If you think the Financial Accounting Standards Board’s (FASB) new revenue recognition standard is only applicable to those in the wine and cheese crowd, think again. The standard impacts companies of all sizes, from specialty shops to corporate lenders. You don’t need to be in an industry with specialized revenue to turn your attention to the new standard. At the Center for Plain English Accounting, we’ve been receiving questions from practitioners on their client’s behalf for some time now. We picked out a couple and provided answers to help you understand the new standard (ASC 606).
How to identify performance obligations under the new standard.
Question: My client runs a direct sales gourmet cheese business. Individuals who join the Cheese Club pay a monthly membership subscription fee of $49.95 and receive $49.95 each month in “Mozzarella Moola” to spend whenever they please. Members of the Cheese Club also receive 25% off all purchases and receive exclusive early access to purchase new products. In this scenario, what are the performance obligations?
Analysis: It looks like the company has at least two performance obligations — the $49.95 worth of store credit and the 25% off future purchases, which looks like it may be a material right. Your client will have to allocate the total consideration transferred ($49.95) between them, and recognize revenue for each as performance is completed, which may differ. Calling it a monthly subscription is a little misleading, as it functions more as a gift card for $49.95 that the subscriber can use for future purchases. Since this performance obligation is essentially a gift card, revenue should be recognized when the “Mozzarella Moola” is redeemed and your client supplies the associated goods to the customer.
When the customer purchases the membership, your client should record a contract liability for its performance obligation related to the gift card— that they have an obligation to transfer goods for the gift card amount. In the event that customers do not use all of their gift cards and they expire (referred to as “breakage”), ASC 606-10-55-46 through 49 explains that there are situations where the expired amount can be recognized prior to the vendor being legally released from its obligation.
Moving to the 25% discount, assuming that it meets the definition of a material right, the revenue allocated to that performance obligation would be recognized when it is used or when the option to use the 25% discount expires. Identification and the accounting for material rights can be somewhat tricky, so we wrote a report that provides some examples and practical advice. This report is usually available exclusively to Center for Plain English Accounting members, but we have unlocked it temporarily so that anyone can access it.
How to determine if breakage is applicable when it comes to gift cards.
Question: One of my clients operates, On the Vine, a chain of wine stores. They charge fees on their gift cards after a certain period of time, where permissible under state law. If the retailer is charging fees and the gift cards are essentially depleted after a certain amount of time, does that mean that my client would not have to worry about calculating breakage?
Analysis: If the fees are enforceable, the entity is relieved from satisfaction of the performance obligation in the amount of the enforceable fee (breakage would not be relevant). If the fee is enforceable and there is no past practice of forgiving the fee, that would take precedent. If the entity has previously forgiven the fee, it would be an implied price concession — a variable consideration. Also, the entity should consider unclaimed property laws that may apply.
Is there an alternative to implementing the new revenue recognition standard? For some of America’s small businesses, the answer is yes. Check out the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs™), an accounting framework that delivers financial statements that provide useful, relevant information in a simplified, consistent, cost-effective way. The FRF for SMEs™ framework may be used when GAAP financial statements are not required.
Practitioners need answers to their difficult A&A questions. The Center for Plain English Accounting is here to help. Make sure your firm has access to top-notch A&A advice by joining the Center for Plain English Accounting.