Output methods

Output methods measure progress toward satisfying a performance obligation based on results achieved and value transferred.

Excerpt from ASC 606-10-55-17

Output methods recognize revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract.

Examples of output measures include surveys of work performed, units produced, units delivered, and contract milestones. Output methods directly measure performance and can be the most faithful representation of progress. It can be difficult to obtain directly observable information about the output of performance without incurring undue costs in some circumstances, in which case use of an input method might be necessary.

The measure selected should depict the reporting entity’s performance to date, and should not exclude a material amount of goods or services for which control has transferred to the customer. Measuring progress based on units produced or units delivered, for example, might be a reasonable proxy for measuring the satisfaction of performance obligations in some, but not all, circumstances. These measures should not be used if they do not take into account work in process for which control has transferred to the customer.

A method based on units delivered could provide a reasonable proxy for the reporting entity’s performance if the value of any work in process and the value of any units produced, but not yet transferred to the customer, is immaterial to both the contract and the financial statements as a whole at the end of the reporting period.

Measuring progress based on contract milestones is unlikely to be appropriate if there is significant performance between milestones. Material amounts of goods or services that are transferred between milestones should not be excluded from the reporting entity’s measure of progress, even though the next milestone has not yet been met.

Question RR 6-3 addresses whether control can transfer at discrete points in time when a performance obligation is satisfied over time.

Question RR 6-3

Can control of a good or service transfer at discrete points in time when a performance obligation is satisfied over time?

PwC response

Generally, no. Although the revenue standard cites milestones reached, units produced, and units delivered as examples of output methods, management should use caution in selecting these methods as they may not reflect the reporting entity’s progress in satisfying its performance obligations.

output measure. An appropriate measure of progress should not result in a reporting entity

accumulating a material asset (such as work in process) as that would indicate that the measure does not reflect the reporting entity’s performance. Refer to US Revenue TRG Memo No. 53 and the related meeting minutes in Revenue TRG Memo No. 55 for further discussion of this topic.

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

EXAMPLE RR 6-6

Measuring progress — output method

Construction Co lays railroad track and enters into a contract with Railroad to replace a stretch of track for a fixed fee of $100,000. All work in process is the property of Railroad.

Construction Co has replaced 75 units of track of 100 total units of track to be replaced through year end. The effort required of Construction Co is consistent across each of the 100 units of track to be replaced.

Construction Co determines that the performance obligation is satisfied over time as Railroad controls the work in process asset being created.

How should Construction Co recognize revenue?

Analysis

An output method using units of track replaced to measure Construction Co’s progress under the contract would appear to be most representative of services performed as the effort is consistent across each unit of track replaced. Additionally, this method appropriately depicts the reporting entity’s performance as all work in process for which control has transferred to the customer would be captured in this measure of progress. The progress toward completion is 75% (75 units/100 units), so Construction Co would recognize revenue equal to 75% of the total contract price, or $75,000.

6.4.1.1 “Right to invoice” practical expedient

Management can elect a practical expedient to recognize revenue based on amounts invoiced to the customer in certain circumstances.

Excerpt from ASC 606-10-55-18

As a practical expedient, if an entity has a right to consideration from a customer in an amount that corresponds directly with the value to the customer of the entity’s performance completed to date (for example, a service contract in which an entity bills a fixed amount for each hour of service provided), the entity may recognize revenue in the amount to which the entity has a right to invoice.

Evaluating whether a reporting entity’s right to consideration corresponds directly with the value transferred to the customer will require judgment. Management should not presume that a negotiated payment schedule automatically implies that the invoiced amounts represent the value transferred to

the customer. The market prices or standalone selling prices of the goods or services could be evidence of the value to the customer; however, other evidence could also be used to demonstrate that the amount invoiced corresponds directly with the value transferred to the customer. Refer to Revenue TRG Memo No. 40 and the related meeting minutes in Revenue TRG Memo No. 44 for further discussion of this topic.

The revenue standard refers to an example of a “fixed amount for each hour of service,” but this does not preclude application of the practical expedient to contracts with pricing that varies over the term of the contract. Reporting entities will need sufficient evidence that the variable pricing reflects “value to the customer” throughout the contract.

Consider a contract to provide electricity to a customer for a three-year period at rates that increase over the contract term. The reporting entity might conclude that the increasing rates reflect “value to the customer” if, for example, the rates reflect the forward market price of electricity at contract inception. In contrast, consider an arrangement to provide monthly payroll processing services with a payment schedule requiring lower monthly payments during the first part of the contract and higher payments later in the contract because of the customer’s short-term cash flow requirements. In this case, the increasing rates do not reflect “value to the customer.”

Other payment streams within a contract could affect a reporting entity’s ability to elect the practical expedient. For example, the presence of an upfront payment (or back-end rebate) in a contract may indicate that the amounts invoiced do not reflect value to the customer for the reporting entity’s performance completed to date. Management should consider the nature of such payments and their size relative to the total arrangement.

Reporting entities electing the “right to invoice” practical expedient can also elect to exclude certain disclosures about the remaining performance obligations in the contract. Refer to FSP 33.4 for further discussion of the disclosure requirements.

Question RR 6-4 addresses whether a reporting entity can use the “right to invoice” practical expedient when a contract includes escalating fees.

Question RR 6-4

A reporting entity enters into a four-year, noncancellable service contract with a customer that

includes a series of distinct services. The contractual pricing increases 10% annually. Can the reporting entity use the “right to invoice” practical expedient and record revenue based on the contractual pricing each year?

PwC response

It depends. Management will need to assess whether the requirements to apply the practical expedient are met. In order to use the practical expedient, the escalating fees in the contract need to correspond directly with the value to the customer of the reporting entity’s performance (that is, the value of the services in the second year are 10% higher than the value of the services in the first year). Management should consider factors such as the business reasons for the escalating fees and expected pricing of the services in future years. If the scheduled price increases in the contract do not correspond directly with the increase in value to the customer of the reporting entity’s performance, management will not be

straight-line recognition). A time-based measure of progress would result in recognition of the total transaction price ratably over the four-year period.