Dec. 18, 2017
By Christopher G. Johnson, CPA, and Mark C. Shannon, CPA
On Dec. 15, 2017, the Financial Reporting Executive Committee (FinREC) of the American Institute of CPAs (AICPA) released, for informal and confidential comment, a draft revenue recognition implementation issue, “Investment Banking M&A Advisory Fees” (the implementation issue). The implementation issue addresses how a broker-dealer should recognize revenue for merger and acquisition and other corporate finance advisory services under the new standard. Comments on the implementation issue are due Feb. 15, 2018.
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 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 (IASB) Joint Transition Resource Group for Revenue Recognition (TRG) to verify that the guide is consistent with how the board intends the standard to be interpreted.
The Advisory Process
Entities engage broker-dealers to assist with corporate finance activities such as mergers, acquisitions, or financial restructurings. Broker-dealers also offer advisory services not specifically related to corporate finance activities.
The significant terms of contracts for advisory services vary widely. For example, a contract might be for a specific or unspecified duration, and it might be terminable at will by either party. A contract might contain a success fee, which could be a specified percentage of transaction value or a fixed fee. Advisory contracts also might contain nonrefundable retainer fees or milestone payments (for example, announcement fees), which might be subtracted from any success fee. Other fees for services such as a valuation fairness opinion might be included in an advisory contract, or such fees might be included in a separate contract.
The Five-Step Revenue Recognition Process
Step One: Identify the Contract With a Customer
An advisory contract typically will be in writing. A broker-dealer should consider the five criteria identified in Topic 606’s definition of a contract, including whether the customer has the ability and intent to pay the consideration when it is due (that is, the collectability criterion).
The term of the contract might be day-to-day or minute-to-minute if either party can unilaterally cancel the contract at will without any significant penalty. A contract might include nonrefundable retainer fees for which a broker-dealer should evaluate whether the fee represents consideration for a transferred good or service or represents an advance payment for future goods and services. In the latter case, the nonrefundable retainer will be deferred and recognized when or as the applicable good or service is provided to the customer.
Step Two: Identify Separate Performance Obligations
Identifying performance obligations in an advisory services contract requires judgment. A broker-dealer should evaluate whether the activities performed to fulfill a contract transfer distinct goods or services to the customer. When the activities performed do not transfer a distinct good or service but instead help to fulfill an overall promise to the customer, the broker-dealer will account for the activities as a single performance obligation. For example, in a contract to broker the sale of a business, a broker-dealer must evaluate whether due diligence services are distinct in relation to the overall promise to broker the sale. Goods or services that are highly dependent on, or highly interrelated with, other goods and services promised in the contract might not be distinct.
Broker-dealers also should consider the guidance in Topic 606 that specifies an entity should account for, as one performance obligation, a series of distinct services that are substantially the same and that have the same pattern of transfer to the customer. In an advisory contract, this concept might affect the number of performance obligations identified and, if the criteria described in Step Five for recognizing revenue over time are met, the pattern for measuring progress toward satisfying performance obligations.
In advisory contracts that include a promise of fairness opinion, the broker-dealer must evaluate whether the opinion is a separate performance obligation. FinREC believes fairness opinions typically will be a separate performance obligation because a separate broker-dealer could provide the opinion and the opinion likely is not highly dependent on or interrelated with advisory services.
Step Three: Determine the Transaction Price
A typical advisory contract might contain a fixed and a variable fee. The fixed fee often relates to a nonrefundable retainer or a fairness opinion, and the variable fee often relates to a success or announcement fee, which typically is due upon completion of a successful transaction or announcement of a transaction, respectively. A broker-dealer must evaluate the amount of the variable fee to include in the transaction price, and the transaction price is limited to an amount that is not probable of reversal in future periods (that is, constrained). Typically, variable fees initially will be constrained under Topic 606 because the amount of variable consideration often is highly susceptible to factors outside the broker-dealer’s influence, and the amount of consideration typically varies substantially based on the actual transaction.
Broker-dealers must update their estimate of variable consideration and include the current estimate in the transaction price at each reporting date during the contract period. As part of their estimate of variable consideration, broker-dealers should consider whether they expect to offer the customer a price concession (for example, waiving fees or reimbursements they would be due under the contract, in order to maintain a client relationship).
Step Four: Allocate the Transaction Price to Performance Obligations
A broker-dealer typically allocates the transaction price to separate performance obligations based on actual or estimated relative stand-alone selling prices. However, a broker-dealer must exercise judgment in determining whether the allocation results in a reasonable outcome. For example, rather than allocate the transaction price based on relative stand-alone selling prices, a broker-dealer might conclude that a variable success fee should be allocated only to a performance obligation to provide advisory services and a fixed fee should be allocated only to a fairness opinion performance obligation.
Step Five: Recognize Revenue When or as the Entity Satisfies a Performance Obligation
A broker-dealer can conclude revenue is to be recognized over time for a specific performance obligation only if the criteria identified in FASB Accounting Standards Codification 606-10-25-27 is met. FinREC believes it is unlikely that the performance obligations related to advisory services are satisfied over time, as a broker-dealer’s performance under the contract does not create or enhance a customer-controlled asset, and broker-dealers typically do not have an enforceable right to payment for services performed to date. However, the criteria for recognition over time may be met in certain arrangements when the customer simultaneously receives and consumes the benefits of the broker-dealer’s services.
Determining whether a customer simultaneously receives and consumes the benefits of the broker-dealer’s work might be difficult and is a matter of significant judgment. To make this judgment, a broker-dealer should consider whether another entity would need to re-perform the work performed to date. FinREC suggests the guidance in FASB/IASB TRG Agenda Reference 46 might be helpful when evaluating re-performance, and the implementation issue provides other data points to consider in evaluating whether one of the criteria for recognition over time is met. If one of the criteria for recognition over time is met, then the broker-dealer recognizes revenue for the performance obligation using a measure of progress over time.
If none of the criteria for recognition over time are met for a performance obligation, then the broker-dealer will recognize revenue at a point in time, which is when a broker-dealer determines that control of the service has transferred to the customer (for example, when the advisory services are completed or when the contract is canceled). The recognition is subject to any constraint discussed in Step Three. Similarly, FinREC believes revenue related to a fairness opinion performance obligation will be recognized at the point in time when the opinion is delivered to the customer.
Given the nature of advisory service contracts and the significant judgment that might be required to apply the five-step process, broker-dealers should consider whether their existing internal controls over financial reporting are sufficient to appropriately account for advisory service contracts after the effective date of Topic 606. Significant effort might be required to inventory and evaluate the population of customized terms included in the contracts that influence the conclusions. Broker-dealers also should consider whether any changes to financial statement disclosures will be required upon adoption.