Remarks before the 2019 AICPA Conference on Current SEC and PCAOB Developments
Lauren K. Alexander
Professional Accounting Fellow, Office of the Chief Accountant
Dec. 9, 2019
The Securities and Exchange Commission disclaims responsibility for any private publication or statement by any SEC employee or Commissioner. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the staff.
Good morning. It is a pleasure to be here today. I would like to provide a few observations on a consultation that we received related to the revenue standard, and an update on some of the Office of the Chief Accountant’s activities related to the new credit losses standard.
Principal versus agent guidance
First, I would like to discuss a consultation on the principal versus agent guidance in the revenue standard because our office continues to receive a number of questions on how to apply this guidance. It seems that staff remarks at this conference would not be complete without a discussion of the principal versus agent guidance.
Determining whether an entity is a principal or an agent in a revenue transaction can be particularly challenging when two parties are involved in providing services to a customer, especially if some of the services can only be provided by a specific service provider.
In the consultation that I will discuss today, the registrant entered into contracts with customers to provide several related services in exchange for a fee. The contracts acknowledged that another service provider would provide some of the services, and the services were marketed to customers using the brand names of both the registrant and the other service provider. The registrant sought the staff’s view on whether it was a principal or an agent in the revenue transaction.
The registrant noted that some of the services promised in the contract were based on its proprietary content, and that it was heavily involved in providing those services to the customer, with limited involvement from the other service provider. However, due to certain regulatory restrictions, the registrant could not legally provide some of the services promised in the contract and therefore had to rely entirely on the other service provider to deliver those services.
The registrant concluded that it was the principal in the transaction for each of the specified services and should record revenue on a gross basis because it controlled the services before transferring them to the customer. In reaching this conclusion, the registrant stated that it had the contractual ability to direct the other service provider to provide services to customers on its behalf, and customers did not have contractual relationships with the other service provider. The registrant asserted that it was primarily responsible for fulfilling the promise to provide the specified services.
However, the registrant noted that it only had the right to dictate certain general parameters about the services to be provided by the other service provider, and that the other service provider had discretion in determining exactly how to fulfill its obligation. The registrant said that it controlled when the other service provider delivered the services, and that contractually the other service provider did not have the right to deny services to customers. Finally, the registrant was responsible for handling most customer concerns that arose from the services provided by the other service provider.
In this fact pattern, the staff did not object to the registrant’s conclusion that it was the principal in the transaction and should record revenue on a gross basis. The staff observed that the registrant could control the specified services by entering into a contract with another service provider in which the registrant defined the scope of services to be performed on its behalf, even if the registrant could not fulfill the contract using its own resources (that is, it could not legally provide certain of the services promised in the contract).
As discussed in previous staff speeches, we continue to observe that applying the principal versus agent guidance may require significant judgment, especially in the case of emerging business models. We encourage registrants to carefully consider their specific facts and circumstances and contractual terms, and any changes to these terms over time, when applying this guidance.
Current expected credit losses
I would now like to discuss the credit losses standard. We continue to be actively engaged in monitoring the standard’s implementation, and we have of course provided staff views when registrants have consulted with our office with questions on the standard.
Today I would like to share some observations arising from a recent consultation about whether certain potential future advances of costs on a borrower’s behalf should be included in an entity’s measurement of expected credit losses.
The current expected credit losses standard replaces today’s “incurred loss” model with a model that requires an entity to record an allowance for credit losses that is deducted from, or added to, the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset. When developing an estimate of expected credit losses, an entity should consider available information relevant to assessing the collectibility of cash flows over the contractual term of the financial asset(s).
In the consultation that I will discuss, the registrant has mortgage loans and plans to measure expected credit losses for these loans using a discounted cash flow method when it adopts the standard. The loan agreements require the borrower to make certain payments relating to the underlying collateral, including payments for property taxes, homeowners’ association fees, and certain insurance premiums. In accordance with the loan agreement, if a borrower fails to make these payments, the registrant has the right, but not the obligation, to make advances to pay outstanding amounts owed on the borrower’s behalf. The registrant sought the staff’s views on whether it should consider these potential future advances to borrowers in its measurement of expected credit losses when using the discounted cash flow method.
The registrant asserted that it should not recognize expected losses on potential future advances in its measurement of credit losses, and instead should recognize them when the advances are made. In reaching this conclusion, the registrant argued:
- Although it may provide advances to avoid additional losses on the credit extended as part of the loan, it does not have an unconditional contractual obligation to extend credit to the borrower for these amounts.
- The guidance on the discounted cash flow method does not prescribe which specific cash flows should be included in the present value of expected cash flows.
- The underlying costs do not meet the definition of a cost to sell, and any potential future advances are not included in the amortized cost basis of the loan and therefore should not be considered in the corresponding valuation allowance.
The registrant concluded that potential future advances for property taxes, homeowners’ association fees, and certain insurance premiums should not be included in its measurement of expected credit losses when using the discounted cash flow method. The staff did not object to this conclusion.
 Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers.
 ASC Topic 326, Financial Instruments – Credit Losses.
 See ASC 606-10-55-36 to 55-40.
 See ASC 606-10-55-37A(b).
 See ASC 606-10-55-39(a).
 See ASC 606-10-55-37A(b).
 See, e.g., Sheri York, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the 2018 AICPA National Conference on Current SEC and PCAOB Developments (Dec. 10, 2018), available at https://www.sec.gov/news/speech/speech-york-2019-12-10.
 See, e.g., Rahim Ismail, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the 2018 AICPA Conference on Current SEC and PCAOB Developments (Dec. 10, 2018), available at https://www.sec.gov/news/speech/speech-ismail-121018.
 See ASC 326-20-30-1.
 See ASC 326-20-30-6 and 326-20-30-7.
 In accordance with ASC 326-20-30-4, when a discounted cash flow method is applied, the allowance for credit losses shall reflect the difference between the amortized cost basis and the present value of the expected cash flows.
 See ASC 326-20-30-4.