Common ASC 606 Issues: Telecom Entities

After years of debate, revision, and refinement, Accounting Standards Codification (ASC) 606 is finally coming into effect. The Financial Accounting Standards Board (FASB) released its initial major Accounting Standards Update (ASU) about revenue recognition in May of 2014—ASU 2014-09—and has since received thousands of comments and issued several subsequent ASUs on the topic. This major overhaul of the revenue recognition framework—formerly ASC 605—takes effect for fiscal years beginning after December 15, 2017 for all public entities, certain not-for-profits, and certain employee benefit plans.

Within the telecommunications industry, the common structure of contractual arrangements creates complexities with revenue recognition. Factors such as variable consideration (e.g., rebates and usage-based fees), renewal options, and the bundling of goods and services should be analyzed for potential impact on the timing and extent of revenue to be recognized. The AICPA and the major accounting firms have assembled industry task forces to research the industry-specific accounting issues within ASC 606, and we will draw from the guides they have published to give you an idea of some of the issues you should expect. For more information on any of these issues, see:

• AICPA: Revenue Recognition: Audit and Accounting Guide
• EY: Technical line: How the new revenue standard affects telecommunications entities 
• KPMG: Issues In-Depth: Revenue for Telecoms 

We will also provide references to other RevenueHub articles for more detailed explanations of related ASC 606 topics. For general information on the basics of revenue recognition, see our RevenueHub article, The Five-Step Method.

The following are issues that companies in the telecommunications industry commonly face:

1. Determining whether a contract exists

The first step in the new revenue recognition standard is determining whether an enforceable contract exists. Per ASC 606-10-25-1, a contract exists if the following four criteria are met:

1. the contract has been approved and committed to by all involved parties
2. the rights to the goods and services, along with the payment terms, can be identified
3. the collectability of the consideration is probable
4. the contract has commercial substance

According to the KPMG industry guidance, the collectability threshold is usually met at contract inception. So, the complexities tend to be related to determining the duration of the contract, which in turn determines the transaction price and its subsequent allocation to the performance obligations. A contract’s duration is determined by the period through which enforceable rights and obligations exist between all parties. The stated duration may not match the duration used in the application of the revenue recognition model if the entirety of the stated duration is not enforceable. The amounts associated with only enforceable rights and obligations are those that are included in the contract’s transaction price. A contract duration may be difficult to determine because telecom consumer contracts may have an implied but not stated term, or a stated but not enforceable term. When multiple contracts are entered into simultaneously with the same customer, the contracts may qualify to be combined and treated as a single contract.

Related RevenueHub Articles:

• Step 1: Identify the Contract
• Definition of a Customer
• Combining Contracts 
• Collectability of Consideration

2. Accounting for contract costs (costs of obtaining a contract)

Under ASC 606, companies will be required to capitalize and amortize incremental costs the entity incurred to obtain (e.g., sales commissions) and fulfill a contract. The costs of obtaining a contract are recognized as an asset if the entity expects to recover them. The standard allows a practical expedient for entities to immediately expense the costs if these costs would have been fully amortized in one year or less. The entity should only capitalize and amortize the costs to fulfill a contract if (1) the costs relate directly to a specific contract, (2) the costs generate or enhance resources that will be used to satisfy performance obligations in the future, and (3) the costs are expected to be recovered. The costs capitalized by the entity should be amortized as the entity transfers the goods or services designated in the contract to the customer.

Related RevenueHub Articles:

• Incremental Costs of Obtaining a Contract

3. Accounting for contract modifications

Due to both the variety of service contracts available and the option for the customer to change contractual elements during the contract term, contract modifications are a common feature of the telecom industry. For example, a wireless customer may choose to add a line to a shared plan. Contract modifications result in a change in or creation of enforceable rights and obligations for the parties in the contract. The approval of the contract modification must comply with the criteria set forth in the contract modification guidance found in Step 1: Identify the Contract with a Customer. If the parties approved a change in scope, but have not yet changed the associated price, the entity should estimate the impact on the transaction price using the guidance on variable consideration and constraining the transaction price.

Related RevenueHub Articles:

• Contract Modifications Part I—Separate Contracts
• Contract Modifications Part II—Contract Modification Treatment
• Contract Modifications Part III—The Hindsight Expedient
• Variable Consideration and the Constraint

4. Considering the effect of the time value of money

The effect of the time value of money should be considered especially in the evaluation of any significant financing components, in the cost-benefit analysis of accounting for contracts using the portfolio approach, and in comparing the repurchase price with the selling price on a put or call option.

