April 27, 2018

PwC has responded to the GASB’s Invitation to Comment on its revenue and expense recognition project. Among the three possible revenue and expense recognition approaches for exchange transactions, PwC favors the “alternative model,” which would look at performance obligations similar to how they are understood under ASC 606, so would align GASB and FASB standards on revenue recognition. It would also provide logical accounting answers for a range of revenue transactions. Use of the “alternative model” would allow governments to leverage existing guidance for nonexchange transactions.

PwC also encourages the GASB to develop implementation guidance, including examples, to ensure a consistent understanding of how to apply the new model.

April 27, 2018

Mr. David R. Bean

Director of Research and Technical Activities

Governmental Accounting Standards Board

401 Merritt 7, PO Box 5116

Norwalk, CT 06856-5116

Dear Mr. Bean:

PricewaterhouseCoopers LLP appreciates the opportunity to comment on the GASB’s Invitation to Comment, Revenue and Expense Recognition (the “ITC”). We commend the Board for taking on this important project and in particular, for exploring the “performance obligation” concepts that the FASB, IASB, and the International Public Sector Accounting Standards Board (IPSASB) have incorporated (or are considering incorporating) into their respective guidance.

For reasons described in more depth in the Appendix, we support the alternative approach, which we find to be most consistent with the performance obligation model used by other standard setters. Under that approach, the focus is on the exchange of direct promises in which the pattern of transfer of control (or benefit) can be specifically identified. While we recognize that nonexchange revenues are the dominant concern of tax-supported governments, we urge the Board not to lose sight of the enterprise activities that are the primary focus of special-purpose governments engaged in businesstype activities. Because many of these government entities compete for capital against private sector counterparts in the municipal market for “revenue bonds,” keeping the revenue models comparable maintains a level playing field and provides the best information for analysts and investors.

We do not support the broader “with/without” performance obligation approach, which appears to move beyond direct exchanges of promises between counterparties to the broad promises that a government makes to its constituency to provide services. In the latter situations, the nature of the promise is so broad—and could aggregate disparate services into a single performance obligation—that no meaningful pattern of transfer of benefit can be identified. In many cases, we believe that satisfying the performance obligation would equate to spending the appropriated resources; a far simpler model could be employed to that end.

Our comments are focused on revenue transactions. While we offer a few comments on expenses, in general, the details provided regarding the proposed model were insufficient for us to comment to any more meaningful degree.

Our detailed views on these and additional topics are described in the Appendix.

* * * *

If you have any questions regarding our comments, please contact David Schmid at (973) 997-0768 or Martha Garner at (973) 236-7294.

Sincerely,

A primary goal of the project is to develop a comprehensive principles-based model for revenue recognition that would apply to both exchange and nonexchange transactions. The “with/without” performance obligation approach would be organized around three-party arrangements in which a resource provider promises to pay consideration to a recipient who agrees to deliver services to a thirdparty (the beneficiary). Revenue from exchange transactions and from certain grants determined to include performance obligations would be recognized based on the pattern in which control of the promised services is transferred to the beneficiary (that is, as the recipient of resources performs). Transactions without performance obligations would be recognized as revenue based on the timing of satisfaction of eligibility requirements (consistent with today’s nonexchange model).

We believe that addressing exchange and nonexchange transactions within a single model will result in a principles-based approach that is overly complex and potentially confusing. For example, the three-party model would view an exchange transaction as one in which the resource provider and beneficiary are the same party (rather than using the simpler concepts of seller and customer). In addition, excluding revenue generated through taxes (a clear nonexchange transaction) would require evaluation of whether the rights and obligations of the parties to a transaction “articulate on equivalent terms.” As described in the ITC, this is a difficult concept to understand, and could easily be misinterpreted as requiring an exchange of equivalent value.

It is not clear whether the volume of grant transactions that would generate a performance obligation is sufficient to justify building an entire model around them. The volume would depend on how direct the linkage of beneficiaries to services is required to be in order to constitute a performance obligation.

