5.6.01 Acting as an agent, a broker-dealer may buy and sell securities on behalf of its customers. In return for such services, the broker-dealer charges a commission. Each time a customer enters into a buy or sell transaction, a commission is charged by the broker-dealer for its selling and administrative efforts.

5.6.02 Typically, a customer signs one contract with a broker-dealer that governs the terms and conditions for trade execution, clearing, custody, and potentially other services (that is, the promised goods and services included in a single contract).

5.6.03 If the contract includes a separate fee for custody services or a guaranteed minimum number of trades, FinREC believes the contract will typically meet all of the criteria in paragraphs 1–3 of FASB ASC 606-10-25 to be accounted for as a contract under the standard when the customer deposits money or transfers securities into an account, executes a trade, or the contractual term of the custody services has begun. Prior to these actions by the customer, a contract does not exist in accordance with FASB ASC 606-10-25-4 because the contract is wholly unperformed and either party could terminate the arrangement.

5.6.04 If the contract does not include a separate fee for custody services or a guaranteed minimum number of trades, FinREC believes the contract will not meet the criteria in FASB ASC 606-10-25-1 until a trade order is submitted by the customer (even if the customer deposits money or transfers securities into an account) because the customer has no obligation to pay the broker-dealer any consideration for its services.

5.6.05 A typical brokerage contract generally can be terminated at will by either the customer or broker-dealer. FASB ASC 606-10-25-3 explains that when a contract has no fixed duration and can be terminated or modified by either party at any time, an entity should apply the guidance in FASB ASC 606 to the duration of the contract (that is, the contractual period) in which the parties to the contract have present enforceable rights and obligations, unless a customer has a material right that extends beyond the contract term. For broker-dealers, this duration may be a one-day period (or shorter) in cases where the contract is terminable at will. Additional consideration and analysis may be required for brokerage contracts with a specified term (such as one year).

5.6.06 In applying FASB ASC 606, a broker-dealer should evaluate all of the services promised in the brokerage contract, including those implied by a broker-dealer’s customary business practice, to identify the separate performance obligations. Some common services in a brokerage contract include trade execution, clearing services, custody services, and investment research services (investment research services are addressed in the section “Soft Dollars” in paragraphs 5.6.62–5.6.77). A broker-dealer should carefully consider whether each service is capable of being distinct and is distinct within the context of the contract in accordance with paragraphs 19–21 of FASB ASC 606-10-25.

5.6.07 Judgment is required when determining whether clearing services are distinct within the context of the contract (that is, separately identifiable). Generally, FinREC believes trade execution and clearing services are not separately identifiable in the context of a typical contract with a retail customer because they are both inputs to the combined output of security trading. Therefore, they are bundled into a single distinct service (hereafter collectively referred to as trade execution).

5.6.08 FinREC believes that trade execution and custody services are distinct. Trade execution and custody services provide a benefit to the customer either individually or together with other resources that are readily available to the customer (that is, a customer can benefit from custody services or trade execution services on their own). The two services are also separately identifiable in accordance with FASB ASC 606-10-25-21. Although the custody affects the trade execution service, the trade execution service does not affect the custody service, so the services do not affect each other and are not highly interdependent or interrelated. For example, a customer could transfer securities to a different broker-dealer without executing a trade with them and receive the benefit of custody services.

5.6.09 Although the custody service performance obligation is required to be performed as part of the contract (see the earlier discussion in paragraphs 5.6.03–5.6.04 on the existence of a contract), trade execution is performed if a customer requests the broker-dealer to initiate a trade. The option for trade execution services represents an option to purchase services in addition to the custody service instead of variable consideration (see TRG Agenda Ref. No. 49)¹ because the customer has a present contractual right to choose the amount of additional distinct services that are purchased (that is, a separate purchasing decision). However, if a contract stipulates a guaranteed minimum number of trades, those trades are considered performance obligations.

5.6.10 Even if a contract does not exist until the first trade is executed, any trades beyond the first are considered optional purchases.

5.6.11 An option gives rise to a separate performance obligation in the contract only if it provides a material right to the customer in accordance with FASB ASC 606-10-55-42. FASB ASC 606-10-55-43 explains that if the price of the additional goods and services to be provided reflects the stand-alone selling price for that good or service, then that option does not provide a material right to the customer. TRG Agenda Ref. No. 11, October 2014 Meeting — Summary of Issues Discussed and Next Steps, paragraph 7 states, “Most TRG members agreed that the evaluation of whether an option provides a material right should consider relevant transactions with the customer (that is, current, past, and future transactions) and should consider both quantitative and qualitative factors, including whether the right accumulates (for example, loyalty points).” A broker-dealer should evaluate the pricing of its trade execution services, among other qualitative factors, to determine whether the option gives rise to a material right.

5.6.12 In accordance with FASB ASC 606-10-55-43, options to purchase trade execution services priced at the stand-alone selling price for that class of customer (for example, retail, institutional) are not considered separate performance obligations and are accounted for only when the customer exercises the option to purchase the trade execution services. Trade execution services priced at a discount to the stand-alone selling price, including trade execution service pricing that includes volume discounts, may represent a material right and be accounted for as a separate performance obligation.

5.6.13 Broker-dealers should also consider whether the typical retail customer has a material right for custody services to be provided beyond the contractual term of the arrangement, for example, one day (see further discussion in paragraph 5.6.05). Paragraph 12 of TRG Agenda Ref. No. 54, Considering Class of Customer When Evaluating Whether a Customer Option Gives Rise to a Material Right, states, “The guidance in paragraphs 606-10-55-42 through 55-43 is intended to make clear that customer options that would exist independently of an existing contract with a customer do not constitute performance obligations in that existing contract.” Custody services that could be provided beyond the contractual term of the contract for no consideration would exist independently of an existing contract with a customer when a broker-dealer provides custody services to customers who do not have an existing contract with the broker-dealer for no consideration. In such a case, FinREC believes there is no material right for future custody services. A material right may exist if the customer only receives the custody services for no consideration because of previously executed trades with the broker-dealer.

5.6.14 Typically, the transaction price for the brokerage contract that covers both trade execution and custody services is based solely on the commission rate quoted by the broker-dealer for trade execution. However, a separate fee may be charged for custody services in contracts that require the processing and handling of physical certificates or legal documents or accounts that have limited or no activity. Any separate fee for custody services is included in the transaction price at contract inception if it is not constrained. In addition, any guaranteed minimum on trade commissions is also included in the transaction price at contract inception.

5.6.15 Because the trade execution service is not accounted for until the option is exercised (assuming it is not a material right and there is no guaranteed minimum number of trades) in accordance with FASB ASC 606-10-55-43, the consideration for the optional services is also not included in the transaction price until the option is exercised. An entity should not estimate the options that might be exercised in determining the transaction price.

5.6.16 At contract inception, there is only one performance obligation (that is, custody services) if there is a separate fee charged for custody services, assuming the option for trade execution services is not a material right and there is no guaranteed minimum number of trades. In this case, the separate fee for the custody services is allocated only to the custody services. If there is no separate fee charged and no guaranteed minimum number of trades, there is no contract until the first trade is executed.

5.6.17 The exercise of each option for trade execution services is accounted for either as a change in the transaction price (in accordance with paragraphs 42–45 of FASB ASC 606-10-32) or a modification (in accordance with paragraphs 10–13 of FASB ASC 606-10-25) of the original contract (see paragraphs 11–12 of TRG Agenda Ref. No. 34, March 2015 Meeting — Summary of Issues Discussed and Next Steps). Most TRG members and the FASB staff thought both views were supportable by the language in the revenue standard (as cited earlier) because the exercise of an option could result in additional consideration being allocated to the option (that is, a change in the transaction price) or a change in the scope or price of a contract (that is, a contract modification). Paragraph 12 of TRG Agenda Ref. No. 34 states,

5.6.18 If a broker-dealer accounts for the exercise of the option as a contract modification in accordance with paragraph 11 of TRG Agenda Ref. No. 34 and determines the trade execution services are priced at their stand-alone selling price, it accounts for the trade execution service as a separate contract and does not allocate any consideration from the trade commission to the custody services, in accordance with FASB ASC 606-10-25-12. If the broker-dealer determines that the trade execution services are not priced at their stand-alone selling price, the modification of the contract is treated as the termination of the existing contract and the creation of a new contract, in accordance with FASB ASC 606-10-25-13a. The amount of consideration to be allocated to the remaining custody services and trades is the sum of the unrecognized custody fee (if any), the unrecognized guaranteed minimum trade commission (if any), and the trade commissions from the additional trades. A broker-dealer then allocates the transaction price to the trade execution services and custody service based on their relative stand-alone selling prices. However, assuming the contract is terminable at will, both performance obligations are satisfied by the end of the day, so no allocation is required in these circumstances unless the broker-dealer separately presents trade execution services and custody services in its financial statements.

5.6.19 If a broker-dealer accounts for the exercise of the option as a change in the transaction price² in accordance with paragraph 11 of TRG Agenda Ref. No. 34, the trade commission from any exercised trade execution option is added to the total transaction price and allocated to the custody services and trade execution services based on their respective stand-alone selling prices in accordance with FASB ASC 606-10-32-29. However, assuming the contract is terminable at will, both performance obligations are satisfied at the same time, so no allocation is required in these circumstances unless the broker-dealer separately presents revenue from trade execution services and custody services in its financial statements.

5.6.20 If volume discounts are provided in the contract and the broker-dealer identifies the option as a material right, it allocates a portion of the transaction price from each trade to the material right based on the relative stand-alone selling price of the option in accordance with FASB ASC 606-10-32-29. FASB ASC 606-10-55-44 provides guidance for estimating the stand-alone selling price of an option. The amount allocated to the material right is recognized as revenue when the option for the additional trades priced at a discount is exercised or the option expires.

5.6.21 In accordance with FASB ASC 606-10-25-24, a broker-dealer should then identify whether any performance obligations are satisfied over time or at a point in time. FinREC believes that custody services meet the criteria in FASB ASC 606-10-25-27 because the customer simultaneously receives and consumes the benefits provided by the broker-dealer as the broker-dealer performs the services and, as such, are considered satisfied over time. The broker-dealer must then determine a measure of progress (for example, time elapsed) that best predicts its performance in satisfying the custody services and recognize the portion of the transaction price allocated to the custody services as revenue as the services are provided (for example, over the one-day period or over a longer period of time if the custody period is specified and not terminable).

5.6.22 A broker-dealer should also evaluate whether the trade execution performance obligation, after the additional purchasing decision is made, meets any of the criteria in paragraph 27 of FASB ASC 606-10-25 to be satisfied over time. FinREC believes it is unlikely that trade execution will meet the criteria in paragraph 27b or 27c of FASB ASC 606-10-25. In addition, because a broker-dealer is performing the service of providing the customer with the ability to acquire or dispose of rights to obtain the economic benefits of a financial instrument (for example, stock, bonds, options), the customer does not simultaneously receive and consume the benefits provided by the broker-dealer’s service as the broker-dealer performs the service (that is, the criterion in paragraph 27a of FASB ASC 606-10-25 is not met). In other words, the customer only consumes the benefits of the broker-dealer’s service when the customer acquires or disposes of the rights to obtain the economic benefits of the financial instrument, not as the broker-dealer performs the underlying service to acquire or dispose of those rights. Therefore, FinREC believes the trade execution performance obligation is satisfied at a point in time.