Related RevenueHub Articles:

• Significant Financing Component

5. Accounting for individual contracts with customers versus portfolio accounting

Portfolio accounting under ASC 606 is a practical expedient for use with similar contracts involving similar classes of customers. The broad nature of wireless contract types, and frequency of significant promotions and contract modifications, should be considered in the decision to use portfolio accounting. An entity may apply the approach at either the contract level or the individual performance obligation level. The choice rests on which level creates the most homogenous groups while having an immaterial difference from accounting for contracts individually. Further, an entity may choose to use the portfolio approach for only certain types of contracts, or even with certain elements within individual contracts (i.e., partial portfolio approach).

A reason an entity may elect to use the partial portfolio approach is that due to the myriad upgrade options and modifications available to customers, the variable consideration element can have a large impact on revenue recognition. If an entity meets the qualifications to use the portfolio approach, that entity can then group, and subsequently apply the same accounting treatment on, all contracts that have a similar variable consideration element.

The company must analyze the individual facts and circumstances of each potential group of contracts to determine both (1) the similarities between contracts or contract elements, and (2) the likelihood that the choice between the individual contract and the portfolio approach may have a material impact on the financial statements. The portfolio approach also may be difficult to maintain in the long run if frequent contract modifications lead to a substantially different transaction price allocation even amongst similar contracts.

Related RevenueHub Articles:

• Contract vs. Portfolio Method

6. Identification of separate performance obligations in the contract

Identifying the distinct performance obligations with a contract may impact the timing and amount of revenue to be recognized. Within the telecommunications industry, where services are commonly bundled with products, it is especially important for the entity to evaluate whether each obligation is a promised good or service, or simply an activity that does not transfer goods or services to a customer. For example, the entity may incur up-front costs relating to the improvement or expansion of its current network to set up, install, or hook up a customer’s services. According to KPMG industry guidance, the accumulation of costs related to improvement or expansion of a telecom entity’s network is not a transferred good or service.

Under the new revenue recognition standard, a good or service is distinct if it is both (1) capable of being distinct, and (2) distinct within the context of the contract. The first criterion is met if the customer can benefit from the good or service on its own or with readily available resources. The second criterion is satisfied if the benefit the customer can derive from the good or service is not dependent on or interrelated with the other goods and services within the contract. If a promised good or service is not distinct within the contract, the entity should combine it with the other goods or services in the contract until a distinct performance obligation is formed.

Related RevenueHub Articles:

• Identifying Promised Goods & Services
• Distinct Within the Context of the Contract
• Distinct Goods or Services: Case Studies

7. Considering month-to-month contracts entered into with installment sales plus material rights

This issue relates to the determination of the contract term of a telecom month-to-month service contract when the customer also purchases equipment under an installment plan. The AICPA has not yet published a finalized statement, but the Big 4 guides offer brief discussions on the focal points of the issue at hand. According to EY, a longer-term contract is to be considered a month-to-month contract if the parties do not have enforceable rights and obligations throughout the entirety of the stated contract term. Enforceable rights and obligations may not exist at a specific point in the contract’s life if there are no longer contractual penalties (common for month-to-month telecom contracts) or if there are non-substantive penalties for termination. The industry’s wealth of historical customer data, which can be used to predict how long a customer will stay contracted, cannot substitute for the absence of enforceable rights and obligations.

8. Step 3: Determine the transaction price

The transaction price, or the amount the entity reasonably expects to collect from the customer in exchange for delivered goods and services, is determined at contract onset. When determining the transaction price of a contract, an entity must consider the existence and effect of any variable consideration, significant financing component, noncash consideration, and consideration payable to a customer. Amounts collected on behalf of third parties, like some telecom regulatory fees, are not included in the transaction price, whereas non-refundable, up-front fees typically are included. Due to the modifiable, and often easily cancellable, nature of most telecom contracts, an entity should consider its business practices regarding variable consideration (e.g., rebates and other incentives) as well as the enforceable rights and obligations in each contract. For example, most wireless contracts deliver a handset to the customer at the start of the contract, but that handset is financed over the course of the wireless contract. An entity should evaluate this arrangement as a significant financing component.

