relevant to the control assessment and that one or more indicators may be more or less persuasive to the control assessment, depending on the facts and circumstances.

The amendments in this Update affect the guidance in Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606), which effective from fiscal years, and interim periods within those fiscal years, commencing on or after 1 January 2018. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements of Update 2014-09.

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FASB Issues Accounting Standards Update 2016-07—Investments—Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting

The amendments in this Update eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by step basis as if the equity method had been in effect during all previous periods that the investment had been held.

The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required.The amendments in this Update require that an entity that has an available-for sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method.

The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.

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FASB Issues Accounting Standards Update 2016-06—Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments (a consensus of the Emerging Issues Task Force)

Topic 815, Derivatives and Hedging, requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met. One of those criteria is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract (the “clearly and closely related” criterion).

Generally accepted accounting principles (GAAP) provide specific guidance for assessing whether call (put) options that can accelerate the repayment of principal on a debt instrument meet the clearly and closely related criterion. The guidance states that for contingent call (put) options to be considered clearly and closely related, they can be indexed only to interest rates or credit risk. However, that guidance raised interpretative questions that the Derivatives Implementation Group (DIG) tried to clarify through implementation guidance in a four-step decision sequence applicable to all call (put) options. The four-step decision sequence requires an entity to consider whether (1) the payoff is adjusted based on changes in an index, (2) the payoff is indexed to an underlying other than interest rates or credit risk, (3) the debt involves a substantial premium or discount,and (4) the call (put) option is contingently exercisable.

Questions emerged about how the four-step decision sequence interacts with the original guidance for assessing embedded contingent call (put) options in debt instruments. Two divergent approaches developed in practice. Under the first approach, the assessment of whether contingent call (put) options are clearly and closely related to the debt host only requires an analysis of the four-step decision sequence. Under the second approach, an assessment of whether the event that triggers the ability to exercise the call (put) option is indexed only to interest rates or credit risk is required in addition to the four-step decision sequence. Those two approaches, which resulted from different interpretations of the intent of the four step decision sequence, may result in different conclusions about whether the embedded call (put) option is clearly and closely related to its debt host, and, thus,may result in different conclusions about which call (put) options should be bifurcated and accounted for separately as derivatives.

The amendments in this Update are intended to resolve the diversity in practice resulting from those two approaches and clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence.

For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016,and interim periods within those fiscal years.

For entities other than public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15,2018.

An entity should apply the amendments in this Update on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. If an entity had bifurcated an embedded derivative but is no longer required to do so as a result of applying the amendments, the aggregate of the carrying amount of the debt host contract and the fair value of the previously bifurcated embedded derivative will become the carrying amount of the debt instrument at the date of adoption.

If an entity is no longer required to bifurcate an embedded derivative as a result of applying the amendments in this Update, the entity has a one-time option, as of the beginning of the fiscal year for which the amendments are effective, to irrevocably elect to measure that debt instrument in its entirety at fair value with changes in fair value recognized in earnings. For those instruments for which the entity elects fair value, the effects of initially complying with the amendments as of the effective date should be reported as a cumulative-effect adjustment directly to retained earnings as of the beginning of the fiscal year for which the amendments are effective. The entity should elect fair value on an instrument-by-instrument basis.

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