5.6.23 For performance obligations that are satisfied at a point in time, a broker-dealer needs to determine the point in time at which the customer obtains control (that is, obtains the benefits from the service) and should consider the indicators of transfer of control in FASB ASC 606-10-25-30.

5.6.24 Acting as an agent, a broker-dealer may buy and sell securities on behalf of its customers. In return for its selling and administrative services, the broker-dealer charges a commission each time a customer enters into a buy or sell transaction. On the trade date, the broker-dealer fills the trade order by finding and contracting with a counterparty and confirms the trade with the customer. On the settlement date, the cash and security from the respective counterparties are transferred to the respective accounts.

5.6.25 The trade execution performance obligation is satisfied at a point in time, as discussed in paragraph 5.6.22. Determining when control has transferred depends on how the trade execution performance obligation is defined. FinREC believes that a broker-dealer is performing the service of providing the customer with the ability to acquire or dispose of rights to obtain the economic benefits of a financial instrument (for example, stock, bonds, options). If the customer or the other counterparty does not remit payment or a financial instrument on the scheduled settlement date, the broker-dealer remedies the failure to perform by either party, so the customer still benefits from the rights to the financial instrument as of the trade date. Fails occur in a very small percentage of trades, are generally easily and rapidly cleared, and the settlement process is well established and does not require significant effort.

5.6.26 FASB ASC 606-10-25-25 defines control of an asset as the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Transfer of control of the trade execution performance obligation should be viewed as occurring on the trade date because that is when the underlying financial instrument (for a purchase) or purchaser (for a sale) is identified and the pricing is agreed upon (that is, the broker-dealer has identified the counterparty and enters into the contract on behalf of the customer).

5.6.27 On the trade date, the customer has obtained control of the service in that it can direct the use of, and obtain substantially all of the remaining benefits from, the asset that comes from the trade execution performance obligation. For example, in a security purchase transaction, the customer receives the benefits from changes in value of the underlying security on the trade date. In addition, the customer may direct the further sale of a purchased security to a third party on the trade date. In a security sales transaction, a customer may not direct the use of the sale proceeds to purchase another security until the settlement date when the cash is deposited into their account. However, the customer is no longer subject to the risk of changes in value of the sold security on the trade date and thus has no rights to the underlying security or related risks and rewards once sold on the trade date.

5.6.28 Furthermore, FASB ASC 940-20-25-2, as amended, states that substantially all the efforts in generating the commissions have been completed on the trade date for purposes of evaluating the expenses that should be accrued.

5.6.29 FASB ASC 606-10-25-30 also lists indicators of the transfer of control. A broker-dealer may evaluate these indicators as follows:

a.     The entity has a present right to payment for the asset (that is, for the service). The broker-dealer has a present right to payment for the trade execution performance obligation on the trade date. However, if the trade ultimately never settles (which only occurs in extremely rare cases), the broker-dealer may refund the trade commission or compensate the customer for any changes in value of the security or asset that the broker-dealer was unable to obtain.

b.     The customer has legal title to the service. Not an applicable indicator when evaluating the transfer of a service.

c.     The entity has transferred physical possession of the service. Not an applicable indicator when evaluating the transfer of a service.

d.     The customer assumes the significant risks and rewards of ownership of the service. The risks and rewards of ownership (that is, benefits) of the trade execution performance obligation are transferred on the trade date because the rights to the underlying security provided by the service are received on the trade date. For example, the customer is entitled to any dividend or interest payments if the record date of the payment is on or after the trade date. The customer also receives the benefits from changes in value of the underlying security on the trade date and may direct the further sale of the security to a third party on the trade date. In a security sales transaction, a customer may not use the sale proceeds to purchase another security until the settlement date when the cash is deposited into the customer’s account. However, the customer is no longer subject to the risk of changes in value of the sold security on the trade date and has no rights to the underlying security once sold on the trade date. If a trade fails, the broker-dealer compensates the customer for any change in value from the trade date to the actual settlement date, so fails do not affect the customer’s risks and rewards of ownership of the service.

e.     The customer has accepted the service. Often, there is no explicit customer acceptance clause to be evaluated in a brokerage contract (that is, there is no explicit requirement for the customer to accept the transfer of ownership). However, any customer acceptance clause in a contract likely would be objective and would not affect the entity’s determination of when the customer has obtained control of the service, as described in FASB ASC 606-10-55-86.

5.6.30 As previously described, a broker-dealer may expect to remedy the failure to perform by either party if the customer or the other counterparty does not remit payment or a financial instrument on the scheduled settlement date. FinREC believes this remedy may be similar to a warranty (that is, a warranty of its agency service), which is specifically addressed in paragraphs 30–35 of FASB ASC 606-10-55. FASB ASC 606-10-55-30 states that “some warranties provide a customer with assurance that the related product will function as the parties intended because it complies with agreed-upon specifications,” which is consistent with the remedy a broker-dealer provides. These types of warranties are not accounted for as separate performance obligations. Thus, FinREC believes the broker-dealer may need to recognize a liability or expense for any obligations to remedy failures to perform.

5.6.31 For those instances described earlier in which the trade is expected to ultimately never settle, the consideration would be variable consideration and the broker-dealer would estimate the amount of consideration that will be refunded and include that portion in the estimate of the transaction price (that is, record that portion as a reduction of revenue instead of as an accrual of costs). The estimated variable consideration in the contract will only include the consideration for the performance obligations in the contract (no consideration should be included for optional purchases) less the amount expected to be refunded based on the broker-dealer’s historical data of trades that never settle. That is, when determining the estimate of variable consideration, the broker-dealer will not include an estimate of the number of trades expected to be executed.

5.6.32 Based on the preceding analysis, FinREC believes control of the trade execution performance obligation transfers on the trade date. The portion of the transaction price allocated to the trade execution performance obligation should be recognized as revenue on that date.

5.6.33 Business entities and governmental entities that want to raise funds through the public sale of securities normally engage securities broker-dealers to underwrite their securities issues. Underwriting is the act of distributing a new issue of securities (primary offering) or a large block of issued securities (secondary offering).

5.6.34 There are several different ways in which a broker-dealer may participate in the underwriting of securities. The broker-dealer may act as managing underwriter (commonly referred to as the lead underwriter), co-managing underwriter (or co-lead), or participating underwriter. Such participation may be on one of the following bases, though this does not represent an all-inclusive list:

a.     Firm commitment. The underwriting group for a transaction on a firm-commitment basis agrees to buy the entire security issue from the issuer for a specified price, whether or not they can successfully sell all purchased securities to investors. Typically, this type of commitment occurs immediately prior to the offering. However, broker-dealers may enter into a contract with an issuer that provides a firm commitment to underwrite securities several days or weeks prior to the actual offering.

b.     Best efforts. The underwriting group for a best-efforts basis agrees to sell the issue at a price to be determined, normally with a minimum requirement to complete the underwriting. Any securities for which the broker-dealer cannot obtain a purchase commitment in the public market will not be underwritten (purchased) by the broker-dealer.

c.     Standby. The underwriting group for a standby basis commits to purchase securities only if called on.

5.6.35 The managing underwriter or underwriters are typically responsible for the following:

a.     Organizing the other participating underwriters and the selling group³

b.     Negotiating the transaction with the issuer of the security

c.     Maintaining the subscription records for the underwriting (such as status of orders from customers)

d.     Maintaining a record of all direct expenses associated with the offering, including marketing and advertising fees, legal fees, and the other costs associated with setting up the syndicate group. These expenses are allocated to the other members of the syndicate on a pro rata basis. Refer to the section "Principal Versus Agent: Costs Associated With Underwriting" in paragraphs 5.7.21–5.7.32 for guidance on accounting for these expenses.

5.6.36 Participating underwriters maintain records of each underwriting participation only to the extent that they are involved. To spread the risk of an underwriting and facilitate its distribution, the underwriters may sell all or part of the securities directly to the public or a selling group that in turn sells the securities to the public. If an issue is not fully sold (in a firm commitment underwriting), the liability is shared among the participating underwriters through either an undivided or divided arrangement. An undivided liability is an arrangement whereby each member of an underwriting syndicate is liable for its proportionate share of unsold securities in the underwriting account regardless of the number of securities it has previously sold. A divided liability is an arrangement whereby each member is liable only for its "divided" or fixed share of the securities and not for any additional unsold securities beyond that amount. Selling groups are not underwriters and have no obligation to sell the securities allocated to them. Accordingly, they are entitled only to a selling concession.

5.6.37 The difference between the price paid by the broker-dealer to the issuer for the securities and the price paid by the public for the securities (the gross underwriting spread) represents the underwriters' and selling groups’ compensation for the risk and cost of selling the issue. The gross underwriting spread is generally apportioned between the underwriters and selling group and represents the compensation for one or more of the following services, which are specified in the underwriting agreement or term sheet:

a.     Management underwriting services. Underwriting services performed by the manager or co-managers (usually referred to as the lead or co-lead) in organizing the syndicate of underwriters and maintaining the records for the distribution (typically 20 percent of the spread)

b.     Underwriting services. Underwriting services performed by the underwriting participants (other than the lead managers) in committing to buy a specified portion of the issue and thereby assume the associated risk (typically 20 percent of the spread)

c.     Selling concession services. Underwriting services performed by all the underwriters in selling the offering (typically 60 percent of the spread)

It should be noted that the split can be any combination agreed upon contractually and would not change the gross underwriting spread.

5.6.38 Underwriting revenues should be accounted for using the five-step revenue recognition model within FASB ASC 606.

5.6.39 In certain transactions, the issuer grants the underwriters the option to sell investors more securities than originally planned by the issuer. This option is legally referred to as an overallotment option and is commonly referred to as a "greenshoe option." The overallotment option is typically exercised when the demand for a security issue proves higher than expected and in situations in which the offering is "oversubscribed" by investors. The exercise of this option is dependent on the trading activity of the underwritten shares, and the option is usually exercised to cover a short position. The broker-dealer is not obligated to exercise this option, and the exercise is solely at the discretion of the broker-dealer.

5.6.40 A broker-dealer should evaluate whether an overallotment option meets the requirements of a derivative contract under FASB ASC 815, Derivatives and Hedging. A broker-dealer will need to assess the facts and circumstances of the underwriting transaction in determining whether the overallotment meets the requirements of a derivative contract under FASB ASC 815. If the broker-dealer concludes that the overallotment option is a derivative contract, the derivative contract should be accounted for under FASB ASC 815 and is therefore outside the scope of FASB ASC 606.

5.6.41 If the broker-dealer determines that the overallotment is not a derivative contract, refer to paragraph 5.6.52 on the accounting for the overallotment option under FASB ASC 606.

5.6.42 In addition to exercising the overallotment option, broker-dealers may also purchase and sell shares directly in the market subsequent to the offering in an effort to stabilize fluctuating share prices by increasing or decreasing the supply of shares according to initial public demand. The broker-dealer is not contractually obligated to purchase and sell shares in the market. These stabilization activities are undertaken by the broker-dealer as part of the capital markets activities and there is no transfer of control of goods or services (that is, there is no additional capital raised as a result of stabilization activities). Although the issuer may benefit from market stabilization activities, these activities are undertaken to benefit the broader capital markets as well as the broker-dealer, and therefore, in accordance with FASB ASC 606-10-25-16, FinREC believes these activities do not represent an implied promise. All revenues associated with price stabilization conducted in the secondary market are not within the scope of FASB ASC 606 and should be recognized in accordance with FASB ASC 860, Transfers and Servicing, and FASB ASC 940, Financial Services—Brokers and Dealers, because these revenues are related to proprietary trading activities. Refer to the section "Scope" in paragraphs 5.7.01–5.7.04.