Related RevenueHub Articles:

• Consideration Payable to a Customer
• Magnitude of the Constraint on Revenue
• Noncash Consideration
• Nonrefundable Upfront Fees
• Price Concessions
• Significant Financing Component
• Variable Consideration and the Constraint

9. Step 4: Allocating the transaction price

In this step of the revenue recognition model, the transaction price is allocated to the identified performance obligations based on the relative standalone selling prices of each good or service. The variety of customer contracts with assorted bundles of goods and services available increases the likelihood that there will be variable consideration.

The three general methods for determining the standalone selling price of each good or service are as follows: (1) adjusted market assessment approach, (2) expected cost plus a margin approach, and (3) residual approach. The respective criteria and application of each of the three methods is discussed in detail in the RevenueHub articles, Case Study: Estimating Standalone Selling Prices and Standalone Selling Prices.

Related RevenueHub Articles:

• Allocating Variable Consideration
• Case Study: Transaction Price Allocation
• Allocating Discounts

10. Miscellaneous revenue

This issue arises when determining whether arrangements that produce miscellaneous receipts meet the criteria of a contract under ASC 606, and if those receipts are to be treated as recognizable revenue. As of the publication date of this article, the AICPA and the Big 4 have not issued finalized discussions on this matter.

11. Indirect channel sales (principal/agent considerations)

The AICPA Telecommunications Entities Revenue Recognition Task Force notes that this issue will address how indirect sales channels should be accounted for, including principal vs. agent considerations, under the new revenue recognition standard. As of the publication date of this article, the AICPA has not issued a finalized discussion on this matter. KPMG’s industry guidance notes that within the telecom industry, it is common practice to sell goods and services through third-party, independent resellers. The entity should consider the facts and circumstances of both the individual contract and their standard business practices in determining whether the arrangement should be accounted for as a consignment sale and whether the reseller is a principal or an agent. The principal vs. agent determination is also a factor in determining which costs are to be counted in the transaction price.

In a working draft of this implementation issue, the AICPA notes that the key determinant in whether the indirect dealer is the principal or the agent in the contract is the transfer of control over the promised goods or services. According to this release, generally, the telecom entity will be considered the principal in the sale of wireless services. The dealer serves in an agent capacity by simply arranging for the entity to provide the services to the end customer. In the sale of wireless devices, if it is determined that the indirect dealer is the principal, then the sale of the device from the telecom entity to the dealer, and the sale from the dealer to the end customer, are treated as two separate transactions. As such, the telecom entity recognizes revenue on a gross basis when control of the device is transferred to the dealer.

Including a financing arrangement with the end customer is also a common element in wireless contracts. However, the AICPA’s Financial Reporting Executive Committee (FinREC) notes that typically, if it was previously determined that the dealer is the principal due to the transfer of control over the promised goods or services, the presence of an installment purchase plan with the end customer does not affect the previous equipment transfer transaction between the telecom entity and the dealer. Rather, the installment plan relates to the sale of the wireless service contract. Similarly, the standard leasing arrangements in which the telecom entity sells the equipment to the dealer and agrees to repurchase the device in order to facilitate a lease to the end customer would not be considered a repurchase agreement accounted for as a right to return per ASC 606-10-55-66 to 78, so long as the following conditions are met:

1. The dealer obtains control of the equipment prior to the consummation of the lease agreement (i.e., the agreement does not change the dealer’s ability to direct use of the equipment)
2. The telecommunication company may not call the equipment and any repurchase would be predicated on the end-consumer’s choice and the telecommunication company's agreement to do so
3. The telecommunication company is not bound solely as a result of their sale of the equipment to the dealer to repurchase the equipment or to provide the lease arrangement to the end-consumer
4. The dealer does not have unilateral ability to return or put the device back to the telecommunication company, including situations where the end-consumer fails to enter into a lease
5. The dealer is a substantive and independent entity that has other transactions with customers
6. The telecommunication company does not restrict the dealer to only offering leases to the customer; the customer may choose from alternatives offered by parties that are independent of the telecommunication entity

Regarding commissions paid for distinct sales services to dealers acting as agents, the fair value of those costs should be considered costs of obtaining a customer.

Related RevenueHub Articles:

• Principal/Agent Considerations (Gross vs Net)

Conclusion

It is likely that many other issues and questions will arise within the telecommunications industry as entities transition to the new revenue recognition standard—ASC 606. This article serves as a base reference point for your research into some of the focal issues anticipated by industry experts. Similar industry-specific issues discussions and resources are available on the RevenueHub site for major industries identified by the AICPA. Click on the following link for a list of these articles: Industry-Specific Issues.