The implementation issue stems from the efforts of the Brokers and Dealers in Securities Revenue Recognition Task Force, one of 16 industry task forces the AICPA established to study industry implementation issues related to Accounting Standards Update (ASU) No. 2014-09, “Revenue From Contracts With Customers (Topic 606),” issued in May 2014 by the Financial Accounting Standards Board (FASB). According to the AICPA, the task forces are “charged with developing revenue recognition implementation issues that will provide helpful hints and illustrative examples for how to apply the new revenue recognition standard” in their respective industries.
Final revenue recognition implementation issues are included in a new revenue recognition guide that the AICPA has developed and continues to update as new implementation issues are finalized. Prior to publishing implementation issues, the AICPA submits the issues to the FASB/International Accounting Standards Board Joint Transition Resource Group for Revenue Recognition to verify that the guide is consistent with how the board intends the standard to be interpreted.
Cost Guidance Included in ASU 2014-09
ASU 2014-09 adds Subtopic 340-40 to the Accounting Standards Codification. Topic 340 provides guidance on whether to defer incremental costs of obtaining and fulfilling a contract. For the costs of obtaining a contract, Topic 340 indicates that only recoverable incremental costs, which are costs that would not have been incurred if the contract had not been obtained, should be deferred and capitalized as an asset.
For costs incurred to fulfill a contract, each of the following three criteria provided in Topic 340 must be met for an entity to defer such costs as an asset:
- The costs relate directly to a contract or an anticipated contract that the entity can specifically identify.
- The costs generate or enhance resources that will be used to satisfy (or continue to satisfy) future performance obligations.
- The costs are expected to be recoverable.
Topic 340 also provides guidance on the amortization and impairment of deferred contract costs.
Costs of Obtaining an Advisory Services Contract
Broker-dealers often incur costs when they obtain an advisory services contract, including advertising, marketing and selling costs, bid and proposal costs, and legal fees. These types of costs are not incremental costs eligible for deferral because such costs generally are incurred regardless of whether the broker-dealer obtains the contract with the customer. In contrast, a broker-dealer also might incur commissions to acquire an advisory services contract, and these are incremental costs because commissions are not incurred unless the broker-dealer obtains the customer contract. Such commissions should be deferred if they are recoverable from the customer.
Costs incurred to obtain an advisory services contract are directly recoverable if the costs specifically are identified in the contract as reimbursable. FinREC believes directly recoverable costs should be deferred. Other costs are recoverable through the margin on the contract (that is, indirectly recoverable). FinREC believes costs that are indirectly recoverable and based on events or circumstances outside the control of the broker-dealer (for example, certain success-based fees) typically will not meet the recoverability criterion for recognizing a deferred asset. However, even if costs are indirectly recoverable, a contract containing nonrefundable fees (for example, a retainer or termination fee) that the broker-dealer expects to collect may demonstrate that the incremental costs of obtaining the contract are recoverable or partially recoverable. A broker-dealer should consider whether to capitalize indirectly recoverable costs when a contract includes nonrefundable fees the broker-dealer expects to collect.
Costs to Fulfill an Advisory Services Contract
The implementation issue notes a broker-dealer typically incurs two types of costs when fulfilling an advisory services contract: 1) out-of-pocket expenses such as travel, fees for legal counsel or other professional advisors, and fees related to industry and market research and 2) compensation costs for employees assigned to the advisory engagement.
FinREC believes out-of-pocket expenses generally will meet all three of the Topic 340 criteria listed earlier to qualify for deferral as an asset, provided: 1) the out-of-pocket expenses are expected to be recoverable either explicitly in the contract or through a nonrefundable retainer or termination fee despite the success of the advisory engagement and 2) the out-of-pocket expenses relate to a performance obligation that will be satisfied in the future.
According to FinREC, the costs incurred to deliver a performance obligation that is satisfied over time, such as a retainer arrangement, generally should be expensed as incurred because they likely do not relate to a future performance obligation (that is, the costs relate to a performance obligation that already has been satisfied).