5.6.43 A broker-dealer enters an underwriting agreement when engaged in securities underwriting. The contract is commonly between a syndicate group, including the broker-dealer, and the issuer. A broker-dealer should evaluate the underwriting agreement to determine if the criteria within FASB ASC 606-10-25-1 are met. Generally, an executed underwriting agreement would illustrate that the contract has been approved, that each party’s rights and payment terms are identified, and that it has commercial substance. Broker-dealers should evaluate the facts and circumstances of the underwriting transaction when assessing the probability of collecting consideration from the issuer. FinREC believes underwriting contracts generally do not meet the criteria in FASB 606-10-25-1 until the underwriting agreement is executed and is legally enforceable.

5.6.44 As discussed in paragraph 5.7.26 of the section "Principal Versus Agent: Costs Associated With Underwriting," FinREC believes that generally, the lead (or managing) underwriter is not acting as a principal to provide underwriting services for the overall issuance, and therefore the lead underwriter should only record underwriting revenues in amounts related to its services and not include any revenues related to the services of the participating underwriters. Therefore, FinREC believes the issuer in a securities underwriting transaction is the customer of each of the underwriters within the syndicate group.

5.6.45 Broker-dealers may be engaged to provide services in addition to being engaged in underwriting securities. Such services could include providing bridge financing, term loans, or credit facilities.

5.6.46 A broker-dealer should consider the guidance in FASB ASC 606-10-25-9 to determine whether these service contracts and an underwriting agreement should be combined and evaluated as a single contract. Two or more contracts entered into at or near the same time with the same customer should be combined if one or more of the following criteria are met:

a.     The contracts are negotiated as a package with a single commercial objective.

b.     The amount of consideration to be paid in one contract depends on the price or performance of the other contract.

c.     The goods or services promised in the contracts (or some goods or services promised in each of the contracts) are determined to be a single performance obligation.

5.6.47 FASB ASC 606-10-15-4 describes how to separate and measure portions of the contract that meet the scope exceptions in FASB ASC 606-10-15-2 before applying the model.

5.6.48 To determine the number of performance obligations in accordance with FASB ASC 606-10-25-14, broker-dealers must identify the promised services, either explicit in the contract or implied through customary business practices, published policies, or specific statements that create a reasonable expectation of the issuer that the broker-dealer will transfer the service.

5.6.49 Typically, broker-dealers promise to perform multiple services in an underwriting agreement that may include a combination of management underwriting services, underwriting services, and selling concession services (seeparagraph 5.6.37).

5.6.50 Promised services between a broker-dealer and an issuer that are distinct represent a performance obligation. Pursuant to FASB ASC 606-10-25-19, a service is distinct if (a) the customer can benefit from the service either on its own or together with other resources that are readily available to the customer and (b) the entity’s promise to transfer the service to the customer is separately identifiable from other promises in the contract. FASB ASC 606-10-25-21 provides guidance for determining whether a service to a customer is separately identifiable.

5.6.51 Although a broker-dealer may perform different roles in the underwriting process, these services are essentially the same; the promised service is ultimately to raise capital for the issuer. These services are highly interrelated in that the issuer’s ability to benefit is dependent on the successful completion of all of the individual promised services. FinREC believes the nature of securities underwriting services is raising capital on behalf of the issuer and will generally be accounted for as a single performance obligation.

5.6.52 In determining whether the overallotment option is a separate performance obligation within the underwriting agreement, a broker-dealer will need to evaluate the enforceable rights and obligations of the underwriting agreement. When the overallotment option does not meet the requirements of a derivative contract under FASB ASC 815, FinREC believes the overallotment option is not a separate performance obligation until such option has been exercised (assuming the broker-dealer is not obligated to exercise this option). Upon the exercise of the option, the performance obligation is treated as a contract modification. Paragraphs 10 and 12 of FASB ASC 606-10-25 provide guidance on contract modifications. FASB ASC 606-10-25-10 states

Based on this, FinREC believes an entity should account for the exercise of an overallotment option as a contract modification and a separate contract upon the exercise in accordance with FASB ASC 606-10-25-12 because the services from the issuance of shares under the overallotment option are distinct and priced at the stand-alone selling price of underwriting services (that is, the underwriting fees earned per share for the overallotment option are the same as those for the original issuance).

5.6.53 FASB ASC 606-10-32-2 requires a broker-dealer to determine the transaction price as the amount of consideration it expects to be entitled to in exchange for transferring the service to the customer. Generally, a broker-dealer is able to determine the transaction price based on the gross underwriting spread between the purchase price from the issuer and the sales price to a public investor, which is generally outlined within the executed underwriting agreement. The gross underwriting spread is apportioned to the broker-dealers in accordance with the underwriting agreement, which is generally based on the services provided (that is, management underwriting services, underwriting services, and selling concession services). As discussed in paragraph 5.7.26 of the section "Principal Versus Agent: Costs Associated With Underwriting," FinREC believes that generally, the role of the lead underwriter with regard to services provided by the participating underwriters is that of an agent (that is, arrangement of services). Consequently, in accordance with FASB ASC 606-10-55-38, the lead underwriter should record underwriting revenues net of revenues allocated to the participating members.

5.6.54 Paragraphs 5–13 of FASB ASC 606-10-32 require broker-dealers to evaluate whether the underwriting agreement contains variable consideration, such as performance bonuses, incentives, or discounts. If so, the broker-dealer would need to estimate the amount of variable consideration and include such amount within the transaction price to the extent that it is probable that a significant reversal in cumulative revenue would not subsequently occur when the contingency is resolved. FASB ASC 606-10-32-12 provides factors a broker-dealer should consider when determining the amount of variable consideration to include in the transaction price.

5.6.55 FASB ASC 606-10-32-29 requires broker-dealers to allocate the transaction price to each performance obligation identified in the underwriting agreement based on the relative stand-alone selling prices for the services being provided to the issuer. FASB ASC 606-10-32-43 explains that the transaction price is not reallocated to reflect changes in stand-alone selling price of the services after contract inception.

5.6.56 As noted in paragraph 5.6.51, with the exception of the exercise of the overallotment option, a securities underwriting service will generally have a single performance obligation, which the entire transaction price determined in step 3 will be allocated to. As noted in paragraph 5.6.52, the exercise of the overallotment option should be treated as a separate contract.

5.6.57 In accordance with FASB ASC 606-10-25-27, a performance obligation is satisfied over time if one of the following criteria is met [analysis added]:

a.     The issuer simultaneously receives and consumes the benefits provided by the broker-dealer’s performance as the broker-dealer performs the underwriting service.

A broker-dealer should evaluate if another entity would not need to substantially reperform the work that the broker-dealer has completed to date if the other entity were to provide the securities underwriting services. That is, if another entity replaced the broker-dealer, would the other entity need to substantially reperform the broker-dealer’s performance to date? In a typical securities underwriting arrangement, another entity would generally not rely on the previous broker-dealer’s services to date. Rather, the other entity would perform its own services, which may include its own due diligence of the issuer, sales and marketing activities with its own investors, and its own securities pricing analysis. Therefore, the performance of these activities prior to the underwriter purchasing securities from the issuer typically does not transfer a benefit to the issuer as those tasks are performed.

b.     The broker-dealer’s performance creates or enhances an asset controlled by the issuer as the asset is created or enhanced.

Securities underwriting services do not create or enhance an asset controlled by the issuer.

c.     The broker-dealer’s performance does not create an asset with an alternative use to the broker-dealer, and the broker-dealer has an enforceable right to payment for performance completed to date.

Securities underwriting services are unique to each issuer because the services are based on the issuer’s specific facts and circumstances. Generally, a broker-dealer would incur significant costs in redesigning the underwriting services for another issuer based on that issuer’s specific facts and circumstances. These services would not create an asset that the broker-dealer would be able to use in the future. To meet this requirement, a broker-dealer must also have an enforceable right to payment in an amount that approximates the selling price (that is, recovery of its cost plus a reasonable margin) for services completed to date. In a typical underwriting agreement, a broker-dealer will not have an enforceable right to payment until the consummation of the securities issuance and therefore has no right to payment for the services performed prior to such date.

5.6.58 Based on the analysis in paragraph 5.6.57, FinREC believes securities underwriting transactions generally do not meet any of the requirements for revenue to be recognized over time. Therefore, a broker-dealer would generally recognize securities underwriting revenue at a point in time.

5.6.59 FASB ASC 606-10-25-30 provides indicators for determining the point in time when the issuer obtains control of the securities underwriting services and the broker-dealer’s performance obligation is satisfied, which include the following [analysis added]:

a.     The entity has a present right to payment for the asset (the service).

A broker-dealer has a present right to payment, in the form of the underwriting spread that occurs on the trade date. The trade date is the date the broker-dealer enters into a firm commitment to purchase the securities from the issuer or, in the case of a best efforts arrangement, the date the securities are sold to investors.

b.     The customer has legal title to the asset (the service).

The issuer has legal title to the capital raised (that is, the underwriting proceeds), which is a result of the consummation of the underwriting services provided, upon the purchase of the securities from the issuer, which occurs on the trade date.

c.     The entity has transferred physical possession of the asset (the service).

Not applicable because underwriting services do not involve the transfer of a physical asset.

d.     The customer has the significant risks and rewards of ownership of the asset (the service).

The issuer has the significant risks and rewards of the securities underwriting services when those securities are purchased by the underwriter (on the trade date). That is, the issuer is entitled to the capital raised and the issuer may also incur certain obligations to the investors (such as principal and interest payments to bond holders or dividends to preferred stock holders) on the trade date.

e.     The customer has accepted the asset (the service).

Although generally there are no acceptance provisions in underwriting agreements, the services are satisfied when the underwriter purchases the securities from the issuer (on the trade date).

5.6.60 Based on the analysis in paragraph 5.6.59, FinREC believes the date on which the underwriter purchases securities (the trade date) from the issuer is the appropriate point in time to recognize revenue for securities underwriting transactions. This conclusion is consistent with the concept of transfer of control related to commission revenues (as discussed in the section "Commission Income" in paragraphs 5.6.01–5.6.32), whereby control is transferred on the trade date. In an underwriting arrangement there are no significant actions that an underwriter takes subsequent to the trade date.

5.6.61 The following example is meant to be illustrative, and the actual application of the guidance in FASB ASC 606 should be based on the facts and circumstances of an entity’s specific situation.

Example 5-6-1

Broker-dealer A negotiates a contract with Customer B on April 1, 20X6, to underwrite Customer B’s equity shares on a firm commitment basis. The offering consists of 6,000,000 equity shares and provides Broker-dealer A with an overallotment option to purchase up to an additional 900,000 shares within 30 days of the equity offering. The initial offering price to the public is $20 and the underwriting discount is $.50 (that is, the underwriter purchases the equity shares from Customer B for $19.50 per share). On April 8, 20X6, the underwriting contract is executed and becomes legally enforceable. In connection with the execution of the contract, Broker-dealer A purchases the equity shares from the issuer (that is, the trade date) resulting in the consummation of the securities issuance. Broker-dealer A also elects to exercise its overallotment option and purchases an additional 900,000 shares from the issuer on April 8, 20X6.

