SEC Staff Accounting Bulletin No. 101: Revenue Recognition

Staff Accounting Bulletin No. 101 (SAB 101) was released by the U.S. Securities and Exchange Commission (SEC) on December 3, 1999. It provided interpretive guidance on applying existing Generally Accepted Accounting Principles (GAAP) to revenue recognition. The bulletin did not create new rules but clarified the SEC’s views on established standards to address diverse practices and earnings management.

SAB 101 was prompted by concerns that many financial reporting frauds involved overstating revenue. It aimed for a more uniform approach by outlining specific criteria for recording revenue. Although SAB 101 has been superseded by newer standards, its principles were foundational to modern revenue recognition rules.

The Four Core Criteria for Revenue Recognition

Persuasive evidence of an arrangement exists

For revenue to be recognized, there must be persuasive evidence that a sales arrangement exists. This evidence is often a written contract signed by both parties, which outlines the specific terms and conditions of the sale. Other forms of evidence, such as purchase orders or online authorizations, may be considered if they are legally enforceable and part of a company’s customary business practices. The evidence must demonstrate a firm commitment from the customer to purchase the goods or services.

Delivery has occurred or services have been rendered

The seller must have substantially completed its obligations to the customer. For goods, this means delivery has occurred, transferring the risks and rewards of ownership to the buyer. This transfer point depends on shipping terms, such as Free on Board (FOB) shipping point or destination. For services, this criterion is met as they are performed over the contract period. If an agreement requires customer acceptance, revenue recognition is delayed until the customer formally accepts the item or the acceptance period lapses.

The seller’s price to the buyer is fixed or determinable

The sales price must be fixed or determinable at the time of the sale. A price is fixed if not subject to change, and determinable if it can be objectively calculated from the agreement. This prevents recognizing revenue based on uncertain amounts. A price is not considered fixed or determinable if the customer can unilaterally cancel the agreement for a cash refund. If the price is variable due to contingencies like performance bonuses or rebates, recognition is delayed until the price becomes certain.

Collectibility is reasonably assured

The seller must have a reasonable expectation of collecting payment from the customer. This assessment, made at the time of sale, involves evaluating the customer’s creditworthiness, payment history, and financial condition. This step is distinct from establishing an allowance for doubtful accounts, which is an estimate of uncollectible amounts from a portfolio of receivables. If there is significant uncertainty about payment, revenue cannot be recognized. In these cases, revenue recognition is deferred until cash is collected.

Guidance on Specific Revenue Arrangements

Bill-and-Hold Arrangements

SAB 101 provided restrictive guidance for “bill-and-hold” transactions, where a seller bills a customer for a product but does not ship it until a later date. To recognize revenue, the risks of ownership must have passed to the buyer, and the buyer must have requested the transaction. There also had to be a fixed delivery schedule, and the product had to be complete, segregated from the seller’s inventory, and not available to fill other orders. These requirements were intended to prevent companies from prematurely recognizing revenue.

Upfront Fees and Nonrefundable Payments

The bulletin addressed nonrefundable fees received at the start of a contract, such as activation or membership fees. SAB 101 clarified that these upfront payments should not be recognized as revenue immediately. If the fee relates to a service or product delivered over time, the revenue should be deferred and recognized over the period that the service is provided. This approach aligns the timing of revenue recognition with the seller’s performance.

Contingent Revenue

SAB 101 reinforced that revenue contingent upon future events should not be recognized until those events have occurred. This is relevant in industries with long-term contracts that include milestone payments, such as in research or construction. For instance, a payment conditional on achieving a specific research outcome cannot be recognized as revenue until that outcome is successfully achieved. This prevents the recording of revenue that is uncertain and may never be realized.

Layaway Sales Programs

For layaway sales, where a customer makes deposits on a product that the retailer holds, SAB 101 provided clear direction. Revenue from these sales should not be recognized until the customer has paid the full purchase price and the product has been delivered. Until that point, the deposits received from the customer are recorded as a liability on the seller’s balance sheet.

Required Disclosures and Documentation

SAB 101 emphasized clear and comprehensive disclosures related to revenue recognition policies. Companies were required to include a detailed description of their specific revenue recognition methods in the footnotes of their financial statements. The disclosures needed to be specific to the company’s business and sales arrangements to provide transparency for investors. Generic, boilerplate language was considered insufficient, as companies were expected to provide enough detail for a user to understand the timing and amount of revenue recognized.

For complex transactions, such as bill-and-hold arrangements, specific disclosure of the accounting treatment was necessary. Effective documentation was also an underlying theme, as companies needed to maintain robust internal records. This documentation serves as the evidence base for the accounting treatment and is a focus of auditors when they review a company’s financial statements.

Codification and Current Relevance

The principles in SAB 101 were codified by the SEC as Staff Accounting Bulletin Topic 13. This formalized the SEC staff’s interpretive views on applying the Financial Accounting Standards Board’s (FASB) ASC Topic 605. The evolution of revenue recognition standards continued, and ASC 605 was eventually superseded by a more comprehensive standard, ASC 606, “Revenue from Contracts with Customers.” To align its guidance with this new standard, the SEC issued SAB 116.

ASC 606 replaced previous guidance with a single, five-step model:

• Identify the contract with a customer.
• Identify the performance obligations.
• Determine the transaction price.
• Allocate the price to the obligations.
• Recognize revenue as the obligations are satisfied.

Despite being superseded, understanding SAB 101 remains valuable as its four criteria established the logic that underpins ASC 606. Concepts like identifying a contract and satisfying performance obligations are central to both models. Studying SAB 101 provides historical context for modern accounting standards and insight into the SEC’s focus on preventing revenue recognition fraud.