The Board’s point of view on this key matter is unclear. At one end of the spectrum, the linkage between the beneficiaries and the services to be provided could need to be as clear as if the beneficiaries themselves were paying for the services – in other words, a clear exchange transaction. The IPSASB illustrates this type of requirement in its proposal (a government pays consideration to an entity to administer a specific vaccination to 1,000 individuals). Alternatively, the Board could intend that both “beneficiary” and “services” be so broadly construed that the linkage between them becomes much more indirect, which would bring a significant number of grant transactions into scope.

We infer from the mention in the ITC of the Community Development Block Grant program that the Board might be focused on the broader view. The ITC cites “low-to-moderate income citizens in need of affordable housing that are eligible for participation in Community Development Block Grant programs” as an example of a “specified beneficiary.” Activities associated with affordable housing programs generally relate to the acquisition, construction, or rehabilitation of structures (such as apartment buildings) or making site improvements to surrounding areas (e.g., creating a park to serve a new apartment structure). The linkage between those services and the related beneficiaries is much less direct than in the vaccination example.

In general, we believe that the performance obligation model of revenue recognition becomes less relevant the broader the categories of “distinct services” and “specified beneficiaries” are permitted to be and the looser the linkage between them. The goal of a performance obligation model is to recognize revenue in a pattern that reflects the service provider’s progress in carrying out its obligation. If the linkage is too indirect, the pattern could become so indistinct as to be meaningless.

Example 3 of the Appendix illustrates application of the performance obligation model to a grant in a manner that does not appear to be consistent with the high-level concepts described in the ITC. In the example, the federal government awards a grant to a state government agency to purchase protective vests for its police department. The grant will be paid on a reimbursement basis (so the state agency must purchase the vests in order to be entitled to the grant). According to the ITC’s analysis, the transaction involves a performance obligation to purchase vests.

A transaction in which the service provider and the service recipient are the same party would appear to be fundamentally incompatible with the notion of a performance obligation model. In effect, the government agency is accepting compensation in exchange for providing services to itself. This transaction is nonreciprocal and should be accounted for using the GAS 33 model for voluntary nonexchange transactions.

We wonder if the Board intended to equate a contingency (i.e., the entity must first incur the expenses) with a performance obligation. While the nature of certain conditions in nonexchange transactions could be consistent with performance obligations (discussed below), that is not true for all conditions.

When attempting to identify performance obligations in grants, it would be difficult for preparers to distinguish between stipulations that create eligibility requirements (which must be satisfied before recognizing revenue) and stipulations that restrict the purpose for which awarded funds must be spent. This is similar to the difficulties encountered under the GAS 33 model today. For example, an award that must be used to provide job training to disabled veterans is a voluntary nonexchange transaction with a purpose restriction, which can be recognized in income immediately. However, if the award specified that job training must be provided to 1,000 disabled veterans, interpretations vary on whether that is a voluntary nonexchange transaction with a more narrowly-defined purpose restriction, or whether the requirement to serve 1,000 veterans imposes an eligibility requirement that results in deferred recognition of income. Under the proposed performance obligation model, a similar question would arise as to whether the requirement to serve 1,000 veterans imposes a performance obligation requiring that revenue be recognized over time as the job training services are provided to the beneficiaries. Therefore, the proposed model would miss the opportunity to clarify the uncertainty of how to distinguish among stipulations that exists today.

We believe that an approach that retains the exchange/nonexchange distinction—while updating the exchange recognition guidance to reflect performance obligation notions–would be a much better path forward.

The alternative model would establish guidance for exchange transactions that relates revenue recognition to an entity’s performance in fulfilling its obligations to customers. We believe that exchange transactions in the government environment are generally similar in nature and substance to transactions in the private sector. Therefore, we believe that a performance obligation model that provides the same outcome as the FASB’s performance obligation model should be used for exchange transactions.