Identify the Contract With a Customer

Based on the preceding facts, the underwriting agreement between Broker-dealer A and Customer B includes a contract that meets the criteria in FASB ASC 606-10-25-1. The underwriting agreement has been approved, each party’s rights and payment terms are identifiable, the contract contains commercial substance, and collectibility is probable on April 8, 20X6. Furthermore, as described in paragraph 5.6.52, Broker-dealer A’s subsequent exercise of its overallotment option represents a contract modification resulting in a separate contract.

Identify the Performance Obligations

Based on the preceding facts, the original contract includes a single performance obligation to raise capital for Customer B. The overallotment option was exercised and issued concurrently with the contractually required shares, resulting in a contract modification and a separate contract. Therefore, Broker-dealer A also has the enforceable rights and obligations to purchase the overallotment securities on April 8, 20X6.

Determine the Transaction Price

Based on the preceding facts, the transaction price of the original contract is calculated as the underwriting discount amount of $3,000,000 (6,000,000 shares × $.50) and the transaction price of the overallotment contract is $450,000 (900,000 shares × $.50).

Allocate the Transaction Price to the Performance Obligations

The transaction price of $3,000,000 is allocated to the single performance obligation in the original contract, and the transaction price of $450,000 is allocated to the single performance obligation in the overallotment contract.

Recognize Revenue

Broker-dealer A would recognize underwriting revenue in the amount of $3,450,000 ($3,000,000 plus $450,000) on April 8, 20X6, which is the date Broker-dealer A raised capital on behalf of the issuer.

5.6.62 As discussed in FASB ASC 940-20-05-4, soft-dollar arrangements generate commission income for the broker-dealer. Many of these arrangements are oral, and the value of the research to be provided is typically based on a percentage of commission income generated from trade order flow from the customer. Research includes research reports and less traditional items such as use of a research analyst’s time to answer customer questions or paying the subscription costs of research equipment (such as a Bloomberg terminal) on behalf of the customer. Soft-dollar customers are typically institutional investors or money managers. Soft-dollar research may be generated either internally by the broker-dealer or purchased by the broker-dealer from a third party. Because soft dollar arrangements vary by broker-dealer and sometimes by customer, each arrangement needs to be evaluated using the criteria in FASB ASC 606.

5.6.63 Soft-dollar arrangements may be in a stand-alone agreement or included in an agreement with clearing, custody, or execution services. To determine whether the agreement meets the definition of a contract with a customer within the scope of the standard, a broker-dealer should consider the required criteria in FASB ASC 606-10-25-1. Soft-dollar arrangements would meet the definition of a contract if all of the following criteria from FASB ASC 606-10-25-1 are met:

a.     Parties have approved the contract.

b.     The services to be provided are explicitly stated.

c.     Consideration to be paid in exchange for such service is explicitly stated.

d.     The arrangement has commercial substance.

e.     It is probable that the entity will collect the consideration to which it will be entitled.

Furthermore, a broker-dealer should also consider FASB ASC 606-10-25-2 to determine whether the contract creates enforceable rights and obligations, especially in arrangements in which the soft-dollar contract is oral and not accounted for as a single contract (as discussed later) with the clearing, custody, or execution contract.

5.6.64 For soft-dollar arrangements included in a separate agreement that is entered into at or near the same time as a clearing, custody, or execution agreement (or other agreement) with the same customer, a broker-dealer must evaluate whether these agreements should be accounted for as a single contract based on meeting any of the criteria at FASB ASC 606-10-25-9. Because the value of research to be provided to a customer in soft-dollar arrangements is typically based on a percentage of commission income generated from trade order flow from the customer, FinREC believes that soft-dollar arrangements will generally be combined with clearing or execution agreements and accounted for as a single contract. Therefore, broker-dealers should incorporate the analysis in the section "Commission Income" in paragraphs 5.6.01–5.6.32, regarding whether the purchase of research is an optional purchase under FASB ASC 606-10-55-42 and provides a material right to the customer.

5.6.65 When soft-dollar arrangements are combined with clearing, custody, or execution agreements and accounted for as a single contract, FinREC believes the research services are generally a separate performance obligation from the clearing, custody, or execution services. A service is distinct if the customer can benefit from the service on its own and the broker-dealer’s promise to transfer the service is separately identifiable from other promises in the contract. Research services meet the definition of being distinct because customers can benefit from the research services on their own and research services are separately identifiable from the clearing, execution, or custody services (that is, they are not inputs to a combined output in accordance with FASB ASC 606-10-25-21). In addition, research services are often separately identified in the contract. If determined to be distinct, the promised services should therefore be accounted for separately. Clearing, execution, or custody performance obligations are discussed in the section "Commission Income" in paragraphs 5.6.01–5.6.32. This section will focus on the research service performance obligations when included within a clearing or execution services contract. For custody services, refer to the section "Commission Income."

5.6.66 If the broker-dealer provides the customer with the option of choosing research reports to be provided at a future date or research in the form of access to systems (for example, Bloomberg), the option presents the customer with a material right to the future research.

5.6.67 Rather than providing research services to a customer or obtaining research from a third party and transferring it to the customer, a broker-dealer may instead directly pay the third party on behalf of the customer for research services provided by third parties. In this situation, the broker-dealer’s performance obligation is to arrange for those goods or services to be provided by the third party. See paragraphs 5.6.71–5.6.72 for additional discussion. Through the remainder of this section, the services noted in the prior sentences will be considered and referred to as research services.

5.6.68 When research services are combined with clearing or execution agreements and accounted for as a single contract, the transaction price is generally the commission fee defined in the contract between the broker-dealer and the customer. A typical transaction price is determined based on the contractually agreed-upon commission rates multiplied by the quantity of trades executed or cleared.

5.6.69 A typical clearing or execution contract generally can be terminated at will by either the broker-dealer or the customer. FASB ASC 606-10-25-3 explains that when a contract has no fixed duration and can be terminated or modified by either party at any time, an entity should apply the guidance in FASB ASC 606 to the duration of the contract (that is, the contractual period) in which the parties to the contract (in this case, both parties) have present enforceable rights and obligations. Further, FASB ASC 606-10-32-4 notes that when determining the transaction price, an entity shall assume that the goods or services will be transferred to the customer as promised in accordance with the existing contract and that the contract will not be cancelled, renewed, or modified. Therefore, only enforceable claims against the customer should be included in the determination of the transaction price of a contract. FinREC believes in many instances, due to at-will termination rights, entities could consider each executed trade, together with the associated research services or material right to such services in a soft-dollar arrangement, to be a separate contract and the fees associated with such trade to be the transaction price under FASB ASC 606. The amounts collected under these contracts are typically not refunded once the contract is terminated, but this practice may vary by entity. Additional consideration and analysis may also be required for brokerage contracts with a specified term (such as one year) or minimum quantity of trades.

5.6.70 Research services provided by the broker-dealer may be internally generated or obtained by the broker-dealer from a third party and transferred to the customer (in which case, they would be considered a performance obligation) or they may be services provided by third parties that are paid directly by the broker-dealer on behalf of the customer (in which case, arranging for those goods or services to be provided by the third party would be considered a performance obligation as noted previously). When the broker-dealer pays third parties on behalf of the customer, the broker-dealer needs to determine if the broker-dealer is acting as an agent or a principal (see paragraphs 5.6.71–5.6.72).

5.6.71 When a third party is used to provide research services, the principal versus agent guidance in paragraphs 36–40 of FASB ASC 606-10-55 should be considered. The broker-dealer may be considered a principal if it controls the research from the third party, regardless of whether the research is provided to the customer directly by the third party or through the broker-dealer. A broker-dealer should consider the indicators that an entity controls the research before it is transferred to the customer in FASB ASC 606-10-55-39 in making this assessment. If the broker-dealer determines that it is acting as the principal, the revenue should be reported gross of any expenses (for example, the cost of the related research).

5.6.72 The broker-dealer may be considered an agent if it does not control the research services before they are transferred to the customer. In this circumstance, the broker-dealer should include the net fee it expects to be entitled to for arranging to have another party provide the research services to the customer in the transaction price. For example, assume a broker-dealer acting as an agent pays $40,000 to Bloomberg on behalf of its customer for the use of a Bloomberg terminal by its customer. In this example, the broker-dealer would report revenue, if any, for the difference between the $40,000 paid to Bloomberg and the transaction price allocated to the research services.

5.6.73 Paragraphs 15–20 of FASB ASC 606-10-32 require that if the timing of payment agreed to by the broker-dealer and the customer provides the customer with a significant benefit of financing the services, the transaction price should be adjusted for the significant financing component. FASB ASC 606-10-32-17 includes factors that would indicate that there is not a significant financing component and, as a result, the transaction price should not be adjusted. FinREC believes the transaction price in these arrangements would generally not be adjusted because either (1) a substantial amount of the consideration promised by the customer is paid in advance and the timing of the transfer of the goods or services is at the discretion of the customer (FASB ASC 606-10-32-17a) or (2) the period between when the entity transfers the research and when the customer pays for it will be one year or less (which is often the case for soft-dollar arrangements), in which case the broker-dealer may apply the practical expedient (FASB ASC 606-10-32-18).

5.6.74 When research services are combined with clearing or execution agreements and accounted for as a single contract and the research services are considered a separate performance obligation, the broker-dealer should determine the stand-alone selling price of the trade execution or clearing and research or agency services and allocate the transaction price in proportion to those stand-alone selling prices. Paragraphs 31–35 of FASB ASC 606-10-32 and FASB ASC 606-10-55-44 provide guidance on allocating the transaction price to multiple performance obligations, including those associated with material rights for which the likelihood of exercise should be considered.

5.6.75 For each performance obligation, the broker-dealer should determine whether that performance obligation is satisfied over time. If the criteria listed in FASB ASC 606-10-25-27 for performance obligations satisfied over time are not met, then the performance obligation is considered to be satisfied at a point in time.

5.6.76 In regard to the research services performance obligation, this analysis will vary depending on the nature of the research services provided. For example, if the broker-dealer provides ongoing access to a research analyst throughout the arrangement term, the performance obligation may be satisfied over time. However, if the broker-dealer provides a fixed number of analyst reports, the performance obligation may be satisfied at the point in time that each report is provided.

5.6.77 The broker-dealer should consider the guidance in FASB ASC 606-10-55-48 to address the impact of nonrefundable amounts not used by customers ("breakage").

5.6.79 A broker-dealer will enter into an M&A advisory contract that may not contain a duration and that may be terminable at will by either party without cause. The contract may contain nonrefundable retainer fees or success fees, which may be fixed or represent a percentage of value that the customer receives if and when the corporate finance activity (for example, the sale of a business) is completed (hereafter referred to as "success fees"). In some cases, there is also an "announcement fee" that is calculated on the date that a transaction is announced based on the price included in the underlying sale agreement. In most cases, the retainer fees, announcement fee, or other milestone fees reduce any success fee subsequently invoiced and received upon the completion of the corporate finance activity. In addition, the customer may require a bespoke valuation or "fairness opinion" in conjunction with the sale of a business. This service can be performed by the broker-dealer as part of, or separate from, the advisory contract with the customer, or by a separate broker-dealer.

