Respondents to the exposure draft stated that the additional guidance for assessing the transfer of control proposed in the 2010 proposed Update was most helpful when applied to performance obligations for the transfer of goods. They commented that applying the concept of control is intuitive in those cases because, typically, it is clear that an asset has transferred from the entity to its customer. But they noted that the guidance was less intuitive and more difficult to apply to performance obligations for services and construction-type contracts because it could be difficult to determine when a customer obtains control of a service. That is because in many service contracts the service asset is simultaneously created and consumed and, therefore, it is never recognized as an asset by the customer. And even in the case of a construction contract in which there is a recognizable asset, it can be difficult to assess whether a customer has the ability to direct the use of and obtain substantially all the remaining benefits from a partially completed asset that the seller is in the process of creating. Consequently, many respondents in the construction industry were concerned that they would be required to change their revenue recognition policy from using a percentage-of-completion method to a completed contract method (on the basis that the transfer of assets occurs only upon transfer of legal title or physical possession of the finished asset, which typically occurs upon contract completion).
The Boards developed the additional guidance in paragraph 35 of the proposed Update to assist an entity in determining when goods or services are transferred over time and, thus, when a performance obligation is satisfied over time. That proposed guidance is divided into two categories—one for when the entity’s performance creates or enhances an asset of the customer and another for when the entity’s performance does not create an asset with alternative use to the entity.
The Boards decided that if an entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced, the entity’s performance transfers goods or services to the customer. Accordingly, in such cases a performance obligation is satisfied over time as the entity creates or enhances that asset. For example, the performance obligation is satisfied over time in many construction contracts when the customer controls any work-in-process (tangible or intangible) arising from the entity’s performance.
This criterion is consistent with the proposed implementation guidance in the 2010 proposed Update on determining whether a good or service is transferred over time. That guidance stated that goods or services would be transferred over time if the customer controls the work-in-process as it is created. Many respondents to the 2010 proposed Update agreed with that concept but thought it needed to be articulated more prominently in the standard itself. In the Boards’ view, the concept of control is similar to the basis for percentage-of-completion accounting in accordance with paragraph 22 of AICPA Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts:
Under most contracts for construction of facilities, production of goods, or provision of related services to a buyer’s specifications, both the buyer and the seller (contractor) obtain enforceable rights. The legal right of the buyer to require specific performance of the contract means that the contractor has, in effect, agreed to sell his rights to work-in-progress as the work progresses. This view is consistent with the contractor’s legal rights; he typically has no ownership claim to the work-in-progress but has lien rights. Furthermore, the contractor has the right to require the buyer, under most financing arrangements, to make progress payments to support his ownership investment and to approve the facilities constructed (or goods produced or services performed) to date if they meet the contract requirements. The buyer’s right to take over the work-in-progress at his option (usually with a penalty) provides additional evidence to support that view. Accordingly, the business activity taking place supports the concept that in an economic sense performance is, in effect, a continuous sale (transfer of ownership rights) that occurs as the work progresses.