Size doesn’t matter. Little things can have a towering impact.
Take semiconductors, for instance. Here’s an industry truly serving as de facto driver and enabler of progress in technology. Developments in the semiconductor industry shape the way we communicate, travel, work and entertain ourselves.
How will developments in the guiding revenue recognition standard – namely, the forthcoming ASC606 – influence this all-encompassing industry?
Let’s take a look at a few key areas:
- Sales to distributors or resellers
- Semiconductor fabrication plants (foundaries)
- Sales- or usage-based royalties
We’ve discussed in this space previously the implications of revenue recognition for companies with product return and pricing adjustment uncertainties. As referenced in the Financial Accounting Standards Research Initiative, such uncertainties are usually minimal for sales to end customers, significant risks are a possibility for sales to distributors. The reason for this is that distributors’ product return and pricing adjustment rights often don’t lapse until the product is resold from a distributor to an end customer. Within such risks, companies will recognize revenue upon delivery of product to distributors (sell-in), when the distributor resells the product to end customers (sell-through) or in some form of combination (sell-in for some distributors and sell-through for others).
Sales to Distributors or Resellers
Since semiconductor firms typically sell their wares through distributors or resellers, the distribution agreements may include price protection or right of return provisions due to frequent price reductions or technology obsolescence.
Under the current practice, the sell-through method is used in which the fee isn’t fixed or determinable and the seller hasn’t transferred risks and rewards of ownership even though control of the product has been transferred, deferring revenue and related costs until the sale to an end customer. Can a semiconductor firm still use sell-through under new guidance? Unfortunately, with this new standard, such a company likely will need to determine the total amount of consideration in which it expects to be entitled and, since things will be more judgement-based, judge whether there is a risk or significant reversal, recognizing revenue in a form of the sell-in method based on that. This is a new constraint which would have to be applied and could alter the amount.
Under the new guidance, sell-through may still be appropriate in situations when inventory is consigned to the distributor or the company in question has a significant call option to reacquire the inventory.
Foundaries typically fabricate wafers or produce semiconductors for an individual customer based upon that customer’s design specifications.
Under the current standard, revenue is usually recognized by foundries at a point in time when the finished product is delivered to the customer. Would this practice of point in time recognition be able to continue under new guidance?
With this new standard, such a service may fall under the criteria of performance obligations satisfied over time as the fabrication services are performed, creating a change in practice.
Sales- or Usage-based Royalties
Semiconductor firms may license to customers the right to use, but not own, intellectual property in exchange for a sales- or usage-based royalty. Such a license may be included in an arrangement which includes tangible goods or services.
In current practice, these companies typically recognize sales- or usage-based royalties when a reliable estimate can be made, usually during the period the sale or usage is reported by the customer.
According to this KPMG podcast report discussing new guidance impact on the semiconductor industry, royalties was one of the most deliberated items during the standard-setting process.
How would such royalties be accounted for under the new standard?
Under new guidance, sales- or usage-based royalties to be earned in future must be evaluated to see whether they would be attributable to the license, the tangible good, a specific service or combination of any of these. For royalties on a license of intellectual property, revenue is recognized at the later of when the subsequent sale or usage is crystallized and the satisfaction of the performance obligation to which said royalties relate. However, for sales- or usage-based royalties not attributable to an intellectual property licensing transaction, these would have to be estimated under the variable consideration guidance and subject to that constraint.
Clearly, this new standard comes with significant impact in timing and patterns of revenue recognition for an industry impacting all of us.