5.6.80 A broker-dealer should evaluate whether the M&A advisory contract meets the definition of a contract with a customer based on the criteria in FASB ASC 606-10-25-1. An M&A advisory contract is accounted for in accordance with the guidance in FASB ASC 606 only when all of the following criteria are met:

a.     The contract has been approved (in writing, orally, or in accordance with customary business practices) and the parties are committed to perform their respective obligations.

b.     The broker-dealer can identify each party’s rights.

c.     The broker-dealer can identify the payment terms.

d.     The contract has commercial substance.

e.     Collection of the consideration is probable.

5.6.81 When assessing the collectibility criterion, a broker-dealer will need to consider the customer’s ability and intent to pay the consideration when it becomes due. Assuming the collectibility criteria are met, FinREC believes that, generally, a signed contract between two parties in an agreement to provide M&A advisory services will meet the definition of a contract with a customer under FASB ASC 606. If either the broker-dealer or the customer has the right to unilaterally cancel the contract without paying a substantive termination penalty, the contract term might be day to day (or minute to minute). However, when a M&A advisory contract includes a nonrefundable retainer payment, a broker-dealer will need to evaluate whether the nonrefundable fee relates to the transfer of a good or service. FinREC believes that, typically, a retainer fee represents an advance payment for future goods or services that would be part of the consideration allocable to the goods or services in the M&A advisory contract and would be recognized when or as the goods or service to which the consideration is allocated is transferred to the customer.

5.6.82 M&A advisory contracts may have one or more services that meet the definition of a performance obligation. To determine the performance obligations included in an M&A advisory services contract, a broker-dealer is required to evaluate the nature of the promise or promises to the customer. As noted in FASB ASC 606-10-25-17, activities that a broker-dealer undertakes to fulfill a contract that do not transfer goods or services to the customer are not performance obligations.

5.6.83 The assessment of what is the promised service in an M&A advisory contract requires judgment. For example, the nature of a promise in an M&A advisory contract may be to successfully broker the sale of a business. In other contracts, the nature of a promise may be to provide advice to a company that may or may not culminate in the purchase or sale of a business.

5.6.84 For example, a broker-dealer may perform tasks common to an M&A advisory agreement, such as the following:

a.     Developing strategies and assisting the customer in preparing financial forecasts and analysis (due diligence)

b.     Providing research and analysis on potential targets, including financial forecasting, cultural fit analysis, and so on

c.     Providing strategy and negotiation assistance

d.     Assisting with internal and external communications regarding the transaction

The broker-dealer should consider whether such activities transfer a good or service (or multiple goods or services) to the customer, or whether the performance of these services helps to fulfill one overall promise made to the customer.

5.6.85 Per FASB ASC 606-10-25-14, at contract inception, a broker-dealer shall assess the goods or services promised in a contract with a customer and shall identify, as performance obligations, each promise to transfer to the customer either

a.     a good or service (or a bundle of goods or services) that is distinct or

b.     a series of distinct goods and services that are substantially the same and that have the same pattern of transfer to the customer.

If a promised good or service is not distinct, a broker-dealer shall combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. In some cases, that would result in the broker-dealer accounting for all the services promised in a contract as a single performance obligation.

5.6.86 In applying FASB ASC 606, a broker-dealer should evaluate all of the goods or services promised in the M&A advisory contract, including those implied by a broker-dealer’s customary business practice, to identify the separate performance obligations. A broker-dealer should carefully consider whether each good or service is capable of being distinct and is distinct within the context of the contract in accordance with paragraphs 19–22 of FASB ASC 606-10-25. For example, the task of providing due diligence services could be considered capable of being distinct. However, in an arrangement in which the customer engages the broker-dealer to broker the sale of a business, the broker-dealer should evaluate whether those due diligence services are distinct in the context of the overall contract.

5.6.87 FASB ASC 606-10-25-21 includes certain factors to evaluate whether the promise to transfer the good or service is distinct in the context of the contract. For example, a good or service that is highly dependent on, or highly interrelated with, other goods or services promised in the contract may not be separately identifiable.

5.6.88 When it is determined that a promise is to provide consulting or advisory services and the criteria for recognizing revenue over time have been met, after assessing which services are distinct in the context of the contract, a broker-dealer should give consideration to whether each of the services is considered a "series of distinct services" that are substantially the same and that have the same pattern of transfer to the customer per FASB ASC 606-10-25-15. This is an important determination in an M&A advisory contract because it affects the number of performance obligations and the pattern of measuring the progress toward satisfying the performance obligations. Under FASB ASC 606-10-25-15, if the otherwise distinct services are substantially the same and transfer to the customer over time using the same method of measuring progress, then an entity would account for them together as a single performance obligation.

5.6.89 When assessing whether providing the customer with a fairness opinion in conjunction with advising on the sale of a business is a separate performance obligation, the broker-dealer should consider whether a good or service is transferred to the customer. FinREC believes that a fairness opinion should generally be considered a distinct good or service accounted for as a separate performance obligation, based on it meeting both criteria in FASB ASC 606-10-25-19:

a.     The fairness opinion can be obtained from another broker-dealer outside of the M&A advisory services contract.

b.     The fairness opinion is not an input to a combined output of selling the business. That is, the fairness opinion and M&A advisory services do not modify or customize each other, are not integrated into a combined output, and are not highly interrelated (meaning the broker-dealer would be able to fulfill its promise to transfer the M&A advisory services independent from its promise to subsequently provide the fairness opinion).

5.6.90 The balance of this section assumes that (with the exception of a fairness opinion) the broker-dealer has concluded that the goods and services provided under an M&A advisory agreement constitute a single performance obligation.

5.6.91 The transaction price is the amount of consideration to which a broker-dealer expects to be entitled in exchange for transferring promised goods or services to a customer. In a typical M&A advisory contract, there may be both a fixed and a variable component. The fixed component usually relates to the nonrefundable retainer fees and the fairness opinion (if part of the same contract). The variable component usually relates to a success fee that becomes due upon completion of the transaction or an announcement fee that becomes due upon the announcement of the transaction.

5.6.92 The amount of variable consideration that the broker-dealer can include in the transaction price is limited to the amount for which it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainties related to the variability are resolved.

5.6.93 FASB ASC 606-10-32-12 provides several factors to consider when assessing whether variable consideration should be constrained and to what degree it should be constrained. Factors that could increase the likelihood or the magnitude of a revenue reversal include, but are not limited to, any of the following:

a.     The amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgment or actions of third parties, weather conditions, and a high risk of obsolescence of the promised good or service.

b.     Resolution of the uncertainty about the amount of consideration is not expected for a long period of time.

c.     The entity has limited experience with similar types of contracts or the experience has limited predictive value.

d.     The entity has a practice of offering a broad range of price concessions or changing payment terms and conditions in similar circumstances for similar contracts.

e.     There is a large number and broad range of possible outcomes.

Based on these factors, particularly the first and last factors, it may be difficult for a broker-dealer to assume that a transaction will be completed and that it is probable that including the variable fee (for example, a success fee) in the transaction price will not result in a significant revenue reversal when the uncertainty related to the variable consideration is resolved.

5.6.94 Estimates of variable consideration can change as facts and circumstances evolve. A broker-dealer should continually revise its estimates of variable consideration at each reporting date during the contract period.

5.6.95 FASB ASC 606-10-32-7a explains that in addition to variable consideration stated in a contract, variability relating to consideration promised by a customer may arise when the customer has a valid expectation that a broker-dealer may accept an amount of consideration less than the price stated in the contract based on the broker-dealer’s customary business practices, published policies, or specific statements. That is, it is expected that the entity will offer a price concession. Broker-dealers sometimes do not invoice customers for reimbursable expenses or fees to which they are entitled in the contract for purposes of maintaining the client relationship for future engagements. The broker-dealer should therefore consider such price concessions in its estimation of variable consideration.

5.6.96 Once the performance obligations have been identified and the transaction price has been determined, the broker-dealer will allocate the transaction price to the distinct performance obligations. If the broker-dealer determines there are multiple performance obligations in the M&A advisory contract (for example, a promise to provide a fairness opinion and to broker the sale of a business), the broker-dealer would then allocate the transaction price to each performance obligation.

5.6.97 In accordance with FASB ASC 606-10-32-29, the transaction price should be allocated to the performance obligations based on their relative stand-alone selling prices. If the broker-dealer determines that the stand-alone selling price of an item is not directly observable, it should be estimated. FASB ASC 606 does not prescribe or prohibit any particular method for estimating the stand-alone selling price, as long as the method results in an estimate that faithfully represents the price that an entity would charge for the goods or services if they were sold separately.

5.6.98 The transaction price is generally allocated to all performance obligations in a contract based on their relative stand-alone selling prices. However, variable consideration might be attributable to one or more, but not all, of the performance obligations in an arrangement. Variable consideration (and subsequent changes in the estimate of that consideration) should be allocated entirely to a single performance obligation only if both of the following criteria are met in FASB ASC 606-10-32-40:

a.     The terms of a variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service).

b.     Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective...when considering all of the performance obligations and payment terms in the contract.

5.6.99 The guidance in FASB ASC 606-10-32-40 may apply to an M&A advisory arrangement in which there is a success fee (that is, variable consideration). For example, in an M&A advisory arrangement that includes multiple performance obligations (such as to broker or to advise on the sale of the business and to issue a fairness opinion), the success fee may relate entirely to the promise to broker or to advise on the sale of the business. This may meet the allocation objective if another fixed fee that is consistent with the stand-alone selling price of the fairness opinion is allocated to that performance obligation.

5.6.100 To meet the allocation objective as stated in FASB ASC 606-10-32-40b, the FASB staff noted in a July 2015 Revenue Transition Resource Group meeting (paragraph 35 of TRG Agenda Ref. No. 44, July 2015 Meeting — Summary of Issues Discussed and Next Steps) that stakeholders should apply reasonable judgment to determine whether the allocation results in a reasonable outcome. Stand-alone selling prices in some cases might be used to determine the reasonableness of the allocation, but they are not required to be used.

5.6.101 As described previously, the amount of variable consideration a broker-dealer can include in the transaction price is limited to the amount for which it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainties related to the variability are resolved.

5.6.102 If other advisory activities such as those discussed in paragraph 5.6.82 do not represent a separate performance obligation because no good or service is transferred to the customer or because the broker-dealer concludes the good or service is highly interrelated with or dependent on other goods or services in the contract, none of the transaction price would be allocated to those individual activities.

5.6.103 Revenue is recognized when a performance obligation is satisfied, which is when the promised goods or services are transferred to the customer. Transfer occurs when the customer takes control of the promised good or service.

5.6.104 In accordance with FASB ASC 606-10-25-24 a broker-dealer should identify whether performance obligations are satisfied over time or at a point in time. To make this determination, a broker-dealer should first assess the criteria for over-time recognition in FASB ASC 606-10-25-27, which states the following:

a.     The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs...

b.     The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced...

c.     The entity’s performance does not create an asset with an alternative use to the entity...and the entity has an enforceable right to payment for performance completed to date.