By limiting application of the performance obligation model to two-party arrangements that are clearly exchange in nature, parties to exchange transactions would not have to determine whether the resource provider and the beneficiary of the services are the same party. Maintaining the existing divide between exchange and nonexchange transactions also eliminates the confusion associated with the ITC’s concept of “articulating in equivalent terms,” which appears to focus on excluding certain categories of nonexchange revenue transactions that, by nature, are entirely nonexchange (such as tax revenues).

This approach is also consistent with private-sector accounting, which requires entities to consider whether a transaction is exchange or nonexchange. If the transaction is exchange, private sector entities apply a performance obligation model; if nonexchange, those entities apply a contribution accounting model. If this approach is taken, we recommend making certain changes to improve the exchange/nonexchange distinction (as noted below). We also have a few suggestions related to the performance obligation model for exchange transactions (see page A4).

For nonexchange transactions, we believe the approach should retain the basic concepts of the existing GAS 33 model, while considering ways to address certain fundamental problems with application of that model that exist today. Our suggestions for improving the GAS 33 model appear on page A5.

In any event, as the Board continues to deliberate, we suggest it develops a flowchart or diagram (for example, similar to the flowchart used in GAS 14 for component units) that would provide a road map to governments to help navigate the applicable decision points.

We do not believe the determination of whether a transaction is an exchange should focus primarily on whether the values exchanged are equal. Instead, we suggest focusing the definition of an exchange on the notion of a quid pro quo—whether an exchange of “something for something” has occurred— without attempting to determine the “equivalency” of the values exchanged. The key questions should be whether an exchange of benefits has occurred directly between two parties in which the resource provider “benefits directly.” Typically, this would mean that the resource provider is purchasing a product or service for its own use.

Significant diversity in practice exists in both the public and private sectors regarding classification of federal grants for purposes such as sponsored research. In keeping with the notion of a direct exchange of value occurring between two parties, we suggest that the model clearly indicate that in situations when the federal government funds activities that will benefit the general public, a “direct exchange” has not occurred. In other words, the federal government’s “outsourcing” of activities that will benefit the general public does not equate to a benefit received by the federal government itself.

The difficulties in determining whether a transfer of resources is exchange or nonexchange is not unique to the public sector. Because the FASB is finalizing a standard that would clarify this determination by not-for-profit (NFP) organizations, we encourage the GASB staff to leverage the FASB staff’s research and outreach, in addition to conducting government-specific research and outreach.

Other recommendations:

We believe that the performance obligation model developed for exchange transactions should align closely with private-sector guidance (i.e., the FASB’s performance obligation model). This is particularly important to governmental entities that compete directly with their private-sector counterparts for resources. For example, governmental and not-for-profit health care entities compete for capital in the municipal bond market. Health care entities typically issue revenue bonds, rather than general obligation bonds, and revenue metrics are a primary focus of both investors and analysts. Today, governmental and not-for-profit health care entities use the same revenue recognition model, so the revenues reported in their financial statements are comparable. We believe this consistency should be maintained.

When a contract (arrangement) transfers more than one good or service, the government must determine whether each good or service represents a separate performance obligation, or if instead some or all should be aggregated/bundled. We agree that goods and services should be bundled in situations when they are “not separately identifiable” or “do not provide benefit on their own.” However, some contracts contain a promise to deliver multiple goods or services, but the customer is not purchasing those individual items. Rather, the customer is purchasing the final good or service that those individual items create when they are combined. For example, a patient admitted to a hospital for knee replacement surgery is purchasing the knee replacement process, not the individual goods and services that comprise the process. We view this as a single performance obligation that is satisfied over time (i.e., benefit transfers to the patient as they move through the surgery and recovery phases). Similar situations exist when a government performs construction. The customer is not purchasing individual bricks and nails, but instead is purchasing the completed facility. Assuming the construction is on the customer’s property, benefit would transfer to the customer as the construction is performed.

