At its joint meeting with the FASB in April, the Board decided to explore revenue recognition based on the following criterion:
Revenue should be recognised if the customer must accept performance to date. That is, the contract�s legal remedy for breach is, or is like, specific performance, or in the event of customer cancellation, the customer is obligated to pay damages reflecting performance to date.
At this meeting, the Board discussed the application of this criterion to an example of a reporting entity�s production contract with a customer in four scenarios.
In the first scenario, the contract required a legal remedy of specific performance if the customer breached it (ie the customer would be required to perform as promised under the contract). The Board tentatively decided that in this scenario revenue would be recognised as the entity created (produced) the asset for the customer. This is because the entity�s production results in a right to consideration. The Board noted that in this scenario the customer could be regarded as implicitly accepting the entity�s performance continuously.
In the second scenario, the contract required a legal remedy of monetary damages if the customer breached it. Those damages would reimburse the entity for its costs to date plus a profit margin. The Board tentatively decided that in this scenario revenue recognition would be similar to the first scenario.
In the third scenario, the contract would also require a remedy of monetary damages if the customer breached it. However, in this scenario the customer was required to compensate the entity for the difference between the contracted price for the completed asset and the price (if any) at which the entity would be able to resell the asset to another customer. The Board tentatively decided that revenue recognition would be similar to the first two scenarios. It noted that until the customer breached the contract the entity would be establishing a claim against the customer for its performance to date. In addition, if the customer breached the contract the entity would have a claim against the customer and potentially an asset to sell to another customer. The Board added that it will need to consider the effects on the entity�s assets and liabilities of uncertainty about enforcement of the legal remedies.
In the fourth scenario, the contract contained explicit acceptance provisions, ie on completion of a specified part of the construction, the customer would be required to accept that part and be unconditionally obligated to pay for it. The scenario also assumed that there would be no other legal remedies if the customer breached the contract. The Board tentatively decided that under the model it is exploring, revenue would be recognised only at the acceptance points, ie when the customer was unconditionally required to pay for the entity�s performance.