5.6.105 FinREC believes it is unlikely that M&A advisory arrangements will meet the criterion in FASB ASC 606-10-25-27b because the performance does not create or enhance a customer-controlled asset nor meet the criterion in FASB ASC 606-10-25-27c because these engagements generally do not provide for an enforceable right to payment for performance completed to date. However, the criterion in FASB ASC 606-10-25-27a may be met for certain arrangements. However, the criterion in FASB ASC 606-10-25-27a may be met for certain arrangements. FASB ASC 606-10-55-5 notes that "for some types of performance obligations, the assessment of whether a customer receives the benefits of an entity’s performance as the entity performs and simultaneously consumes those benefits as they are received will be straightforward." For other types of performance obligations, FASB ASC 606-10-55-6 states "an entity may not be able to readily identify whether a customer simultaneously receives and consumes the benefits from the entity’s performance as the entity performs," and it provides the following additional guidance to evaluate whether a customer simultaneously receives and consumes the benefits from the entity’s performance as the entity performs:

a.     Disregard potential contractual restrictions or practical limitations that otherwise would prevent the entity from transferring the remaining performance obligation to another entity.

b.     Presume that another entity fulfilling the remainder of the performance obligation would not have the benefit of any asset that is presently controlled by the entity and that would remain controlled by the entity if the performance obligation were to transfer to another entity.

5.6.106 The application of the concept in FASB ASC 606-10-55-6 was further discussed in TRG Agenda Ref. No. 46, Pre-production Activities. Paragraph 10 of TRG Agenda Ref. No. 46 states the following:

Although this guidance in TRG Agenda Ref No. 46 was provided in the context of preproduction activities in a manufacturing arrangement, the guidance may be helpful when evaluating whether another entity would be required to substantially re-perform the work that the broker-dealer has completed to date if the other entity were to fulfill the remaining performance obligation to the customer.

5.6.107 FinREC believes the obligation by a broker-dealer to provide a fairness opinion that is a separate performance obligation would likely be recognized at a point in time when the fairness opinion is provided to the customer. That is, the customer is not simultaneously receiving and consuming the benefit of the entity’s performance to provide the fairness opinion in accordance with FASB ASC 606-10-25-27a, the services would not meet the criterion in FASB ASC 606-10-25-27b, and it is unlikely the services would meet the criterion in FASB ASC 606-10-25-27c.

5.6.108 In regards to other performance obligations in M&A advisory engagements, entities will need to determine whether any of the criteria for recognizing revenue over time in FASB ASC 606-10-25-27 are met. As noted previously, FinREC believes it is unlikely that M&A advisory arrangements will meet the criteria in FASB ASC 606-10-25-27b or c; however, FASB ASC 606-10-25-27a may be met for some arrangements. The determination about whether the criterion in FASB ASC 606-10-25-27a is met may require significant judgment and should take into consideration all the facts and circumstances in the arrangement, including the specific contract terms (including payment terms), nature of the services being provided to the customer, knowledge and information provided to the customer or retained by the broker-dealer, and other relevant details of the arrangements.

5.6.109 If the broker-dealer determines that the criterion in FASB ASC 606-10-25-27a is met for a performance obligation, revenue allocated to the performance obligation (subject to the constraint in FASB ASC 606-10-32-11) would be recognized over time as performance occurs using an appropriate measure of progress as determined in accordance with paragraphs 31–37 of FASB ASC 606-10-25.

5.6.110 If the broker-dealer determines that the criterion in FASB ASC 606-10-25-27a is not met for a performance obligation, revenue (including milestone payments, retainer fees, announcement fees, success fees, or other fees) allocated to the performance obligation (subject to the constraint in FASB ASC 606-10-32-11) would be recognized at the point in time the broker-dealer determines control of the service transfers to the customer in accordance with FASB ASC 606-10-25-30 (likely at the point in time that performance under the M&A advisory engagement is completed or the contract is cancelled).

5.6.111 Managed accounts or other pooled investment vehicles (collectively, "funds") enter into agreements with distributors to distribute (that is, sell) shares to investors.⁴ There are different ways distributors may be compensated for the same service. Fees may be paid up front, over time (for example, 12b-1 fees) on the basis of a contractual rate applied to the monthly or quarterly market value of the fund (that is, net asset value [NAV]), upon investor exit from the fund (that is, a contingent deferred sales charge [CDSC]), or as a combination thereof.⁵

5.6.112 Up-front, ongoing, and CDSC fees are discussed later as "distribution fees."

5.6.113 Distributors may incur costs such as commission charges for the performance of sales or distribution services by sales representatives (their employees) or third-party distributors on their behalf.

5.6.114 Selling or distribution commissions and fees are generally stated in written agreements such as selling or distribution agreements. To determine whether the written agreement meets the definition of a contract with a customer within the scope of the revenue standard, an entity should consider the criteria in FASB ASC 606-10-25-1:

a.     The contract has been approved (in writing, orally, or in accordance with customary business practices), and the parties are committed to perform their respective obligations.

b.     The distributor can identify each party’s rights.

c.     The distributor can identify the payment terms.

d.     The contract has commercial substance.

e.     Collection of the consideration is probable.

5.6.115 FASB ASC 606 defines a customer as a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration. In this regard, a fund typically contracts with a distributor to, over a period of time, sell or distribute securities on its behalf (in exchange for specified commissions and fees), which is the distributor’s ordinary business activity. Given this contractual relationship and consideration of the indicators in the section "Determining the Customer in an Asset Management Arrangement" in paragraphs 4.1.01–4.1.10 of chapter 4, "Asset Management," FinREC believes that the fund will generally be the distributor’s customer for purposes of applying FASB ASC 606. For purposes of this section, the fund is considered the customer under the selling or distribution contract with the distributor. However, entities should consider their own contracts and related facts and circumstances when identifying the customer.

5.6.116 Distribution contracts are typically terminable upon notice by either party without incurring a significant termination penalty. When the distributor gives or is given notice of termination, the contract ceases at the end of the notice period, typically 60–90 days. In the event that the distributor is terminated by the fund, the distributor may still be entitled to ongoing fees as long as the investors it placed in the fund remain invested. These ongoing fees terminate only if and when the investor terminates the distributor as its broker of record. FASB ASC 606-10-25-3 explains that when a contract has no fixed duration and can be terminated or modified by either party at any time, an entity should apply the guidance in FASB ASC 606 to the duration of the contract (that is, the contractual period) in which the parties to the contract have present enforceable rights and obligations.

5.6.117 Services promised in a selling or distribution contract generally include (1) the sale of fund interests, (2) marketing services, and (3) other shareholder services. Marketing services may include development, formulation, and implementation of marketing and promotional activities and preparation, printing, and distribution of prospectuses and reports. In some cases, distribution contracts may also include ongoing shareholder services such as processing of shareholder transactions and the maintenance of shareholder records. Depending on the promises within a selling or distribution contract, the distributor may identify a single performance obligation or multiple performance obligations.

5.6.118 Each distributor should consider the specific terms of a given selling or distribution contract and identify performance obligations as defined in FASB ASC 606-10-25-14. In order to evaluate the performance obligations included in a selling or distribution contract, the distributor should identify the goods or services promised to the customer and evaluate the nature of these promises to the customer. In making this assessment, consideration may need to be given to the guidance on combination of contracts in FASB ASC 606-10-25-9 when the different types of services are contracted separately but at or near the same time with the customer.

5.6.119 As discussed in FASB ASC 606-10-25-14, a performance obligation is a promise to transfer to the customer either

a.     a good or service (or a bundle of services) that is distinct or

b.     a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.

5.6.120 Each service included in a contract should be analyzed under paragraphs 19–22 of FASB ASC 606-10-25 to determine whether it is a distinct service that represents a performance obligation that should be accounted for separately.

5.6.121 The nature of the distributor’s overall promise in the contract is to provide marketing services in conjunction with the sales of shares. In order to sell shares to investors, the distributor may develop and formulate marketing materials related to the fund offering. Generally, the marketing and selling of the shares are performed by the same distributor where the distributor is paid only upon a sale of shares with no separate fee for marketing.

5.6.122 Because the success of selling shares is highly dependent on the marketing efforts, sales and marketing are highly interrelated and interdependent on one another because the sole purpose of marketing is to sell shares. The distributor integrates marketing and selling services to provide the combined output of selling the shares for which the customer has contracted. In other words, the entity is using the services as inputs to deliver the combined output specified by the customer. Therefore, FinREC believes both sales and marketing generally would not be considered separately identifiable based on FASB ASC 606-10-25-19b, 606-10-25-21a, and 606-10-25-21c. However, individual facts and circumstances of specific agreements and arrangements should be carefully evaluated.

5.6.123 As noted in paragraph 5.6.117, a distribution agreement generally includes (1) the sale of fund interests, (2) marketing services, and (3) other shareholder services. As noted in paragraph 5.6.122, FinREC believes that, generally, the sale and marketing services are combined to make one performance obligation. Judgment and additional analysis are required when determining whether shareholder services meet the definition of a performance obligation that is separately identifiable under FASB ASC 606-10-25-21. See paragraphs 5.6.133 and 5.6.137.

5.6.124 A distributor’s compensation for selling or distribution services is established by the contract between the distributor and the fund and is normally included in the prospectus written by the fund. Contracts may be structured with distribution fees that become determinative (that is, uncertainty is resolved) at different times, including up front, over time, upon an investor’s redemption, or a combination thereof.

5.6.125 Up-front distribution fees are generally a fixed percentage of the share price. In this manner, the transaction price for up-front fees is fixed at the date the shares are sold to the investor.

5.6.126 A distributor’s compensation from ongoing distribution fees received is generally variable. The fee is generally calculated as a fixed percentage of the then-current value of the shares and received on an ongoing periodic basis so long as the investor remains invested in the fund.⁶ The total amount of compensation is dependent on the value of the shares at future points in time as well as the length of time the investor remains in the fund.

5.6.127 A distributor’s compensation from CDSCs is generally variable. CDSCs may be paid upon an investor’s exit from the fund. The amount of compensation generally varies based on the length of time the investor remained in the fund as well the value of the shares at the time of redemption.

5.6.128 FASB ASC 606-10-32-11 requires that an entity include variable consideration in the transaction price only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

5.6.129 FASB ASC 606-10-32-12 provides factors to consider when assessing whether variable consideration should be constrained based on

a.     The amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgment or actions of third parties, weather conditions, and a high risk of obsolescence of the promised good or service.

b.     The uncertainty about the amount of consideration is not expected to be resolved for a long time.

c.     The entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.

d.     The entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.

e.     The contract has a large number and a broad range of possible consideration amounts.

5.6.130 Distributors should evaluate whether the estimated variable consideration should be constrained (that is, excluded from the transaction price and hence from revenue recognition) in accordance with the factors noted previously.

5.6.131 FinREC believes that if contracts with customers are characterized by the following factors, then it is likely that a distributor’s circumstances would result in a constraint of the variable consideration because variable consideration is included in the transaction price only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved:

a.     Variable consideration in selling or distribution contracts is highly susceptible to factors outside the distributor’s control such as the market value of the fund’s shares at future points in time and the length of time the investor will remain invested in the fund.

b.     There is uncertainty about the amount of ongoing distribution fees and CDSCs and this uncertainty is not expected to be resolved for a long time. However, a portion of the fees will become fixed and no longer constrained when the uncertainty is resolved at subsequent dates.

c.     Despite a distributor’s historical experience with similar contracts, that experience generally would be of little predictive value in determining the future market value of investor shares or the period of time an investor will hold investments.

d.     The ongoing distribution fees and CDSCs generally have a large number of and a broad range of possible amounts.

