Disclosures in ASC 606

In their comments on the revenue recognition exposure draft, investors and other financial statement users indicated that revenue-related disclosures did not provide sufficient detail to perform worthwhile analysis. One of the goals of Accounting Standards Codification (ASC) 606 was to introduce disclosure requirements that improve the information communicated in financial statements (ASC 606-10-50-1).

Disclosures Under ASC 606

ASC 606 requires additional disclosures to better communicate the nature, amount, timing, and uncertainty of an entity’s revenue and cash flows (ASC 606-10-50-1). Filers are required to provide qualitative and quantitative information about the following:

Contracts with customers
Significant judgments, and changes in the judgments, made in applying ASC 606
Assets recognized from the costs to obtain or fulfill a contract

Contracts with Customers

An entity is required to disclose revenue recognized from contracts with customers as well as impairment losses on any contract assets arising from those contracts, unless these amounts are presented separately on its financial statements. ASC 606 also requires information about the following categories: (1) disaggregation of revenue, (2) contract balances, and (3) performance obligations.

Disaggregation of Revenue

An entity is required to disaggregate revenue from contracts with customers into categories that help financial statement users understand the nature, amount, timing, and uncertainty of the related cash flows. The Financial Accounting Standards Board (FASB) does not specify which characteristic(s) should be used when disaggregating revenues, but does provide the following examples:

Type of good or service
Geographic region
Market or type of customer
Type of contract
Contract duration
Timing of transfer of goods or services
Sales channels(ASC 606-10-55-91)

The FASB noted in the Basis for Conclusions (BC) that “the most useful disaggregation of revenue depends on various entity-specific or industry-specific factors,” and decided each entity must determine which characteristics best meet the goal of disaggregating revenues (BC336). Entities should consider how financial information is disaggregated when reporting to decision makers and evaluating segment performance as this information is likely useful to investors.

Entities that are neither public nor not-for-profit may choose not to disaggregate as granularly as outlined in the above guidance. These entities are still required to disaggregate revenues into categories based on timing, such as separating revenue from goods or services transferred at a point in time from those transferred over a period of time.

ASC 280 (Segment Reporting) and IFRS 8 (Operating Segments) already require disaggregation of revenue. An entity that disaggregates revenue in compliance with other guidance does not need to provide additional disaggregation as long as it accomplishes the ASC 606 disclosure objective (BC338-BC340). If an entity determines that a separate revenue disclosure is needed, it must reconcile the revenue amounts displayed in both disclosures so that financial statement users can understand the relationship between the revenue and segment reporting disclosures.

Contract Balances

The goal of contract balance disclosures is to help financial statement users understand the relationship between revenue recognized and changes in contract assets and liabilities related to those revenues. Entities must disclose the following about its contract balances:

The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed
Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period

Entities must explain how the timing of satisfying a performance obligation relates to the typical payment schedule, and the impact they both have on contract asset and contract liability balances (ASC 606-10-50-9). For example, if an entity typically collects payment before beginning work on a performance obligation, the disclosure would discuss the fact that unearned revenue accounts are typical business practice. This helps financial statement users understand that cash inflows typically occur before the entity earns the revenue. Filers must also quantitatively and qualitatively explain any significant changes in contract asset and contract liability balances. The guidance provides the following examples of changes that would require disclosure:

Changes due to business combinations
Cumulative catch-up adjustments to revenue that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price (including any changes in the assessment of whether an estimate of variable consideration is constrained), or a contract modification
Impairment of a contract asset
A change in the time frame for a right to consideration to become unconditional (i.e., for a contract asset to be reclassified to a receivable)
A change in the time frame for a performance obligation to be satisfied (i.e., for the recognition of revenue arising from a contract liability)(ASC 606-10-50-10)

Non-public entities are only required to disclose the beginning and ending balances of receivables and other contract-related assets and liabilities. (ASC 606-10-50-11).

Performance Obligations

An entity must describe the following about its performance obligations in contracts with customers:

The timing of when performance obligations are usually satisfied (e.g., upon shipment, upon delivery, as services are rendered, etc.)
Significant payment terms (i.e., whether the contract has a significant financing component, if consideration is variable, and whether the estimate of variable consideration is constrained)
The nature of the promised goods or services and whether the entity is acting as an agent
Obligations for returns, refunds, and other similar obligations
Types of warranties and related obligations(ASC 606-10-50-12)

In addition, the entity must disclose the amount of the transaction price allocated to performance obligations that have not been fully satisfied as of the reporting date. This disclosure must contain either a qualitative or quantitative explanation of when the entity expects to receive the related revenues (ASC 606-10-50-13). As a practical expedient, no performance obligation disclosure is required if either (1) the performance obligation is part of a contract expected to be fulfilled in less than a year, or (2) the amount of unrecognized revenue is equal to the value of the unsatisfied portion of the performance obligation.