FinREC believes compensation costs generally will not meet the third criterion for deferral in Topic 340. Unlike out-of-pocket costs, compensation costs typically are not explicitly reimbursable in an advisory services contract. Additionally, because the magnitude of compensation costs is sufficiently large, compensation costs might not be recoverable if the advisory engagement is not successful. Nevertheless, a broker-dealer should consider whether the advisory services contract includes nonrefundable fees it expects to collect and whether the costs incurred relate to a future performance obligation. A nonrefundable fee might demonstrate the broker-dealer can recover compensation costs, or a portion of the costs, and therefore meet the recoverability criterion for capitalization up to the recoverable amount, provided the broker-dealer expects to collect the nonrefundable fee and the incurred costs relate to a future performance obligation.
Amortization and Impairment
The implementation issue indicates that costs capitalized in accordance with Topic 340 should be amortized on a systematic basis consistent with the transfer to the customer of the performance obligation(s) in the advisory services contract. The pattern of revenue recognition for the advisory services, which will be discussed in a related FinREC paper, “Issue 3-5: Investment Banking Advisory Fees,” typically dictates the pattern of amortization for capitalized costs (for example, if fees are recognized at a point in time, any related capitalized costs are recognized in full on that date).
The services provided under an advisory services contract frequently are transferred to a customer within one year. Topic 340 provides a practical expedient for incremental costs incurred in obtaining an advisory services contract under which such costs may be expensed as incurred if the expected amortization period is one year or less.
Any costs capitalized under Topic 340 are subject to periodic impairment testing by comparing the carrying amount of the capitalized costs to the remaining revenue and costs to be recognized under the contract.
Income Statement Presentation
A broker-dealer should consider whether the out-of-pocket expenses it incurs to fulfill an advisory services contract should be presented on a gross basis (that is, the broker-dealer is acting as a principal) or net basis (that is, as contra-revenue when the broker-dealer is acting as an agent).
Topic 606 indicates that a principal obtains control of a good or service from another party and then combines the good or service with other goods or services in providing the contractually specified good or service to the customer. FinREC believes a broker-dealer generally uses the services for which it incurs out-of pocket expenses and combines them with other services in delivering its performance obligation(s) under an advisory services contract. Therefore, a broker-dealer must determine whether it obtains control of such services before they are transferred to the customer.
Topic 606 provides indicators about whether a broker-dealer obtains control of the services for which it incurs the out-of pocket expenses. FinREC believes a broker-dealer usually is primarily responsible for fulfilling the performance obligations under the advisory services contract, and the broker-dealer has discretion in establishing the fee for the services from the third-party suppliers for which the broker-dealer incurs out-of-pocket expenses. On balance, FinREC believes these two factors that indicate a broker-dealer is acting as a principal outweigh the other factors in Topic 606 that might indicate the broker-dealer is acting as an agent. According to FinREC, therefore, the broker-dealer should present as both revenue and expense in its income statement reimbursable costs to fulfill an advisory services contract at the gross amount of consideration it expects to be entitled.
The views expressed in the implementation issue might affect the extent to which a broker-dealer capitalizes costs associated with an advisory services contract and how those costs are amortized when compared to current guidance. The views expressed in the implementation issue are not expected to have a significant impact on impairment considerations. However, some entities might have concluded under current U.S. generally accepted accounting principles to present advisory services expenses net of reimbursements. The results of the views expressed in the implementation issue will gross-up revenue and expense to the extent reimbursements historically have been netted with expenses. Note that the increase in revenue related to the gross-up of reimbursed expenses will not result in an increase in the Securities Investor Protection Corporation (SIPC) general assessment for the broker-dealer, as the reimbursement for out-of-pocket expenses incurred can be deducted on line 2c(8) of form SIPC-7, “General Assessment Reconciliation.” The facts and circumstances of each arrangement should be separately considered.
Interested parties should submit any comments, including the implementation issue number, to email@example.com by May 1, 2017.