5.6.132 Generally, the nature of the distributor’s overall promise in the contract is to sell the security and provide marketing services, which generally form a single performance obligation as noted in paragraph 5.6.123. As noted in paragraph 5.6.122, judgment and additional analysis are required when assessing whether shareholder services are distinct in terms of the contract and therefore meet the definition of a performance obligation.

5.6.133 If shareholder services do not meet the definition of a performance obligation that is distinct in terms of the contract, FinREC believes the distribution arrangement will generally only have one performance obligation that generally includes sales, marketing, and shareholder services. If shareholder services meet the definition of a performance obligation that is distinct, FinREC believes the distribution arrangement generally includes two performance obligations: sales and marketing combined as one performance obligation and shareholder services as a separate performance obligation.

5.6.134 In accordance with FASB ASC 606-10-32-29, when there are multiple performance obligations, the distributor should determine the stand-alone selling price of each performance obligation and allocate the transaction price in proportion to those stand-alone selling prices. Paragraphs 31–35 of FASB ASC 606-10-32 provide guidance on allocating the transaction price to multiple performance obligations.

5.6.135 Variable consideration (and subsequent changes to that amount) should be allocated entirely to one or more, but not all, performance obligations or to one or more, but not all, distinct services promised in a series of distinct services that forms part of a single performance obligation, if both of the following criteria in FASB ASC 606-10-32-40 are met:

a.     The terms of the variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service...

b.     Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28 when considering all of the performance obligations and payment terms in the contract.

5.6.136 FASB ASC 606-10-32-28 explains that the objective of allocating the transaction price to performance obligations is to allocate an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.

5.6.137 If the distributor concludes that there are two performance obligations, one for sales and marketing and one for ongoing shareholder servicing, the transaction price should be allocated between the two performance obligations and the amount allocated to shareholder servicing recognized as discussed in FASB ASC 606-10-32-28.

5.6.138 For each performance obligation, in accordance with FASB ASC 606-10-25-24, the distributor is required to determine whether that performance obligation is satisfied over time or at a point in time. If the criteria listed in FASB ASC 606-10-25-27 for performance obligations satisfied over time are not met, then the performance obligation is considered to be satisfied at a point in time.

5.6.139 This analysis will vary depending on the services promised in a contract. For example, if the distributor’s sole performance obligation is the sale of securities to investors, the performance obligation may be considered to be fulfilled at a point in time (that is, on the trade execution date). Once the trade is executed (for example, shareholders purchase the securities), the distributor has a present right to payment from the fund (although certain of the fees may be variable based on future events). Additionally, once the trade is executed, the fund has the risks and rewards of the services provided (by accepting the shareholder’s investment in the security).

5.6.140 If the contract promises shareholder services that meet the definition of a separate performance obligation, FinREC believes the performance obligation for providing shareholder services should be considered to be satisfied over time as the customer is simultaneously receiving and consuming the benefits provided by the distributor as the distributor performs this service in accordance with FASB ASC 606-10-25-27a.

5.6.141 Distributors often pay sales commissions to external distributors or their internal sales representatives for distribution and sales of securities on their behalf. FASB ASC 606-10-15-5 refers to FASB ASC 340-40 for guidance on costs incurred that relate to contracts with customers. In addition, FASB ASC 946-720-25-4 provides guidance on accounting for certain distribution costs. Distributors should evaluate the nature of the contracts and associated costs to determine whether FASB ASC 946, Financial Services—Investment Companies, or FASB ASC 340, Other Assets and Deferred Cash, applies.

5.6.142 FASB ASC 340-40-25 provides accounting guidance for two categories of costs related to contracts with customers: (1) incremental costs of obtaining a contract and (2) costs to fulfill a contract. If the fund is determined to be the customer in the contract, FinREC believes that sales commissions are costs to fulfill a contract, because the contract with the fund is already in place.

5.6.143 Costs incurred in fulfilling a contract with a customer that are within the scope of another FASB ASC topic should be accounted for in accordance with the other applicable topics or subtopics. In this regard, for sales commissions paid to third-party sub-distributors, consideration should be given to the applicability of FASB ASC 946-720-25-4. FASB ASC 946-720-25-4 provides guidance on the accounting for distribution costs for mutual funds with no up-front fees. The term "distribution costs" as used in FASB ASC 946-720-25 is interpreted in practice to refer to costs related to third-party service providers. This understanding is also acknowledged by FASB in paragraph BC303 of FASB Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), where this specific paragraph is mentioned in relation to sales commissions paid to third-party brokers. If FASB ASC 946-720-25-4 applies, then incremental direct costs, such as sales commissions, should be deferred and amortized, and indirect costs expensed. For a similar analysis of deferred distribution commission expenses, refer to the discussion in the section "Deferred Distribution Commission Expenses (Back-End Load Funds)" in paragraphs 4.7.01–4.7.10 of chapter 4 of this guide.

5.6.144 Other costs incurred to fulfill a contract with a customer that are not within the scope of another topic should be assessed to determine if the costs meet the criteria of FASB ASC 340-40-25-5. FinREC believes that sales commissions do not meet the criteria of FASB ASC 340-40-25-5 because the commissions do not generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future (FASB ASC 340-40-25-5b); therefore, sales commissions not in the scope of FASB ASC 946-720-25-4 should be expensed when incurred.

Incremental Costs of Obtaining a Contract

5.7.06 To obtain an advisory contract with a customer, a broker-dealer may incur costs such as advertising, selling and marketing costs, bid and proposal costs, sales commissions, and legal fees. FASB ASC 340-40-25-1 requires an entity to recognize an asset for the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. Generally, legal fees to draft the contract to provide services to the customer, advertising, selling and marketing costs, and bid and proposal costs are not incremental, as the broker-dealer would have incurred those costs even if it did not obtain the advisory contract. Sale commissions would be incremental costs as these costs would not have been incurred if the contract had not been obtained. In accordance with FASB ASC 340-10-25-1, if the incremental costs are recoverable from the customer, the broker-dealer should defer the costs and recognize an asset. An entity can expect to recover contract acquisition costs through direct recovery (reimbursement under the contract) or indirect recovery (through the margin inherent in the contract). FinREC believes the recoverability criterion for recognizing a deferred asset typically will not be met when the acquisition costs are expected to be indirectly recovered solely through fees that are dependent upon events and circumstances that are outside the control of the broker-dealer (for example, certain success-based fees). However, an entity should consider if the arrangement includes nonrefundable fees that it expects to collect (for example, retainer fee, termination fee) that may demonstrate the entity can recover these costs, or a portion of the costs, and therefore meet the recoverability criterion for capitalization up to the recoverable amount.

5.7.07 FASB ASC 340-10-25-4 provides a practical expedient whereby the broker-dealer may recognize the incremental costs of obtaining a contract as an expense when incurred, provided the amortization period of the asset that it otherwise would have recognized the expense over is one year or less. Often, the service for many advisory contracts will be transferred to the customer within one year and therefore an entity may elect to expense the costs to obtain such contracts as incurred.

Costs to Fulfill a Contract

5.7.08 The compensation of employees assigned to the advisory engagement are direct costs of fulfilling the advisory contract. In addition, out-of-pocket expenses may be incurred as part of performing the advisory service. Customary out-of-pocket expenses incurred in connection with fulfilling an advisory contract may include travel (for example, airfare, hotel, and meals), fees for external legal counsel and other professional advisers and fees related to business information services (for example, market and industry research), (collectively "out-of-pocket expenses").

5.7.09 A broker-dealer should evaluate if compensation and out-of-pocket expenses incurred to fulfill an advisory contract should be deferred and recognized as an asset. FASB ASC 340-40-25-5 states the following:

a.     The costs relate directly to a contract or an anticipated contract that the entity can specifically identify (for example, costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved).

b.     The costs generate or enhance resources of the entity that will be used in satisfying (or continuing to satisfy) performance obligations in the future.

c.     The costs are expected to be recovered.

5.7.10 FinREC believes that the first criterion for cost capitalization in FASB ASC 340-40-25-5 is generally met in a typical advisory contract. The terms and conditions under which the broker-dealer is engaged to provide services are documented in an advisory contract between the broker-dealer and the customer. A portion of the compensation of employees assigned to work directly on the advisory engagement are direct costs of fulfilling the advisory contract. The out-of-pocket expenses incurred as part of performing the advisory services relate directly to the specific advisory contract between the entity and customer.

5.7.11 In regards to the second criterion for cost capitalization in FASB ASC 340-40-25-5, the compensation of employees assigned to work directly on the engagement and out-of-pocket expenses incurred in connection with performing the advisory work are costs that may generate or enhance resources used to provide advisory services to the customer, depending on whether the advisory service is satisfied over time or at a point in time. For example, as there may be litigation risks associated with certain advisory transactions, outside legal counsel may be engaged to represent the broker-dealer and assist with activities such as reviewing and drafting the fairness opinion, reviewing all transaction-related documents and drafting proxy statements related to the deal. The work performed by the employees and additional resources (for example, legal advice, market research, and travel costs) all help the broker-dealer build the requisite knowledge (intangible benefit) needed to inform its views and provide sound advice to the customer. If the requisite knowledge is used to satisfy future performance obligation(s), these costs meet this criterion to be capitalized as an asset, as they generate or enhance resources of the entity that will be used to satisfy a future performance obligation. However, in situations where the costs incurred are related to satisfied performance obligations (often the case if a performance obligation is satisfied over time as opposed to at a point in time in the future), the second criterion for the costs to be capitalized is not met. Therefore, costs that are incurred to satisfy performance obligations over time shall be expensed as incurred. This is consistent with BC308 of FASB ASU No. 2014-09, which states that “only costs that meet the definition of an asset are recognized as such and that an entity is precluded from deferring costs merely to normalize profit margins throughout a contract by allocating revenue and costs evenly over the life of the contract.”

5.7.12 In regards to the third criterion for cost capitalization in FASB ASC 340-40-25-5, an entity can expect to recover costs incurred to fulfill a contract through direct recovery (reimbursement under the contract) or indirect recovery (through the margin inherent in the contract). FinREC believes this criterion generally will be met for out-of-pocket costs in arrangements in which these costs are explicitly reimbursable or otherwise expected to be recovered despite the success of the engagement, such as through a nonrefundable retainer fee or termination fee if the underlying transaction does not close. FinREC believes this criterion is not typically met for employee compensation costs, because, unlike out-of-pocket costs, compensation costs generally (a) are not explicitly reimbursable and (b) may be sufficiently large that they would not be recoverable through up-front or termination fees despite the success of the engagement. Therefore, recovery of such costs is dependent upon events and circumstances that are outside the control of the broker-dealer. This situation may indicate that sufficient evidence does not exist to support a conclusion that the costs are expected to be recovered. However, an entity should consider if the arrangement includes nonrefundable fees that it expects to collect (for example, retainer fee, termination fee) that may demonstrate the entity can recover these costs, or a portion of the costs, and therefore meet the recoverability criterion for capitalization up to the recoverable amount.

5.7.13 In summary, FinREC believes that out-of-pocket expenses typically will qualify for deferral and capitalization as an asset if the costs incurred are (a) related to performance obligations satisfied in the future and (b) explicitly reimbursable or expected to be recovered despite the success of the engagement. However, compensation of employees assigned to work directly on the advisory engagement will not generally qualify for deferral and capitalization as an asset because, unlike out-of-pocket expenses, compensation generally are not explicitly reimbursable and may be sufficiently large that they would not be recoverable despite the success of the engagement. However, an entity should consider if the arrangement includes nonrefundable fees that it expects to collect (for example, retainer fee, termination fee) that may demonstrate the entity can recover these costs, or a portion of the costs, and therefore meet the recoverability criterion for capitalization up to the recoverable amount. The specific facts and circumstances of each arrangement should be considered when making these determinations.

