Input methods

Input methods measure progress toward satisfying a performance obligation indirectly.

Excerpt from ASC 606-10-55-20

Input methods recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labor hours expended, costs incurred, time elapsed, or machine hours used) relative to the total expected inputs to the satisfaction of that

performance obligation.

Input methods measure progress based on resources consumed or efforts expended relative to total resources expected to be consumed or total efforts expected to be expended. Examples of input methods include costs incurred, labor hours expended, machine hours used, time lapsed, and quantities of materials.

Judgment is needed to determine which input measure is most indicative of performance, as well as which inputs should be included or excluded. A reporting entity using an input measure should include only those inputs that depict the reporting entity’s performance toward satisfying a

performance obligation. Inputs that do not reflect performance should be excluded from the measure of progress.

Management should exclude from its measure of progress any costs incurred that do not result in the transfer of control of a good or service to a customer. For example, mobilization or set-up costs, while necessary for a reporting entity to be able to perform under a contract, might not transfer any goods or services to the customer. Management should consider whether such costs should be capitalized as a fulfillment cost as discussed in RR 11.

6.4.2.1 Input methods based on cost incurred

One common input method uses costs incurred relative to total estimated costs to determine the extent of progress toward completion. It is often referred to as the “cost-to-cost” method.

Costs that might be included in measuring progress in the “cost-to-cost” method if they represent progress under the contract include:

□ Direct labor

□ Direct materials

□ Subcontractor costs

□ Allocations of costs related directly to contract activities if those depict the transfer of control to the customer

□ Costs explicitly chargeable to the customer under the contract

□ Other costs incurred solely due to the contract

Some items included in the “cost-to-cost” method, such as direct labor and materials costs, are easily identifiable. It can be more challenging to determine if other types of costs should be included, for example insurance, depreciation, and other overhead costs. Management needs to ensure that any cost allocations include only those costs that contribute to the transfer of control of the good or service to the customer.

Costs that are not related to the contract or that do not contribute toward satisfying a performance obligation are not included in measuring progress. Examples of costs that do not depict progress in satisfying a performance obligation include:

□ General and administrative costs that are not directly related to the contract (unless explicitly chargeable to the customer under the contract)

□ Selling and marketing costs

□ Research and development costs that are not specific to the contract

□ Depreciation of idle plant and equipment

These costs are general operating costs of a reporting entity, not costs to progress a contract toward completion.

Other costs that do not depict progress, unless they are planned or budgeted when negotiating the contract, are excluded from the ‘cost-to-cost’ method. This will include costs of wasted materials, labor and other resources that represent inefficiencies in the entity’s performance, rather than progress in transferring control of a good or service.

Example RR 6-7 illustrates measuring progress toward satisfying a performance obligation using an input method.

EXAMPLE RR 6-7

Measuring progress — “cost-to-cost” method

Contractor enters into a contract with Government to build an aircraft carrier for a fixed price of $4 billion. The contract contains a single performance obligation that is satisfied over time.

Additional contract characteristics are:

□ Total estimated contract costs are $3.6 billion, excluding costs related to wasted labor and materials.

□ Costs incurred in year one are $740 million, including $20 million of wasted labor and materials.

Contractor concludes that the performance obligation is satisfied over time as Government controls the aircraft carrier as it is created. Contractor also concludes that an input method using costs incurred to total cost expected to be incurred is an appropriate measure of progress toward satisfying the

How much revenue and cost should Contractor recognize as of the end of year one?

Analysis

Contractor would recognize revenue of $800 million based on a calculation of costs incurred relative to the total expected costs. Contractor would recognize revenue as follows ($ million):

Total transaction price $ 4,000

Progress toward completion 20% ($720 / $3,600)

Revenue recognized $ 800

Cost recognized $ 740

Gross profit $ 60

Wasted labor and materials of $20 million should be excluded from the calculation, as the costs do not represent progress toward completion of the aircraft carrier.

6.4.2.2 Uninstalled materials

Uninstalled materials are materials acquired by a contractor that will be used to satisfy its performance obligations in a contract for which the cost incurred does not depict transfer to the customer. The cost of uninstalled materials should be excluded from measuring progress toward satisfying a performance obligation if the reporting entity is only providing a procurement service. A faithful depiction of a reporting entity’s performance might be to recognize revenue equal to the cost of the uninstalled materials if all of the following conditions are met:

Excerpt from ASC 606-10-55-21(b)

1. The good is not distinct.

2. The customer is expected to obtain control of the good significantly before receiving services related to the good.

3. The cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation.

4. The entity procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the entity is acting as a principal…)

Example RR 6-8 illustrates accounting for an arrangement that includes uninstalled materials. This concept is also illustrated in Example 19 of the revenue standard (ASC 606-10-55-187 through ASC 606-10-55-192).

EXAMPLE RR 6-8

Measuring progress — uninstalled materials

Contractor enters into a contract to build a power plant for UtilityCo. The contract specifies a

particular type of turbine to be procured and installed in the plant. The contract price is $200 million.

Contractor estimates that the total costs to build the plant are $160 million, including costs of $50 million for the turbine.

Contractor procures and obtains control of the turbine and delivers it to the building site. UtilityCo has control over any work in process. Contractor has determined that the contract is one performance obligation that is satisfied over time as the power plant is constructed, and that it is the principal in the arrangement (as discussed in RR 10).

How much revenue should Contractor recognize upon delivery of the turbine?

Analysis

Contractor would recognize revenue of $50 million and costs of $50 million when the turbine is delivered. Contractor has retained the risks associated with installing the turbine as part of the construction project. UtilityCo has obtained control of the turbine because it controls work in process, and the turbine’s cost is significant relative to the total expected contract costs. Contractor was not involved in designing and manufacturing the turbine and therefore concludes that including the costs in the measure of progress would overstate the extent of its performance. The turbine is an uninstalled material and Contractor would therefore only recognize revenue equal to the cost of the turbine.

6.4.2.3 Learning curve

Learning curve is the effect of gaining efficiencies over time as a reporting entity performs a task or manufactures a product. When a reporting entity becomes more efficient over time in an arrangement that contains a single performance obligation satisfied over time, a reporting entity could select a method of measuring progress (such as a cost-to-cost method) that results in recognizing more revenue and expense in the earlier phases of the contract.

For example, if a reporting entity has a single performance obligation to process transactions for a customer over a five-year period, the reporting entity might recognize more revenue and expense for the earlier transactions processed relative to the later transactions if it incurs greater costs in the earlier periods due to the effect of the learning curve. Refer to RR 11.3.2 for further discussion on the accounting for learning curve costs.