Equinix, Inc

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Equinix, Inc (Equinix) is a multinational real estate investment company. In an August 2020 letter, the Securities and Exchange Commission (SEC) asked Equinix to explain the timing of revenue recognition of Equinix’s remaining performance obligation and the rationale for the disclosures related to this issue. Equinix responded with the following explanation and additional disclosure:

“Equinix respectfully advises the Staff that most of our revenue contracts have an initial term varying from one to three years, and thereafter, automatically renew in one-year increments. Included in the $8.4 billion are remaining performance obligations which are either under the initial contract terms or under one-year renewal periods. Of the $8.4 billion, approximately 70% is expected to be recognized in the first two years, with the remaining 30% generally expected to be recognized as revenue over the next three to five years. Furthermore, of the 70% to be recognized in the first two years, more revenues are expected to be recognized in the first year because a portion of these amounts relate to contracts that are under one-year renewal periods or are in the final year of the initial contract term.

Additionally, for a portion of our remaining performance obligations, the timing of recognition in the first two years is subject to a certain level of uncertainty due to several factors, including: (a) possible delays in site readiness, (b) the timing of completing large customers’ deployments, and (c) contractual early terminations. Furthermore, subsequent contract modifications (e.g. customers’ deployment expansions) can also change the timing and the amount of revenue to be recognized in the future, causing fluctuations in what is disclosed from period to period. Given the uncertainties and potential fluctuations, we believe our disclosed time bands (i.e. the next two years and thereafter) represent how revenues associated with our remaining obligation will ultimately be recognized and thus provide meaningful information to the users of our financial statements. When coupled with the additional qualitative disclosures proposed below, we believe this presentation complies with the guidance in ASC 606-10-50-13(b).

In response to the Staff’s comment, Equinix will revise its disclosure in future quarterly and annual reports to include the following disclosure:

‘Most of our revenue contracts have an initial term varying from one to three years, and thereafter, automatically renew in one-year increments. Included in the remaining performance obligations are contracts that are either under the initial term or under one-year renewal periods. We expect to recognize approximately 70% of our remaining performance obligations as revenues over the next two years, with more revenues expected to be recognized in the first year due to the impact of contracts under a one-year renewal period. The remainder of the balance is generally expected to be recognized over the next three to five years. We estimate our remaining performance obligations at a point in time. Actual amounts and timing of revenue recognition may differ from these estimates due to changes in actual deployments dates, contract modifications, renewals and/or terminations.’”

Significant Judgments

To help investors better understand an entity’s revenues, filers are required to disclose any significant judgments and changes in those judgments that are used in determining (1) the timing of the performance obligations being satisfied, and (2) the transaction price and amounts allocated to performance obligations (ASC 606-10-50-17).

Timing of the Performance Obligations Being Satisfied.

For performance obligations satisfied at a specific point in time, an entity must provide the significant judgments in determining when a customer obtains control of the goods or services. For performance obligations satisfied over time, an entity must explain the method used to recognize revenue (e.g., input or output method), and why that method best describes the transfer of the promised goods or services.

Transaction Price and Amounts Allocated to Performance Obligations.

An entity must explain all methods, inputs, and assumptions used to do the following:

Determine the transaction price
Assess if variable consideration is constrained
Allocate the transaction price
Measure returns, refunds, and similar obligations

Non-public entities may elect to exclude certain disclosures, as defined in ASC 606-10-50-21. If any practical expedients are used, a company must disclose that it is applying those practical expedients.

Assets Recognized from Costs to Obtain or Fulfill a Contract

Revenue recognition is subject to disclosure guidance in Topic 340 (Other Assets and Deferred Costs), because the FASB believes that Topic 340 helps accomplish the disclosure goals of ASC 606. Public entities must include the following disclosures:

The judgments made in determining the amount of the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph 340-40-25-1 or 340-40-25-5)
The method it uses to determine the amortization for each reporting period
The closing balances of assets recognized from the costs incurred to obtain or fulfill a contract with a customer (in accordance with paragraph 340-40-25-1 or 340-40-25-5) by main category of asset (e.g., costs to obtain contracts with customers, pre-contract costs, and setup costs)
The amount of amortization and any impairment losses recognized in the reporting period(ASC 340-40-50-2 & 50-3)

Interim Reporting

Filers must provide the disaggregated revenue information described above in interim reports (e.g. quarterly and semiannual). ASC 606 requires the disclosure of the following, if material:

Opening and closing balances of contract assets and liabilities, if they are not separately presented on the financial statements
The amount of revenue recognized in the current period that was included in the opening contract liability balance
The amount of revenue recognized in the current period from performance obligations that were satisfied (or partially satisfied) in previous periods
Information about the entity’s remaining performance obligations (described above)(KPMG Issues In-Depth Revenue from Contracts with Customers – Section 12.2)

Conclusion

The goal of ASC 606 is to provide information that better meets the needs of financial statement users. Public entities are required to disclose the following:

Contracts with customers—including disaggregation of revenue, contract balances, and outstanding performance obligations
Significant judgments, and changes in the judgements, made in applying ASC 606
Assets recognized from the costs to obtain or fulfill a contract

These requirements apply to both interim and year-end financial reports. Because the requirements are extensive, entities need to evaluate their current operating environment and update as necessary.

Resources Consulted

ASC 340-40-50-2 to 50-3
ASU 2014-09: "Revenue from Contracts with Customers." BC336, BC338-BC340.
EY, Financial Reporting Developments: "Revenue from contracts with customers." September 2021. Section 10.
KPMG, Handbook: "Revenue Recognition." December 2021. Section 15.