While we acknowledge that measurement is outside the scope of the ITC and will be the subject of future deliberations, we note that paragraph 15 in Chapter 3 of the ITC states that revenue should be recognized for the amount the government expects to receive. The ITC includes a footnote on that statement indicating that the Board may consider changing “expected” to “stipulated.” We encourage the Board to retain reference to revenue being recognized for the amount expected to be received.

We point to the experience of health care entities in adopting the FASB’s performance obligation model. In health care, credit is rarely extended to patients based on an assessment of their creditworthiness, as that term is used in the commercial world. Instead, the health care entity provides an essential public service, recognizing the reality that some individuals will be unable to pay for some or all of those services. Under the FASB’s performance obligation model, health care entities will measure revenue based on the amount expected to be received on day one, and will no longer recognize stipulated amounts. If an entity only expects to receive pennies on the dollar, then the amount of revenue to be reported would be pennies on the dollar. This is done using a concept of “implicit price concessions,” which the industry believed was a better economic representation of those write offs (as opposed to calling them bad debts). In these situations, consideration is variable and must be estimated based on historical collections experience for “portfolios” of similar contracts. The difference between price concessions and bad debt is a significant issue for health care entities, but likely has applicability to other government services as well. We encourage the Board to consider these types of transactions in future deliberations.

Among nonexchange grants and contributions in the public sector, revenue is recognized when the eligibility requirements specified in GAS 33 are met. In most cases, revenue is recognized based either on cost-reimbursement principles (i.e., over time as qualifying expenses are incurred), or upfront. When developing the new model, the Board may wish to consider whether changes to the upfront “Day 1” recognition of some grants might provide more useful information to financial statement users in making decisions and assessing accountability. For example, unless the resource provider specifies otherwise, the model might presume that the grant resources would be recognized evenly over the period of the grant. The benefits of switching to over time recognition might be limited by the fact that in general, governments only issue annual financial statements. However, it might result in more useful reporting of interim financial information in bond offering documents.

Regardless of the overall model the Board selects for revenue recognition (exchange/nonexchange; with/without performance obligation; or the alternative approach), it appears that GAS 33’s principles will continue to provide guidance for some or all nonexchange transactions. We agree with the points made in the ITC that certain aspects of GAS 33 have been difficult to apply and have led to diversity in practice. In particular, we believe the guidance in GAS 33 with respect to evaluating whether stipulations in grant agreements constitute eligibility requirements (e.g., contingencies) or are simply purpose restrictions needs to be clarified. The more narrowly a purpose-restriction is defined, the more closely it can resemble an eligibility requirement (a contingency) under GAS 33, as mentioned previously in our example of a grant to provide job training for disabled veterans.

The persistent problem of distinguishing contingencies from restrictions will need to be solved in order for either approach to result in an improvement in the consistency of application of the model. We therefore encourage the Board to take up a separate project to improve GAS 33 in the near term, rather than waiting to make those improvements as part of the larger revenue project. The final revenue recognition standard is not slated for issuance until 2023; we believe preparers and financial statement users would benefit from more timely clarification. Working on this issue simultaneous with the revenue model would also set the stage for better application of the proposed new revenue model.

We also believe the Board should reconsider its existing guidance for public universities that receive Pell grants. Currently, as a result of IG 2015-1, question 7.72.10, Pell grants are recorded by some institutions as non-operating revenue. However, Pell grants are applied to a student’s tuition, which is reported as operating revenue. This means that public universities reduce tuition revenue by the amount of the Pell grant, which reduces income from operations. This accounting distorts the amount of tuition revenue being earned by the institution from its customer. We believe Pell grants are simply third-party payments on behalf of a customer in an existing exchange transaction, similar to Medicare and Medicaid payments to a hospital, and therefore should not be recorded as reductions to the revenue generated by that exchange transaction. This change would also enhance the comparability between public and private institutions of higher education.