Amortization and Impairment

5.7.14 In accordance with FASB ASC 340-40-35-1, when the broker-dealer incurs advisory costs that meet the criteria to be capitalized in accordance with FASB ASC 340-40-25-1 or 340-40-25-5, it should recognize an asset on the statement of financial condition and amortize it on a systematic basis consistent with the transfer to the customer of the advisory services to which the asset relates. See the section “Investment Banking M&A Advisory Fees” in paragraphs 5.6.78–5.6.110, which describes circumstances where advisory fees may be recognized over time or at a point in time, depending on the nature of the underlying services. Conclusions related to the nature of the advisory services and the resulting pattern of revenue recognition for the advisory fees will impact the amortization pattern of capitalized costs. For fees recognized at a point in time, any related capitalized costs should be amortized in full on that date. Additionally, in accordance with FASB ASC 340-40-35-3, costs capitalized in accordance with FASB ASC 340-40-25-1 or 340-40-25-5 are tested for impairment by comparing the carrying amount of the capitalized costs to an amount that considers the revenue and costs that remain to be recognized under the contract.

Presentation

5.7.15 When another party is involved in providing goods or services to a customer, the broker-dealer should determine whether the nature of its promise is a performance obligation to provide the specified goods or services itself (that is, the broker-dealer is a principal) or to arrange for those goods or services to be provided by the other party (that is, the broker-dealer is an agent). To apply the principal versus agent guidance, a broker-dealer must first properly identify the specified good or service to be transferred to the customer. See the section “Investment Banking M&A Advisory Fees” in paragraphs 5.6.78–5.6.110 for guidance on defining the performance obligation.

5.7.16 A broker-dealer should apply the guidance in paragraphs 37A and 39 of FASB ASC 606-10-55 to determine if it controls the specified good or service before it is transferred to the customer and is therefore acting as principal. In accordance with FASB ASC 606-10-55-37B, reimbursable advisory costs should be presented gross when the broker-dealer is acting in a principal capacity and in accordance with FASB ASC 606-10-55-38 presented net (that is, contra revenue) when the broker-dealer is acting in an agent capacity.

5.7.17 FASB ASC 606-10-55-37A indicates that when another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of any one of the following:

a.     A good or another asset from the other party that it then transfers to the customer.

b.     A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf.

c.     A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer...

5.7.18 A broker-dealer incurs out-of-pocket expenses as part of providing advisory services to the customer. The out-of-pocket expenses pertain to services that help the broker-dealer build the requisite knowledge needed to perform under the advisory engagement. The broker-dealer uses these services and combines them with other services as part of delivering on its performance obligation to provide advisory service to the customer as discussed in FASB ASC 606-10-55-37Ac.

5.7.19 Additionally, FASB ASC 606-10-55-39 provides indicators that an entity controls the specified good or service and is acting as principal. FinREC believes a broker dealer would evaluate these indicators as follows:

a.     The entity is primarily responsible for fulfilling the promise to provide the specified good or service —

The specified service is the advisory service agreed to in the contract between the broker-dealer and customer. FinREC believes this criterion is met as the broker-dealer is the party responsible for fulfilling the promise of providing the advice to the customer. The broker-dealer separately engages and contracts with third-party service providers such as law firms, airlines, and hotels, and in doing so is not acting as an agent between these providers and the customer.

b.     The entity has inventory risk before the specified good or service has been transferred to a customer or after that transfer.

FinREC believes this criterion is not met. The broker-dealer does not commit to obtain the services from the supplier before entering a contract with the customer.

c.     The entity has discretion in establishing prices for the specified good or service.

FinREC believes this criterion is met as the broker-dealer has discretion in establishing the fee for the services from third-party suppliers (for example, law firms engaged for the advisory services by the broker-dealer). That is, the broker-dealer could cover the third-party supplier fees by charging a direct reimbursement fee or cover them by charging a higher overall advisory services fee.

5.7.20 FinREC believes the broker-dealer generally is acting as principal and consequently, in accordance with FASB ASC 606-10-55-38, the reimbursable costs incurred to fulfill the advisory contract should be presented as revenue and expense in the gross amount of consideration to which it expects to be entitled. FinREC believes this because (a) the broker-dealer obtains control of these services and combines them with other services as part of delivering on its performance obligation as discussed in FASB ASC 606-10-55-37Ac, and (b) based on the weight of the indicators in FASB ASC 606-10-55-39. However, the specific facts and circumstances of each arrangement should be considered when making this determination.

5.7.23 FASB ASC 606-10-55-37A indicates that when another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of any one of the following:

a.     A good or another asset from the other party that it then transfers to the customer.

b.     A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf.

c.     A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer...

5.7.24 The lead underwriter organizes the other participating underwriters and the selling group, negotiates the transaction with the issuer of the securities, maintains the subscription records for the underwriting, and maintains a record of all the direct expenses of the underwriting. These activities (a) do not give the lead underwriter control of any good or asset of the participating underwriters, (b) do not give the lead underwriter any right to the services performed by the participating underwriters, and (c) do not combine the goods or services of the participating underwriters in order to provide services to the issuer. Rather, each syndicate member, including the lead underwriter, is responsible to the issuer only for its committed share of the total offering (that is, underwriting services provided by any individual underwriter do not impact services provided by any of the others).

5.7.25 Additionally, FASB ASC 606-10-55-39 provides the following indicators that an entity controls the specified good or service and is acting as principal. A lead underwriter could evaluate these indicators as follows:

a.     The entity is primarily responsible for fulfilling the contract. Each syndicate member named in the underwriting agreement is legally responsible to perform services for the issuer in accordance with the terms of the contract. Each syndicate member is severally obligated to perform and, in the event that there is alleged wrongdoing, each underwriter in the group is severally liable under the terms of the contracts. Although the lead underwriter negotiates with the issuer on behalf of the entire syndicate, its role is to arrange for the services of the syndicate. This is an indicator of an agent relationship.

b.     The entity has inventory risk before or after the goods have been ordered, during shipping, or upon return. The lead underwriter does not have inventory risk because it does not purchase or commit to purchase the services of the participating underwriters at any time. Further, the lead underwriter does not commit to provide services to the issuer (that is, raise capital, which includes engaging other vendors to provide services necessary to help sell securities) prior to execution of the underwriting agreement (and, at that point, all syndicate members have been identified). This is an indicator of an agent relationship.

c.     The entity has discretion in establishing the price for the specified good or service. The lead underwriter is ultimately responsible for negotiating the engagement terms, including economics, with both the issuer and with the members of the syndicate. However, the level of discretion the lead underwriter has in such negotiations should be considered in the context of the facts and circumstances of the offering. Because the underwriting spread and the syndicate underwriter compensation arrangements are disclosed in the agreements, there is generally transparency between the parties in the deal, ensuring that compensation to all members of the underwriting syndicate must be competitive among the group, that is, the lead underwriter does not have a greater influence on the ultimate pricing than the other members of the syndicate. In such circumstances, this indicator may not be determinative.

5.7.26 FinREC believes that, generally, the lead underwriter is not acting as a principal to provide underwriting services for the overall issuance because (a) the underwriter does not obtain control over the services of the other members of the syndicate as discussed in FASB ASC 606-10-55-37A and (b) based on the weight of the indicators in FASB ASC 606-10-55-39. Consequently, in accordance with FASB ASC 606-10-55-38, the lead underwriter should only record underwriting revenues in amounts related to the underwriter’s services and not include any revenues related to the services of the participating underwriters. However, the specific facts of each arrangement should be considered when making this determination.

5.7.27 FASB ASC 606-10-55-37A indicates that when another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of any one of the following:

a.     A good or another asset from the other party that it then transfers to the customer

b.     A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf.

c.     A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer...

5.7.28 The members of the underwriting syndicate incur expenses such as, but not limited to, marketing and advertising, legal fees, and other costs (for example, accounting, travel, printing, and taxes) of setting up the syndicate group. The vendors that the underwriting syndicate contracts with for these services are not directly responsible for the performance obligation in the underwriting agreement. Rather, they are engaged to perform services for the underwriting syndicate. The underwriters use these services and combine their benefits as part of their efforts to deliver the performance obligation (raise capital) to the issuer as discussed in FASB ASC 606-10-55-37Ac.

5.7.29 Additionally, FASB ASC 606-10-55-39 provides the following indicators that an entity controls the specified good or service and is acting as principal. Each member of the underwriting syndicate could evaluate these indicators as follows:

a.     The entity is primarily responsible for fulfilling the contract. This is the case for each participating underwriter’s pro rata obligation to perform. The vendors hired for the services have no obligation to the issuer, and the issuer does not have recourse to the vendors; rather, the obligation to the issuer lies with each member of the underwriting syndicate. This is indicative of a principal relationship for the members of the underwriting syndicate for the services they are performing on behalf of the issuer.

b.     The entity has inventory risk before or after the goods have been ordered, during shipping, or upon return. Pursuant to the syndicate agreement entered into among the members of the underwriting syndicate, each member of the underwriting group is obligated to pay their proportionate share of the amounts charged by the service providers even if the members do not deliver the performance obligation to the issuer. In addition, certain vendor services are often provided prior to the execution of the underwriting agreement. This is indicative of a principal relationship for the members of the underwriting syndicate.

c.     The entity has discretion in establishing the price for the specified good or service. The prices for the underwriting services are negotiated by the lead underwriter on behalf of the syndicate. Often, the terms of the underwriting contract are subject to highly competitive market conditions that limit the variability in spreads. In addition, for public U.S. underwritings, underwriters’ compensation is subject to regulation by FINRA. Therefore, the underwriters often have limited discretion in the pricing of the combined elements of their service, as well. That is, the underwriting syndicate does not charge a direct reimbursement fee for the third-party vendor costs (for example, legal, marketing, and advertising) and may not be able to negotiate a higher underwriting fee to cover the increased costs. In such cases, this indicator may not be determinative.

5.7.30 FinREC believes that, generally, the role of the members of the underwriting syndicate, including the lead and participating underwriters, is that of a principal for their respective share of the underwriting expenses because (a) the underwriters obtain control of these services and combine them with other services as part of delivering on their performance obligation as discussed in FASB ASC 606-10-55-37Ac and (b) based on the weight of the indicators in FASB ASC 606-10-55-39. Consequently, in accordance with FASB ASC 606-10-55-37B, each underwriter should reflect their proportionate share of the underwriting costs on a gross basis in the underwriter’s statement of earnings, and the lead underwriter should not recognize expenses attributable to the participating underwriters because these reflect costs that are legally the responsibility of the participating underwriters. However, the specific facts of each arrangement should be considered when making these determinations.

5.7.31 In accordance with FASB ASC 940-340-25-3, underwriting expenses incurred before the actual issuance of the securities shall be deferred.

5.7.32 In accordance with FASB ASC 940-340-35-3, underwriting expenses deferred under the guidance in FASB ASC 940-340-25-3 shall be recognized at the time the related revenues are recorded. In the event that the transaction is not completed and it is determined that the securities will not be issued, at that time, the entities that have agreed to participate in the costs associated with the underwriting shall write those costs off to expense.