To the extent that there is a sufficiently large population of grants that are three-party transactions (that involve a resource provider and identified goods and services being delivered to a specific population), we believe it would be helpful to explore a variation of the performance obligation approach articulated in the ITC to be applied to such transactions as a separate category of nonexchange transactions, subject to practical considerations. If the Board decides to separately address this third category, we recommend:

The most significant practical consideration in whether to consider this third category is how revenue associated with those grants is recognized today. To the extent such grants are cost-reimbursed today (and thus, revenue is recognized over time based on expenditures incurred), we suggest an evaluation of whether switching to a model that recognizes revenue based on progress in satisfying the performance obligation provides sufficient incremental benefit to justify such a significant change. Absent being able to point to a significant improvement in the information provided to financial statement users, it may be preferable to account for these grants under the GAS 33 cost reimbursement model.

We were unable to discern a clear message from the ITC with respect to the proposed comprehensive expense recognition model.

We support use of a symmetrical model for revenue and expense recognition in nonexchange transactions, as exists currently. Therefore, if the GASB adopts a performance obligation approach for recognizing revenue on certain grant transactions, we agree that the resource provider should recognize expense in a similar pattern, as the service provider reports its progress to the resource provider. Similarly, if the GASB were to consider an approach whereby entities that recognize grant revenues upfront today would instead recognize those revenues ratably over time, we believe the resource provider should recognize the expense ratably over time.

We do not have sufficient understanding of the proposed accounting for procurement transactions (that is, where the government is purchasing goods or services for its own use) and so are unable to provide a perspective. Presumably, aside from inter-governmental grants, most expenses of governments are recognized in exchange transactions with employees, service providers, and other counterparties. Is the Board proposing that governments would assess each of their expense transactions under the multi-step performance obligation model, and recognize expense when or as the counterparty satisfies its obligation? We question the practicability of such an approach.

It is also not clear how this might interact with the traditional matching concept used in both the public and private sectors for expense recognition, in which expenses associated with generating revenues are generally recognized in the same period as those revenues.

As the Board acknowledges in the ITC, other standard setters have adopted a performance obligation model for revenue recognition. The transition period is now over and entities are in the process of adopting this guidance. During the transition period, stakeholders expended significant effort addressing how the guidance would apply to various industries and types of transactions. These efforts have led to amendments to the original guidance, the issuance of practical expedients, and the creation of industry-focused whitepapers on application of the model.

For the “special entities” that apply GASB standards, the Board has the opportunity to benefit from the performance obligation approaches developed in the private sector portion of those industries for their respective revenue models. The output of the industry revenue recognition task forces is in the form of draft whitepapers that are being incorporated into industry chapters of an AICPA revenue guide. If the Board elects a model similar to the model now being applied by private-sector entities, we encourage the Board to seek feedback from those industries that have addressed (or are addressing) the challenges inherent in this model (health care, higher education, utilities, construction) and consider the whitepapers that have been issued.

As this project progresses, we encourage the Board to include examples from a cross-section of its constituency, including governments engaged in business-type activities (BTAs). BTAs engage in a variety of revenue transactions, some of which may be complex (for example, revenues with significant variability, as is often the case for hospitals, or revenues that contain milestones, as is often the case for construction entities). These complexities should be incorporated into the Board’s deliberations and examples should be provided in future exposure documents related to this project. We believe providing examples will help preparers to better understand the proposed model and thereby elicit higher-quality feedback from preparers.

We also suggest that the Board address how the revenue and expense recognition approaches would apply in the separately-issued financial statements of blended component units that provide services to the primary government.

In addition, we encourage the Board to include as much implementation guidance in the standard as possible, including illustrative examples (similar to the examples provided in GAS 33). In recent years, the Board has issued standards on complex topics, such as fiduciary activities and leases, but has not provided implementation guidance or examples in the standards. Subsequently, the Board has issued implementation guides to help governments apply the standards. We believe this has the following unintended consequences:

Considering the extended timeline of this project and the abundance of lessons learned from other standard setters that have already issued new revenue recognition guidance, we believe that implementation guidance and examples can efficiently be included as part of this project, rather than as a separate future project.